BUSINESS FRONT

THE RECOVERY BEGINS

WILL THE END OF COVID-19 MEAN THE BEGINNING OF STAGFLATION?

At the time of writing, more than 80 per cent of Canadians have received at least one dose of vaccine for COVID-19 and about half of us aged 12 or older are fully vaccinated. It seems to me – from my perspective in Toronto – that if someone hasn’t received a shot, it’s because they don’t want one. I think that in the not-so-distant future we’ll see that vaccination is required before you can get on an airplane, and individual employers may mandate full vaccination in order to return to work. For all intents and purposes, COVID-19 is behind us.

Almost all the developed countries of the world made the decision to greatly restrict individual liberty and economic activity to combat the pandemic. I believe that historians will conclude that there was a huge over-reaction. Governments turned what should have been a temporary public health emergency (Does anyone else remember the phrase: flattening the curve?) into a severe economic downturn and I’m unsure about how long it will take for North America to fully recover. Or whether the entire arc of economic history will be altered because of COVID-19.

This sounds, even to me, a bit hyperbolic. But let’s take a good, hard look at the public policy response in both the US and here in Canada. America is running a $3 trillion deficit for the second straight year. Canada’s deficit last fiscal year was $354 billion. That is more than $10,000 dollars of spending for every man, woman and child. In the year we’re in right now (fiscal 2022), it is still projected to be $155 billion. Looking out the year after that, 2023’s deficit is estimated at $60 billion which is an amount never before seen preCOVID-19 in Canadian history.

That’s one part of the story. The second part is interest rate policy. The bank rate currently stands at .25 per cent. But more important is the “quantitative easing” (QE) that the Bank of Canada is engaging in. QE means that the Bank of Canada is buying Government of Canada (GOC) bonds; however the bank claims that it is not “printing money” because it is showing an offsetting liability on its balance sheet. This is the type of double-talk that only the government or a quasi-government agency can get away with. The Bank of Canada argues that because eventually the bonds will mature, that it’s not like it’s printing money. Sure.

A WEALTH AFFECT

This is where we are right now in Canada. The federal government has taken on enormous debt, even as the population ages and the public demands more and more services. The Bank of Canada has pushed interest rates almost down to zero by (let’s cut the nonsense) printing money which has greatly inflated asset prices. This has led to a “wealth effect” that has created artificial demand, at least among a significant segment of the population. Now let’s imagine that the federal government cuts back on its spending and that arm’s length investors decide that a return of 1.8 per cent on 10-year GOC bonds just doesn’t cut it. Then what?

Here’s what I’m guessing what the next few years will look like. There has been a one-time bump in consumer demand as we “open up.” But that is temporary and fuelled by the massive amount of government spending. I would not be surprised if future deficits are much higher than the current projections, but eventually this would be inflationary and this disproportionately negatively impacts a key electoral demographic and that is senior citizens. Sooner or later, spending and revenues will be brought in line and I see higher taxes on middle and upper-middle income Canadians.

The Bank of Canada will be keeping short-term interest rates at a very low level for an extended period. This will allow the federal government to roll over its debt inexpensively. It’s possible that it can extend its QE programs indefinitely and I would not be surprised if it does. But eventually this too will be inflationary and then the question will be whether it appears in the consumer price index (in which case it’s highly problematic politically) or will we continue to see the appreciation of asset prices, which is something that tends to benefit older Canadians at the expense of younger ones.

Everything I see suggests that over the next three to five years we will be entering what should be understood as an extended period of stagflation: stagnant growth combined with higher levels of inflation than the Bank of Canada’s two-per cent target. We’ve seen this occur before. The midto-late 1970s saw tepid growth coupled with high inflation. With 20-20 hindsight, we know that the technological revolution propelled us out of that economic funk. Here’s to hoping that history repeats itself. SP

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.

“The Bank of Canada argues that because eventually the bonds will mature, that it’s not like it’s printing money. Sure.”