Why Is Canada’s Financial System So Stable?

By David Dittman • April 10, 2013 • Canadian Edge Weekly

We know Canada didn’t experience a banking crisis during the 2007-09 global meltdown that afflicted nearly every other developed-world country’s financial system.

What may come as a surprise is that the Great White North has never in its history suffered a run on its banks. Since 1790 the US has experienced 16 banking crises, Canada zero. Since 1840, when Canada became a single colony under British rule, there have been systemic crises in the US, zero north of the border.

According to research presented at this week’s Financial Markets Conference hosted by the Federal Reserve Bank of Atlanta, all credit for this remarkable achievement is due the French.

Charles W. Calomiris, Henry Kaufman Professor of Financial Institutions at Columbia University, and Stephen Haber,  A.A. and Jeanne Welch Milligan Professor in the School of Humanities and Science at Stanford University, argue in their paper The Political Foundations of Scarce and Unstable Credit, extracted from their forthcoming book Fragile By Design: Banking Crises, Scarce Credit and Political Bargains, that Canada’s French legal history created a “highly-centralized federal government which controlled economic policy making and had built-in buffers for banker interests against populist forces” and therefore established a framework for long-term stability in the nation’s banking system.

The population of Canada, which then consisted of two provinces, Lower Canada and Upper Canada, at the time it became a British colony was mostly French. And, reflecting the longstanding rivalry between England and France, most of the people in what was once the Province of Quebec, under French control from 1763 until 1791, had little love for their new masters.

According to Calomris and Haber, British policymakers established a system of government designed to limit the power of the French majority that simultaneously provided for increased self-government. What came about was a highly centralized federal government that controlled economic policy-making and had built-in buffers for banker interests against populist forces.

The authors’ attempt to demonstrate that Canada’s anti-populist political system–known in academia as “liberal constitutionalism” or “liberal democracy”–is the key factor explaining the absence of banking crises in Canada’s history. These types of political systems make it difficult for political majorities to gain control of financial systems and manipulate them to their own gain.

Calomiris and Haber contrast Canada’s system with “populist democracies” that sprang up in places such as the US. Here we’ve created the framework for dysfunctional financial systems because majorities are able to gain control over banking regulation and steer credit to themselves and their allies at the expense of political enemies.

The US-Canada dichotomy is the primary evidence supporting the broader thesis that dysfunctional banking systems–which are by far the norm rather than the exception–are the result of political factors.

According to Mr. Calomiris’ presentation at the Atlanta conference, the history of the US banking system is one in which the government forms partnerships with different interest groups at different points in history, and those coalitions jointly influenced the way the banking system was regulated. 

“Whether societies have dysfunctional banking systems is really not a technical issue at all. It’s a political issue,” Mr. Calomiris said at the Atlanta conference.

“In populist democracies, such as the United States, the regulation of banking is used as a political tool to favor some parties over others. It is not that the dominant political coalition in charge of banking policy desires instability, per se, but rather, that it is willing to tolerate instability as the price for obtaining the benefits that it extracts from controlling banking regulation,” Calomiris and Haber write in their paper.

Compelling as it is, the authors don’t address specific features that may distinguish, at least in modernity, Canada from the US. Chief among these, at least with regard to the present crisis, is that the US experienced a period of rapid and radical deregulation that began late in the 20th century.

As for our friends in the Great White North, as Barry Ritholtz points out, Canadian bankers can’t lobby regulators. And, unlike the US Supreme Court, the Supreme Court of Canada doesn’t consider corporations to be people, and that means spending money on political campaigns, for example, does not qualify as “speech.” There are also explicit limitations on corporate political donations.

Regulation is also not so subject to “capture” in Canada because there are serious restrictions on personnel movements between government and private-sector employment.

The Loonie’s New Status

Recent data from the International Monetary Fund indicates foreign central banks continue to diversify their currency holdings beyond the traditional US dollar, Japanese yen, Swiss franc, British pound sterling and euro mix.

The March 29, 2013, IMF report on its database of global reserves, the Composition of Foreign Exchange Reserves (COFER), showed that the share of central bank reserves tied up in dollars and yen declined during the fourth quarter of 2012, while the share devoted to the euro was unchanged.

Meanwhile, the share invested in the category labeled “other”–which includes non-traditional currencies such as the Canadian dollar and the Australian dollar–surged to an all-time high of 6.12 percent.

Although there are problems in the Canadian economy, including a housing market that still has room to come down (though it’s doing so in an orderly manner and in accordance with new policy measures to tighten mortgage eligibility) as well as the pernicious impact of oil-price differentials on its key resource sector, the financial system up north remains sound and government finances are in relatively good order.

This rough patch will pass, in due time. In fact the bounce off today’s lows suggests central banks continue to step into loonie-denominated assets on weakness.

The “big five” still command the lion’s share of central bank foreign currency holdings. But the trend toward the loonie and the aussie–which share in common underlying economies focused on resource production and export as well as supporting governments with relatively low levels of debt–is clear.

“Other” surpassed the Japanese yen to take fourth place during the fourth quarter of 2009 and leapt over the British pound for third place in the third quarter of 2010.

The US dollar and the euro remain in first and second place, respectively, but “other’s” share has grown substantially in the 21st century, from 1.49 percent of allocated reserves at the end of 2000 to 5.49 percent in 2011 to the present accounting above 6 percent as of Dec. 31, 2012.

An August 2012 IMF report had found that the loonie and the aussie should be broken out from the group of currencies reported as “other.” A March report in The Wall Street Journal indicates this will happen by June 30, 2013.

“The IMF is expanding the list of currencies separately identified in the COFER template,” an IMF spokeswoman told the WSJ. “The implementation of the revised COFER Report Form, with separate identification of the Australian dollar and Canadian dollar, is scheduled for the first half of 2013.”

It’s important to note that the IMF is simply breaking out data for the loonie and the aussie. This alone should have no substantive impact, as it’s an after-the-fact accounting of actions central banks have already taken.

A new line-item doesn’t make these currencies any more or less fundamentally attractive. But it does acknowledge the fact that the Canadian dollar, as well as the Australian dollar, has achieved a certain critical point in the eyes of central banks around the world.

The Roundup

Here’s where to find analysis of Canadian Edge Portfolio Holdings’ fourth-quarter and full-year 2012 earnings.

Conservative Holdings

Aggressive Holdings

And here’s when Portfolio Holdings will report numbers for the first quarter of 2013. Those that have revealed firm dates for announcements are noted as “confirmed,” while we provide an “estimate” for those yet to make specific commitments.

Conservative Holdings

  • AltaGas Ltd (TSX: ALA, OTC: ATGFF)–April 26 (estimate)
  • Artis REIT (TSX: AX-U, OTC: ARESF)–May 7 (confirmed)
  • Bird Construction Inc (TSX: BDT, OTC: BIRDF)–May 14 (estimate)
  • Brookfield Real Estate Services Inc (TSX: BRE, OTC: BREUF)–April 17 (estimate)
  • Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF)–June 7 (estimate)
  • Canadian Apartment Properties REIT (TSX: CAR, OTC: CDPYF)–May 9 (estimate)
  • Cineplex Inc (TSX: CGX, OTC: CPXGF)–May 10 (estimate)
  • Davis + Henderson Income Corp (TSX: DH, OTC: DHIFF)–May 8 (estimate)
  • Dundee REIT (TSX: D-U, OTC: DRETF)–May 3 (estimate)
  • EnerCare Inc (TSX: ECI, OTC: CSUWF)–May 15 (estimate)
  • Innergex Renewable Energy Inc (TSX: INE, OTC: INGXF)–May 14 (estimate)
  • Keyera Corp (TSX: KEY, OTC: KEYUF)–May 8 (estimate)
  • Northern Property REIT (TSX: NPR, OTC: NPRUF)–May 8 (confirmed)
  • Pembina Pipeline Corp (TSX: PPL, NYSE: PBA)–May 3 (estimate)
  • RioCan REIT (TSX: REI, OTC: RIOCF)–May 3 (estimate)
  • Shaw Communications Inc (TSX: SJR/A, NYSE: SJR)–April 12 (confirmed)
  • Student Transportation Inc (TSX: STB, NSDQ: STB)–May 9 (estimate)
  • TransForce Inc (TSX: TFI, OTC: TFIFF)–April 18 (confirmed)

Aggressive Holdings

  • Acadian Timber Corp (TSX: ADN OTC: ACAZF)–May 1 (estimate)
  • Ag Growth International Inc (TSX: AFN, OTC: AGGZF)–May 15 (confirmed)
  • ARC Resources Ltd (TSX: ARX, OTC: AETUF)–May 2 (estimate)
  • Atlantic Power Corp (TSX: ATP, NYSE: AT)–May 7 (estimate)
  • Chemtrade Logistics Income Fund (TSX: CHE-U, OTC: CGIFF)–May 9 (estimate)
  • Colabor Group Inc (TSX: GCL, OTC: COLFF)–May 2 (estimate)
  • Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF)–May 10 (estimate)
  • Enerplus Corp (TSX: ERF, NYSE: ERF)–May 10 (estimate)
  • Extendicare Inc (TSX: EXE, OTC: EXETF)–May 8 (estimate)
  • IBI Group Inc (TSX: IBG, OTC: IBIBF)–May 10 (estimate)
  • Just Energy Group Inc (TSX: JE, NYSE: JE)–May 17 (estimate)
  • Newalta Corp (TSX: NAL, OTC: NWLTF)–May 8 (estimate)
  • Noranda Income Fund (TSX: NIF-U, OTC: NNDIF)–May 15 (estimate)
  • Parkland Fuel Corp (TSX: PKI, OTC: PKIUF)–May 8 (estimate)
  • PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF)–May 2 (estimate)
  • Peyto Exploration & Development Corp (TSX: PEY, OTC: PEYUF)–May 9 (estimate)
  • Vermilion Energy Inc (TSX: VET, OTC: VEMTF)–May 3 (estimate)
  • Wajax Corp (TSX: WJX, OTC: WJXFF)–May 8 (estimate)

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