What would it mean to abolish the Bank of Canada?
Paul Simon once wrote a song entitled 50 Ways To Leave Your Lover. I imagine there are at least 50 ways in which the Bank of Canada could be abolished. Let’s start with the most implausible method:
1. Monetary nihilism: The Bank of Canada (BoC) could suddenly announce it was closing up shop, washing its hands of any role in the monetary system. It could tell Canadians that they are free to construct any system they like. Counterfeiting would be legalized.
The legalization of counterfeiting would almost immediately reduce the value of Canadian currency and Canadian bonds to roughly zero. This option would be extremely unpopular and obviously will not happen. So let’s consider some more measured approaches to getting the Canadian government out of the monetary system.
2. Auction the BoC: The BoC could be auctioned to the highest bidder. Counterfeiting would remain illegal. Banking would be deregulated so that competing entities could offer competing currencies.
I’m not quite certain what would happen in that case, but here’s my best guess. The BoC would be bought by a consortium of large Canadian banks. Perhaps there would be a board that determined the BoC’s monetary policy, and each commercial bank in the consortium could have one voting member. But lots of other options are possible. Perhaps the BoC would be bought by a large US firm or a large Chinese firm. I just don’t know.
Due to network effects, I would expect that the Canadian dollar would remain dominant in Canada. The biggest question mark is inflation. Many studies have been done estimating the profit-maximizing rate of inflation (aka seignorage), and all the estimates are extremely high figures. (I don’t recall the exact estimates, but it’s on the order of 100%/year, not merely high in the sense that our current 8% inflation is high.)
On the other hand, with complete laissez-faire perhaps the profit-maximizing rate of inflation would be lower for the new BoC than for monopolistic central banks. Nonetheless, I’m almost certain it would be a relatively high figure. Network effects in currency are extremely powerful, and it’s hard to competing currencies to gain much traction until the dominant currency is very badly mismanaged–like Zimbabwe or Venezuela bad. Perhaps the following thought experiment would make it easier to see my point:
Consider a central bank deciding between two options:
A. Increase the monetary base at 4%/year.
B. Increase the monetary base at 20%/year.
Option B will provide more seignorage unless it reduces base demand by more than 80% as a share of GDP. That would be a huge reduction in base demand. Is the amount of money you typically carry in your wallet highly sensitive to the inflation rate? 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 the profit maximizing inflation rate is so high. (This is true for many products—the revenue maximizing tax rate for cigarettes is also very high.)
Of course the Canadian government could auction off the BoC with a legal restriction on how fast the monetary base could be increased. But if the government has such specific macro goals, then why auction the BoC in the first place?
3. A fresh start: Let’s say you buy my “network effects” argument, and wish to make a fresh start in Canada with a level playing field. You want to abolish the Canadian dollar and give each alternative system an equal chance of success. In that case, Canadian dollars could all be redeemed for assets of roughly equal value. This is how individual European countries got rid of their national currencies. But instead of being paid off with a new money (euros), Canadians could be paid off with some existing asset, such as silver bullion, Bitcoin, or equities in a global stock index fund.
In that case, I’d expect the Canadian public to spontaneously adopt the US dollar. I cannot be certain—perhaps they’d adopt the gold standard—I just think the US dollar is the most likely winner in an open contest for the Canadian public to pick a new monetary regime. If this transition occurred in Denmark or Sweden, their public would probably adopt the euro.
This is just 3 of the 50 ways that Canada could get rid of the BoC. I have no doubt that there are at least 47 others. And note that these are not three outcomes that might occur spontaneously. The Canadian government would have to decide how it plans to fold up shop. I get annoyed with libertarians who seem to think it’s possible to just wave a magic wand and move from a government fiat monopoly to a laissez-faire regime. Hard decisions about what to do with the existing monetary base and the existing stock of Can$ denominated debt are unavoidable.
Some commenters tell me I’m wrong because free banking regimes have worked. They don’t seem to read my posts very carefully, as multiple occasions I’ve said I favor 100% free banking. Some commenters advocate a national gold standard, and cite evidence that an international gold standard once worked. They seem to have no idea that the success of an international gold standard has no bearing on the question of whether a national gold standard would work. (Hint, it would not work very well.) Others seem to think that a gold standard with an official price of gold is laissez-faire. It isn’t, under laissez-faire the market would decide whether it preferred to use gold as money.
The fact that commenters seem unable or unwilling to describe in detail how the government will extricate itself from the existing monetary system makes me think they underestimate the complexity of what they are asking for. Removing the government from money is far more complex than removing the government from something like passenger rail. Amtrak could simply be auctioned off—dozens of countries have done something similar. It’s far less clear as to what it would mean to remove the government from money. The US has more than $20 trillion in debt, which involves promises to pay a very specific type of money as far as 30 years out in the future. It’s often said that, “You may not be interested in war, but war is interested in you.” The same is true of the US dollar.
Some might argue that this post shows three ways that the Canadians could achieve monetary laissez-faire. I see it as showing one implausible option, and two others that are either fairly similar to what they have now, or even worse.
PS. You might think that I am too pessimistic about outcomes that move us away from fiat currencies. And yet most of the libertarians that advise real world governments–even those who view me as insufficiently libertarian—recommend reforms linked to a fiat currency. This might recommend that El Salvador dollarize or that Argentina adopt a currency board. None of these options get us out from under the yoke of a government fiat money central bank.