What will the cancellation of the Bank of Canada mean?

Paul Simon once wrote a song titled 50 Ways to Leave Your Lover. I imagine there are at least 50 ways that the Bank of Canada could be liquidated. Let’s start with the most unlikely method:

1. Financial Nihilism: The Bank of Canada (BOC) may suddenly announce that it is closing up shop, washing its hands of any role in the financial system. It could tell Canadians they are free to build whatever system they want. Duplication will be legalized.

Legalization of counterfeiting would almost immediately reduce the value of Canadian currency and Canadian bonds to almost zero. This option would be extremely unpopular and obviously won’t happen. So let’s consider some more measured ways to get the Canadian government out of the financial system.

2. BoC Auction: BoC can be auctioned to the highest bidder. Duplication will be illegal. Banking will be deregulated so that competing firms can offer competitive currencies.

I’m not entirely sure what will happen in this case, but here’s my best guess. BoC will be bought by a consortium of major Canadian banks. There would likely be a board that would set the BoC’s monetary policy, and each commercial bank in the consortium could have a voting member. But many other options are possible. Perhaps BoC will be bought by a large US firm or a large Chinese firm. I just don’t know.

Because of network effects, I would expect the Canadian dollar to remain dominant in Canada. The biggest question mark is inflation. Many studies have been done estimating profit-maximizing rates of inflation (aka seignorage) and all estimates are extremely high figures. (I don’t remember the exact estimate, but it’s on the order of 100%/year, not merely high in the sense that our current 8% inflation is higher.)

On the other hand, the profit-maximizing rate of inflation would probably be lower for the new BoC than for a monopolistic central bank with full trade-offs. Still, I’m almost certain it will be a relatively high figure. Network effects in currencies are very strong, and it is difficult for currencies to compete unless the dominant currency is very badly mismanaged—like Zimbabwe or Venezuela. Perhaps the following thought experiment will make my point easier to see:

Consider a central bank’s decision between two options:

A. Increase the financial base by 4%/year.

B. Increase the financial base by 20%/year.

Option B would provide more seigniorage unless it reduced base demand by more than 80% as a share of GDP. This would be a huge reduction in base demand. Is the amount of money you usually carry in your wallet highly sensitive to the rate of inflation? Probably not. Studies show that people carry less cash as a share of GDP at higher inflation rates, but not dramatically less. That’s why profit margins are so high above inflation. (This is true for many products—the revenue maximum tax rate for cigarettes is also very high.)

Of course the Canadian government could auction off the BoC with a legal limit on how fast the monetary base can expand. But if the government has such specific macro goals, why take the BoC in the first place?

3. A New Beginning: Let’s say you buy my “network effects” argument, and want to start over in Canada with a level playing field. You want to scrap the Canadian dollar and give every alternative system an equal chance of success. In that case, Canadian dollars can be redeemed for assets of roughly equal value. Thus individual European countries got rid of their national currencies. But instead of paying with a new currency (the euro), Canadians could be paid with some existing asset, such as silver bullion, bitcoin or equity in a global stock index fund.

In that case, I would expect the Canadian people to automatically accept the US dollar. I can’t be sure—maybe they’ll take the gold standard—I just think the US dollar is the clear winner in an open competition for the Canadian public to choose a new monetary regime. If this conversion happened in Denmark or Sweden, their people would probably adopt the euro.

These are just 3 of the 50 ways Canada can get rid of the BoC. I have no doubt that there are at least 47. And remember that these are not three outcomes that can happen spontaneously. The Canadian government will have to decide how they plan to close the store. I resent liberals who think it’s possible to just wave a magic wand and go from a government fiat monopoly to a laissez-faire regime. Difficult decisions about what to do with the existing financial base and the existing stock of Can$ denominated debt are inevitable.

Some commentators tell me I’m wrong because free banking has worked. They don’t seem to read my posts very carefully, as I have stated more than once that I am 100% in favor of free banking. Some commentators advocate a national Gold standard, and cite evidence that a international The gold standard worked once. They seem to have no idea about the success of an international gold standard The question of whether a national gold standard would work has no bearing. (Hint, that wouldn’t work very well.) Others think that a gold standard with an official price of gold is laissez-faire. This is not the case, under laissez-faire the market will decide whether it prefers to use gold as money.

The fact that commentators seem unable or unwilling to elaborate on how the government will remove itself from the existing monetary system makes me think they underestimate the complexity of what they are asking for. Removing government from finance is much more complicated than removing government from something like passenger rail. Amtrak could simply be auctioned off – dozens of countries have done something similar. What it means to remove government from finance is much less clear. The United States has more than $20 trillion in debt, including a very specific type of payment commitment up to 30 years into the future. It is often said that, “You may not be interested in war, but war is interested in you.” Same goes for the US dollar.

Some may argue that this post shows three ways that Canadians can achieve financial inclusion. I see this as showing an unimaginable alternative, and the other two being roughly the same as what they have now, or worse.

Rest assured. You might think I’m very pessimistic about an outcome that moves us away from fiat currencies. And yet most libertarians who advocate real-world government—even those who strike me as inadequate libertarians—recommend reforms tied to a fiat currency. It may suggest that El Salvador dollarize or that Argentina adopt a currency board. None of these options can get us out from under the yoke of official fiat money central banks.

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