Oh Canada: An Economic Experiment

It seems like the only time Canada makes the news is when America elects some right wing President the Hollywood elite don’t like, and they all threaten to move to Canada. We are usually too polite to say something, as it is often clear the Americans are in the midst of quite the family squabble, but what makes these Hollywood shmoes think we want them? Leah Dunham? Alec Baldwin? Whoopi Goldberg? It’s not like we have an open door policy for Hollywood complainers. But while we are on the subject, we would like Seth Rogen back (tell him our pot laws are about to loosen up, that should get him), and my daughters have asked to put in word for the two Canadian Ryan’s to return home (Gosling and Reynolds). America, you can keep Justin Bieber, Howie Mandel and William Shatner.

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But that’s often the most news coverage that Canada receives. And in terms of economic news, Canada has trouble making the B segment on even the most boring day of financial network TV. That’s a real shame because there are some interesting economic experiments happening in Canada.

There are two major differences occurring with Canadian economic policy, and many experts are watching with great interest how they play out. The first is on the fiscal side. Canada was at the forefront of electing a leader who promised more infrastructure spending. Before Justin Trudeau, most politicians were running on platforms of promising to balance the budget and cut spending. But Trudeau’s win ushered in a new worldwide wave of politicians advocating the opposite. The second interesting development is Canada’s monetary policy. Bank of Canada Governor Poloz has taken a much different approach than most Central Bankers. Whereas it has been typical for Central Bankers to guide markets and remove short term policy uncertainty, Poloz believes this unproductive, and has instead recently surprised the market with a rate hike that was not telegraphed in advance.

Are Canadian politicians and Central Bankers on the cusp of new trends that will sweep financial markets? Or will this be like maple syrup on bacon - purely a Canadian thing? Easier fiscal policy with less reliance on monetary stimulus is the opposite of policy trends of the past decade. Canada’s success or failure might set the tone for the rest of the developed world for years to come.

Recapping Canada’s recent economic past

Much to the surprise of the legions of Canada bears (yes, hedgies, I am talking about you), the Great White North has been the best performing G7 economy over the past year.

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This growth occurred despite warnings about the unsustainability of the Canadian housing bubble and the prediction of doom from the energy market’s collapse. By most measures, Canada should have been nowhere near the top of the G7 growth list. Usually, Canada’s performance follows its main trading partner, the United States, with a little bit of a commodity kicker/drag. But US GDP is not as robust, with GDP growth declining, and is now, in fact, sitting below Canada’s.

So what’s going on in the land of frozen ponds and hockey sticks?

For the next part, I am going to rely on the terrific work of Bloomberg reporter Luke Kawa for a bunch of charts, starting with this one. Justin Trudeau was elected on a platform of increasing infrastructure spending. It took a little time for Trudeau to get the fiscal stimulus flowing, but since mid-2016, infrastructure spending has spiked higher.

(Click on image to enlarge)

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Many of my free-market / libertarian readers will view this sort of government spending as wasteful, inefficient and ultimately counter productive for the economy. To which I reply, that is your prerogative and you should pull out a stack of pink tickets because there is even more infrastructure spending scheduled. This infrastructure spending pulse is not about to roll over, but instead, accelerate from here.

I am a huge fan of Richard Koo’s work. Koo coined the term “Balance Sheet Recession” and believes monetary policy is ineffective after the bursting of a credit bubble. Here is his explanation from a 2015 Maclean’s article:

A balance sheet recession typically happens after the bursting of a debt-financed bubble. In the bubble days, people leverage themselves up, and once the bubble bursts, liabilities remain, asset prices collapse and people realize their balance sheets are underwater. When that happens, people start repairing balance sheets by paying down debt or increasing savings, which is basically the same thing. That’s the right thing to do at the micro level: everyone in that situation has to get their financial house in order. But when everybody does it all at the same time, then we enter a massive fallacy of composition problem [in other words, while individuals are correct to save and pay down debt, if everyone does this at the same time it hurts the economy by lowering consumption]. If someone is saving or paying down debt, you’ve got to have someone on the other side borrowing and spending money. But when a debt-financed asset bubble collapses, everybody could be paying down debt and no one is borrowing money, even at zero per cent interest rates. In that case, all the savings that are generated and all the debt that’s repaid comes into the financial sector but won’t be able to leave the financial sector. That becomes the leakage to the income stream. And this can happen even with zero interest rates.

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