When the Sept. 15, 2008, Lehman Brothers bankruptcy turned an American mortgage crisis into a global financial meltdown, governments in the United States and Europe staved off catastrophic banking failures by providing debt guarantees and injecting equity.
As the crisis subsided, national treasuries profited from bank equities purchased at the nadir of the recession. Act 1 of the governments’ response to the crisis was clearly a winner. Regrettably, Act 2 has been a gigantic loser.
John Maynard Keynes’ theory that governments should spend their way out of recession proved disastrous during the recessions of the 1970s and ’80s: interest rates and inflation skyrocketed while economic growth remained stagnant, a phenomenon that became known as “stagflation.” Given this woeful legacy, it seemed certain that Keynes’ stimulus spending theory had no greater chance of rising from the grave than the late economist himself.
But rise from the grave it did. In a desperate effort to end the 2008 recession as quickly and painlessly as possible, “everyone is a Keynesian” became the rallying cry. In the three-year period ending last week, the American national debt clock was pushed ahead by more than 40 per cent to US$14.6 trillion. Total gross government debt of the European Union jumped by more than a third to 9.8 trillion euros from 2008 to 2010. Yet, after the largest government spending in history, the U.S. and EU economies remain stagnant.
Rather than stimulating economic recovery, this massive government spending has had the opposite effect.
The Obama administration’s fixation on multiple debt-fuelled stimulus injections and “quantitative easing” (i.e. printing money) has taken the country progressively closer to insolvency, causing the private sector to eschew expansion in favour of hoarding cash. Unemployment remains high, consumer confidence low and economic growth anaemic. This has hobbled and demoralized the great American entrepreneurial engine that has always lifted the country out of past economic doldrums.
The economic picture is similarly bleak in many EU countries, and now the sovereign debt crisis threatens financial armageddon. It is now clearly evident that, rather than creating economic recovery, those trillions in stimulus spending have wrought a much and more devastating malaise.
Canada is one of the few countries that cut spending and paid down debt prior to the financial crisis. Consequently, it entered the recession with one of the strongest balance sheets in the OECD. But its decision to join the stimulus spending bandwagon increased Canada’s national debt by 23 per cent to some $560 billion since the fiscal year starting April 2008. While this deficit spending is a departure from years of fiscal prudence, the fact that we entered the recession with surpluses should make rebalancing the books within three years attainable.
Throughout the financial crisis, Canada’s mortgage portfolios remained sound and our banking system gained international acclaim. Strong demand and prices for our natural resources also helped us weather the storm. As the current sovereign debt crisis sweeps through the Euro-zone and the United States struggles to maintain financial respectability, Canada is viewed globally as a prudent and safe refuge.
Given this context, one would have thought that the last words passing any Canadian Parliamentarian’s lips would be “stimulus spending.” Yet, when Finance Minister Jim Flaherty appeared before the House of Commons Finance Committee on Aug. 19, there sat NDP finance critic Peggy Nash stating “Canada needs a countercyclical measure of more government … spending to boost the economy.”
Canada is not immune to the economic struggles of our largest trading partner or the very serious sovereign debt crisis in the Euro-zone, the world’s largest economic unit. The fallout is likely to stress our economic resiliency to the max. But adding more debt to our national balance sheet would reduce that resiliency, putting us on the same regrettable path to financial ruin that Keynesian theories have taken the U.S. and the EU.
Gwyn Morgan is the retired founding CEO of EnCana Corp.
