Spending must be cut while we still can

NationalPost.com – FPcomment – Spending must be cut while we still can: Given the challenge of paying for medicare for our aging population, our current deficit is reckless
Posted: September 22, 2009.   Mark Mullins and Rick Peterson

Here is some great news that might surprise you: It is once again safe to open up your monthly statement from your investment broker or portfolio manager.

Up until recently, most Canadians have not had the courage to see the effects that the market meltdown that started in full force this time last year has had on their investment portfolios. Today, however, is a different story. The Canadian equity markets are up 50% from March of this year alone. Last week saw more than $5-billion raised on the Toronto Stock Exchange — a record amount — and real estate is again on a roll in many urban Canadian markets.

What is the message in all this? It’s clear: The recession is over. Markets in stocks, corporate debt, credit default swaps and most commodities have been broadcasting this simple truth since March. And when markets turn in such a profound way, it can only mean that a multi-year economic expansion and a further bull market in these assets are ahead.

So, what is the response of government officials here in Canada and across the globe to this news? Contrary to such turning point developments, policy makers are talking down the recovery, continuing with efforts to intervene in the economy, and planning to take no steps whatsoever to bring unprecedented deficit spending into balance.

This ultra-conservative approach — sticking with last year’s status quo strategy — is at the same time a radical change from the moderate policy settings of the past several decades that brought us to our current level of prosperity. The ultimate net result is a dead weight on the expansion that will shave points off future economic growth. That is lost opportunity for us all — and an implicit policy of keeping unemployment artificially high and wealth creation below its potential.

We have a close-up example of this stimulate-for-all-seasons mentality here at home in Canada, along with a seeming inability to change policy thinking for the updated economic circumstances. As background, the political constellations aligned in such a way in December (remember the coalition?) that the federal government deliberately generated a record deficit of over $50-billion. Finance Minister Jim Flaherty provided the most recent update last week, which projects significant deficits until at least 2015 and a rise in indebtedness of over $160-billion.

This may be an underestimate of the fiscal risks. It’s therefore more critical than ever, we believe, to begin a program of fiscal retrenchment sooner than contemplated by most commentators.

For example, the government is forecasting high revenue growth of 7.5% over the next three years. That has not been experienced in the early stages of an economic expansion in 40 years, and even then it happened only in the inflationary 1970s. Pegging revenue growth at the rate of the economic expansion instead, takes the projected debt total past $200-billion.

Another serious risk is related to wishful thinking. In this case, the government expects to hold non-interest spending to less than 1% annually over the next three years. That has not happened in Canadian fiscal history, aside from the spending cuts that took place in the mid-1990s under the Chretien government. A more reasonable assumption of spending growth at even half the pace of the economy (which by itself will be difficult to achieve in a minority government) leads to a further $30-billion increase in debt.

Less than expected revenue and higher spending, along with the impact on debt servicing costs, lead to a profoundly depressing conclusion: $50-billion annual deficits as far as the eye can see. Given the coming challenge of paying for currently unfunded medicare costs in our aging population, this potential overspending can only be described as shortsighted and reckless.

Which brings us to political realities. The Conservative government is not alone in supporting deficits and other myriad economic interventions. All four federal parties are pro-stimulus, pro-deficit, and anti-market. None wish to take responsibility for spending reductions, which are the only way to balance the budget short of swinging tax increases that will slow the economy.

Perhaps the current relief that we are not holding an election this autumn should be given a second thought. The only way to get the fiscal situation under control may be to break the recent minority government trend and produce either a majority or a coalition that will take action. A political mandate for this approach can be earned on the campaign trail but it requires an honest discussion with Canadians about our fiscal realities.

Baring that outcome in the next year or two, we will likely see a return message from the government to markets akin to what we saw in the early 1990s: bigger deficits, higher credit risk, and a rise in interest rates. And if that happens, you definitely will not want to be opening your brokerage account statement.

A far better course would be to take action now and restore Canada’s hard earned reputation for fiscal discipline. The electorate deserves better than the current all-party consensus in Ottawa.

Mark Mullins is CEO of Veras Inc and Rick Peterson is President of Peterson Capital.

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