Beware The Pain-for-no-gain Scenario

Beware the pain-for-no-gain economic scenario Gwyn Morgan, Globe and Mail – Jan 19, 2009

VICTORIA — It's only been six months since Japan hosted the G8 leaders' summit in Hokkaido Toyako, but the issues discussed then stand in sharp contrast to those of today. Topping the Hokkaido agenda was the economic impact of skyrocketing oil prices and the resulting transfer of economic power from the West to East, along with the dangerous supply dependency on countries such as bellicose Iran, Hugo Chavez-led Venezuela and geopolitically ambitious Russia. Food prices were escalating at the time and the devastating prospect of food shortages loomed for the world's poorest people. On another front, enormous U.S. fiscal and trade deficits were battering confidence in the world's benchmark currency. In Canada, robust revenues from the export of high-priced oil, base metals and grain had driven the loonie from 85 cents (U.S.) to par in only fifteen months, allowing little time for struggling manufacturers to adjust. The commodities boom fuelled high steel, concrete and transportation prices, resulting in huge cost overruns, labour and materials shortages, as well as severe project delays. For first-time buyers, years of escalating housing prices and the prospect of inflationdriven increases in mortgage rates made buying a home increasingly difficult. In the midst of today's gloom we might wish to turn the clock back, but could we have lived with ever-increasing food and energy prices and yielding the West's economic sovereignty to Russia and the Middle East? I think not. This financial crisis is painful, but we'll get through it and the fortuitous gain from this shorter-term pain is the avoidance of a more dangerous outcome. That is, unless ill-considered reactionary attempts by Western governments to soften the crises brings back those same problems, as well as saddling taxpayers with enormous public debts and deficits. What are the signs that this pain-but-no-gain scenario may well happen?

BAILOUTS OF THE DOOMED Private sector enterprises survive by constantly adapting to a changing environment, but even corporate great-grandfathers eventually die. Governments of successful countries strive to create an enterprise ecosystem populated by companies at all stages in their life cycle. Artificially interfering with this birth-growth-death cycle by subsidizing dying businesses wastes taxpayer dollars and pollutes the enterprise ecosystem. The longer-term outlook for Western countries, Canada included, is for a shortage of trained workers. A far better choice for public expenditures is in transitioning and retraining workers for the new jobs being created by the growing enterprises that are crucial to our country's prosperity. ILL-CONCEIVED SPENDING Global governments seem to be in a race to spend trillions of dollars trying to get their economies moving again. Panicky politicians are unlikely to make choices that both optimize value for the public dollars spent and have real-time impact. The danger is that lead times associated with new projects cause these huge public expenditures to occur after the economic crisis has passed, thereby competing for labour and materials with private-sector projects. This may well bring back labour and material shortages, driving cost overruns for both public and private projects. PRINTING TOO MUCH MONEY In an effort to head off a perceived threat of depression-style deflation, central banks are using all traditional tools, and an unprecedented array of new ones, to add "liquidity" to financial markets. Since the supply of assets, goods and services is finite, more money circulating in the economy necessarily means that the value of each unit of a nation's currency will decrease, causing the nominal cost of almost everything to increase. Zimbabwe is the extreme case in point. The global economic crisis has reduced the cost of fuel, food, housing and most other things. Given where costs were going, that is a good

thing. However, printing too much money would put us back into the inflationary spiral we entered only six months ago. DEFLATING INVESTMENTS The collapse of stock markets has hammered the value of both personal investments and pension funds. The value of most stocks will likely recover, restoring the nominal value of investments and pension funds. However, if the combination of government stimulus programs and money-printing creates an inflationary spiral, the buying power of those apparently recovered investments and pensions may be drastically lower than before the crisis. The fact is, inflation is great for debtors, including governments which have deficit spent their way into un-repayable debt, and individuals who have done the same. But for savers and pensioners, high inflation is a crippling plague. The cruel irony of high inflation for savers and pensioners is pain when the markets collapse, while being little no better off when they recover. STRUCTURAL DEFICIT DISEASE Experience has demonstrated that "temporary" government spending programs result in dependencies that spawn special interests who lobby to delay ending their taxpayer-funded largess. The so-called temporary transition program implemented after the collapse of the East Coast cod fishery is a sad case in point. The perceptions and realities that make new spending programs good politics and their demise bad politics means inflationary government deficits will likely continue long after the financial market meltdown ends. The result higher taxes and inflation, which prevents our country from fulfilling its economic potential. We must not forget that the real cause of this economic crisis is

imprudent lending practices and the handoff of bad loans, disguised and rated as quality investments, to unsuspecting investors. The pain is great, but many of the dangers discussed by G8 leaders only six months ago have faded. Let's hope government actions don't negate the gains, resulting in greater long-term pain.