Ben White’s excellent Morning Money newsletter on POLITICO carried an item yesterday on the U.S. government deficit. The subject has of course gained fresh importance in light of the oncoming fiscal cliff deadline. Jim Paulsen, chief investment strategist at Wells Capital Management, was quoted explaining that Washington’s finances are driven more by economic cycles than by government spending or tax policy.
“[M]ost of the contemporary budget problem is cyclical in nature rather than structural,” he said. Deficits balloon during recessions and then come back into line once the economy recovers. Paulsen said that the ratio of government deficit to gross domestic product (GDP) in the U.S. is about 30% better than it was at the height of the recession. And in his view, government debt-to-GDP could peak in a couple of years and then start to come back down.
I expect Canadian policy makers are having much the same conversation right now. Federal Finance Minister Jim Flaherty announced yesterday that the country will undershoot its deficit targets for the next four years as a result of the global economic slowdown.
Lower commodity prices are primarily to blame. Downturns in Asia, Europe and a slower than hoped-for recovery in the U.S. have depressed global demand for our commodities and so prices have fallen. Lower prices mean less revenue for Canadian companies in that sector, which in turn means lower corporate tax revenues.
It’s a real-time demonstration of what happens to government budgets when the global economy weakens. Canadians, because of our national economy’s reliance on commodities, are particularly vulnerable. Our federal deficit has reached $26 billion. Ottawa is projecting a $7.2 billion hit to its revenues during the next five years.
Flaherty warned yesterday that the federal government will be a year late in its efforts to balance the budget. That takes us to the 2016-17 budget year before the current federal government debt of $600 billion is erased.
Here’s the point, though. This is a natural byproduct of the damage done to the global economy during the run-up to the 2008 financial crisis. It will pass, in time.
Inevitably, there will be calls to cut government spending more aggressively in the short term. I’d argue those calls are misguided. We can ride this out. Canada has retained its top-level credit rating with each of the three major rating agencies, and bond holders continue to pay a decent price for our debt. We’ll continue to hear plenty of rhetoric about government debt in Ottawa. In my opinion, though, there is nothing to worry about.
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