Peter Misek is managing partner of Framework Venture Partners
Low inflation and liquidity concerns, followed by war in Eastern Europe, soaring inflation and rising interest rates. Sound familiar?
Today’s circumstances are eerily reminiscent of the early 1990s, which precipitated a financial reckoning in Canada. If circumstances and Canadian government decision-making continue on the present track, a repeat generation-defining fiscal crisis is imminent.
Let’s revisit the past. In 1993, the new Chrétien government was ripe with ideas for pumping stimulus into the country. Its problems were familiar: health and education were clamouring for investment and every government department had needs.
Less than a year into the government’s mandate, a usually uneventful moment became a watershed lesson for Canada. With hours to go before a regular bond auction, there were no bids at any price, Mr. Chrétien confirmed in a 2011 Reuters interview.
Without the auction, the Canadian government would not be able to meet its financial obligations that month. Neither government employees nor recipients of assistance cheques would receive their money.
At the last minute, the auction received bids, but the damage was done. In a rare moment of clarity, common sense and heroism, Mr. Chrétien called emergency cabinet meetings and set the painful but needed course toward renewed prosperity in Canada.
The prime minister made a highly unpopular move and announced an immediate spending freeze. By cutting deeply, the Chrétien government averted much worse: an IMF-style bailout not unlike the bailout of Greece in the 2000s.
Mr. Chrétien’s problem was a decade in the making as the federal debt-to-GDP rose to 67 per cent in 1994 from 29 per cent in 1980. A Wall Street Journal editorial infamously claimed “bankrupt Canada” had reached a “debt wall.” To course correct, Canada’s prime rate jumped to 7.5 per cent from 5.5 per cent that year, on its way to 9 per cent. A deep recession ensued: the economy was in disarray, poverty soared homeownership crashed and hope waned. Canada was an economic disaster.
Now, compare that with Canada today. Federal debt-to-GDP has jumped to about 50 per cent in 2021 from 31 per cent in 2019, while deficit spending has remained at approximately 5 per cent - assuming interest rates stay at 2021 levels.
But the Bank of Canada is on a serious rate-hiking trajectory, with 125 basis points of hikes so far in 2022, and more ahead. (A basis point is one 100th of a percentage point.) With this new rate regime, actual debt-to-GDP is likely to rise to 65 per cent within three years, assuming current government spending trends and a doubling in interest costs, which may prove to be a conservative estimate.
Given these dynamics, it is possible we will see the BoC raise rates to as high as 6 per cent before inflation materially slows. This implies the government may have to spend triple what it budgeted to service the debt over a three- to five-year period.
But aren’t all countries facing similar challenges due to the pandemic? No. Canadians on average have become poorer than the Organisation for Economic Co-Operation and Development, or OECD, average.
Canadian households have a debt-to-disposable-income ratio that is more than 65 per cent higher than Americans’ and almost 20 per cent more than in Britain, according to OECD research. Meanwhile, our home prices have increased more than in almost any country in the OECD – 15 per cent higher than American homes, on average, and approximately 25 per cent higher than the OECD average. This means Canadian households are more prone to live paycheque-to-paycheque and to be “house poor” than those in almost any OECD country. Inflation and interest-rates hikes will hurt Canadians more.
It will take leadership and another act of heroism for Canada’s politicians to be honest with citizens about the facts. Governments cannot continue to fight past pandemic-induced battles while ignoring the economic future. Taxing the rich, as the Trudeau government has pledged to do, is a Faustian bargain because at a 53-per-cent top marginal rate, Canada is already uncompetitive and could face capital and talent flight.
The best chance for avoiding economic catastrophe requires swift action in three ways.
First, immediately cut government spending by 5 to 10 per cent to lower the fiscal drag on monetary policy.
Second, create a Minister of Digital Transformation to evaluate and review all government services and implement their digital transition. We believe 35 to 65 per cent of all government services can be delivered digitally with a significantly improved experience for Canadians, while lowering the cost. As it does in the private sector, digitization could slash 10 to 20 per cent from spending, initiate much-needed productivity gains, spur capital investment, and free up funding for needs like health care and education.
Lastly, the government must publish a plan to pay down debt in absolute terms – not to “anchor” debt to GDP. (Anchoring debt would allow deficit spending as long as the economy grew faster than the deficit.)
Jean Chrétien worried he would be a one-term prime minister during his economic crisis; instead, he saved the country from its worst financial crisis since the Great Depression and won two more mandates. The economic prosperity he created by lowering government debt lasted for decades. Owning that choice ultimately translated into his political gain. Now is again the time for such brave leadership and innovation.
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