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APPENDIX C

The Business Cycle

 

This Appendix probes key aspects of the implicate order1 of the business cycle (the implicate order is discussed in more detail in Book III). The important structural issues include:

  1. The distribution pattern of bank-money (specifically, the pattern of overinvestments in commercial real estate). The pattern at the largest bank is used to order and calibrate the events we seek to investigate.
  2. The propagation of the pattern through the economy. The unfoldment of the business cycle.
  3. The links and connections (if any) between overinvestments in commercial real estate and:
  1. non-accrual business loans,
  2. non-accrual residential mortgages,
  3. the number of business bankruptcies,
  4. the unemployment rate,
  5. government net lending,
  6. the criminal code rate, and
  7. net income and dividends at the largest bank.

The Charts demonstrate that changes in the distribution of bank-money were not uncorrelated with changes in the national economy. One troublesome finding must be pointed out: the changes in the structure and distribution of bank-money appear to have had a major negative impact on the economy.

 


1 For the concepts of implicate order, see David Bohm, Wholeness and the Implicate Order, 1980.   

 

CAUSALITY AND RESPONSIBILITY

If it can be demonstrated that speculative overinvestments (if any) had "strongly injurious" (Schumpeter's expression) effects on the National economy, then:

  1. How should the responsibility for these effects be partitioned and distributed?
  2. How should people and businesses be compensated for any losses or damages they may have suffered as a result (direct, indirect, collateral, etc.) of speculative overinvestments by others?
  3. What must individuals, businesses, banks, and governments do to protect the Nation from the potential devastations of the next business cycle -- especially if these can trigger or cause catastrophic local or global consequences (e.g., in the case of Canada, the breakup of the country)?

 

THE BUSINESS CYCLE
COMMERCIAL REAL ESTATE LOANS

 

Plate C-1
CYCLE COMMERCIAL REAL ESTATE LOANS
  P
T
PEAK
TROUGH
$ MIL. %
a P
P
T
1981
1982
1985

--
3,714
1,781

8.89
--
3.95

b P
T
T?
1991
1995
1996

7,098
4,334
--

9.04
--
4.20

c P?
T?
2002/3
2006/7

?

?

  

   
Plate C-1   The Business Cycle: Commercial Real Estate Loans, as Percent of Total Domestic Loans -- The Royal Bank of Canada, 1980-1996.

What was the impact of overinvestments in commercial real estate (if any) on Canadians? What caused the overinvestments (monetary policy, credit creation, manipulation of interest rates, etc., as alleged by some; or monopolistic practices1 and rapacious capitalism, as alleged by others)? Did economic and social dislocations or devastations follow overinvestments? To answer these questions, one must probe and investigate a variety of hypothesized or potential creative destruction2 effects -- recessions, increases in non-accrual loans, surges in business bankruptcies, increases in unemployment or underemployment, decreases in personal saving, increases in personal and unincorporated business debts, increases in governmental deficits, increases in the criminal code rate, increases in government deficits or debts, transfer payments to families, etc. The effects (if any) would have to be traced as if they were LINKS IN A CHAIN of economic and social events. The links in the chain would have to be followed -- one link at a time, until a complete picture of the hypothesized creative destruction process (if any) emerges. But where do we start? How do we instantiate, order, and calibrate the effects we seek to investigate? One possible solution is to start with the business cycle (if any) at Canada's largest banks. The phases of the last two business cycles at the Royal Bank (commercial real estate cycles a and b, for which data are available from bank annual reports3) can be used to order and calibrate some potential effects we seek to investigate. It must be pointed out that the Royal Bank of Canada (Canada's largest bank) was not the only player that was involved in overinvestments in real estate. The phases of the business cycle at Canada's top three banks are compared in Plate B-2. Note that cycle b had a duration of about 10 years and that it incorporated a much shorter cycle that peaked in 1987, the year the stock market crashed. If this cycle corresponds to Schumpeter's "short-run" cycle (lasting about 9.5 years),4 then we should expect, in Schumpeter's words, "strongly injurious" effects.

Note: underlying trend generated using smoothing (1x) and splining.

Sources:
1 On "monopolistic practices," see Joseph A. Schumpeter, Capitalism, Socialism and Democracy (1942), with an Introduction by Tom Bottomore, 3rd ed., 1942, 1947, 1950, and 1976, at 87-106 (Monopolistic Practices).
2 On "creative destruction," see Joseph A. Schumpeter; Ibid.
3 Royal Bank annual reports (domestic commercial real estate and total domestic loans, net of specific and general provisions, as at September 30).
4 Joseph A. Schumpeter, Capitalism, Socialism and Democracy (1942), at 94 (nature, structure, and duration of short-term cycles affecting recessions).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle1
The Link Between Overinvestments in Commercial Real Estate
and Business Non-Accrual Loans

 

Chart C-1

   
Chart C-1   The Business Cycle: The Link Between Overinvestments in Commercial Real Estate, Recessions, and Business Non-Accrual Loans -- Royal Bank of Canada

Royal Bank domestic commercial real estate loans swelled from $3,714 million in 1985 to $7,098 million in 1991. As a percentage of total domestic loans, they swelled from 3.95% in 1985 to 9.04% in 1991 (arrow a). Overinvestments led to a "credit crunch" at many banks, beginning around 1989 (arrow b). Simultaneous overinvestments at banks and trust companies were followed by a recession (arrow c) and by substantial increases in total net non-accrual business loans (arrow d). Royal Bank data are used to calibrate business cycle curves. Data in percent and in millions of dollars.

Source: Royal Bank annual reports (loans by industry, as at September 30; non-accrual loans, net of allowance for credit losses, as at October 31).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle2
The Link Between Overinvestments in Commercial Real Estate
and Non-Accrual Residential Mortgages

 

Chart C-2

   
Chart C-2   The Business Cycle: The Link Between Overinvestments in Commercial Real Estate and Non-Accrual Residential Mortgages -- Royal Bank of Canada

Royal Bank domestic commercial real estate loans swelled from $3,714 million in 1985 to $7,098 million in 1991 (arrow a). Overinvestments led to a "credit crunch" at many banks (arrow b). Simultaneous overinvestments at banks and trust companies were followed by a recession (arrow c) and by substantial increases in net non-accrual residential mortgages (arrow d). These were also followed by substantial increases in the number of foreclosures.

Source: Royal Bank annual reports (loans by industry, as at September 30; non-accrual loans, net of allowance for credit losses, as at October 31).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle3
The Link Between Overinvestments and Business Bankruptcies

 

Chart C-3

   
Chart C-3   The Business Cycle: The Link Between Overinvestments and Business Bankruptcies

Excessive channeling of loans into commercial real estate (arrow a) led to a "credit crunch" at many banks (arrow b), and was followed by a recession (arrow c). Overinvestments were also followed by substantial increases in non-accrual loans, and in the number of bankruptcies (arrow d).

Sources: Royal Bank annual reports (loans by industry, as at September 30); and Consumer and Corporate Affairs Canada, Bankruptcy Branch (number of business bankruptcies in Canada).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle4
The Link Between Overinvestments and Unemployment

 

Chart C-4

   
Chart C-4   The Business Cycle: The Link Between Overinvestments and Unemployment

Overinvestments in commercial real estate (arrow a) led to a "credit crunch" at many banks (arrow b). Overinvestments were followed by a recession (arrow c), by increases in non-accrual loans, and by substantial increases in the number of bankruptcies. Jobs were lost. Unemployment swelled (arrow d). Business and consumer failures, corporate downsizing, etc., had devastating social effects.

Sources: Royal Bank annual reports (loans by industry, as at September 30); and Economic Report of the President, February 1995 (Department of Labor, Bureau of Labor Statistics: U.S. and Canadian civilian unemployment rates).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle5
The Link Between Overinvestments and Government Net Lending

 

Chart C-5

   
Chart C-5   The Business Cycle: The Link Between Overinvestments and Government Net Lending

Overinvestments in commercial real estate (arrow a) culminated with a recession (arrow c). Substantial increases in non-accrual loans and bankruptcies followed. Jobs were lost. Unemployment swelled. As a percentage of total direct taxes, direct taxes from corporate and government business enterprises fell. To deal with the devastations of the recession, transfer payments to families were increased. Substantial increases in government net lending followed (arrow d). (Net lending = Saving + Capital consumption allowances - Investment in fixed capital and inventory.)

Sources: Royal Bank annual reports (loans by industry, as at September 30); Statistics Canada, Canadian Economic Observer, Historical Statistical Supplement 1994/95, Catalogue 11-210, July 1995 (net lending, all government levels).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle6
The Link Between Overinvestments and the Criminal Code Rate

 

Chart C-6

   
Chart C-6   The Business Cycle: The Link Between Overinvestments and the Criminal Code Rate

Overinvestments in commercial real estate (arrow a) led to a "credit crunch" (arrow b), and culminated with a recession (arrow c). Increases in commercial real estate loans were followed by increases in bankruptcies and by increases in federal statute incidents reported to police (arrow d). Property crime rate skyrocketed to over 1.7 million incidents in 1991! Crime rates in incidents per 100,000 population.

Sources: Royal Bank annual reports (loans by industry, as at September 30); D. Hendrick, Canadian Crime Statistics, 1994, Juristat, 15 (12), August 1995, Catalogue 85-002 (crime statistics) (cited source: Uniform Crime Reporting Survey, Canadian Centre for Justice Statistics); Crime Trends in Canada, 1962-1990, Juristat, 12 (7), March 1992, Catalogue 85-002; and R. Kong, private communication (crime statistics).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 

The Business Cycle7
The Link Between Overinvestments, Net Income, and Dividends

 

Chart C-7

   
Chart C-7   The Business Cycle: The Link Between Overinvestments in Commercial Real Estate, Net Income, and Dividends -- The Royal Bank of Canada

Overinvestments in commercial real estate (arrow a) led to a "credit crunch" (arrow b), and culminated with a recession (arrow c). While recessions, and the stock market crash of October 19, 1987 (arrow b' ), appear to have impacted the bank's net income, the graphs provide powerful evidence that neither the overinvestments nor the recessions impacted the bank's ability to declare gargantuan profits -- $1.169 billion in 1994, $1.262 billion in 1995, and $1.430 billion in 1996 --, or to declare increasingly higher total dividends (arrow d). Net income and dividends in millions of dollars.

Source: Royal Bank annual reports (loans by industry, as at September 30; net income and dividends).

[Copyright 1998 by MACROKNOW INC. All rights reserved.]

  

 


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