Sunday, February 26, 2023

Stubborn PCE: What is "Sticky Inflation?"

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3 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff offers some color analysis explaining what most news stories reporting “sticky inflation” won’t.

So despite the Federal Reserve’s recent campaign of rapid interest rate hikes, and a great degree of success stopping growth of the money supply in its tracks, the January PCE inflation numbers were still elevated. Month to month headline and core were both up 0.6%.

Although inflation numbers vary greatly from one month to the next, a core month-to-month of +0.6%, compounded over twelve months, translates to an annual inflation rate of 7.4%.

Both are still far higher than the Fed’s 2% inflation target.

(1.006^12 = 1.0744 = +7.44% inflation)

Read more on the PCE report at Bloomberg:

So if the money supply is no longer growing, and in fact has actually contracted by 2.2% over the last three quarters, why are prices still rising at a 7.4% clip?

Many business news articles are now blaming “sticky” inflation, but few really explain what’s causing price increases to be sticky in the first place.

Well the Economics Correspondent fingered the potential culprit two months ago, and new data show it’s still to blame: rising monetary velocity.

As we prove it using junior high math, the Correspondent can’t stress enough how valuable the Equation of Exchange is for understanding what causes inflation.

mv = py

Where m = the money supply, v = monetary velocity, or how many times each dollar of the money supply is spent each year, p = the price level, and y = real GDP or the dollar value of all economic transactions in the economy.

If we isolate (p) to understand what makes prices move we get:

p = mv/y.

So if the money supply falls, prices fall. If the quantity of goods and services in the economy grows, prices also fall.

Both have happened the last three quarters (St. Louis Federal Reserve source links are below). From 22Q1 to 22Q4:

-The money supply measured by M2 contracted from $21.846 trillion to $21.363 trillion or -2.2%

-GDP has grown—barely. From 22Q1 to 22Q4 real GDP rose from $19.924 trillion to $20.198 trillion or +1.4%.

Therefore if velocity were constant prices should have fallen the last three quarters by 4.3% (0.978/1.022 = 0.957 or -4.3%).

But they haven’t fallen. They’re still rising.

Two months ago the Economics Correspondent wrote he was concerned about the last variable, M2 velocity, which had risen Q1 to Q3 from 1.14 to 1.19, an increase of 4.39% in half a year.

Compounded over a full year such an increase would equate to a 9% annual increase in prices, and the Correspondent argued the Fed sees this, is probably concerned about it, and is still raising rates because of it.

Well, we have a new quarter of velocity data and the trend is confirmed. In Q4 M2 velocity reached 1.226.

So from Q1 to Q4 velocity increased from 1.14 to 1.226 or up 7.5% which, when annualized, translates to an even worse yearly inflation rate of 10.1%.

Of course velocity is being partially offset by falling money and barely rising GDP, so when we plug all three variables into the equation we get our final nine-month inflation rate:

(0.978 x 1.075)/1.022 = +3.7% inflation.

Extrapolate that out one more quarter for a full year and the Fed is looking at an annualized inflation rate of +5%. That’s lower than the implied January number, but consistent with the Fed’s worries about inflation persisting despite its success slowing and even slightly reversing money supply growth.

And what’s causing velocity to rise? Monetary economists blame “inflation expectations.” That is, inflation itself changes consumer and business behavior, both of whom start moving their purchases forward to buy stuff before it gets more expensive. When consumers and businesses move purchases up the rising velocity itself pushes prices up even higher, leading other consumers and businesses to spend even faster and a vicious cycle can ensue.

The Fed wants to squash those inflation expectations and stop the growth in velocity.

And that’s why it’s still tightening even as the money supply has been falling.

Source data:

1) Q1 to Q4 M2: $21.846T to $21.363T

2) Q1 to Q4 real GDP: $19.924T to $20.198T

3) Q1 to Q4 M2 velocity: 1.14 to 1.226

Wednesday, February 22, 2023

Larry Summers Predicts $2.2 Trillion Average Deficits For The Next Decade

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2 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff heard former Assistant Treasury Secretary and Harvard President Larry Summers on the radio night before last discussing inflation and the federal government’s fiscal outlook.

Summers cited a Congressional Budget Office Report that forecasts a federal debt-to-GDP ratio of 140% within a decade, up from the current 120.7%.

This ties in to the Economics Correspondent’s depressing article last week outlining how growth and inflation will allow the Treasury to easily run $1 trillion deficits every year forever without raising the debt-to-GDP ratio, and calculations that even $1.8 trillion deficits for the next decade would result in no change to the debt-to-GDP ratio remaining at 120.7%.

Well it’s even worse than that. A hike to 140% of GDP means even bigger forecasted deficits.

The Correspondent hasn’t read the CBO report but let’s go with some conservative assumptions: an average of 2% annualized real GDP growth and 2% inflation over the next decade.

Compounding 2% real GDP growth plus a 2% increase in prices over ten years means current GDP of $26.1 trillion will grow to a nominal $38.8 trillion.

(1.02^10)x(1.02^10)x$26.1 trillion = $38.8 trillion

Since the CBO predicts the debt-to-GDP ratio will rise to 140%, that means the national debt will be $54.3 trillion by 2033.

Today the debt is $31.5 trillion.

Therefore the CBO predicts the debt will grow by $22.8 trillion over ten years.

That’s an average of $2.28 trillion annual deficits we can look forward to, much higher than the $1 trillion the Correspondent argued was easily sustainable.

Right now the projection for 2023 is a $1.4 trillion deficit. But of course as GDP grows over time future Congresses and presidents will run much higher than $1.4 trillion shortfalls to reflect higher nominal GDP—probably well north of $2 trillion by the time 2033 arrives.

And of course if there’s a recession or two in between, falling tax revenues and higher government spending—much higher if Washington is controlled by Democrats who believe in Keynesian economic theories and massive deficit spending to “promote recovery”—will raise the thin years deficits well above $2 trillion.

And the best part is Summers predicts 140% of GDP is too low and that America is on course for a debt-to-GDP ratio of 150% by 2033.

That's a national debt of $58.2 trillion by 2033 and average annual deficits of $2.67 trillion.

Enjoy folks. Inflation, the loss of your money’s purchasing power, finances a great deal of Uncle Sam’s ability to borrow and spend like this, and they’re still not happy leaving the debt alone at 120% of GDP. They’re on course to raise it to 140% or 150%.

Wednesday, February 15, 2023

Yes, Uncle Sam Can Now Run $1+ Trillion Deficits Forever

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5 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff regrets to inform CO Nation that $1+ trillion federal deficits are now sustainable—forever.

The Economics Correspondent by no means endorses this trickery method of financing the federal government and is only demonstrating the sinister power of economic growth plus a little inflation for maintaining the national debt.

Yes, the U.S. economy has reached a point where even $1+ trillion deficits are sustainable indefinitely. And policymakers know it.


To explain, here are a few facts and assumptions.


-The current federal debt is $31.5 trillion

-US nominal GDP is $26.1 trillion

-Therefore, the current debt-to-GDP ratio is 120.7%


-Going forward the Federal Reserve System produces an average annual inflation rate of 2.5%

-Going forward the U. S. economy averages 2.5% real GDP growth, except…

-Every eight years a recession interrupts that growth. We’ll assume after two or three quarters of negative growth and another five or six quarters of subpar growth the two-year interruption averages GDP growth of just 0.5%. Meaning…

-Over the 10-year cycle real GDP growth is lowered to an average of just 2.1%.

(anyone who wants to double-check the math can verify at the end of the article)

Therefore, if the federal government runs a $1 trillion deficit every year for the next decade the federal debt will grow from $31.5 trillion to $41.5 trillion.

Unthinkable. Right? A disaster. Right?

But over the next decade real GDP will grow at an annualized compounded rate of 2.1% per year. Therefore real GDP will grow from $26.1 trillion to $32.12 trillion.

And most importantly, atop real GDP growth the Federal Reserve will drive up prices with an average inflation rate of 2.5%. Therefore GDP will grow from a real $32.12 trillion to a nominal $41.1 trillion.

Hence in ten years, with a national debt of $41.5 trillion and nominal GDP of $41.1 trillion, the debt-to-GDP ratio will be just 101% or a decline of 19 percentage points.

Yes, running ten straight years of $1 trillion deficits and never balancing the budget the debt-to-GDP ratio will actually fall.

The math is unrelenting. The federal government can actually run even higher deficits - $1.81 trillion for the next decade - and the debt-to-GDP ratio will remain unchanged at 120.7%.

And if the official inflation numbers are understated and prices are actually rising faster than the government says, well... that's better for the politicians because nominal GDP (and by extension the IRS's tax collections) rise even faster.

That’s the dark magic of growth plus inflation. Governments, particularly central banks, treasury departments, and finance ministries, are well aware of how the math works and have been playing this game for nearly a century.


Actually the growth part is not so bad. It’s honest, it’s hard work, and everyone benefits from more stuff.

The inflation part? Not so much.

Yes, the sleight of hand is successful because holders of U.S. dollars are silently drained of 2.5% of their money’s value year after year—the proceeds being a gift quietly transferred to the federal government by watering down the real value of its past debts.

As if direct taxation wasn’t tribute enough to Washington, DC.

If we stretch our horizon out to twenty years, maintaining the same assumptions, the federal deficit will increase to $51.5 trillion, but thanks to growth and inflation nominal GDP will be $64.8 trillion.

The debt-to-GDP ratio will have fallen yet again, this time to 79.5%.

Which is why Congress and future presidents won’t stop at $1 trillion deficits. They know that over time they can borrow more and more. Soon it will be $1.5 trillion deficits. Within some of our lifetimes the Treasury will be consistently borrowing $2 trillion a year or more, never balancing a budget and never running a surplus, yet maintaining a manageable debt-to-GDP ratio.

And if their appetites grow too large and they borrow so much that the debt-to GDP ratio starts to get worrisomely high? No problem, the Fed can have a few “accident” years where inflation hits 6% or 7%--like 2022—and the debt-to-GDP ratio will be cut back down to size.

Just the inflation of the 1970’s alone watered the dollar down to 38 cents from 1971 to 1983. The Federal Reserve said “Oh we’re sorry, but we’ve learned our lesson” while the federal government’s debt-to-GDP ratio was reduced by 62%--from 35% of GDP to 11% (not including new deficits).

And holders of U.S. dollars got to foot the bill.


This sleight of hand has been practiced by western governments going back to at least World War II. They all went off their domestic gold standards during the Great Depression, giving their central banks a great deal more room to inflate the money supply.

America’s national debt in 1945 was $260 billion or 120% of GDP, both astronomical figures at the time, the result of massive borrowing for World War II.

Not to worry. By 1980 it was reduced to 30%.

But not by paying down debt. The federal debt had actually grown by 1980 to $860 billion, over triple its size in 1945.

But through the magic of growth and especially inflation the original $260 billion was no longer so much money anymore. Thank you holders of devalued dollars!

And boy were they devalued. The Federal Reserve went off the last vestiges of the gold standard in 1971—gold redemption for international central banks—and there was no longer any limit as to how much inflation the Fed could create.

It’s no surprise that in the 51 years since 1971 prices have risen 623% (if you trust government statistics) and the dollar’s purchasing power has declined to 13.8 cents.

Even in Ronald Reagan’s day, when the federal debt reached $2 trillion, the number was unimaginable. People said “$2 trillion? We’ll NEVER pay that off!”

They were more right than they knew. The federal government already knew that with growth and inflation there was no need to pay it off. Because today a $2 trillion debt is also nothing—a mere 7.7% of GDP—thanks to growth plus inflation.

Presidents who enter office determined to balance the budget and do something about the national debt are quickly educated by the Treasury Secretary that growth and inflation will always be there to bail out the government, so there’s no need to tighten any belts.

And the moment the first budget standoff with Congress happens, the first time partisan fingerpointing begins, the moment a government shutdown looms, all sides agree: “Hey, why are we fighting? Let’s just borrow another trillion dollars and future generations will pay it off with growth and inflation. And the best part is most of them won’t even realize they’re paying.”

For those who want to check the compounded percentage math

1) $1 trillion deficits

-2.1% real GDP growth over ten years = 1.021^10 = 1.231 = 23.1% growth
-Eight years of 2.5% GDP growth + two years of 0.5% GDP growth = 1.025^8 x 1.005^2 = 1.231
-(1.231^(1/10) = 1.021 = 2.1% annualized GDP growth)
-2.5% inflation growth over ten years = 1.025^10 = 1.280 = 28.0% price increase
-$31.5 trillion debt + ten years of $1 trillion deficits = $41.5 trillion
-$26.1 trillion nominal GDP plus ten years 2.1 % GDP growth and ten years 2.5% inflation = 26.1 x 1.231 x 1.280 = $41.1 trillion
-New debt-to-GDP ratio = $41.5 trillion/$41.1 trillion = 101%

2) $1.8 trillion deficits

-Current debt-to-GDP ratio = 120.7%
-$31.5 trillion debt + ten years of $1.81 trillion = $49.6 trillion
-$26.1 trillion nominal GDP plus ten years 2.1 % GDP growth and ten years 2.5% inflation = 26.1 x 1.231 x 1.280 = $41.1 trillion
-New debt-to-GDP ratio = $49.6 trillion/$41.1 trillion = 120.7% (unchanged from today)

Thursday, February 9, 2023

Gavin Newsom Demands Federal Investigation Into California Power Prices

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The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff suggests Gavin Newsom starts by investigating himself and the years of bans on California natural gas drilling/fracking he has championed.

Next he might want to focus investigating members of his own party who have blocked pipelines and oil/gas production projects all across the United States.

Read more details at:

Tuesday, February 7, 2023

Free vs Regulated Banking: Canada's Free Banking Era - Why Was the Bank of Canada Established?

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5 MIN READ - Cautious Rockers who’ve even glanced at the Cautious Economics Correspondent for Economic Affairs and Other Egghead Stuff’s articles on Canadian free banking would be justified in asking a logical question: 

“Given how well free banking worked for a century and even withstood the Great Depression without a single bank failure, why on earth did the Canadian government feel it necessary to authorize a central bank in 1935?”

The answer lies in 1930's politics. Curious Rockers feel free to read on to learn more.

Bank of Canada building, circa 1938
As we’ve covered in multiple past entries, Canada’s banking system was the industrialized world’s second least regulated from 1817 to 1844, and least regulated from 1845 to 1935. 

All throughout its entire 118-year “free banking” era the Canadian banking system was crisis-free in contrast to the heavily regulated United States which bore fifteen crises before 1935.

However the free banking era is universally considered as having abruptly ended in 1935 when Canada’s first central bank, the Bank of Canada, opened for business by order of the 1934 Bank of Canada Act.

Why then, if Canada’s free banking system was performing so well, did Canadian Parliament elect to establish a central bank?

As one might expect the answer is rooted in politics.


There were two primary political catalysts for Ottawa’s embrace of a new central bank.

The greatest, by far, was domestic Great Depression politics. 

In the depths of Canada’s economic hardship an eccentric upstart party named the Social Credit Party (interesting name given China’s modern Social Credit System) won a large bloc of parliamentary seats, mostly in Alberta where the party won 46% of the popular vote.

The Social Credit Party’s platform, based in the theory of social credit, was considered radical in its day.

Social Credit called for redistribution of wealth and mass printing of government “prosperity certificates” which would be doled out to the public plus any business that sold below cost to consumers. Furthermore the party platform was presented in agrarian Christian populist packaging, marketed with slogans hailing the national construction of “A Utopia of Our Own.”

Compounding problems was the surging “Cooperative Commonwealth Federation” (CCF), a socialist party founded in 1932 on a platform that included nationalization of financial institutions. Capitalizing on widespread public discontent with the depression, the CCF rose in just two years to official opposition status within the provincial governments of Ontario and Saskatchewan.

The rapid ascent of these fringe movements so alarmed the establishment Liberal and Conservative parties that they sought some form of political compromise to curb the most extreme elements of the Social Credit and CCF platforms.

A linchpin of that compromise was the Bank of Canada.

Although the Canadian banking sector held up extremely well during the Great Depression and weathered the slump without a crisis, the public nevertheless largely blamed banks—a historically unpopular and easy target—for the depression itself. 

Hence the Liberal and Conservative parties believed the creation of a central bank to conduct monetary policy would appease all disgruntled parties: not only the Social Credit Party and Cooperative Commonwealth Federation but restless Canadian voters as well.


A secondary impetus for the decision to establish a central bank was national prestige.

By the mid 1930’s most developed countries were attending regular international monetary conferences, and the post-1933 period saw a particularly rapid flurry of meetings where governments regularly sought to quell competitive “beggar thy neighbor” monetary policies—effectively a cycle of national currency devaluations to boost exports and dig their way out of their problems at the expensive of other trading partners.

However only countries with central banks were invited.

Canadian officials felt they were being left off the world stage, so the two major political parties supported the Bank of Canada Act in order to bring Canada the worldly prestige they thought it was due.

According to Bordo and Redish (1986)…

“The World Monetary and Economic Conference in 1933 had stated that all developed countries without a central bank should create them to facilitate monetary cooperation and recovery. In an article analyzing the need for a central bank, Queen's University economists had stressed the need for a central bank to send representatives to world monetary conferences; ‘There are few countries… …more vitally interested in international cooperation in the monetary and economic fields than Canada and yet we lack any institution which would permit effective participation in such cooperation.”

Shortly after a government commission headed by pro-central bank parliamentarian Hugh MacMillan handed down its central bank endorsement, Prime Minister R. B. Bennett…

“…announced that he would introduce a Bill to establish a central bank, ‘to regulate credit and currency in the best interests of the economic life of the nation, to control and protect the external value of the national monetary unit and to mitigate by its influence fluctuations in the general level of production, trade, prices and employment.’”

Canada’s banking sector had navigated the challenging depression economy just fine without a central bank, but Parliament created one anyway to satisfy politicians of all stripes: populist, socialist, international, and establishment.


Once opened the Bank of Canada rapidly took control of monetary functions previously performed by private competitive banks and the historic 118-year era of very light regulation abruptly ended.

-In 1935 the Bank of Canada became the official arbiter of banking system reserves and official lender of last resort.

-By 1936 the Bank of Canada was government-majority owned.

-In 1938 the Bank of Canada was completely nationalized by the federal government.

-By World War II private banknote issuance was effectively monopolized by the Bank of Canada, the last-ever private banknote issued in 1943 by the Royal Bank of Canada.

After World War II Canadian Parliament itself took a more active role in bank regulation. 

Federal deposit insurance was introduced in 1967.

Canada went off gold completely after Richard Nixon effectively ended the Bretton-Woods international gold-exchange standard.

Today Canadian regulators dictate capital ratio requirements to banks, monitor market shares for antitrust violations, and restrict Canadian banks from investing in risky assets.

And just like the Bank of England, Federal Reserve System, and every other modern day central bank, the Bank of Canada has embarked on a campaign of deliberate long-term monetary inflation to serve the central government's fiscal interests. Since 1935 prices in Canada have risen nearly 2,100% or an annualized inflation rate of 3.57%.

Put another way, the Loonie has lost 95.4% of its value, much as the US dollar has lost 95.6% of its value in the same period.

However even with such a dramatic departure from free banking since the Great Depression, Canada’s banking sector has still managed to avoid any systemic crises – unlike the United States which has still braved crises in 1990 and 2008.

What has Canada done differently even in the modern era to outperform the United States? We’ll discuss that subject in our final two chapters.

Wednesday, February 1, 2023

Free vs Regulated Banking: Canada's Free Banking Era - Modern Day Praise and Debate

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8 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff continues analyzing the historically successful and stable Canadian banking system with the academic question of Alexander Hamilton’s influence on its original blueprint.

Canadian banking: A Hamiltonian framework (or not)?

Although the story of Canadian banking’s success under very light regulation has been largely stricken from history books, there are a few intellectuals who have kept the history alive.

As one might expect the story is more widely known in Canada where many monetary economists and historians still study the subject. Some the Economics Correspondent has read or followed include Angela Redish (University of British Columbia), James Darroch (York University) and Joe Martin (University of Toronto).

In the United States the Free Banking School of economics writes extensively on Canada’s experience, notably George Selgin (Professor Emeritus, University of Georgia), Lawrence White (George Mason University), and Kurt Schuler (Johns Hopkins, George Mason, and most recently the U.S. Treasury Department).

Several scholars at Rutgers University’s unique economics department have written on the Canadian experience such as Michael Bordo and Hugh Rockoff.

And Charles Calomiris of Columbia University–now at the United States Office of the Comptroller of the Currency—has written much on Canada’s banking success.

What all these academics agree on is that Canada’s nationwide branch banking networks made its industry far more resistant to crisis than the United States where state laws prohibited interstate branching and often banned branching of any kind whatsoever from 1787 to as late as the 1990's.

U.S. economists, also having naturally studied problems in the American system, have cited problems with the U.S. National Banking System (1863-1914) that forced U.S. banks to buy and hold U.S. government bonds to back their private banknote issuances – even when Treasury bonds were disappearing as the Civil War national debt was paid down. 

And the mainstream economics community is acutely aware of massive failures by the U.S. Federal Reserve during the Great Depression.


Where opinions differ concerns the original blueprint for the Canadian system.

Many Canadian economists, along with Calomiris, argue the original authors of Canada’s 1871 Bank Act borrowed Alexander Hamilton’s vision of banking which in turn planted the seeds of success for over 150 years.

The Free Banking school economists disagree with this characterization and the Economics Correspondent hasn’t yet found a position from the Rutgers economists.

But first let’s clarify what is meant by a “Hamiltonian” framework.

American founding father Alexander Hamilton advocated for a much stronger central government than his political nemesis Thomas Jefferson. Among their many disagreements, Hamilton wanted the federal government to charter private banks and pressed for the establishment of a privileged, national central bank in the mold of the Bank of England.

Jefferson, who distrusted centralized government power, argued consistently that the federal government had no constitutional authority to either charter banks or establish a central bank.

Hamilton won out on the issue of a central bank. Congress and George Washington approved the First (1791-1811) and Second Bank of the United States (1816-1836), both of which were 20% owned by the federal government itself.

But Hamilton lost on the question of chartering which was left to the individual states. From the nation’s founding to the Civil War, private banks other than the First and Second Bank of the United States were chartered exclusively by state legislatures.

The Economics Correspondent has already discussed the aftereffects: state governments largely traded bank favors for charters and became shareholders in the banks themselves. To maximize bank profits and state government revenue streams, legislatures granted monopoly privileges to thousands of banks by making them “unit banks” that were forbidden from branching, but by extension enjoyed exclusive banking rights in their own townships.

The vulnerability in this arrangement was unit banking made it impossible for banks to diversify their loans outside of their local towns, and the result was waves of bank failures and frequent banking panics when the prices of certain crops fell in farming regions or when imports or exports declined in trading cities.

One more criticism leveled at the Jeffersonian model is that, lacking a centralized government banking authority, individual states regulated their own banks. 

Later at the outset of the Civil War the federal National Banking Acts established the Office of the Comptroller of the Currency to regulate new nationally chartered banks.

After 1914 the Federal Reserve was tasked with regulating its member banks, and once the FDIC was created in the 1930’s it too took on regulatory responsibilities since it was liable for depositor claims in the event of bank failures.

But in Canada, which granted chartering and oversight powers to the central government shortly after Confederation, a single national agency has regulated banks: OSFI or the Office of the Superintendent of Financial Institutions, although its origins go back to embryonic predecessors in 1925.

Hence another argument for the success of adopting a Hamiltonian model arises: the splintered American system led to four agencies capriciously regulating different and often overlapping groups of banks while the Canadian system has been straightforward with a single national entity applying a single, consistent set of rules.


In the Economics Correspondent’s opinion, the “stable Hamiltonian vision” argument is mostly, albeit not entirely, mistaken. The Free Banking School shares skepticism towards the Hamiltonian hypothesis.

But first let’s start with what’s right about the Hamiltonian theory.

Yes, it’s true that had Hamilton gotten his way and American banks were all required to obtain national charters then it’s very unlikely the American states would have been able to engineer the fractured unit banking system that dominated finance for over 150 years.

This is not an inconsequential argument. Unit banking was a major originator of banking crises in the United States from the late 18th century through the Great Depression although it wasn’t alone – part of a trio comprised of central banks and bondholding mandates, both state and federal, that share the blame.

Also, to the extent one wants governments regulating banks, it is indeed simpler for one national agency to consistently apply rules than assigning oversight responsibilities to separate state regulatory agencies, the OCC, the Federal Reserve, and the FDIC all at once.

However the Hamiltonian argument falters on several fronts.

1) Hamilton championed a government-connected central bank.

Not only did Canada not have a central bank for the first 118 years of its banking history –a very un-Hamiltonian framework – but it was also precisely the absence of a central bank that contributed heavily to financial stability.

By contrast Alexander Hamilton’s central banks produced horrendous results. The First Bank of the United States (1791-1811) and its successor, the Second Bank of the United States (1816-1836), inflated three different asset bubbles, all of which burst and set off banking panics in 1792, 1797, and 1819 with the last two hatching major depressions.

America’s modern central bank, the Federal Reserve System is largely blamed for transforming the Recession of 1929 into the Great Depression, and the Economics Correspondent has written in detail on the Fed’s inflation of the stock market and real estate bubbles of the 1920’s that started the whole catastrophe.

There’s more anguish associated with central banks. Since the United States went off the international gold standard in 1971 central banks have dominated the global monetary system, spawning an unprecedented 107 financial crises in 83 countries including the S&L Crisis and 2008 Great Financial Crisis in the United States.

Thus in at least one major respect Canada absolutely did not model its banking system on Hamilton’s vision and subsequently avoided a lot of pain and suffering.

2) Per Hamilton’s design America’s antebellum central banks were 20% owned by the federal government, his objective being to align the interests of the State with those of the bank.

To further align their interests Hamilton deliberately packed the Bank of the United States’ coffers with U.S. Treasury bonds, and he required subscribers to the Bank’s shares to pay with Treasuries in a scheme to inflate demand for sovereign debt thereby lowering the government’s borrowing costs.

The outcome was a bubble in Treasury securities that burst in 1792, instigating the young United States’ first banking panic.

But the Canadian Bank Acts contained no such crony provisions. Hence the new Dominion of Canada averted the government securities bubble and collapse that rocked the United States.

3) One might argue that it’s more efficient to have a single, all-powerful federal bank regulator than multiple state bureaucracies, an OCC, a central bank, and a deposit insurance agency all regulating at once.

However, as we’ve noted at length, it was precisely bad regulations that triggered the United States’ seventeen banking panics from 1792 to 2008 (one possible exception: 1837-1839).

We’ve discussed several of America’s old regulations before, but new bad regulations both forced and rewarded banks to lower lending standards on home mortgages during the 1990’s and 2000’s which led to massive real estate loan losses and the 2008 financial crisis.

Canada avoided any crisis in 2008, all its banks remained profitable, and none of its banks took a penny of government bailout money.

In fairness to Canada, bad regulations *were* floated in the House of Commons in 1869: a bill to convert the Bank of Montreal into a central bank and condemn all remaining private banks to no branches (effectively recreating unit banking in Canada), but Parliament soundly rejected it. 

Which reveals the hazards of crediting the “single regulator” concept for Canada’s stability. For the key is not the number of regulators but rather good versus bad regulations, and Canada has had mostly the former and very little of the latter.

In the Economics Correspondent’s opinion Canada’s success was rooted more in its decisions to avoid adopting bad bank regulations, not in assigning fewer agencies to administer them.

4) Even though the “Hamiltonian vision” crowd agrees with everyone else that the U.S. unit banking system was horrible all-around, unit banking laws were regulations too. 

Once again the real issue is whether bad regulations were imposed on the banking sector or not, not whether a powerful central government or states/provinces enforced the rules. Canada could have imposed bad regulations in 1869 but declined.

Professor Joe Martin of the University of Toronto goes out of his way to reject the alternate “free banking” narrative of Canada's success – that Scottish immigrants emulated their native country’s lightly regulated system when they arrived – and insists Canada followed the Hamiltonian model, not the Scottish one.

The Economics Correspondent is impressed with Martin’s breadth of knowledge and has enjoyed several of his articles and interviews, but based on the evidence and historical record maintains the Canadian banking system's first 118 years were molded more in the spirit of Adam Smith than Alexander Hamilton.

In summary the Economics Correspondent believes Canada’s free banking era was so successful because it was, well… so free, not because the federal government molded it from Alexander Hamilton’s template.

The one and only Hamiltonian aspect of Canadian banking that can claim credit for stability is the national charter which prevented provincial-level unit banking from ever taking hold.

That’s about it. Because there are many more traits of Hamiltonian banking that would have spawned crisis and panic, but which Canada avoided precisely by not adopting them.