During the financial crisis not one Canadian bank failed, the housing market didn’t collapse, and the unemployment rate topped out at levels much lower than many other countries. So, what is the problem?
In the final days of November, Canada’s national federal debt crossed a dubious mark, for the first time ever it cross the $600 billion mark. Compared to some other nations, $600 billion of federal debt is a laugh as is the debt to GDP ratio that hovers around approximately 33%. No country made it through the 2008 financial crisis and the recession that followed unscathed, but it can definitely be argued that some countries made it through better than others. Canada was one of those countries.
The Canadian Prime Minister has hyped the Canadian economy as a bastion of stability. This news of recent poaching of the Bank of Canada Governor Mark Carney by the Bank of England has been touted as another example of Canadians showing the world how to get their finances in order. During the crisis not one Canadian bank failed, the housing market didn’t collapse, and the unemployment rate topped out at levels much lower than many other countries. So, what is the problem?
First, some history. In the early 1990s Canada’s economy was in trouble. Efforts in the late 1980s to control inflation resulted in a deep recession in 1990-91, while a looming debt crisis from over two decades of deficit spending resulted in debt levels that were comparable to some of the modern European examples. Meanwhile the Canadian business community had been slow to respond to the liberalizing and freeing world economy that resulted in them being internationally uncompetitive. All added up, this left them with an economically struggling nation.
The answer to these issues was austerity with deep federal government budget cuts along with a liberalizing of Canadian markets as well as the addition of financial regulations. It was the legacy of this action that resulted in a decade of federal surplus leading up to 2008 and a financial system that could weather the financial storm that wracked the world economy. It was the legacy of these measures that laid the foundation for a potential crisis.
Today, Canada faces a pair of challenges, the first of which comes from its provinces. Although Canada’s federal debt is only about $600 billion, the provinces together hold approximately $500 billion in debt themselves giving the nation as a whole a total national debt of approximately $1.1 trillion.
As Andrew Coyne, a national political commentator pointed out this past fall, Canada has a monetary union without a fiscal one. Canadian provinces unlike US states or members of the EU have no mandatory constraints on their debt levels (note the three territories do have budgetary debt limits due to the fact that they are funded directly by the Federal government).
Currently, every province but two (Saskatchewan and Newfoundland & Labrador) are running deficits; surprisingly this list does include oil rich Alberta. Canada’s two largest provinces (Ontario and Quebec) both have per capita debt levels exceeding those of the federal government. Each of these indebted provinces can use federal transfers as a form of annual bailout to help maintain credit ratings and spending priorities while putting off tough austerity measures that are needed in some cases. Most projections for when most of the provinces will reach balanced budgets are not until 2016 assuming current estimates are accurate.
The second challenge comes from the people of Canada whose personal debt to income ratios, reached 163% in the second quarter of 2012. What this means is that the average Canadian is carrying $1.63 of debt for every dollar of disposable income they have. This debt has been part of the reason why Canada didn’t suffer as badly during the recession; Canadians just kept buying. At the peak of the housing crisis in the US, their consumer debt was approximately 170% and as a result you can see the concern.
Although the federal government has already taken action by tightening mortgage rules by requiring larger down payments and higher minimum monthly payments on government insured mortgages, the fear is that when interest rates begin to climb (and the Bank of Canada has warned they could as soon as late 2013) many financially burdened Canadians will struggle to make ends meet in the face of higher monthly payments.
Of course this debt burden and the threat of higher interest rates may have a ripple effect across the economy. As consumers spend less, the risk of bankruptcies and foreclosures increases and the danger of a US-style housing crash coming to Canada truly becomes real. This all feeds back into government tax revenue and spending policy and the question of when they will get their books in order.
Canada isn’t about to go bankrupt, nor do we face the debt challenges of the United States or some of the nations of the EU. What Canada and Canadians do face is a fork in the road which can lead us to a return to the legacy of the 1990s, where fiscal responsibility became ingrained in society, or we can continue down our current path towards a fiscal cliff of our own.
Photo credit: Cindy Andrie