Thursday, 26 November 2015

Osborne takes a leaf from Harper's playbook

The UK's Chancellor of the Exchequer, George Osborne, obviously likes giving fiscal updates. Counting the one he delivered on Wednesday, he's now tabled four of them in the past year. As ever, this latest update is a budget in all but name, and is designed to set the UK's public finances on course to reach a surplus by 2020.

Bringing the budget back to surplus has, of course, been Osborne's lodestar ever since the Tories got back into power in 2011. It's remarkable how little progress has been made so far, and the 2020 target date for balancing the books represents considerable slippage from the Tories' early goals -- if things had gone as Osborne initially expected, the deficit would have been eliminated by this year.

In part, this slippage reflects the fact that cutting spending has proved a lot more difficult than Osborne and his boss, David Cameron, imagined it would. Despite howls of protest from all quarters at the supposed severity of the Tories' spending reductions, program spending continued to expand in the early years of the Tories' first mandate -- when they were, it should be recalled, governing in coalition with the Liberal Democrats. As I commented more than once at the time, Osborne was achieving the worst possible outcome, taking political flak and possibly damaging confidence while doing very little to get the budget back in balance.

The return to surplus forecast in this year's update relies on three main elements, the details of which you can read in the linked article. First, projected GDP growth for the forecast period, including the current year, has been revised modestly but significantly higher, resulting in an improvement in the projected revenue stream.  Second, program spending outside the so-called "ring fenced" areas (including health care) will be reduced by an average of 0.8 percent per year in real terms during the forecast period. Third, persistently low interest rates will result in lower debt service charges than previously expected.

That reduction in spending may look modest, but if it actually happens (big IF), and if the economy grows as forecast (ditto), then something quite startling happens. By 2020, the ratio of public spending to GDP, currently around 45 percent, would fall by about 9 percentage points. This would bring it back to levels not seen since the 1930s, well before the Beveridge Report boosted education spending and the establishment of the NHS pushed public health spending sharply higher.

Given this outlook, it's fair to ask if the Tories' apparent deficit fetishism was in fact simply cover for an ideologically-driven plan to shrink the size of the state. There are some obvious parallels here with the fiscal record of the late and unlamented Harper government in Canada. Harper and his finance ministers presided over significant cuts in a wide variety of spending programs over a multi-year period, all the while trumpeting the need to balance the budget, yet only managed to squeeze out a tiny surplus in the last full year of their mandate by selling assets.

This article from Open Democracy suggests Osborne may be plotting to copy another element of the Harper playbook in time for the next election.  If indeed the deficit does shrink as the Chancellor hopes, then in the run-up to voting day he may well have the flexibility to offer the kind of targeted spending and tax moves that Harper's Tories were spraying around just before Canada's recent election. It didn't work in Canada, but given the disarray in the UK's opposition parties right now, who's to say it wouldn't work there?      

Friday, 20 November 2015

Canada's fiscal update

A few posts ago ("A legacy of deficits"), I noted that the Parliamentary Budget Office (PBO) had issued a report indicating that the fiscal surpluses that the Harper Tories had made a big part of their re-election campaign were entirely fictitious. Today, new Finance Minister Bill Morneau has released a fiscal update that confirms this.

The Tories had claimed that the budget for fiscal 2015/16 would show a surplus of $2.3 billion; now, it appears that there will be a deficit of $3 billion. Reflecting a lower medium-term growth outlook, small deficits are expected to continue until 2019/20 -- which means, if nothing changes, that the budget will remain in deficit right through the lifetime of current Parliament.

If the Tories are ashamed of this legacy, and of the lies they told about the fiscal outlook during the election campaign, they're not showing it. The party's new finance critic, Lisa Raitt, has immediately accused the Liberals of putting some of their planned spending into the numbers in order to make them look worse. There may be a small element of truth to this -- the PBO forecast a deficit of $1.2 billion rather than the $ 3 billion in today's update. Like the new Finance Minister, however, the PBO was forecasting a multi-year string of deficits rather than the surpluses promised by the Tories, so the actual size of the shortfalls is arguably not the real issue here.

It remains to be seen whether Morneau will allow the worsened base-case outlook to affect the new government's fiscal plans. The Liberals promised to run small deficits, about $10 billion per year, in an effort to stimulate the economy.  Morneau made it clear today that the general direction remains intact -- "it's just not possible to cut our way to prosperity" --  but we will have to wait for a full budget, early in the new year, to see whether these deficits will be added onto the baseline projections, or scaled back slightly to avoid too much red ink.  As the economics department at TD Bank points out, even if the Liberals add the full $10 billion to the baseline deficit projection, the resulting annual deficits would still amount to only 0.7 percent of GDP -- far lower than in the US, the UK, Japan and most other developed nations.

The anti-deficit rhetoric of the Harper Tories, regardless of their own very poor fiscal record, is likely to return to fever pitch no matter what the Liberals announce at budget time. In truth, however, a better question might be this: is a 0.7 percent deficit enough to make a real difference to the growth outlook, or should the government consider doing more while financing is so cheap?

Monday, 16 November 2015

A Yellen put?

Share prices around the world have been looking a bit shaky in recent weeks, which is perhaps no surprise after a seven-year bull market. Today has seen markets, at least initially, pull back sharply in response to the appalling events in Paris on Friday. Does all of this have any implications for the Fed's policy decision in December?

In the absence of strong global economic fundamentals, there's little room for doubt that the steady rise in stock prices has been largely driven by the abundant cheap money doled out by the major central banks.  The combination of free money and low yields on fixed income assets (two sides of the same coin, of course) has inevitably driven yield-hungry investors towards riskier asset classes, including equities and real estate. It can be no coincidence that as the Fed has begun to signal its resolve to start raising rates, if not in December then soon after, global equity markets have run out of momentum.

If Alan "Three Bubbles" Greenspan were still at the Fed, there would be every reason to think that the Fed would hold off on a rate hike in December. The Greenspan Fed regularly demonstrated that it saw maintaining confidence in equity markets as a key part of its mandate, along with keeping inflation in check and promoting economic expansion. It happened so many times that equity investors even coined a term for it: the Greenspan put. If your equity investments were about to go sideways, fear not: the Fed would be along to bail you out with a rate cut.

Will Janet Yellen do the same?  Although today's early market selloff is not surprising, it's difficult to make a case that the Paris massacres in and of themselves will have a severe effect on the global economic outlook. The market weakness that was evident before last week may be a different matter, but if the Fed focuses, as it should, primarily on the US domestic economy, then the case for some modest tightening remains unanswerable. Look at it this way: if the Fed can't raise rates when unemployment is at a seven-year low and wage gains are at a seven-year high, just when will it ever be able to raise rates?

Friday, 13 November 2015

Mr Good Example

Before Stephen Harper came along, Canada's international reputation was positive, though maybe not quite as positive as Canadians liked to believe. Governments of both parties were quick to stretch the underfunded military gossamer thin in order to contribute to peacekeeping missions around the world, and the country could generally be counted on to pull its weight whenever there was a refugee crisis. Budgets always seemed to be tight, so Canada's deeds always fell short of its words, but at least we were generally on the side of the angels.

That all changed under Stephen Harper, whose contempt for most of his fellow Canadians was matched by his disdain for foreigners -- the man couldn't even bring himself to be friendly to the United States.  The only countries Harper seemed to have time for were Israel and Ukraine, in both cases as much for domestic political reasons as for any point of principle. The aid budget shrank even further and instead of peacekeeping, Harper sent the still-underfunded military into combat zones, deploying ancient fighter jets to the Baltic and, more recently, to Iraq to join the fight against ISIS. As The Economist scathingly put it just before the recent election, Canada under Harper was "Strong, proud and free-loading".

In his speech to his supporters on election night, Justin Trudeau made a point of speaking about this. Directing his remarks to foreign countries that missed the "old Canada", Trudeau announced "We're back!"  He will have a chance to prove it soon enough: in the next few weeks he will be travelling to the G20 summit in Turkey, to a Commonwealth meeting in Malta, and to the climate summit in Paris. This article from today's Toronto Star looks at how he might try to reposition the country on key issues.

The Syrian refugee crisis will be a key issue at the G20 meeting, not least because the host country, Turkey, has taken in more than 2 million refugees, as well as playing a growing military role. Trudeau has already pledged to end Canada's air campaign against ISIS.  This was probably not a welcome decision in Washington, London or Paris, but it is a recognizable return to the policies of his Liberal predecessors -- Jean Chretien famously upset George W Bush by refusing to join the invasion of Iraq.

Trudeau has also pledged to bring 25,000 refugees to Canada by year end, a hugely ambitious goal. Here is where we start to see the old, self-righteous Canada starting to rear its head again: according to the linked article, Trudeau has said he hopes that commitment stands as an example for other nations. Well, which nations would those be? He can't mean Turkey, obviously, or neighbouring Jordan and Lebanon, both buckling under the strain of the refugee influx. He can't mean Sweden, which with a population less than a third of Canada's has been seeing more than 25,000 refugee arrivals per month. He certainly can't mean Germany, the preferred destination of hundreds of thousands of refugess, or France, which has pledged to take far more than Trudeau is proposing.

I'm not trying to put Trudeau down here: any contribution to the crisis is better than none. However, in the overall context, what Trudeau is proposing is not much more than a pinprick.  It's more than a little pompous to set it up as some kind of example to others, many of whom are already doing much more.

Then there's the climate summit. Stephen Harper was famously cavalier about climate change, withdrawing from the Kyoto Protocol and muzzling the country's climate scientists, while enthusiastically boosting the oil sands industry. Trudeau has pledged to change all that, but once again there's a risk that the rhetoric will far outrun the action.

Trudeau's team has been heard to say that Canada will be taking a leadership role at the Paris summit,  but it's hard to imagine countries that have been focused on the issue for years allowing the prodigal son to take a seat at the head of the table. In truth, the main decision that Canada could have taken to look good at the conference, the cancellation of the Keystone XL pipeline, has already been taken in Washington. Recall, too, that Trudeau expressed his "disappointment" at President Obama's decision, though to be fair that statement may have been made for a domestic audience.

Truth to tell, and oil sands aside -- and I acknowledge that's a huge aside -- Canada's environmental record is not all bad. No developed country gets more of its electrical power from renewables, largely thanks to the abundant hydropower resources found from Niagara Falls to Churchill Falls to Quebec's awe-inspiring Baie James. Quebec must be the only major jurisdiction in the world in which electricity is the most economical form of home heating, and it's all produced from renewables. That said, however, this is a vast country, cold in winter and stifling in summer, that will always be a relatively heavy energy consumer. Trudeau will have to weigh his long-term commitment to the environment with the need to avoid short-term damage to the economy.

What it comes down to is that, in energy policy as well as the refugee crisis, Trudeau needs to avoid committing to more than he can safely deliver. Given the budget constraints he faces, there is a risk that Canada will quickly be seen as a country that speaks loudly but carries a small checkbook.  Trudeau's fellow world leaders may be glad to see the back of the lumpen Harper, but they won't want to be preached at by the new guy.

Tuesday, 10 November 2015

A legacy of deficits -- thanks, Stephen Harper!

Well, who'd have thought that could happen? Two weeks on from the election, Canada's Parliamentary Budget Officer (PBO) has revealed that the baseline fiscal outlook sees small budget deficits in each of the next three years.

Think about that. The Tories castigated Justin Trudeau's Liberals for the "irresponsible" suggestion that a Liberal government would run small deficits for three years in order to invest in infrastructure and boost the economy.  Harper, in contrast, was promising to "keep the economy safe" by balancing the budget. It now turns out, as Harper surely must have known, that the tiny surplus eked out in the most recent fiscal year was only made possible through the one-time sale of a government asset (the GM shares the government acquired during the financial crisis). The underlying budget is in fact in deficit, as it has been through each of the past six years of Tory government.

It's not clear that this will make a huge difference to the first part of the new government's fiscal plans. The PBO's projected deficits are only $2.4 billion a year on average, so even if the Liberals stick to their pledge of keeping annual deficits to $10 billion, there is still some room to maneuver -- just not as much as the Trudeaupians were counting on. However, the PBO's projections largely reflect a less buoyant growth outlook than was previously assumed, which implies that it will be that much more difficult to get the budget back into surplus by the time of the next election, as the government has pledged.

The budget news is part of a difficult backdrop that the inexperienced Trudeau team is already facing, even as the new ministers try to figure out the way to the executive washrooms.  Ineptly-run Bombardier has its hands out for yet more government largesse, President Obama has effectively cancelled the Keystone XL pipeline project (though it's unlikely that Trudeau is too upset about that, his public statements notwithstanding), the pledge to bring in 25,000 Syrian refugees by year end looks by turns unachievable and irresponsible.....and so on. By and large, Canadians are happy to see the back of Harper and like what they're seeing from Trudeau. but it's unlikely that the new government will enjoy much of a honeymoon.

Friday, 6 November 2015

North America's jobful recovery

Employment data for October were released in both the US and Canada this morning.  In both countries, the data were much stronger than analysts had expected. In the US, this is seen as cementing the possibility that the Fed will start hiking rates next month; in Canada, however, the gains may be attributable to a one-off event -- the election -- meaning that there is a real risk of a decline in employment when the November data appear.

The US numbers are unambiguously strong, and should put to rest the fears of a renewed economic slowdown that were voiced after the tepid September employment report.  The economy added 271,000 jobs in the month, almost twice the number reported for September, and well above the market consensus of 150,000. Although the slowdown in global growth seems to be weighing on US exports, and hence on the manufacturing sector, continued strength in final domestic demand is supporting the rest of the economy. Strong job gains were reported in the retail, construction and health care sectors, and the unemployment rate dipped to a seven-year low of 5.0%.

It seems certain that Fed Chair Janet Yellen had some advance knowledge of the data when she remarked earlier this week that a rate hike in December was a "live possibility". The Fed will certainly take note of the fact that the gradual tightening in the labour market is starting to have an impact on wage growth: the average hourly wage is now 2.5% higher than a year ago, the largest year-on-year increase since 2009. The December jobs report will be released before next month's FOMC session: unless it contains a totally unexpected setback for the job market, it seems all but certain that the Fed will finally start to move rates off their rock-bottom levels at the conclusion of that meeting.

In Canada things are less clear -- and the overall unemployment rate, at 7 percent, is still much too high for anyone's liking. The headline employment number of 44,000 jobs added was far above the market consensus of 10,000, but StatsCan was quick to point out that this largely reflected a 32,000 gain in public sector employment, much of it temporary.  (StatsCan has noted similar increases around past elections, but evidently nobody told the analysts as they were preparing their estimates).

If you assume that many of those jobs will disappear in November, and if you further assume that the underlying rate of job creation in Canada is less than 20,000 per month (the extreme volatility in the data make it hard to be precise about that), then the early best guess for the December report would be for no net job gains, or even a small loss.  If this happens we will no doubt see a fresh round of unwarranted handwringing in certain sections of the media, where calm analysis of trends always takes a back seat to the writing of doom-laden headlines.

However the December data come out, it's inevitable that the Bank of Canada will look to delay following any rate moves by the US for as long as it possibly can. A weak exchange rate is one of the Bank's favoured instruments for getting the economy moving again. It's far from certain that this will be enough:  a report from CIBC this week suggested that the weak currency might be a hindrance rater than a help for the small business sector, so beloved of politicians of all stripes. However, the rebalancing of policy implied by the new Liberal government's plans to run small budget deficits may start to set the stage for some reduction in monetary stimulus, possibly in the second half of 2016.

Tuesday, 3 November 2015

Canada's basic (im)balance

You can call it, I guess, Stephen Harper's parting gift to Justin Trudeau, who will be sworn in as Canada's Prime Minister tomorrow (November 4). A study by economists at BofA/Merrill Lynch  has revealed a sharp deterioration in Canada's so-called basic balance -- or as the headline on the linked article soberly expresses it, "money is flooding out of Canada at the fastest pace in the developed world".

The basic balance is an infrequently-used statistic that combines the trade balance and autonomous capital flows. In looking at what's happening to Canada at the moment, it's very easy to see that the deterioration in both of these components, and hence the sharply negative swing in the basic balance, is directly attributable to the collapse in energy prices.

Canada's monthly trade balance has predictably worsened in the past two years as the global oil price has fallen. In fact, the oil sector in Alberta has been hit even harder than most other oil producers because of the lack of pipelines to get the product to market -- of which, more in a moment. What the Merrill Lynch study indicates is that as the Harper government's all-in bet on the resource sector unravels, capital flows have turned sharply negative too. Both individual and corporate investors are redeploying funds not just out of the energy sector, but out of Canada altogether.

Given all this, it's no surprise that the exchange rate has weakened so sharply in the last couple of years. What's more, it's hard to be confident that the decline in the Canadian dollar is over. There are only the most tentative signs that the lower exchange rate is making non-oil sectors of the economy more competitive. Meanwhile, the outlook for energy just gets worse: TransCanada's request to the US government this week to delay a decision on the Keystone XL pipeline may well be the final death-knell for the project. Other pipeline proposals, to take Alberta tar sands crude either west to the Pacific or east to the Atlantic, face severe opposition.

In short, Harper's ten years in office have left the economy in a bit of a mess, even though Canada avoided the worst effects of the global financial crisis. The incoming finance minister, whoever that may be, is going to have a lot on his or her plate, right from day one.