Opinion: Ottawa must act quickly to avoid another economic catastrophe

Peter Misek is managing partner of Framework Venture Partners

Low inflation and liquidity problems, followed by war in Eastern Europe, rising inflation and rising interest rates. Sounds familiar?

The current circumstances are eerily reminiscent of the early 1990s, which caused a financial settlement in Canada. If conditions and Canadian government decision-making continue on their current track, a new generation-defining fiscal crisis is imminent.

Let’s go back to the past. In 1993, Chrétien’s new government was ripe with ideas for pumping stimulus into the country. The problems were well known: healing and education were crying out for investment, and every government department had needs.

Less than a year into the government’s mandate, a usually quiet moment became a turning point for Canada. With hours to go for a regular bond auction, there were no bids at any price, confirmed Mr. Chrétien 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 welfare checks would receive their money.

The auction got offers at the last minute, but the damage was done. In a rare moment of clarity, sanity and heroism, Mr. Chrétien called emergency cabinet meetings and charted the painful but necessary course for renewed prosperity in Canada.

The prime minister made a very unpopular move, announcing an immediate spending freeze. By cutting deep, Chrétien’s government has prevented much worse: an IMF-style bailout akin to Greece’s bailout in the 2000s.

Chrétien’s problem was a decade in the making when the federal debt-to-GDP ratio rose to 67 percent in 1994, from 29 percent in 1980. A Wall Street Journal editorial infamously claimed that “bankrupt Canada” had reached a “debt wall.” To be correct, of course, Canada’s prime rate rose from 5.5 percent that year from 5.5 percent to 7.5 percent, on its way to 9 percent. A deep recession followed: the economy was in disarray, poverty skyrocketed, home ownership collapsed and hopes waned. Canada was an economic disaster.

Now compare that with present-day Canada. Federal debt-to-GDP has risen to about 50 percent in 2021 from 31 percent in 2019, while deficit spending has remained at about 5 percent — assuming interest rates remain at 2021 levels.

But the Bank of Canada is on a serious rate hike, with 125 basis points of rate hikes so far in 2022, and more to come. (A basis point is one-hundredth of a percentage point.) With this new tariff system, real debt-to-GDP is likely to rise to 65 percent within three years, based on current trends in government spending and a doubling of interest costs, which could appear to be a conservative estimate.

Given these dynamics, we may see the BoC raise interest rates as much as 6 percent before inflation slows significantly. This means that the government may have to spend money triple what it had budgeted to pay off the debt over a period of three to five years.

But aren’t all countries facing similar challenges due to the pandemic? No. Canadians have become poorer on average than the Organization for Economic Co-operation and Development or the OECD average.

According to OECD research, Canadian households have debt-to-disposable income ratios more than 65 percent higher than Americans and nearly 20 percent higher than Britain’s. Meanwhile, our home prices have risen more than almost any country in the OECD — 15 percent higher on average than U.S. homes and about 25 percent higher than the OECD average. This means that Canadian households are more likely to live paycheck to paycheck and to be “home poor” than those in nearly every OECD country. Inflation and rate hikes will hurt Canadians more.

It will take leadership and one more act of heroism for Canadian politicians to be honest with citizens about the facts. Governments cannot continue to fight pandemic-induced battles of the past while ignoring the economic future. Taxing the rich, as the Trudeau administration has promised to do, is a Faustian bargain, as Canada’s top rate of 53 percent is already uncompetitive and could face capital and talent flight.

The best chance of avoiding an economic catastrophe requires acting quickly in three ways.

First, immediately cut government spending by 5 to 10 percent to ease fiscal pressure on monetary policy.

Second, appoint a Minister of Digital Transformation to evaluate and assess all government services and implement their digital transition. We believe 35 to 65 percent of all government services can be delivered digitally with a significantly improved experience for Canadians while reducing costs. As in the private sector, digitization can cut 10 to 20 percent of spending, deliver much-needed productivity gains, boost capital investment and free up funding for needs such as healthcare and education.

Finally, the government should publish a plan to repay the debt in absolute terms – not to “anchor” the debt to GDP. (Anchoring the debt would allow for deficit spending as long as the economy grew faster than the deficit.)

Jean Chrétien was concerned that he would be one-time 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 the national debt lasted for decades. Possessing that choice ultimately translated into his political gain. Now is the time again for such courageous leadership and innovation.

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