Wheat from the Chaff

With economy so bad, Bank of Canada my revert to printing money

Didn't they try this in Germany after World War One? Perhaps I'll need to be more cautious when I gloat about my variable rate mortgage!

Of course, in Germany, there was a real shortage of goods and resources, as Germany was directly stripped of much of its resources by the Treaty of Versailles and by the requirements of reparation. Printing too much money was only one part of the story. In North America, for the moment, a shortage of resources and goods is not the problem. Hopefully Joseph Stiglitz is right: the relationship between inflation and money supply growth is weak when inflation is low. In other words, printing a lot more currency will not lead to hyperinflation IF the situation isn't aggravated by an increasing scarcity of resources. If so, we might be able to ramp up the money press for the time being without negative consequences. Nevertheless, I wonder if investors, especially major overseas institutions like sovereign wealth funds, will continue to hold large American investments. If they leave for greener pastures - and countries that will not devalue their investments - the American and Canadian economies could be in even worse trouble than they are now. Regardless of low inflation, we would probably be confronted by rapidly rising interest rates as the central banks attempt to recapture foreign investors.

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By Julian Beltrame, The Canadian Press
Mon Apr 6, 6:10 PM

OTTAWA - With economic recovery still looking shaky, the next move by the Bank of Canada may be to just start printing money.

Increasing the money supply, or quantitative easing as the term is known, has become the latest and perhaps last major tool open to central bankers to try and spark some life into the stalled engine of their economies.

The price can be high. Devaluation of the loonie and run-away inflation down the road. But, with economies running on empty, central bankers are inclined to focus more on solving the real mess at hand than theoretical messes of the future, say economists. "Printing money," says CIBC chief economist Avery Shenfeld, "looks like the key ingredient in preventing a global recession from tipping into a lasting depression."

Bank of Canada governor Mark Carney opened the door to quantitative easing last month when he cut the overnight rate to 0.5 per cent, all but emptying the chamber on the central bank's ability to directly impact interest rates. And although he appeared to close the door part way in a speech last Thursday, economists say it's unlikely Carney would have sent the signal in the first place unless he intended to carry through.

They note that nothing that has happened in the economy since Carney's original pronouncement would likely have changed the game plan. If anything, the prospects for a quick and strong recovery appears to have receded. "This is not going to be a V-shaped recovery," said Derek Holt of Scotia Capital Markets, referring to the traditional quick updraft that often follows a sharp downturn. Canada is getting the sharp downturn in spades, with estimates of an up to nine per cent contraction in economic activity in the first quarter of 2009, a post-Great Depression record. But the updraft is increasingly being discounted - the Organization for Economic Co-operation and Development now says Canada's economy will be flat at best in 2010.

Even Carney, who a few months ago held out hope of a strong recovery, warned last week that the potential for future world growth has become more muted, suggesting the same is likely true of Canada. "In the next few months, we're going to see the worst of the lag effects from U.S. supply chains catching up to Canada," predicted Holt. "And also, there had been a labour hoarding going on for much of last year because many Canadian businesses thought this was a U.S. problem and held on to their workers. Now you are going to get total capitulation by employers."

The economist is looking for another 80,000 jobs contraction to be reported on Thursday, which would bring total losses to 375,000 since October. Monday brought further evidence that the smattering of encouraging signals recently may be a mirage, as Statistics Canada reported the value of building permits plummeted by almost 16 per cent in February, four times worse than expectations. The Conference Board also downgraded its growth forecast for Canada to a negative 1.7 per cent, which is actually far better than the output contraction of between 2.5 per cent and three per cent envisioned by many other private sector economists.

Avery believes the fact the U.S. Federal Reserve and the Bank of England have started up the money printing presses to buy up government treasury bills and other market assets in order to free up credit makes the decision easier for Carney.

But with Canada's banking system still mostly functioning, Carney won't go nearly as far and may even devise a Canadian-made middle ground that allows him to achieve the benefits of quantitative easing - lower borrowing costs for consumers and businesses - without pumping up the money supply. The central banker could withdraw from the overnight market as much money as he needs to buy up such assets as treasury bills, and such non-bank assets as corporate bonds, or pools of auto leases and credit card credit, said Avery.

Other economists see Carney being bolder, although with the Bank of Canada's pre-occupation about keeping inflation at two per cent, they doubt he will go as far as the United and Britain. "When you start printing money willy nilly, you are flirting with a serious inflation issue down the road," explained Bank of Montreal economist Douglas Porter.

"Inflation is the least of anybody's concern in the immediate time, but we're running an experiment we haven't done in the post-war period, so I don't think anybody can say with confidence it won't eventually spark inflation."