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UBC Theses and Dissertations

The Canadian conversion loan of 1958 : a study in debt management Christofides, Loizos Nicolaou

Abstract

World War II was partially financed through the issue of Victory Bonds. By 1958, Victory Bonds amounting to roughly 50% of the public debt were still outstanding, maturing at discrete intervals over the following seven years. In September, 1958, the Canadian Government launched the Conversion Loan — a successful attempt to refund the Victory Bonds. This enormous debt management operation raised the average term to maturity of the public debt from 8 to 14.75 years. Debt management operations, and the Conversion Loan in particular, have received little attention in the Canadian context. The scant existing literature has not rigorously examined the effects of the Loan on the level and term structure of interest rates, nor has it investigated its impact on the real sector of the economy. In this thesis regression analysis and simulation -- using the Bank of Canada RDX2 model -- were used to investigate these problems. The following conclusions were reached. There is convincing evidence that the Loan increased long rates and some less convincing evidence that it decreased short rates. In contrast to the U.S. there is no doubt that, in Canada, debt management operations significantly affect the term structure of interest rates. Other determinants of the term structure are expectations, monetary policy, transactions requirements, private sector wealth and the U.S. term structure of interest rates. The Loan was contractionary. Its effect during 1958 is estimated at 1% of GNE, increasing to 5% between 1959 and 1961, and decreasing thereafter. The overall cumulative effect is likely to have exceeded $1 billion. Contrary to conventional wisdom, it was the interest sensitivity of investment rather than the reduction in Canada's competitive position in world markets -- the Loan raised interest rates, attracted "hot capital" and led to an exchange rate appreciation --that engendered the depression.

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