Not surprisingly, as the 1930s progressed with little sign that the Depression was ending, pressure began to mount on the government to do something. In addition to concerns about the adequacy of the Finance Act, there was also widespread public distrust of the banking system, largely because of the high cost and low availability of credit. Farmers, especially those in western Canada, who were suffering from a sharp fall in both crop yields and prices, were particularly critical of banks and consequently very supportive of the formation of a central bank. They hoped that a central bank would be a source of steady and cheap credit. With effective nominal interest rates on farm loans in excess of 7 per cent, real interest rates were very high—about 17 per cent in 1931 and 1932, owing to sharply declining consumer prices. But interest rates were high for everyone because of the high Advance Rate. The traditional rate for a prime commercial loan was 6 per cent, while the standard deposit rate was 3 per cent, until the latter was reduced to 2.5 per cent in 1933 with the approval of the federal government.
In July 1933, the government set up a commission with a mandate to study the functioning of the Finance Act and to make "a careful consideration of the advisability of establishing in Canada a Central Banking Institution . . . .” (Macmillan Report 1933, 5). Lord Macmillan, a famous British jurist and known supporter of a central bank, was chosen by Prime Minister Bennett to chair the commission. The other members were Sir Charles Addis, a for mer director of the Bank of England; Sir William T. White, the former wartime Canadian Finance Minister and banker; John Brownlee, Premier of Alberta; and Beaudry Leman, a Montreal banker.
Public hearings began on 8 August 1933, and the final report was presented to the government less than seven weeks later on 28 September. While the commission voted only narrowly in favour of the establishment of a central bank, its conclusion was never really in doubt. The two British members of the committee, joined by Brownlee, voted in favour of a central bank, a position supported by both the Conservative government and the Liberal opposition.
The Canadian bankers on the committee opposed. White dissented from the majority on the grounds that it was unwise to establish a central bank in the prevailing uncertain economic environment. In his view, a newly established and untried central bank might hinder the government. Favouring a return to the gold standard,
White contended that Canada’s main problem was excessive debt (Macmillan Report 1933, 89). Leman shared this view and also believed that the establishment of a central bank raised constitutional issues that needed exploring (Macmillan Report 1933, 95).
In general, Canadian banks opposed the formation of a central bank. Reasons cited included concerns about the availability of central banking expertise in Canada, the absence of a Canadian money market, the ineffectiveness of the Federal Reserve in countering the Depression in the United States, and the long-time stability of the Canadian banking system. Banks were also unanimously concerned about a reduction in their profits associated with the loss of their note-issuing
(Macmillan Report, cover, 1933
The Macmillan Report is a seminal document in the history of the Bank of Canada. It records the recommendations of the Royal Commission, chaired by Lord Macmillan, that considered the feasibility of establishing a central bank in Canada.)
The Bank of Canada Act received royal assent on 3 July 1934, and the central bank officially started operations on 11 March 1935. Graham Towers, who had been assistant general manager of the Royal Bank, became the central bank’s first Governor. To provide some practical central banking experience, J. A. C. Osborne, former secretary of the Bank of England, was made deputy governor.
(Bank of Canada, share certificate, 1935
The Bank of Canada was established as a widely held, privately owned institution, and shares with a par value of $50 were sold to the general public on 17 September 1934; $12.50 payable on application, with the balance due on 2 January 1935. Following a change of government, the Bank was fully nationalized by 1938.)
The Dominion Notes Act and the Finance Act were also repealed on 11 March. Dominion notes were quickly replaced by new Bank of Canada notes. A revised Bank Act governing the operations of the chartered banks also took effect in 1934. Revisions to this act initiated a gradual phaseout of private bank notes in favour of Bank of Canada notes.
(Bank of Canada, $5, 1935 series
These notes were part of the first series issued by the new central bank. It was the only series to feature separate English and French notes. A portrait of Edward, Prince of Wales, appears on the left and the official seal of the Bank of Canada is on the right.)
With the conduct of monetary policy now in the hands of the Bank of Canada, a dedicated monetary institution, there were greater prospects for a more activist monetary policy. However, the Bank maintained the Bank Rate (which was equivalent to the Advance Rate under the Finance Act) at the same 2.50 per cent rate that it had inherited. It was not until February 1943, in the midst of the war, that the Bank Rate was cut.
(Bank of Canada balance sheet
The Bank of Canada’s first balance sheet, 31 December 1935)
Another important piece of legislation was the Exchange Fund Act, which received royal assent on 5 July 1935. The primary purpose of the act was to provide a fund that could be used to "aid in the control and protection of the external value of the Canadian monetary unit” (Statutes of Canada 1935). The resources of the Exchange Fund came from the profits associated with the revaluation of the Bank of Canada’s gold holdings from the old statutory price of Can$20.67 per ounce to the prevailing world market price of US$35 per ounce.69 Although the Exchange Fund Act was passed in 1935, the section of the act dealing with the use of the fund to protect the value of the Canadian dollar was not put into effect until 15 September 1939, following Canada’s entry into World War II.
In any event, an Exchange Fund Account was not required to stabilize the Canadian dollar during the mid-1930s. With the currency trading in a relatively narrow range around parity with its U.S. counterpart, little intervention by the Bank of Canada was required.
By late 1938, as the international political climate deteriorated, the Canadian dollar began to slip, falling to a small discount of roughly 1 per cent against the U.S. dollar. The decline was modest, however, compared with that of the pound sterling, which fell by roughly 6 per cent in the second half of 1938, reflecting a considerable shift of funds out of the United Kingdom (Bank of Canada Annual Report 1939).
After several months of relative stability, the Canadian dollar came under renewed, and this time significant, pressure in the last days of August 1939, as world tensions increased and funds moved to the safety of the United States. The Canadian dollar fell roughly 6 per cent vis-à-vis the U.S. dollar in the two weeks prior to Canada’s declaration of war with Germany on 10 September 1939, and by another 3 per cent by the time the government imposed foreign exchang e c o n t r o l s i n
mid-September (Bank of Canada Annual Report 1940). The pound sterling fell even more sharply, declining from US$4.86 to US$4.06, a depreciation of roughly 14 per cent, before the imposition of exchange controls in the United Kingdom in early September.
(Laying the cornerstone for the Bank of Canada, 10 August 1937
Prime Minister Mackenzie King (left) and the Bank's first Governor, Graham Towers (right) watch as the stone is lowered into place.)