THE THREE LITTLE LETTERS THAT COULD SPELL BIG TROUBLE FOR THE LOONIE
If Ontario’s NDP win, balance sheet could take a big hit, David Rosenberg argues.
The poor Canadian dollar. It never could benefit from the rise in global oil prices because of the surplus of supply here at home, courtesy of an incoherent national energy strategy. NAFTA concerns have been a constant overhang this year, not to mention the heightened risks of a U.S.-led global trade war, and what that could mean for a country with a 25 per cent export-to- GDP ratio. Ottawa’s lack of response in the federal budget to U.S. tax reform was a real blow, allowing net effective corporate tax rates to move above stateside levels, which will only deflect capital investment and job creation to south of the border. Talk about shooting yourself in the foot. The illadvised January rate hike by the Bank of Canada, along with the myriad of fiscal and re-regulatory measures to combat the housing bubbles in Toronto and Vancouver, have created a major reversal on those real estate markets that will result in negative economic spillover effects.
So while the Fed is gently raising rates, the BoC is now on hold, and maintaining negative interest rate differentials will ensure that the Canadian dollar remains weak as far as the eye can see, irrespective of what commodity markets do. Even on this score, the outlook for the resource sector has been dealt a bit of a blow from the general coolingoff in global growth — the hot synchronized story is now in the rear-view mirror — as well as the Saudi/Russian decision to lift some the oil production curbs, which finally had helped recently to bring the world crude market back into balance.
Finally, a revival in the Eurozone existential threat, this time led by Italy as opposed to Greece, is going to cause the loonie to get caught in the crossfire of the renewed shift in investor sentiment towards safety.
Now the critical numbers have little to do with commodities or the economic data as much as the overall political backdrop. If the polls are correct, the country is poised to take another turn to the left (we are already down to just two pro-business governments across the land, in Saskatchewan and Manitoba). What I am referring to specifically are the latest Ontario election polls now showing the NDP with 47 per cent support among decided or leaning respondents (vs. 33 per cent for the Conservatives and 14 per cent for the Liberals). The PCs have no concrete platform and have sounded incoherent on the policy front outside of platitudes; the Liberals have eviscerated the province’s once-stellar balance sheet, and so the polls suggest that the NDP is the least unattractive alternative. Sort of like the smartest kid at summer school. The NDP “Change For the Better” policy platform is a classic socialist manifesto that may very well play into an electorate lining up for giveaways — the NDP plans to introduce dental care for everyone, pharmacare for everyone, free child care “for families who need it most” and a slate of spending initiatives that will take up too much space here to comment on.
But in aggregate, government spending in this plan is estimated to balloon nearly 20 per cent in the next four years, to be paid for with even higher taxes. The NDP would push the top provincial tax rate up by two percentage points for individuals and 1.5 percentage points for corporations. This, in turn, would bring the combined federal/provincial top personal income tax rate to 55.5 per cent, which starts to enter the domain of confiscation, and to 28 per cent for the business sector, creating an even larger competitiveness gap with our U.S. as well as global competitors.
This doesn’t sound all too different from the “tax and spend” policies of the last NDP government more than a quarter century ago. Recall that in the September 1990 Ontario election, the NDP won a majority government (74 out of 130 seats in the Legislature) with 38 per cent of the vote. The NDP right now have 47 per cent support. Also note that the very last poll taken a week before that election showed the NDP with 38 per cent support, so this latest survey has to be taken very seriously. Also, as is most surely the case today, there were 18 per cent “undecideds” in that last poll leading up to the 1990 vote. Even though it seemed increasingly likely that Bob Rae would pull it off, his party’s victory was still enough of a shock to the financial markets that the Canadian dollar slid 0.5 per cent the very next day.
No doubt, there were a variety of factors undermining the currency in those days, from the adjustment to the FTA and the GST to the hangover from the housing bust in the GTA and the prior sharp tightening in monetary policy under the John Crow regime at the Bank of Canada. But the facts are still the facts, and the fact is that throughout the entire NDP government in Ontario from September 1990 to June 1995, the Canadian dollar lost more than 15 per cent of its value.
It may pay to dig into the memory bank and recall that the NDP took over in 1990 with the provincial debt/GDP ratio of 13.4 per cent and a AAA credit rating and left it in 1995 with a 30.2 per cent debt ratio and a AA- ranking. The Conservatives then took said ratio down to 26.8 per cent by 2002 and had the credit status of Ontario upgraded to AA, to only then have the Liberals, over the next 15 years, boost the debt/ GDP ratio to 37.1 per cent, resulting in the poorest credit rating we have ever had to endure at A+.
We go into this election with current total government debt relative to GDP in Canada, both provincial and federal combined, at 113 per cent versus 103 per cent back in 1990. Tack on business and household indebtedness, and this ratio is at 290 per cent versus 197 per cent back then, and a level that would even make the Italians blush. Add in Canada’s rising net external liabilities, and the picture for the Canadian dollar is no Tom Thomson masterpiece to say the least — today’s three per cent current account deficit-to- GDP ratio is not that far off the four per cent level prevailing the last time the Ontario NDP took office back in 1990. Perhaps the complete dilapidation of the balance sheet, specifically in Ontario but for the country at large (Saskatchewan may be an exception) is of little concern for an election where the personalities and character of the leaders have emerged as the key determining factors for the electorate writ large, but that doesn’t mean that it shouldn’t be a concern. It should be a very big concern, all the more so after the latest auditor general report, because as we have seen in the past (and in Italy today), inexorably rising debts and heavy tax loads come with a heavy price tag for the economy down the road. The grim reality is that no party really has a firm grip on this historical fact, and the party in the lead does at least have a platform, while one does not and the other has a horrible track record in managing the province’s finances.
And that party with the platform is in the lead in the polls, so if the NDP does win, investors at least will have a template from 1990-95, which means a weakening path for the Canadian dollar and widening bond yield spreads for the province of Ontario.