Thursday, October 22, 2009

$100 Billion: Not yet a tipping point

Ontario $25B
Canada $55
Quebec $10 (I’m not using their fudged numbers- I’m using the increase in debt)
BC $3
Alberta $7

Total $100 billion (Let’s count the big guys for simplicity).

I warned about a return to deficits almost 2 years ago, when everyone was talking surpluses.

$100 billion is a lot of money. This represents about 7% of GDP. Similar deficits in the 90s caused a lot of belt tightening that was well absorbed by the economy during the booming 1990s. In the 1990s, the population was much younger (baby boomers moving into their peak spending and earnings), the technology bubble was just starting and credit was flowing freely as consumers were just getting started on the shop ‘till you drop mentality. In addition, there was a wave of deregulation hitting the Canadian economy. Remember Wal-mart only came to Canada in 1994, and you had no choice but Bell Canada for your wireline phone.

Now, we are an older population with a looming health care crisis. Health care spending is now almost 50% of most provincial government spending. Education is about a quarter. Consumers need to deleverage and start saving (unlike 1994), and housing is overvalued (unlike 1994).

TD Bank assumes that about $30 billion of this is one-time stimulus. However, to remove this, GDP would drop by 2%. To grow 3% next year as the BoC is expecting, the Canadian economy will need to grow 5% organically. Good luck with that! Therefore, expect the one-time stimulus to mostly remain for 2010 and maybe onward.

If one is optimistic and assumes that this is not a L shaped recovery, then some of this deficit will disappear as the economy grows and new spending is restrained.

However, just remember that during the recovery (again, assuming that there a recovery right now and indeed the recession is over), government revenues have to organically increase by $100 billion more than expenses over the next decade to arrive at a balanced budget. It is possible, as we did it in the 1990s (from about 10% of GDP) but as I mentioned, things were different then. Also, interest rates are historically low right now. Any increase in interest rates (something that should happen if the economy recovers) is going to make that task harder. In the 1990s, interest rates fell despite the boom. Those interest savings were passed on to taxpayers via tax cuts, as well as used to balance the budget and increase spending. Don’t expect that to happen this time!

If I am right and this recession is longer and more severe than most expect, we are going to go beyond $100 billion ($150, $200?) and we are going to reach a point of no return, where we can’t simply pretend that everything will go back to the way things were (I think we are still doing that,
case in point the housing market).

There will then need to be draconian spending cuts, where the medicare system as we know it will no longer exist, tuition increases, large cuts to the payments to the poor & elderly and to the bureaucracy. In addition, tax increases and higher user fees will probably be attempted. If lenders do not wish to pay for our spending habits, long term rates could increase despite being in a deflationary world.

I believe we are heading a 21st century New Deal, where due to the current crisis, government will be forced to step away from the nanny state and focus on a few key services. The rest will be left to the private sector and regulated or managed by the government. It will not be ideology driven. It will be driven by realism. Ultimately, this will lead to a better Canada, but the next decade will be unpleasant.

All this with
the shortest recession….

1 comment:

Screwee said...

Yes, we are screwed and you weren't the only one predicting this. An aquaintance who used to lable me a "doom and gloomer" just got forclosed after loosing his job. Sometimes it sucks to be right.

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