I watched Steve Pakin interview three capable economists on The Agenda this evening and debate whether deficits were a problem for world governments in general and Canada in particular. Not surprisingly, the guests disagreed with one another.
Two of the economists expressed the view that deficits were not a problem for countries that issue their own currency and not even a problem for a Province like Ontario that, while it cannot issue its own currency, is backstopped by Ottawa which can. The third, Chris Ragan (Director of McGill's Max Bell School of Public Policy) presented the conventional (and realistic) view that Governments can spend money they raise through taxes, borrowing or creating by printing more money and that the balance between these is important. The discussion about Modern Monetary Theory (MMT) was less about theory and more about comments by economist Stephanie Kelton, author of “The Deficit Myth”, who argued that MMT was less a theory and more a description of how government spending works that has existed for decades no matter how labeled.
Leaving aside the entomological debate, Ms. Kelton’s argument was that a currency issuing state could spend whatever it wanted since the banks would clear their cheques regardless of whether the spending was supported by taxation or otherwise. I admit to a cocked eyebrow listening to her argument and the concurrence of economist Armine Yalnizian, Atkinson Fellow on the future of workers, wondering why they didn’t just argue that raising taxes was an unnecessary distraction since deficits didn’t matter.
History teaches us that deficits do matter, even in countries that issue their own currency. The most extreme example was the 1923 attempt by the Weimar Republic of Germany to issue increasing amounts of currency to meet reparations obligations arising from Germany’s loss in World War I. The hyperinflation that resulted destroyed that country’s economy, bankrupted many businesses and millions of Germans, with the ensuing chaos causing widespread devastation to citizens on fixed incomes. People and businesses with fixed rate debt profited handsomely as inflation destroyed the value of the currency and they could repay their debt with worthless money.
Germany was not alone with its attempts to “print money” to meet its debts. In the early 2000’s, Argentina suffered not only hyperinflation but also experinced the largest ever default on foreign debt in history. Even more recently Turkey verged on financial collapse owing to out-of-control inflation triggered by profligate spending funded by “printing money” to try and deal with foreign debt obligations.
It is convenient for left wing political groups and their supporters to claim deficits don’t matter and look to MMT and its support from economists like Skelton to justify profligate spending. It seems the Biden Administration is persuaded that it can fund trillions of dollars of deficit spending with a salutory result in the American economy, and the Trudeau Liberals are following a similar path. During an economic downturn, there is no doubt that deficit financing can soften an otherwise destructive decline and the U.S. and Canada’s response to COVID demonstrates the value of such outlays. But there is a limit.
In Canada and similarly in the United States, the two left wing governments buy into the “climate change” alarm and contemplate spending literally trillions of dollars “investing” in a “transition” to a “green economy”. The quotes are to highlight the obvious buzzwords since the outlays are hardly “investments” and the promotion of a transition to a green economy is pure hype. It is neither desirable or possible to convert the 80% of the Earth’s energy sources from fossil fuels to any other possible source in the timeframe set out by leaders in COP26 this year or in the Paris Accord which gets so much press.
Rather, the attempt to curtail use of fossil fuels will have a dramatic and devastating effect on government revenues since this vital industry contributed some $672 billion to governments in the years 2000-2018 without which government deficits would be much wide and government debts higher by the amounts collected. By contrast, the so-called “renewables” industry provides a tiny fraction of Canada’s energy but is a consumer of massive government subsidies rather than a source of revenue. Ontario alone is expected to spend $2.8 billion subsidizing “renewables” over the next three years, and the United States “Green New Deal” if enacted is expected to cost $93 trillion over the next decade. Treasury Secretary Janet Yellen sees an even higher price tag which she puts at $150 trillion for the global “Great Reset”.
Unless reason prevails and voters replace the current crop of left-wing leaders with a cast exhibiting more common sense and fiscal prudence, the inevitable result will be a period of high inflation akin to the late 1970’s with little economic growth. Today, there is scant evidence of a political party in Canada capable of bringing common sense to bear, with the once sensible Conservative Party now embracing both “climate change” and the “energy transition” narrative and no more likely to enact sensible legislation than the toxic policies of the Trudeau Liberals, and the New Democrats and Green Parties comprise even worse choices.
Excessive government spending ultimately hits a wall when investors eschew bond issues and reliance on central banks to continually increase the supply of money destroys the value of that money leading to the hyperinflation experienced by Germany, Argentina, Turkey and Venezuela. Stated simply, MMT is an elegant theory that does not work in practice except in a very narrow range. $150 trillion is a long way from a “narrow range”.
As a result, I suggest Canadians lock up low interest rate mortgages with fixed rates for as long as they can negotiate; avoid fixed income investments; and, stay liquid. Interestingly, the policies intended to limit fossil fuel use will drive up the price of those fossil fuels in the face of inelastic demand and investors can safely ride that train to substantial profits. My own energy investments have returned over 250% in the past year and I see no evidence the global energy shortage is about to end quickly.
Otherwise, the ill-conceived policies of left wing governments will destroy the foundation of several major economies including Canada and the United States. This could be a rough ride and likely a long one.