ECW.ca - Earthwide Credit Watch

In January 1995, the Wall Street Journal ran an editorial entitled Bankrupt Canada? It warned that our country flirted with economic ruin (a la the Mexican peso crisis) because of profligate government spending, chronic deficits, and lack of fiscal and monetary policy co-ordination. The Journal’s shot across our policy bow helped firm up support for action by the political class and by the Bank of Canada.

Fourteen years later, and in the midst of a recession, it is encouraging to see how our progress has been noted, this time by another American publication.

In this week’s edition of Newsweek, foreign affairs editor Fareed Zakaria praises Canada’s virtues. He begins with a comparison of the banking system, where he notes that unlike the U. S. where several dozen banks went under in the past year, Canada has seen no bank failures.

As to why, Zakaria points out American banks are leveraged with $26 for every $1 in actual capital; here, the equivalent ratio is $18-to-$1. Europe’s banks–prepare to gasp–are leveraged $61-to-$1. The European figure perhaps explains why the Royal Bank of Scotland just lost a whopping $50 billion in 2008.

On another measurement, Zakaria notes Canada’s public pension system is on surer footing. In the United States, revenues from pension deductions are pooled into the larger pot of money spent annually by the U. S. federal government; ours is separated from the federal government’s annual books and managed at arm’s length and the Canada Pension Plan is managed with an eye to actuarial tables that project necessary pension payouts into the future. The difference is all the difference in the world: the American government has a huge looming pension liability; the Canadian version is prefunded.

There are aspects of the Newsweek analysis with which Canadians should quibble. Zakaria’s flattery shouldn’t blind us to the reality of some yet necessary hard policy lifting. For example, Zakaria looks north and sees a country that spends just 9.7 per cent of GDP on health care and provides universal access; the United States spends 15.2 per cent and doesn’t.

Zakaria calls our health care version “cheaper.” Actually, “cheap” is a better description. Spending less doesn’t always mean spending smarter. Delay oil changes on your automobile and the engine replacement you’ll later need will reveal the initial “cheaper” approach as penny-wise and pound-foolish.

The reality is that both the U. S. and Canadian systems have their flaws and neither is “universal.”Here, we cheat the principle of universality by forcing patients onto waiting lists where they suffer and in some cases die. In addition, we cheat doctors by under-paying them for their time and skills. Both the U. S. and Canada could learn from Europe where every country has a better mix of private and public health-care delivery and insurance options. The result is that both private and public money are more effectively spent and patients get better health care.

Other aspects of the Zakaria essay that need qualification include his praise of our real estate market. He notes, properly, that Canada’s housing market experienced less of a bubble because mortgage interest is not deductible here the way it is in the U. S. That, along with subprime foolishness tempted too many Americans to gorge on houses they really couldn’t afford. But we had similar albeit smaller temptations thanks to our own government-owned lending agent, the Canada Mortgage and Housing Corp., which started to approve and guarantee 40-year mortgages before the federal Conservatives shut down the practice.

As for the housing bubble, hold the champagne in at least some regions. Gary Shiller, one of the American economists responsible for the Case-Shiller Index on housing prices, and who predicted the U. S. housing bubble burst long before it did, was asked last year about Canada’s real estate market. He noted it was not, in general, as over-inflated as the American market. But Shiller did specifically point to Vancouver and Calgary’s dramatic price spikes as eerily similar to the U. S. pattern.

Major quibbles like that aside, along with my own concern that federal and provincial governments are about to again bust the taxpayer bank with their deficits, Zakaria is correct to note the sensible policies implemented since the last time an American publication deigned to look up north.

So if the world comes to see Canada as the North American version of Switzerland–conservative, cautious, prudent, and stable–great. When other nations must deal with severe economic eruptions including failing banks, such characteristics are rather desirable.

Finance Minister Jim Flaherty is encouraging Canadian businesses to borrow and invest with budget measures meant to improve access to credit and provide modest tax breaks for capital expenditures.

In his budget released Tuesday, the finance minister also backed away from a controversial measure – announced two years ago – to limit the interest deductibility when companies borrow to finance a foreign affiliate.

He also said he would move quickly to create a national securities regulator - over the objections of Quebec and Alberta - by the tabling legislation later this year.

In his speech before Parliament, Mr. Flaherty said lack of access to credit remains one of the biggest concerns for Canadian businesses and families. He increased federal financing for credit markets by $69-billion yesterday, bringing it to a total of $200-billion since the crisis deepened last fall.
 
“Well-run businesses find it harder to finance the purchase of machinery,” Mr. Flaherty said. “This shortage of financing can make a difficult economic situation much worse.”

To fill the gap left by traditional lenders, Ottawa will plow additional money into the Business Development Bank of Canada, Export Development Canada and Canada Mortgage and Housing Corp.

That effort includes $12-billion to re-purchase auto-related loans from banks and other financial institutions to provide increased liquidity for the financing of auto dealers, and consumer car loans and leases.

It also includes an additional $5-billion to the EDC and BDC to provide credit at market rates for Canadian companies with viable business models whose access to credit would otherwise be restricted.

Mr. Flaherty complained consistently in the lead-up to the budget that Canadian banks were not doing enough to provide access to capital. But on Tuesday, he committed an additional $50-billion to the Insured Mortgage Purchase Program, bringing to $125-billion the amount Ottawa has allocated to buy mortgage-backed securities from banks to improve liquidity and boosting lending.

The minister moved to encourage companies to make capital investments by extending generous tax writeoffs on new machinery and equipment.

The budget promises temporary increases in the capital-cost-allowance rates for computers and software, and for machinery and equipment used in manufacturing and processing.

Mr. Flaherty also announced the government will eliminate import tariffs on a range of machinery and equipment, which should save Canadian business some $440-million over the next five years.

Finance Canada says the tax breaks will provide economic stimulus and assist Canadian businesses during this challenging period. The government expects the accelerated writeoffs for computers will cost $695-million over two years, while the two-year extension for manufacturing and processing businesses will cost nearly $1-billion between 2011-2012 and 2013-2014.

While Mr. Flaherty provided additional access to credit and some target tax breaks for business, he also retreated from a highly contentious plan to reduce a corporate tax break for companies that borrow to finance overseas operations.

In 2007, the minister created a storm on Bay Street when he announced that Ottawa would no longer allow companies to deduct such borrowing costs in both Canada and the jurisdiction of the foreign affiliate, a common practice among competitor countries.

In December, a committee in international taxation headed by Peter Godsoe, former chief executive officer at the Bank of Nova Scotia, recommended Ottawa scrap that plan, and on Tuesday, Mr. Flaherty accepted that recommendation.

“The change in the interest deductibility plan is a fairly major change,” said Bruce Flexman, chair of the tax policy committee for the Canadian Institute of Chartered Accountants.

“If you want a purely technical approach to tax policy, [the double deduction] is hard to justify. But if you want a Canadian tax system that is competitive, it makes sense to give Canadians to same ability to get deductions as their international competitors.”

Mr. Flaherty maintained the pace of business tax cuts, which will reduce the general corporate income tax rate to 15 per cent by 2012 from 22.12 per cent in 2007.

He also provided some added relief for medium-sized businesses by increasing the amount of income eligible for the small business tax rate to $500,000 from $400,000.

The Canadian dollar
strengthened versus the U.S. currency on Wednesday, as thin
market volumes forced the currency to ride the wave of
corporate buyers and fund managers readjusting portfolios ahead
of the year end.

 Bonds ended little changed in a holiday-shortened session,
outperforming U.S. treasuries.

 At an early close of 1 p.m. (1800 GMT), the currency was at
1.2092 to the U.S. dollar, or 82.70 U.S. cents, up from
C$1.2146 to the U.S. dollar, or 82.33 U.S. cents, at Tuesday's
close.

 With many market players out finishing up Christmas
shopping rather than watching data screens, the currency paid
little heed to its traditional drivers, rising despite a 3
percent drop in oil prices and not moving on
stronger-than-expect Canadian October growth data.

 "Really it's just been about the flows," said Steven
Butler, director of foreign exchange trading at Scotia Capital
in Toronto.

 "We did see a bit of corporate (U.S. dollar) selling today.
I think there was a bit of an overhang of (U.S.) dollar
sellers."

 Canada's economy contracted by 0.1 percent in October,
compared with analysts' expectations of a 0.3 percent decline.

 Market players are largely in a wait-and-see mode as
January will bring an expected stimulus package in Canada's
federal budget, the inauguration of U.S. President-elect Barack
Obama, and an interest rate decision and Monetary Policy Report
Update by the Bank of Canada.

 BONDS MIXED

 Bond prices were little changed, outperforming U.S.
treasuries, which gave back early gains.

 Canadian bond yields hit their lowest in more than a decade
last week, and U.S. yields -- which have declined as the U.S.
Federal Reserve has chopped its key interest rate to nearly
zero -- are even lower.

 While Canada's economy is now believed to be in recession,
the country has not experienced real estate and financial
services meltdowns anywhere close to those in the United
States.

 The two-year bond rose 2 Canadian cents to C$102.93 to
yield 1.205 percent. The 10-year bond climbed 7 Canadian cents
to C$111.92 to yield 2.801 percent.

 The yield spread between the two-year and 10-year bond was
at 161 basis points, up from 159 at the previous close.