Updated: Wells vs. Geddes on the Euro and the new Jim Flaherty

Merkel-Hollande, austerity-vs.-growth, blowing bubbles vs. tightening rules

by Paul Wells

A transcript of an email exchange between two guys who sit eight feet apart in our Ottawa bureau.

Paul Wells: John, I see it’s going badly between Angela Merkel and François Hollande. He’s Mr. Growth, she’s Ms. Austerity. Each has repeatedly endorsed the other’s political opponents. And this roundup in Le Figaro shows that both at a human level and a policy level, Europe’s most important relationship is in trouble.

Hollande’s determination to follow through on some of his more exuberant election promises is amazing to the Germans, who don’t just want spending restraint, they want the kind of structural labour-market reforms they went through in a decade ago. So when Hollande lowered France’s retirement age to 60 for some workers, “we were floored,” a senior German official tells Le Figaro. “We don’t understand Hollande’s determination to join the PIGS (the crisis-racked southern club of Portugal, Italy, Greece and Spain).” I’m also enjoying the German headlines. Süddeutsche Zeitung: “François, Nightmare of Business.” Financial Times Deutschland: “Mr. President, Break Your Promises!”

So the Germans may be irritated with Canada, but they’re furious at France. What do you make of it all?

John Geddes: As a hopelessly parochial Canadian, my initial reaction is that I’m glad the Germans don’t have time to dwell on their quite understandable irritation with us. At a deeper level, the Merkel-Hollande, austerity-vs.-growth tension makes me think of debate that’s played out here in recent times.

We learned that you need both. I’ve argued before that the key to Canadian deficit-eliminating success in the 1995-1999 period was tax-generating growth; but the Liberal formula included real restraint, too. It would be more rhetorically satisfying to argue for one over the other, but you need both when a serious debt crunch looms.

The problem is that concocting a policy blend that includes short-term pain with medium-term gain is going to be far harder in Europe circa 2012 than it was in Canada circa 1995. As Royal Dutch Shell CEO Peter Voser, no less, told Maclean’s recently, there’ s no quick solution to be had.

And, by the way, on Hollande’s lowering of the retirement age, isn’t it fascinating the Finance Minister Jim Flaherty managed to nudge up the eligibility age for Old Age Security to 67 from 65, albeit not until 2023, has gone over pretty smoothly. You can do things in this country without filling the streets with protestors. Well, sometimes.

Paul Wells: Indeed it should be possible to reconcile growth with the kind of structural reform that can keep these countries fiscally sustainable. The Europeans are getting no end of advice on this front. Robert Zoellick and Stephen Harper are saying a lot of the same things, and the leader they sound the most like is Merkel. But she won’t get far without a France-sized ally, and as long as Hollande is busy replaying the worst of early François Mitterrand, they’ve got trouble.

But enough about Europe. Why is Jim Flaherty suddenly containing the ardours of the Toronto condo market? Since we work at Maclean’s, I’ve always felt a little proprietary about housing-bubble speculation and I hope Flaherty hasn’t managed to ruin our fun.

John Geddes: It’s hard to remember now that back in 2006 Flaherty was all for blowing bubbles, or at least for making it easier to get mortgages for very long terms. But after introducing 40-year mortgages [very sloppy of me to phrase it like that; I've added an update at the bottom for more detail] opening the Canadian market wider to private mortgage insurers,  he’s spent the six years tightening, tightening, tightening.

This week, he reduced the  maximum mortgage amortization to 25 years. And that’s after he said in April that he wanted to avoid tightening the rules for the fourth time (since he first loosened them), hoping for “the market itself to correct to the extent correction is necessary.”

Apparently the market didn’t do its job. (The market can be lazy that way.) Hence Flaherty’s move to discourage marginal house hunters won’t buy unless they can really spread those payments out. Yet this powerful fear of an overstimulated housing market—especially the Toronto and Vancouver housing markets—comes against the backdrop of an economy that shows no sign of revving up, and is considered vulnerable to the interminable threat of a “shock” from Europe.

Bank of Canada Governor Mark Carney recently issued this warning (and woe betide us if we fail to pay heed to this giant who strides among us): ”Given the reality of global finance, it’s not enough to have our house in order unless we seal ourselves off from the world,” he said. “And, of course, if we seal ourselves off from the world, we would end up much poorer.”

So the policy trick is to cool an overheated housing market without choking our economy just as it might be hit hard by a European setback. That’s no easy matter. It’s why the spring budget looked so delicately—some might say awkwardly—balanced between austerity and let’s-not-go-overboard-with-the-austerity-here.

Note that Carney stresses the need not to view our problems in isolation, which brings us back to the dance of Merkel and Hollande. It would be silly to suggest Canada can do anything decisive to aid the EU. But shouldn’t we be doing something? The only something in play was the International Monetary Fund’s plan to bulk up its resources to help shore up EU economies, and Harper refused to contribute.

Maybe that’s justifiable: not our problem, fix it yourself. The other viewpoint (argued well here) is that anteing up to the IMF would have been a rather low-cost way to ensure our traditional Canadian place at the table. Why have the likes of Carney hanging around Basel, Switzerland, if our national policy doesn’t lend him as much clout and credibility as possible?

Paul Wells: For what it’s worth, I think there’s a strong case for keeping Canadian money (even loaned, even if from foreign-currency reserves and not from general revenues) out of a European solution, and it’s the case Bob Zoellick makes in the piece I linked to above. Europe needs reform; reform is hard; and constant lifelines don’t concentrate the minds of national European leaders who would prefer not to concentrate. The nativist “Don’t bail out rich European socialist” rhetoric the Conservatives are peddling doesn’t help, but just because they are oafish in selling their policy doesn’t mean it’s bankrupt policy.

I do wish Harper would simply explain his viewpoint to some actual Europeans. I continue to wonder why this prime minister, who was briefly so eager to get on U.S. television when the Fox-obsessed Kory Teneycke was his communications director, has not bothered to write an op-ed for the Financial Times or some German tabloid now that the fate of Europe is the biggest cloud on Canada’s horizon. But that’s the columnist in me talking, not the realist. The realist says it’s the weekend and we should enjoy it. Have a good one.

UPDATE:

John Geddes: Finance Minister Jim Flaherty’s office rightly points out by email that he did not introduce 40-year mortgages, as I originally and incorrectly phrased it in my exchange with Paul. The 40-year amortization was introduced to the Canadian market by a private mortgage insurer in the fall of 2006. That was my mistake, for which I’m sorry; I’ve corrected it in the text above.

What Flaherty did do in his first budget, back in the spring of 2006, was double the amount available, to $200 billion from $100 billion, as a government guarantee for private companies that insure mortgage loans. That move was plainly intended to pave the way for a big expansion of private mortgage insurance in Canada, and unequivocally signalled the government’s aim of stimulating the housing market.

Flaherty’s undisguised hope at the time was that private insurers would make it easier for would-be home owners to buy. Here’s how his May 2, 2006 budget explained the purpose of encouraging more private insurers to join the Canadian residential real estate game: “These changes will result in greater choice and innovation in the market for mortgage insurance, benefiting consumers and promoting home ownership.”

By way of innovation, private insurers introduced 35-year- and 40-year amortizations in the spring of 2006, even before the budget was tabled. The federal Canada Mortgage and Housing Corp., in step with the government’s policy bent, also began backing 30-year and then 35-year amortizations that spring. In that email note to me today, Flaherty’s office says there was no reason at the time to worry about any of this. “In 2006,” the minister’s officials write, “risks relating to mortgage markets were not top of mind.”

Evidently such risks were not top of mind around Flaherty’s office. However, the danger inherent in those spring 2006 “innovations” in the Canadian mortgage insurance business certainly worried David Dodge, the Bank of Canada governor of the day, and arguably the most respected voice in Ottawa on economic issues.

Canadian Press broke the story of Dodge’s urgently worded, promptly written June 30, 2006, letter to the head of CMHC.  ”I read with interest and dismay your press release of June 28 which indicated that CMHC would offer mortgage insurance for interest-only loans and for amortizations of up to 35 years,” Dodge wrote.”Particularly disturbing to me is the rationale you gave that ‘these innovative solutions will allow more Canadians to buy homes and to do so sooner.’”

Beyond Dodge’s remarkable blunt and prescient intervention, the recollection of Flaherty’s staff regarding the worry-free atmosphere regarding mortgage risks in 2006 seems to me a bit off. Just to cite just a couple of mainstream examples from the same month as Flaherty’s first budget, BMO economist Douglas Porter warned of worrisome “bubble-like activity” in Canadian real estate, and, down in the U.S., Fortune reported: “The great housing bubble has finally started to deflate.”

 




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Updated: Wells vs. Geddes on the Euro and the new Jim Flaherty

    • I would argue it was more than just monetary stimulus. When the BoC lowered interest rates below the Fed’s rate (around 1996,) this also caused the dollar to fall (bottoming out at 63 cents US by 2002.)

      Aside from providing stimulus, this lowered the real cost of wages which helped produce a 10 year manufacturing boom. This turned Mulroney-era $20B trade deficits (current account) to $20B trade surpluses. By earning more than we spent we were better able to pay down the budget deficit.

      Now the circumstances are reversed. Considering the OECD fair value of the dollar 81 cents US, real wages in Canada are now inflated and uncompetitive. This has caused the trade balance to tank producing $50B trade deficits.

      So unlike the mid-1990s, there will be no growth to counter the austerity. Canadians will belt-tighten, pay down bloated personal debt, which will cause economic growth to decline. As Carney predicted in 2010, “Canadian economy expanding quickly, but will soon trail G7 countries.”

      http://www.theguardian.pe.ca/Business/Personal-finance/2010-04-23/article-1287318/Canadian-economy-expanding-quickly,-but-will-soon-trail-G7-countries%3A-Carney/1

  1. “…both at a human level and a policy level, Europe’s most important relationship is in trouble.”

    I believe Fritz and Marianne’s marriage is about to end in bitter, long drawn out divorce. EU is politically driven by bureaucrats without regard to what European people want – referendums or votes are rarely held – but this crisis about $$$ which means national legislatures are involved and EU bureaucrats are sidelined.

    Europe is socialist continent but there is fundamental clash between protestant and catholic types of socialism. Finland, Estonia and Germany use Euro and they are ones who are putting pressure on other countries to reform their economies. It is catholic socialist countries – Spain, France and Italy – that are basically bankrupt and can’t afford to pay their bills.

    There are at least two different cultures in Europe – retirement age is good example of completely different mindset. Hollande just lowered retirement age from 62 to 60 while the Germans recently raised their retirement age from 65 to 67. Germans are not exactly going to be keen to work longer so they can pay for others to retire early.

    • France and Canada have the same levels of debt according to the 2011 IMF numbers (86% debt/GDP and 85%.) France has the highest level of public social spending in the world. Canada ranks #23 according to the OECD. The US spends even less (#25) but has a debt/GDP of 102%. America is a testament to the fallacy of faith-based economics including silly ideas that tax cuts pay for themselves. (A lesson Canada is refusing to learn the easy way.)

  2. The reduction in the cost of servicing debt started well before 1995 – roughly the mid-80s, in fact – and was, along with revenue increase, a more significant factor than restraint/cuts.

  3. Geddes is simply wrong that deficit consolidations are successfully driven by a mix of tax cuts and spending cuts.

    The truth: spending cuts are the key.

    This has shown by numerous studies, primarily historical analyses, such as this one from the OECD analyzing the past 37 years:

    http://www.oecd-ilibrary.org/docserver/download/fulltext/5k9fdf5xptlq.pdf?expires=1340477158&id=id&accname=guest&checksum=51AE6D554BA93F6730BEE88432B9E05D

    “The typical consolidation that failed relied on 47 percent spending cuts and 53 percent tax increases.
    The typical consolidation that succeeded consisted of 85 percent spending cuts and 15 percent tax increases.”

    Even the Euro Central Bank has said so:
    http://www.ecb.int/pub/pdf/scpwps/ecbwp1241.pdf

    “First, major debt reductions are mainly driven by decisive and lasting
    (rather than timid and short-lived) fiscal consolidation efforts focused
    on reducing government expenditure, in particular, cuts in social
    benefits and public wages. Revenue-based consolidations seem to have a
    tendency to be less successful”

    Of course, GDP growth that results in increased tax revenues is a benefit, but there is no evidence that running deficits actually increases tax-generating growth when it is deficits themselves causing the fiscal crisis. In short, you can’t fix a debt problem with more debt! In fact, it’s been shown that excessive government spending crowds out the private sector. Canada’s consolidation benefited from GDP growth, but that growth was not generated by government spending, it was generated by the boom in our biggest trading partner to the south.

    • If all the borrowing the US was doing was crowding out private sector investment, demand for bonds would drop and interest rates would spike. But the opposite is happening: demand for bonds is very high; bond yields are very low.

      Many people were making this argument during the 1990s in Canada. But the reality is when interest rates were very high (early 1990s) this was due to the central bank raising them to fight inflation (peaking at 14% here; 8% in the US.) That was not the result of market forces but an inflation-hawk governor of the BoC (John Crow.) In the mid-1990s, the BoC slashed interest rates to spur economic recovery from the massive recession (after the Liberals fired John Crow.) To suggest interest rates went down because the government was reducing the deficit is a fallacy.

      Cameron is making similar remarks in the UK. But its absurd when looking at other countries with low-interest long-term bonds who are not slashing their deficits.

      The reason why people and businesses are holding on to their cash (or parking it in gold) preferring lousy returns on their investments to investing and spending the money? Because they have zero confidence in the global economy. It can all be explained by a lack of global demand caused by the 2008 global free-market meltdown we have yet to recover from. We are in the same boat as the 1930s. (Keynesian interpretation.)

      • BTW, it’s also a fallacy to suggest that cutting social spending creates more economic growth: the idea that people’s money is more effective in their own pockets. The reality is that when governments offer public benefits that means the average person has to spend less on benefits out of pocket, which increases their disposable income.

        If one compares the 30-year centrist post-war era to the past 30-year free-market era, living standards and economic growth were much higher in the Keynesian era. Also during that time we had the mildest business cycles in history and paid down most of our government debt.

        The free-market reforms of the past 30 years have been a complete disaster that culminated in a global economic meltdown founded on flaky banking deregulation. The reckless tax cuts and cuts to social spending didn’t put more money in the average person’s pocket. They caused soaring inequality and government debt. Not only that, we have a flailing global economy that is years away from recovery.

        I don’t know of anything in human history that has failed on as many levels as libertarian ideology has failed over the past 3 decades. Last time around a massive free-market failure led to world war. Hopefully we will be smart enough to turn around the SS Titanic instead of listening to corrupt businessmen proclaim: full speed ahead, damn the icebergs.

        • I’m not sure that I understand the logic of your first paragraph. I see that you are rebutting the idea that “people’s money is more effective in their own pockets” than when it is spent by government. But I do not see how this can possibly increase the average individual’s disposable income if the money for those benefits comes out of that individual’s pocket (out of his income) via taxation. The only way that this can make any sense is if we assume that the government provides or purchases these benefits more cheaply than individuals do. Is this your assumption?

          • First, if a society implements progressive taxation (as we did in the post-war era — as even Adam Smith advocated) then people of lesser means pay less for benefits than they would out of pocket. That frees up disposable income which also increases GDP growth and tax revenues. People who have better benefits are also more productive and have better opportunities to succeed.

            Second, there are examples where free-market delivery of benefits and insurance can be ineffective or nonexistent. US private health insurance and delivery produced a system with a bloated bureaucracy that cost twice what other developed nations paid and left tens of millions of people uninsured. In the post-war era, businesses provided workers with company pensions. After 30 years of downsizing they are practically nonexistent and now the government has to step in where the marketplace has failed.

            There are also conflicts that occur when governments try privatizing public services. Like with the 407 toll highway in ON, the government sold off a monopoly to a private company; they began gouging customers; now the highway’s original function of alleviating gridlock has been negated. In the Bush government there were ample examples of private companies looting taxpayer money; instead of delivering more services more efficiently taxpayers payed more for less.

            In short, Reagan’s vision was an abysmal failure. Americans are poorer and deep in debt thanks to failed tax cut, privatization and deregulation schemes. Looks like critics who originally called it “voodoo economics” were right on the money.

          • I’m afraid I keep getting tripped-up on your first paragraphs. Can you explain to me how GDP growth and tax revenues are increased?

          • Rich people increase their spending less relative to their income increases than to poor people. The reason being that rich people can generally satisfy their needs already. When they gain extra resources, there isn’t an immediate need to spend them. Poor people, on the other hand, have immediate needs, so when they find themselves with extra money, they spend it. Similarly, when more money is taken from rich people via taxation, they don’t slow down their spending habits as much as poor people — for the same reason. Taxes come out of the excess of resources for the rich, out of required resources for the poor.

            Thus, the average individual’s *disposable* income increases when more of the necessities are taken care of via progressive taxation — aka, the required needs for the poor have a larger part covered by the rich. The poor folk can thus spend more on other things increasing demand and thus increasing employment, etc. GDP goes up, a broader tax base is created (more employed) meaning more taxation, etc.

          • If those “excess resources” (money) had not been taken from the richer, is there any way that they could have contributed to GDP?

          • Sure, there’s plenty of ways they could have.
            There’s not many ways they *would* have, however, that’s the problem.
            Unless you’re arguing there’s absolutely no difference in how anybody spends money, in which case, there’s no difference if the government has it or not either.

            See, the poor get money and they spend it.
            The rich get money and it goes into a bank account, which right now the banks use to try to recapitalize themselves so that they’re not as over-extended.. meaning they’re not actually using it/loaning it out, they’re sitting on it.

            Now the rich person may choose to put it with his/her investment advisor, but these days, odds are that’ll be invested over in emerging economies. Something which does nothing for our GDP until the rich guy pulls it out and actually spends it on something here.. but.. because he’s rich.. there’s no need to.

          • Yes money in the hands of the rich can produce GDP. But one must also keep in mind that corrupt businessmen recently perpetrated a global “financial innovation” Ponzi scheme that bilked investors and taxpayers out of trillions of dollars causing the global economy to collapse (which we have yet to recover from.)

            It’s all a matter of balance. And the balance lies in leveling out inequality. High levels of inequality destroy an incredible amount of GDP because it impoverishes and enslaves people robbing them of their ability to realize their full human and economic potential.

            When government balances things out by bringing inequality down and offering citizens better opportunities to improve themselves, this raises productivity, GDP per capita and creates a greater market for businessmen to get rich off of and create more jobs. The right-wing cheaponomics used over the past 30 years has been doing the very opposite, which is why the global economy is in its present miserable state.

          • You are being very kind. The first paragraph is full of obvious non-sequiturs. He’s not good at writing bunk that could conceivably make sense and fool a few people.

          • This guy likes to throw around the term “non sequitur” (which he doesn’t appear to comprehend the meaning of) and use other forms of rhetoric instead of attempting to counter points I actually made. This is a typical ploy of someone incapable of supporting their position when it is challenged. The reality is my assertions are logically consistent and facts-based. I challenge anyone (who has capability) to prove otherwise (i.e. debate the issue.)

      • “If all the borrowing the US was doing was crowding out private sector investment, demand for bonds would drop and interest rates would spike”

        That is a non-sequitur. There is a small correlation between interest rates and capital investment. Interest rates are determined by supply and demand, but also by central bank fiat, and a number of other factors such as competition amongst lenders, and the performance of the stock market. None of these necessarily have any causative relationship to levels of private investment.

        And then you go off on a tangent about interest rates and deficit reduction for no apparent reason.

        And then you go off on another tangent talking about 2008, Keynesians, and gold. I’m sorry, but you are not replying to my comment at all.

        • “That is a non-sequitur. There is a small correlation between interest rates and capital investment.”

          For one, you just contradicted yourself. You say it makes no sense to establish a relationship between government borrowing and interest rates. (Like interest rates and the price of tea in China.) Then you turn around say there is a correlation.

          Second, I’m not the one who came up with that theory. It was supply-side free-marketers who predicted government borrowing would crowd out private investment causing an increase in interest rates as demand for government bonds fell.

          David Cameron is such a free-marketer who claims his austerity measures are responsible for the low-interest on long-term government bonds in his country (which is untrue given this is a global phenomenon.) Conservatives in Canada also falsely claimed the Chretien-Martin austerity measures lowered interest rates in Canada.

          Nobel Laureate Paul Krugman, BTW, is the one who originally pointed out the fallacy of this crowding out argument.

          • “You say it makes no sense to establish a relationship between government borrowing and interest rates”

            No, I didn’t. You seem to be confused.

          • I said: “If all the borrowing the US was doing was crowding out private sector investment, demand for bonds would drop and interest rates would spike”

            You said: “That is a non-sequitur [sic].”

            I interpreted your dim-witted accusation as: “You say it makes no sense to establish a relationship between government borrowing and interest rates”

            Clearly, I am not the one confused here.

            Perhaps you are suffering from a brain wasting disease. I strongly suggest you seek medical treatment immediately. (If you can’t comprehend what I just wrote then it looks like you’re toast.)

          • That one was even worse. Logic is not your strong suit. Nor is decorum.

          • “Nor is decorum.”

            Looks like I don’t suffer fools gladly. Thanks for pointing that out…

          • That’s not an improvement. Try harder.

  4. Paul Wells’ second-last paragraph was spot-on. The only part I disagree with is the “don’t bail out the rich Euro socialist” line being peddled by Conservatives. As far as I can tell, Harper and the Conservatives have gone out of their way to avoid saying anything of the sort. All they say is the Euros need to take decisive action. That’s it. I agree that they have not sold their policy on the issue, but on the other hand, the few statements that Harper has made has resulted in quite a strong backlash from the Euro parliament.

      • Well, he did use the more specific term welfare-state rather than the more general term socialist.

        And now I see what he wrote, I think what he said is a breath of fresh air.

        “They tax to the max, borrow to the brink and…they are seeking a bailout to continue spending what they do not have,”

        “This prime minister will not force hardworking Canadian taxpayers to bail out sumptuous euro welfare state countries and the wealthy bankers that lend to them.”

        In contrast to your characterization of those words, “rich, Euro socialist”, I think what he said does help, most notably because it is true and it does describe the situation well. Euro countries cannot tax more because they already take close to 50% of GDP in taxes. Not only do they spend every cent of that, but they borrow vast amounts in addition. And this is while they are all amongst the richer countries of the world. That is what Poilievre said.

        Do his words help with the Europeans? Not at all. But it does help describe the situation to ordinary Canadians who might not know the facts, or to people like Geddes who have some bizarre desire to send our own money into the Euro bottomless pit of spending. Seriously, the concept of sending bailout funds to one country who recently lowered the retirement age in the midst of the crisis, and a ruling that said that workers who get sick on vacation days are entitled to more vacation days, the concept of giving these people Canadian money is offensive.

        • Harper just agreed to bailout the state of Michigan to the tune of $500M (their share of the Detroit River International Crossing) and they just passed two new income tax cuts. Why is Harper doling out welfare to rich, capitalist Americans while, at the same time, telling Canadians they are living beyond their means?

          • What on earth does that have to do with anything I said? Secondly, you use the term “bailout” to mean practically anything. Thirdly, you use the term “welfare” to mean practically anything. Finally, you should really look up the term non-sequitur, the meaning is very simple.

          • Thankfully, the vast majority of people who participate in these discussions are not as dense as you.

  5. I love this little exchange, nicely done gentleman. Keep them coming.

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