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By :Andre Gouslisty

Former Professor of Economics

Faculty of Administration

Sherbrooke University


September 9 2002


To have transformed, at first sight, and we insist on the words " at first sight ", a series of budget deficits in a series of surpluses as the first two columns of the table below show it


Position of the Canadian government in million $



Surplus or deficit (-)

Variation of the Assets of the Bank of Canada

Variation of the federal debt


- 39 675

  1 603

   34 361


- 35 088

  1 005

   27 139


- 31 685


   25 095


- 16 921


   11 048


    6 535

  1 165

-    6 471


    7 689

  2 060

-    6 824


    8 194

  9 254



  17 764

- 3 510

-  18 401


  11 203

  2 256



Source:  Bank of Canada Banking and financial statistics - August 2002


the former Canadian Minister of Finance Paul Martin, is taken as a finance genius, almost Nobelisable and a statesman, to which the governance of Canada should return without discussion.


It is in any case what Thomas J. Courchesne of Queen University and researcher affiliated to the Institute of Research in Public Policy (IRPP), makes it clear, in a study entitled " Half-Way Home: Canada's Tax Remarkable Turnaround and the Paul Martin Legacy ", dated July 2002.


Unfortunately for everyone, all the surpluses of Paul Martin are only illusions, not to say bluffs straightforwardly, because they had to be necessarily financed by the Central Bank in the form of purchases of bonds which are an expenditure and by refundings of the debt, which are also

expenditure.  The destiny of the State, its essence, is to have deficits contrary to the destiny of the private enterprise, its essence, which is to have profits.


The State, it is the Treasury  +  the Central Bank.  The Treasury, it is the right pocket of the State and the Central Bank the left pocket. When the right pocket filled thanks to the exits of the left pocket, one cannot say that there is surplus.


The Central Bank injects liquidities, in the overnight money market by buying bonds and by increasing its assets or, on the contrary, sponge, absorbs liquidities, by selling bonds and by decreasing its assets, all that, with an aim of reaching the most suitable interest rate


In the preceding table, years 1999 and 2000 are typical years because, in 1999, the refunding of the debt is almost null and, in year 2000, there was a very strong refunding of the debt.  In 1999, the budgetary surpluses absorb liquidities and this absorption not having been compensated by refunding of the debt, the Central Bank injects liquidities to compensate for the bad effects of the surpluses on the liquidities.  In year 2000, the budgetary surpluses absorb 17,7 billion liquidities, but as this absorption is more than compensated by an injection of 18,4 billion by way of refunding the debt, the Central Bank, vis-à-vis this surplus of liquidities, is forced to still absorb liquidities for 3,5 billion $ by selling securities and by decreasing its assets.  As it is seen, the budgetary surpluses have bad effects on the liquidities by decreasing them.  On the other hand, refunding of the debt, an expenditure of the government and the purchases of bonds  by the Bank of Canada, an another expenditure of the State, have on the liquidities good effects by increasing them.


We propose, in the lines which follow, to show how the payment of the taxes and the budgetary surpluses by the taxpayers reduces the reserves of the banks and how the reduction of the reserves of the banks obliges the Central Bank to intervene and buy bonds to maintain the interest rate at the best level .


We propose, to show also, that the criteria, in virtue of which  the valuation of the financial management of the former Canadian Minister for Finance Mr. Paul Martin, was made, namely the following ratios of Maastricht : Debt / GDP = or < that 60 % and the Deficit / GDP = or < that 3 %, are criteria without any financial value, neither being recognized nor used by financial science.



1.  Every time a bank receives 1 $ in deposit it puts a certain percentage in reserve and with the remainder  made loans and/or buys securities.


2.  The reserve can be legal or voluntary.  It is, in both cases, a rule of good management which makes it possible to the bank to face the withdrawals of funds.


3.  Each time that there is withdrawal of funds, the bank draws from its reserves to refund the customer.


4.  If the rate of the reserves is for example 10 %, a bank loses the totality of its reserves each time its deposits drop by 10 % and must reconstitute them, if not entirely, at least in large part.


Let us suppose that a bank has at the starting point the following simplified balance sheet:




Reserves              10  billion $

Deposits                    100 billion $

Loans                   90

Capital                         10

Securities             10                       



When the bank faces a withdrawal of 10 billion $ of the depositors the preceding balance sheet becomes:




Reserves                0 billion $

Deposits                        90 billion $

Loans                   90

Capital                          10

Securities             10




The withdrawal of 10 billion $ made the reserves to fall to 0 and the bank must reconstitute the reserves necessary  for deposits of 90 billion $. The bank must find 9 billion $ if the rate of the reserves is 10 %.


The bank to reconstitute its reserves has four options.


a) To borrow from other banks in the overnight money market in Canada or in the market of the fed funds in the United States.  The balance sheet of the bank becomes:




Reserves                9 billion $

Deposits                     90 billion $

Loans                   90

Banks                           9

Securities             10

Capital                       10


b)  To sell securities and the balance sheet becomes:




Reserves                9 billion $

Deposits                     90 billion $

Loans                   90

Capital                       10

Securities               1




c) To borrow from the Central Bank and the balance sheet becomes:




Reserves                9 billion $

Deposits                    90 billion $

Loans                   90

Central Bank              9

Securities             10

Capital                      10



d)To reduce the loans and the balance sheet becomes:




Reserves                  9 billion $

Deposits               90 billion $

Loans                     81

Capital                  10

Securities               10        




Each option has its advantages and its disadvantages but, it is generally to the first option that the banks have recourse, i.e. to get funds in the overnight money market .


5) Each time there is a reduction of a deposit: 

- to refund a loan; 

- to cash banknotes; 

- to pay taxes; 

there is a loss of reserve for the concerning banks. The demand in the overnight money market

or the fed funds becoming stronger and higher than the offer, the interest rate on this market increases.


6.  To prevent an increase of the interest rate in the overnight money market or, in the fed funds market, the Central Bank must intervene and inject liquidities by its purchases of governmental securities.


7.  As the banks and the public cannot eternally sell securities of the government at the Central Bank it is understood that this source of securities can be possibly dried up.


8.  So that the public can pay the taxes and the budgetary surpluses it is absolutely necessary that the Central Bank injects monetary liquidities.


9.  One is then in the presence of a juggling act.  While the Treasury has surpluses, the Central Bank has deficit.  It is because the purchases of bonds of the government, of private securities, of foreign currencies by the Central Bank, are not counted like a government expenditure that  budgetary surpluses are possible.


10.  The surpluses of the government are not bearable because no one sees how the Central Bank can perpetually buy securities from the public and banks without this source of securities drying up, and if it is not fed by sales of securities by the State which is impossible with

surpluses, but possible with borrowing and deficits.


11.  Many people presents the refunding of the governmental debt like one of the most virtuous acts of the former Minister of Finance Martin.  But a virtue is a virtue if it is free act and is not forced act.  When one is constrained to be virtuous one is not virtuous at all. The refunding of the debt was a necessity.  The State, because of its surpluses, spending less, must necessarily spend differently by refunding the debt.  The refunding of the debt has, on the reserves of the banks, the contrary effects to those of the payment of the taxes, by increasing them.  The refunding of the debt, an expenditure, reconstitutes the reserves of the banks and relieves the Central Bank of the burden to reconstitute them itself.  When the governor of the Central Bank applauded the refunding of the debt it is because this refunding will allow him to reduce its purchases of securities in the open market.


12.  Many people sought to appreciate the management of the Minister of Finance Martin by means of two ratios created by the experts behind of the Maastricht treaty, February 1992, instituting the European Union, namely:  - the ratio Debt / GDP = or smaller than 60 %; - the

ratio Deficit / GDP = or smaller than 3 %. M. Martin  would have beat these records, by reducing the debt to 50 % of the GDP while eliminating purely and simply the deficit to replace

it by surpluses.


However, these two ratios are of a total irrationality, without any financial value.  They constitute whimsical inventions and without the least utility, of the so-called experts of Maastricht.


13.  The ratio Debt / Income is a ratio which does not exist in the financial literature.  It is an invention of the experts of Maastricht.  What one finds in the financial literature, it is the

ratio Debt / Assets which indicates the share of the funds borrowed in the formation of the assets.  When one is in the presence of a debt, the significant thing  to know, is not if the debt accounts for 60 % or 600% of the income, because that is of no utility to know that, but if the income can ensure the debt servicing i.e. the payment of the interests and the refunding of the borrowed capital.  Financial Sciences attach for this reason a great importance to the ratio

Debt servicing / Income. The banks for example when they lend to households or companies ensure that the ratio Debt servicing / Income does not exceed 35 % of the gross income of the borrower.


14.  The ratios Debt / GDP and Deficit / GDP connect the governmental debt and the governmental deficit with the National Income and not with the governmental income.  However the National income, it is a thing and the governmental income, another thing.  To say that the governmental deficit should not exceed 3 % of the GDP, it is as to say that the deficit of Microsoft should not exceed the income of General Motors. It is difficult to swallow that.


15.  The second ratio of Maastricht, namely that the deficit of the government should not exceed 3 % of the GDP, is even more irrational, from the financial point of view, than the first ratio.


a)  To say that the deficit of the State should not exceed 3 % of the GDP  signify, that the deficit should not exceed a fixed amount equal to 3 % of the GDP.


b)  If, in the mind of the experts of Maastricht, the State must be managed like a private enterprise, which qualifies any head of company for the post of Minister for Finance, i.e., to have receipts which exceed the expenditure, to fix, at precise amount, the losses, is against the essence of the enterprise which should make only profits, in the absence of what, its very existence is threatened


c) If, in the mind of the experts of Maastricht, the State must be managed like a unique and original institution, which has the immense power to define the currency, to give it legal tender and to emit it, as well as the immense power to give to the money a value by taxing, and which consequently does not need to borrow to spend, in this case, the budget deficit plays an important  role in the saving of the public.  In this case, the experts of Maastricht badly understood the following equation:  Annual saving = Investment + Deficit + Foreign trade surplus and did not understand that the deficit of the government does not have to be, at the maximum, equal to 3 % of the GDP but can and must be such as it provides to the public the currency (non productive of interest) and the bonds (productive of interest) which it needs and desire.


16.  If it is not forbidden to invent whimsical ratios, like the experts of Maastricht do it, it is not prohibited to suspect either.  The suspicion is  the starting point of scientific research and the

starting point of the criminal police investigation.  We suspect the experts of Maastricht of having wanted, by their ratios, apparently financial, to limit the size of the State, in the hope to see it, transferring to profiteers, qualified wrongfully private sector, assets, generally for a bread mouthful.  A minister like Paul Martin and a government, who would respect and which by zeal would exceed the Maastricht ratios, would give pledges of goodwill to the business community

that they intend to enrich this community  by selling to it, generally at cheap price, the assets the State holds, not in proper, but on behalf of the citizens.  The size of the State, which can be measured by the value of its assets, would not be any more a rational question, but an ideological question. The State should hold only the assets which the businesses community does not wish to hold. That too, is difficult to swallow.


In the private sector, at the level of the enterprise, the surplus of the receipts on the expenditure is called " profit ".


In the public sector at the level of the government the same surplus of the receipts on the expenditure is called " surplus ".


Whereas in the enterprise the profit is a peremptory necessity, its absence putting in danger the very existence of the company, the surplus, at the level of the budget of the State, is an aberration and has a harmful effect because of the equation:  Saving  = Investment + Budget deficit + Foreign trade surplus.


If  M. Paul Martin had carried out his surpluses at the head of a company one could have qualified him a genius of finance because it is very difficult to carry out profits.  It is so difficult

that certain businessmen have recourse to the cheating and the traffic of the financial statements to carry out, on paper, the profits difficult to realize on the ground.


At the head of the ministry of finance Mr. Paul Martin did not understand that the public finances must be managed not by a business man and with the principles specific to the private enterprise, but by a statesman and according the principles and knowledge specific to the field of the State.


The statesman, in a modern State, is the man that knows and which never forgets that the State has a big and unique capacity, that to define the money, to give it legal tender and to create it.


The statesman, in a modern State, is who which knows and never forgets:


- that the State needs neither the taxes nor the loans to spend, but which knows that it is the spending of the government which will provide to the public the means of paying the taxes and to save in the form of currency and bonds


- that the State = Treasury + Central Bank and that when the Central Bank buys securities in the open market it is an expenditure which must be deduced from the surpluses;


- that when the Central Bank modifies the discount rate it is by no means necessary to send to the governor great blows of hat of approval and to speak in praise of its independence;


- that the Central Bank has only one power, to fix the interest rate in the overnight money market ;


- that the rate of interest in the overnight money market must be such that the prime rate of the banks is lower by at least 3 % than that of the growth rate of Gross domestic product, GDP, expressed in currents $, and that the Central Bank must ensure the following structure:  Growth rate of the GDP in currents $ - 3 %  =  Rate of the prime rate - 3 % = Interest rate of the overnight funds.


- that banks and the money lenders must have a comfortable profit margin, that is to say a difference in at least 3 % between the rate of the overnight funds and the prime rate, not only for the comfort of the banks, but so that they can, in their turn, provide to the public (households, companies, local communities) the services which the Canadian banks are not able to currently provide, like, for example, a 30 years mortgage loans and at a fixed rate;


- that the interests, all the interests of all the loans without exception, must be deductible from the taxable income for all the taxpayers and this in the interest of the economic activity;


- that the taxes must normally be lower than the expenditure of the government because of the desire of the public and the banks to hold reserves in legal money;


- that households and the banks hold government bonds;  that these bonds issued by the government are part of the monetary policy of fixing of the interest rates in the overnight money market;  that they make it possible to sponge the excessive reserves of the public;  that they

allow the Central Bank, by buying and  selling them, to fix the interest rate in the overnight money market at the most suitable level for the economic activity;


- that the government can and must generate deficits, until the moment when it provided to the public, the currency (non productive of interest) and the bonds (productive of interest) which it wishes to hold for its safety;  that the Bush Administration, with a deficit envisaged of 157 billion $ for year 2002, shows a better comprehension of the monetary mechanisms than the Clinton Administration or than Paul Martin with their budget surpluses;  that John

Manley, a candidate for the succession of Jean Chrétien, who declares repeatedly that it will continue the policy of the budget surpluses of Paul Martin but, without Paul Martin, makes a

double fault, a policy one and a financial one. The political fault being to want to work like Paul Martin and in this case one does not need John Manley. The financial fault being to want to continue a policy of budget surpluses which is an error;


- that, when the experts of Maastricht invite a statesman to respect the following ratios:  Debt / GDP = or < that 60 % and Deficit / GDP = or < that 3 %, he send them to stroll, showing by that that he intends to give to the State the optimum size; that he does not intend to manage

the State for the only profit of the businessmen community but for the profit of the Nation i.e. of the businessmen community and other communities, especially after the recent financial scandals and the financial statements falsification by certain businessmen;


- that there are two categories of assets, the assets which one holds on a purely individual basis, private basis and the public assets that one holds by the channel of the State.  The importance

and the volume of these last assets must be such as they maximize the well being of the citizens and the communities forming the Nation and not depend on a ratio fixed in advance and theoretically.


- that the existence of an unemployment is a proof of the insufficiency of the budget deficits.


The statesman, in a modern state, it is that which knows and which never forgets the following equation:  Annual saving = Investment + Budget deficit + Foreign trade surpluses;


In the light of this last equation, one can say that the surpluses of the former Canadian Minister of Finance, Mr. Paul Martin, impoverished the Canadians and were very harmful to them and that they would have been more harmful, without the expenditures, which are the refunding of the debt and the purchases of securities by the Central Bank .


It is this equation, which the competitors of Mr. Paul Martin, at the high position of Prime Minister of Canada, that is:  John Manley, Allan Rock, Sheila Copps, Martin Cauchon, Brian Tobin, Frank McKenna, must initially understand themselves, then  explain to the business community, if they want to win against Paul Martin.





The destiny and the duty of a private enterprise are to make profits.  The destiny and the duty of the State are to make deficits.  The payment of the surpluses by the taxpayers, reduce the reserves of the banks. Their reconstitution involves a rise of the interest rate in the overnight money market which obliges the government and the Central Bank to inject liquidities in the form of refunding of the debt for the government or purchases of bonds for the Central Bank to prevent the rise of the interest rate.  The refunding of part of the debt and the purchase of bonds are expenditures which accompanies necessarily the budgetary surpluses making them without any utility.  To increase the contents of the right pocket by emptying that of the left pocket and

to declare that there is a benefit raise resort more to magic, the art to create illusions, than to  rational management of the public finance.  The budgetary surpluses of Paul Martin, if they are the proof of something, make especially the proof that Paul Martin is probably a good businessman but certainly not a statesman, which really understand the very nature of  a modern State.