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Deficits, Debt and Climbing Back Out:
Lessons from Canada
Deficits, Debt and Climbing Back Out Deficits, Debt and Climbing Back Out
• Canada – back from the brink Canada – back from the brink
• The U.S: Will the Canadian solutions The U.S: Will the Canadian solutions work?work?
U.S. Deficits Have Been Deepening
-1600
-1400
-1200
-1000
-800
-600
-400
-200
0
200
400
1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 200120042007 2010
Budget Surplus/Deficit (Billions of $US)
Source:Congressional Budget Office
The Debt Figures are Staggering
0
20
40
60
80
100
120
1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Gross Debt Public Debt
U.S. Debt/GDP
Source: U.S. Budgets
But Money Keeps Flowing In..
0
500
1000
1500
2000
2500
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Foreign Assets in the U.S., Net Capital
Source: U.S. Treasury, St. Louis Federal Reserve (FRED)
And the U.S. Dollar Stayed High for a Long Time
10
100
1000
'95 '98 '01 '04 '07 '10
Source: St. Louis Fed (FRED)
U.S. Dollar against a basket of currencies
But things have But things have changed…changed…
Why Have Things Gone in Separate Directions??
0
50
100
150
200
250
300
350
400
450
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Canada U.S.
Source: Canadian Business Magazine
Public Debt Index, 1990 =100
Canada: Back from Canada: Back from the Brink the Brink
Canada Had Years of Reckless Spending
0
20000
40000
60000
80000
100000
120000
140000
1966/ 67 1970/ 71 1974/ 75 1978/ 79 1982/ 83 1986/ 87 1990/ 91 1994/ 95
Program expenses (Millions of $C)
Source: Canadian Department of Finance
Deficits Got Progressively Bigger
-40000
-35000
-30000
-25000
-20000
-15000
-10000
-5000
0
5000
1966/ 67 1970/ 71 1974/ 75 1978/ 79 1982/ 83 1986/ 87 1990/ 91 1994/ 95
Budget Surplus/Deficit (Millions of $C)
Source: Canadian Department of Finance
And So Did the Debt
0
100000
200000
300000
400000
500000
600000
1966/ 67 1970/ 71 1974/ 75 1978/ 79 1982/ 83 1986/ 87 1990/ 91 1994/ 95
Accumulated Deficits ($C)
Source: Canadian Department of Finance
Which Kept Claiming a Bigger Share of the Economy
0
10
20
30
40
50
60
70
80
1966/ 6
7
1968/ 6
9
1970/ 7
1
1972/ 7
3
1974/ 7
5
1976/ 7
7
1978/ 7
9
1980/ 8
1
1982/ 8
3
1984/ 8
5
1986/ 8
7
1988/ 8
9
1990/ 9
1
1992/ 9
3
1994/ 9
5
Accumulated Deficits/GDP
Source: Canadian Department of Finance
Meaning Debt Payments Claimed a Bigger Share of Expenditures
0
5
10
15
20
25
30
35
1966/ 6
7
1968/ 6
9
1970/ 7
1
1972/ 7
3
1974/ 7
5
1976/ 7
7
1978/ 7
9
1980/ 8
1
1982/ 8
3
1984/ 8
5
1986/ 8
7
1988/ 8
9
1990/ 9
1
1992/ 9
3
1994/ 9
5
Gross Public Debt Charges/Total Expenditures
Source: Canadian Department of Finance
The Canadian Dollar was Sinking
0.7
0.72
0.74
0.76
0.78
0.8
0.82
'93 '96
Source; St. Louis Federal Reserve/FRED
$Cdn/$U.S.
In 1995, the Wall Street Journal In 1995, the Wall Street Journal
referred to the Canadian Dollar as referred to the Canadian Dollar as the ‘Northern Peso’ the ‘Northern Peso’
And the Ratings Agencies Weren’t And the Ratings Agencies Weren’t Impressed Either..Impressed Either..
• Moody’s put Canada Moody’s put Canada on credit watch in on credit watch in the fall of 1994, then the fall of 1994, then downgraded the downgraded the debt from ‘AAA’ in debt from ‘AAA’ in 19951995
It Kept Getting Worse...It Kept Getting Worse...
• Canada’s Finance Canada’s Finance Minister warned that Minister warned that the IMF might the IMF might impose conditions impose conditions on Canada on Canada
Eventually there wasn’t Eventually there wasn’t much choice...and the public much choice...and the public bought into the need to turn bought into the need to turn
things around... things around...
Spending Cuts Were the Tool of Spending Cuts Were the Tool of Choice...Choice...
• In the 1995 budget, In the 1995 budget, there were 6 to 7 there were 6 to 7 dollars in dollars in expenditure cuts for expenditure cuts for every dollar of every dollar of increased taxesincreased taxes
Program Spending Plummeted
0
50000
100000
150000
200000
250000
1966/ 67 1972/ 73 1978/ 79 1984/ 85 1990/ 91 1996/ 97 2002/ 03 2008/ 09
Program expenses (Millions of $C)
Source: Canadian Department of Finance
The Public Sector was SlashedThe Public Sector was Slashed
• The Federal civil The Federal civil service was slashed service was slashed by 15% (or more) by 15% (or more)
Provincial Grants were AmendedProvincial Grants were Amended
• Federal transfers to Federal transfers to the provinces were the provinces were slashed by 14%, slashed by 14%, forcing welfare forcing welfare reform within reform within provincesprovinces
Canadian Taxes were Cut Canadian Taxes were Cut
• Corporate taxes, Corporate taxes, taxes on corporate taxes on corporate capital and personal capital and personal income and capital income and capital taxes were reducedtaxes were reduced
But the ‘GST’ was Introduced But the ‘GST’ was Introduced
• To pay for the tax To pay for the tax cuts, Canada cuts, Canada brought in a value-brought in a value-added taxadded tax
By Luck, Interest Rates Went Down
012345678910
'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
Government of Canada Marketable bonds 5 -10 year maturity
Source: Bank of Canada, Statistics Canada
Debt Payments Fell
0
5
10
15
20
25
30
35
1966/ 6
7
1969/ 7
0
1972/ 7
3
1975/ 7
6
1978/ 7
9
1981/8
2
1984/ 8
5
1987/ 8
8
1990/ 9
1
1993/ 9
4
1996/ 9
7
1999/ 0
0
2002/0
3
2005/0
6
2008/0
9
Gross Public Debt Charges/Total Expenditures
Source: Canadian Department of Finance
The Economy Improved the Next Few Years
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
'94 '05
Canadian Unemployment Rate (%)
Source: Statistics Canada
The Books were Balanced in Three Years
-60000
-50000
-40000
-30000
-20000
-10000
0
10000
20000
30000
40000
1966/ 67 1972/ 73 1978/ 79 1984/ 85 1990/ 91 1996/ 97 2002/03 2008/09
Budget Surplus/Deficit (Millions of $C)
Source: Canadian Department of Finance
Debt Started to Consume a Lesser Share of the Canadian Economy
0
10
20
30
40
50
60
70
80
1966/ 6
7
1969/ 7
0
1972/ 7
3
1975/ 7
6
1978/ 7
9
1981/8
2
1984/ 8
5
1987/ 8
8
1990/ 9
1
1993/ 9
4
1996/ 9
7
1999/ 0
0
2002/0
3
2005/0
6
2008/0
9
Accumulated Deficits/GDP
Source: Canadian Department of Finance
Part I: Part I: The U.S.: Can it Learn The U.S.: Can it Learn
from Canada?from Canada?
The U.S. Has a Worse Deficit Problem than Canada Did
-12
-10
-8
-6
-4
-2
0
2
4
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Deficit/GDP Ratios
Source: Canadian Department of Finance, U.S. Budget for 2012
The Same is True of Debt
0
10
20
30
40
50
60
70
80
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
Canada U.S.
Public Debt/GDP Ratios
Source: Canadian Department of Finance, U.S. Budget for 2012
Government was a Bigger Share of Canada’s Economy
30
35
40
45
50
55
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Canada U.S.
Government Outlays/GDP
Source: Canadian Department of Finance, U.S. Budget for 2012
The U.S. is in a Better Situation on Interest Payments – for Now
0
5
10
15
20
25
30
35
1966/ 6
7
1969/ 7
0
1972/ 7
3
1975/ 7
6
1978/ 7
9
1981/8
2
1984/ 8
5
1987/ 8
8
1990/ 9
1
1993/ 9
4
1996/ 9
7
1999/ 0
0
2002/0
3
2005/0
6
2008/0
9
2011/
12
2014/ 15
Gross Public Debt Charges/Total Expenditures
Source: Canadian Department of Finance, U.S. 2012 Budget
You Cannot Cut Discretionary You Cannot Cut Discretionary Spending Enough to Balance the BooksSpending Enough to Balance the Books
• To balance the books in the U.S. by cutting spending alone would need cuts in discretionary spending of 48% a year
Source: George Washington University
The Big Decisions Have to Be Made The Big Decisions Have to Be Made
• Social Security, Medicare and Medicaid – are what’s on the table
And the Wars are Pretty ExpensiveAnd the Wars are Pretty Expensive
• The two wars fought by the U.S. over the past decade have meant bills of $1.3 trillion
One Difference: Monetary Policy Can’t One Difference: Monetary Policy Can’t be Adjusted Too Muchbe Adjusted Too Much
• The Bank of Canada was able to offset tight fiscal policy with loose monetary policy – but the Fed can’t loosen much more
• Interest rates have hardly any room to fall
Which Means Less Relief on DebtWhich Means Less Relief on Debt
• If interest rates can’t fall, then the U.S. won’t get the same relief on debt payments that Canada did
The U.S. Has Made the Transition Before…The U.S. Has Made the Transition Before…
• In the post-war world the U.S. cut spending, and the economy boomed anyway…but things are different this time
The U.S. Economy is Not Back to Pre-Recession Levels
-8
-6
-4
-2
0
2
4
6
'06 '07 '08 '09 '10 '11
%change in U.S. GDP $K
Source: BEA
The Unemployment Rate is Stuck
0
2
4
6
8
10
12
'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11
U.S. Unemployment Rate
But given that there But given that there is not much choice....is not much choice....
What are the costs???What are the costs???
One Concern: Lower Economic GrowthOne Concern: Lower Economic Growth
• Even though current plan has cuts back-end loaded, economic growth will be necessarily lower
• Also – cuts will hit as population ages
One Concern: Deflation One Concern: Deflation
• Too much in terms of cuts without private sector offset could be deflationary
• At the least – probably good for bonds
So What’s the So What’s the Payoff???Payoff???
Canada Got Hit Less During the Recession
90
92
94
96
98
100
102
104
2008
2009
2010
2011
CanadaU.S.
GDP by country, 2008 Q1 =100
Nobody Laughs at the Loonie Now
0.60.650.70.750.80.850.90.95
11.051.1
'93 '96 '99 '02 '05 '08
Source; St. Louis Federal Reserve/FRED
$Cdn/$U.S.
And Canada is a And Canada is a “AAA” Credit all “AAA” Credit all
around…around…
Canada Can Even Spend if it Has Canada Can Even Spend if it Has To... To...
• If there is another recession Canada has some room to expand fiscal policy – or to lower interest rates
The Canadian plan The Canadian plan may not be a perfect may not be a perfect
fit, but it is an fit, but it is an example of what example of what worked once…worked once…
And there may be some lessons n And there may be some lessons n it of what might work again…it of what might work again…
