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William Watson: The mystery of the great Toronto (literal) liquidity crisis

Strange patterns in Canadians’ use of cash last year have caused a stir among monetary analysts. Last October the value of banknotes in circulation fell $1.2 billion. Drops that big are rare. In fact, that’s the biggest October decline since data on notes in circulation began to be collected back in 1935, the year the Bank of Canada started operations.

Let’s see now, can we think of anything that happened in Canada last October that might explain why Canadians wouldn’t be needing quite so much cash? Wikipedia tells us that last October there was a Quebec provincial election, University of Waterloo’s Donna Strickland won the Nobel Prize in Physics, and Kelowna hosted the world mixed curling championships (we beat Spain in the final. Spain?) And, oh yes, though the memory of it is a bit hazy, on Oct. 17 this country legalized marijuana.

Was cannabis legalization the culprit?

None of those other events should have affected Canadians’ use of cash but one of the main purposes of marijuana legalization was precisely to bring the illegal underground trade above-ground, to de-stigmatize it and to tax it, which our various governments have been doing. If you stroll the streets of any major city and inhale (as you should do regularly when strolling!) you will conclude that marijuana de-stigmatization has worked.

When buying marijuana was illegal it wasn’t prudent, or even possible, to pay for it with a credit or debit card. But now that the stigma is gone, cash payment is no longer mandatory. If legalization for the final 14 days of last October did give rise to such a big drop in banknotes in circulation, maybe the new regime really will have the desired effect of blowing up a big part of Canada’s underground economy. True, the $1.2 billion decline in notes in circulation only represented 1.4 per cent of the $85 billion’s worth that are out there in the economy. But $500+ million a week is hardly small change.

As august a monetary commentator as Charles Goodhart of the London School of Economics suggested this January that, to quote his paper’s title in full: “Canadian legislation of cannabis reduces both cash usage and the ‘black’ economy.” Though noting it was early days yet, he and his co-author, Jonathan Ashworth, concluded that “The movements in cash in circulation around the time of cannabis legalization would seem to provide early evidence to suggest that Canadian Prime Minister Trudeau’s policy has already been successful in crimping the black economy.” Doubtless such kudos would have been — maybe still will be — quoted in the main political event for October 2019, namely, the federal election scheduled for the 21st of that month.

Well, hold the kudos. Last month four Bank of Canada staffers published a “staff analytical note” de-bunking this up-from-underground story. If pot legalization were responsible for the dip in currency demand, they argue, it would have been observed all across the country. In fact, it was almost entirely concentrated in Ontario, which Statcan says is responsible for only about a fifth of the country’s cannabis trade.

The Bank of Canada distributes its banknotes via 10 “regional distribution points” across the country. At these regional distribution points financial institutions regularly deposit their surplus banknotes and withdraw new notes when they need them. Unfortunately for the cannabis story, all the cash action last October was in the Toronto distribution centre — which is not what you’d expect from nationwide marijuana legalization.

Moreover, the big drop in cash demand in Toronto in October mirrored a big spike in demand in August 2018. What event in Toronto in August 2018 might have affected the demand for cash? Not any change in federal laws but flash flooding Aug. 7 after a sudden heavy rainfall.

The most dramatic story coming out of that flood was of two men trapped in an elevator who were rescued by police who swam into their building’s basement and reached them just before the elevator cabin filled completely. But it turns out there was equivalent though unreported drama in the banking sector. Two presumably big banks lost access to their cash because of the flooding. Their cash may or may not have been underground but it was evidently underwater.

As a result of this (sorry, can’t help it!) liquidity crisis, the two banks had to make special withdrawals from the Bank of Canada’s Toronto cash distribution centre. And that temporarily boosted the overall amount of cash in circulation — even if the cash the two banks couldn’t access wasn’t really “in circulation.” Because of being underwater.

I’d love to tell you which two banks we’re talking about — and I did ask — but because of confidentiality agreements the Bank of Canada won’t name them. In any case, in early October last year, fully eight weeks later, the two banks regained access to their own cash and signed back the extra notes they’d secured from the Toronto regional distribution centre.

 

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