Monday, March 17, 2014

What Was “The Coyne Affair” ?

James Elliott Coyne would have been 104 years old this July, if he had lived past the ripe old age of 102. A lawyer by training, Coyne first joined the Bank of Canada in 1938 in the Research Department, but left during the War years to work in various government departments that were instituting wage and price controls. He returned to the Bank in December 1944, rising to Deputy Governor before taking the top position in January 1955. After a turbulent period with the Diefenbaker government, financial institutions and academia (which came to be known as the “Coyne Affair”), Coyne resigned as Governor on July 13 1961, six months shy of his seven-year term. It is the purpose of this post to shed some light on the “Coyne Affair” and assess whether the negative criticisms directed at Coyne were justified. As an Austro-libertarian, I’m leery of taking sides with a central banker, but as will be seen, James E. Coyne was not your typical central banker. And while I don’t agree with Coyne’s economic nationalism, I sympathize with his anti-inflationary stance and his rejection of the Keynesian Revolution that was sweeping the economics profession in the post-World War 2 period.

Coyne’s governorship was characterized by his “tight money” policy that drove the Diefenbaker government nuts. Additionally, the idea that “easy” money and lower interest rates fuel economic growth was rejected by Coyne and didn’t help him win friends among borrowers, lenders and the academia. Part of this criticism may be appropriate, as central bankers are always setting rates at arbitrary levels. While Coyne correctly denounced inflation as “economically unsound and morally reprehensible,”[1] he nevertheless inflated the money supply at will, assuming that the economic data being analyzed by BoC economists were verifying his actions as Governor. Hence, instead of allowing the market to set rates, Coyne intervened to promote his ideas of economic growth. As former Fed Chairman William McChesney Martin put it, the central bank’s role is to “take away the punch bowl just when the party gets going.” Coyne took this quip to heart.

Unfortunately Coyne’s motives were less than sound. In a series of speeches he gave (that eventually got him oust by the government), Coyne denounced foreign borrowing as detrimental to the well-being of Canadians. “[T]he general level of interest rates,” said Coyne, “should be such as to encourage new savings each year equal to the level of new capital expenditures, without large inflows of capital from abroad.” And that, “much more money and credit and capital [are] made available when money is “tight” than when it is easy.”[2] For a central banker to encourage savings is breath of fresh air in today’s Keynesian environment, but at the time Department of Finance assistant deputy minister Wynne Plumptre pointed out some fundamental flaws with Coyne’s approach.

Canada’s high living standards relative to most other countries are based on the richness of our natural resources when combined with large amounts of capital and technology. Because of these resources we have a comparative advantage, compared with other countries, in exporting products dependent on or closely related to them. If we attempted to model our economy on those of European countries we would in fact be denying ourselves the benefits of the international division of labour and this would be reflected in our wage levels and standards of living. [3]

Nevertheless, Coyne maintained that “growth based mainly if not entirely on our production and savings would be sounder, more sustainable, and in the long run larger.” He then proceeded to recommend a series of interventions and protectionist measures that the government ought to adopt to reach this goal. [4] One of Coyne’s major characteristics was “moral suasion.” He often lectured the Chartered Banks on how to conduct their business, even setting ratio requirements that were, technically, “voluntary.” He advocated lending for mortgages and denounced consumer loans. He sought to regulate non-bank financial institutions as to discourage loans for anything he felt was detrimental to the Canadian economy.

As Governor of the Bank of Canada, Coyne made the case for floating the currency, as opposed to the fixed-exchange rates of the Bretton Woods agreement. Accepted by the Department of Finance – despite the disapproval of the IMF – Coyne’s BoC let the Canadian dollar float as to help control capital inflows and inflationary pressures. This, along with Coyne’s other actions, helped infuriate academia. In late 1960, a petition signed by Canadian economists was sent to the Government (and the Globe and Mail) that called for the forced resignation of James E. Coyne. Their grievances also included the confusion left in the wake of the 1958 Conversion Loan.

As a “fiscal agent” for the government, the Bank of Canada manages the government’s debt. The most important debt-management operation of the Coyne years was the Conversion Loan of 1958. In the summer of that year, the BoC purchased $6 billion of the federal government’s debt, roughly 40% (or 60% of its marketable debt). The idea was to lengthen government debt by selling long-term bonds to the public in exchange for the short-term Victory Loans already being held from World War 2. The federal government preferred to sell long-term bonds in exchange for bonds that were maturing in the immediate years ahead. Despite the massive propaganda to sell the idea, the BoC was compelled to acquire long-term bonds in order to maintain bond prices at par with the Americans. At one point, the BoC was the only buyer. Nevertheless, the Conversion Loan of 1958 proved to be a success, at least for the government. Rising inflation eroded the bonds’ value for investors, not to mention the American bond market fell a few weeks later, significantly impacting the Canadian bond market leaving investors disgruntled and pinning the blame on Coyne’s Bank of Canada. [5]

Coyne’s desire to influence the allocation of credit, his handling of the Conversion Loan, his decision to let the Canadian dollar to float and his vocal criticisms of the Diefenbaker government was enough to get him into trouble with influential people. In addition to this, Coyne was blatantly anti-Keynesian, refusing to budge on the issue of creating more inflation to combat unemployment. As he wrote in a speech that was never delivered, unemployment “has not been caused by monetary policy and is not curable by monetary policy.” [6] Clarence Barber from the University of Manitoba felt as if he had “experienced a Rip Van Winkle in reverse … having awakened in the nineteen-twenties, my memory of a Keynesian revolution and an age of economic enlightenment is all a dream.”[7]

This, of course, should come as a welcome relief for free market advocates. Despite some of Coyne’s economic autarky, one does not need to be an Austrian to appreciate the destruction caused by inflation. Coyne’s BoC published reports that said, “The evils of inflation need no elaboration… Inflation forcibly restricts consumption by exacting the greatest sacrifice from those least able to bear it. It sets up many social and economic stresses and it feeds on itself – the so-called spiral of inflation and cost.” [8] Coyne himself wrote in 1958,

I believe that monetary policy must strengthen and reaffirm its determination to remain true to the basic principles of sound money. Perhaps the greatest obstacle to the proper use of monetary policy is the spread of the theory that democracies cannot have both high employment and stable prices, that they must inevitably choose between unemployment and inflation, that high employment can only be achieved by the acceptance or even the deliberate creation of some degree of inflation. I am certain that these views are fundamentally wrong. The idea that readiness to create or tolerate inflation can make a useful contribution to the problem of maintaining a high and expanding level of employment and output, is in danger of becoming the great economic fallacy of the day. [9, emphasis added]

Coyne wasn’t alone either. A.C Ashforth, president of the Toronto-Dominion Bank in 1956, wrote in his annual report, “unless we keep the purchasing power of the dollar on an even keel, we destroy savings and thrift.”[10] Coyne hinted, probably unintentionally and unknowingly, at the Austrian Business Cycle Theory. “Inflation is particularly insidious in that it seems to some to encourage production and employment and expansion for a time, but it continually cumulates excesses, distortions, inefficiencies and injustices which in due course produce recession, loss of confidence, and contraction.”[11]

And these aren’t outdated opinions. Coyne was interviewed in June 2005 where he reiterated, “the capitalist system requires there should savings, and you either have to do the savings yourself or borrow from other countries who will do it for you.”[12] And, “I don’t even like to think of inflation at the rate of 1 per cent a year because after thirty years, what have you got? Savings are cut in half, if you had any savings.” [13]

The criticisms of James E. Coyne that eventually led to his dismissal are somewhat justified. As Governor of the Bank of Canada, he probably shouldn’t have criticized the Diefenbaker government as much as he did, and in his speeches he clearly went beyond the role of a central banker by offering fiscal policy suggestions. The Conversion Loan was not entirely his fault, as the government’s fiscal agent, whoever headed the BoC would have had to act in the same way. (The problems with the Conversion Loan are really problems with government borrowing, not anything specific to James E. Coyne’s governorship). His decision to allow the currency to float was actually ahead of its time, regardless of the soundness of the policy, the world would follow Coyne’s idea after the breakdown of Bretton Woods. His interference with the Chartered Banks and desire to embrace economic nationalism was actually popular among Canadians, despite its backwardness.

The criticisms launched at Coyne from academia were completely unjustified and now even the mainstream recognizes this. The Phillips Curve has no merit and as James Powell writes, “with Coyne’s resignation Canada lost a powerful voice against inflation at a time when it was increasingly perceived as a necessary evil to achieve full employment – a view subsequently proved, at great cost, to be seriously flawed.”[14]. One can only hope that current and future BoC governors recognize Coyne’s other contribution: that the capitalist system requires savings, and inflation, at any percentage, will erode this vital function of the market economy. As Ludwig von Mises wrote, “But the certain fact about inflation is that, sooner or later, it must come to an end. It is a policy that cannot last.”


Powell, James. The Bank of Canada of James Elliott Coyne. Montreal & Kingston: McGill-Queens University Press, 2009. Print.

[1] page 31

[2] page 92

[3] page 96

[4] For a full list, see page 101

[5] For a detailed account, see Chapter 8

[6] page 99

[7] page 111

[8] page 30

[9] page 31

[10] page 32

[11] page 30

[12] page 149

[13] page 151

[14] page 142

Also available at Mises Canada

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