One of the mysterious aspects of public sector debt is what happens to the bondholders when debt is retired. Take the Canadian government`s debt repayment plan as a case in point. The Government intends to pay down as much as 31.5 billion dollars according to its economic plan over the next 6 years.
First of all the bulk of Canadian federal government debt holders (about 80 %)are Canadian residents and taxpayers. So paying off these debt holders will return money in the form of interest and principal payments within the domestic economy. Previously invested savings will now have to seek new outlets for investment.
As less and less new government debt is issued because governments are with the exception of Ontario running surpluses where will these savers turn ? Alberta alone has an 11 billion dollar plus surplus.
In addition the interest payments unless they are sheltered within RRSPs will be subject to taxation thereby returning a portion of the income flow back into the Government`s revenues. This has been true even before the debt was retired as regular interest paid on the debt went in large measure to Canadian taxpayers. But the absence of new issues will likely lead to an increase in the supply of savings seeking investment outlets. Where will the money go ? The stock market ? The corporate bond market ? The foreign bond and stock markets ? These are interesting questions that have implications for the future value of stocks, the behaviour of medium and long term interest rates and the exchange value of the Canadian dollar.
Beyond this paying down the debt will not be stimulative, although reducing the Government`s surplus through tax reductions and new program spending is. Unless you believe that paying down the debt significantly reduces interest rates through increasing the supply of loanable funds there is nothing stimulative about increasing the supply of liquid savings.So long as the overall economy is growing there is no problem. But should it slow down the increase in liquid savings will complicate matters.Of course, if these former bond holders become consumers with their savings thats a different story. But not a likely one.
More about this later.
Saturday, October 9, 2010
On exchange rates and trade balances
A Rising Exchange rate on our dollar complicates the problem of selling our exports.Some politicians apparently believe that a strong dollar is good for Canada and that a rise in the exchange rate is good for our exports. This could only be so if the rise in the price of our exports abroad due to the rise in the value of our currency can be offset by a rise in productivity which cheapens the cost of production despite the rise in price due to the rising exchange rate . But how can that happen?
Theoretically it can happen in two ways. One way is virtuous, perhaps , the other definitely not virtuous. The first possible virtuous way is if new technology which increases output without causing job loss in the industry concerned appears on the scene, paid for by rising profits in the industry. This might happen.
But all too often the incentive of new technology is to displace labour. Workers are replaced by machines and not necessarily absorbed in new industries. Furthermore, there is the danger that industries under pressure from rising exchange rates will seek to raise productivity by forcing workers to work longer hours with less pay or lay off some workers to reduce labour costs while simultaneously trying to increase output. This is the non virtuous way.
It is this latter approach that all too often has been resorted to by manufacturing concerns in the auto industry in the United States . The labour unions in Canada are understandably opposed to these kinds of anti-worker labour practices and have vowed to fight this pressure for reduction in wages, working conditions and benefits. So if the Federal government wants to give itself and manufacturing interests some leeway to plan for virtuous productivity gains it needs to restrain the Bank of Canada`s enthusiasm for higher interest rates. Because higher rates result in a higher exchange rate for the dollar and greater pressure on the manufacturing export industries.
It sounds complicated but its what the new globalized world is all about. Thinking smarter about economic policy makes good sense for everyone.
Theoretically it can happen in two ways. One way is virtuous, perhaps , the other definitely not virtuous. The first possible virtuous way is if new technology which increases output without causing job loss in the industry concerned appears on the scene, paid for by rising profits in the industry. This might happen.
But all too often the incentive of new technology is to displace labour. Workers are replaced by machines and not necessarily absorbed in new industries. Furthermore, there is the danger that industries under pressure from rising exchange rates will seek to raise productivity by forcing workers to work longer hours with less pay or lay off some workers to reduce labour costs while simultaneously trying to increase output. This is the non virtuous way.
It is this latter approach that all too often has been resorted to by manufacturing concerns in the auto industry in the United States . The labour unions in Canada are understandably opposed to these kinds of anti-worker labour practices and have vowed to fight this pressure for reduction in wages, working conditions and benefits. So if the Federal government wants to give itself and manufacturing interests some leeway to plan for virtuous productivity gains it needs to restrain the Bank of Canada`s enthusiasm for higher interest rates. Because higher rates result in a higher exchange rate for the dollar and greater pressure on the manufacturing export industries.
It sounds complicated but its what the new globalized world is all about. Thinking smarter about economic policy makes good sense for everyone.
The Liberals mini budget
The Canadian Federal Government's economic statement or mini budget contains some interesting information. Because it intends to reduce taxes, increase spending and reduce the surplus in the coming year from over 13.6 billion dollars to just 4.6 billion if we include the contigency funds of 3 billion the net effect will be more stimulative or at least less contractionary than would otherwise be the case.
So long as the unemployment rate stays at 6.6% or hopefully drops further and the central bank doesn't raise interest rates the results ought to be positive for growth. What is also revealing about the statement is the enormous size of the surpluses that are going to be available for the forseeable future provided there are no surprises on the revenue front because of a business cycle downturn due to energy shock or central bank shock.
The Government also plans to pay down an additional 31.5 billion dollars in debt reduction in order to reduce the debt to GDP ratio to 25 and then 20 % by far the lowest debt ratio in the G7. Since the debt ratio will drop anyway simply by the growth in the GDP and the ratio is already below 30 % on a national accounts basis there is lots of room for moving some of the funds from debt reduction to program spending investments in health care, education, infrastructure and refurbishing the military over the coming years.
Program spending despite the increase in spending that is announced in the statement of an additional 10 billion dollars is still at the lowest it has been as a share of the GDP since the 1950s. If the Government wanted to lower the unemployment rate further down to below 6 % and repair more of the damage to the health care system and infrastructure the opportunity is definitely there.
So long as the unemployment rate stays at 6.6% or hopefully drops further and the central bank doesn't raise interest rates the results ought to be positive for growth. What is also revealing about the statement is the enormous size of the surpluses that are going to be available for the forseeable future provided there are no surprises on the revenue front because of a business cycle downturn due to energy shock or central bank shock.
The Government also plans to pay down an additional 31.5 billion dollars in debt reduction in order to reduce the debt to GDP ratio to 25 and then 20 % by far the lowest debt ratio in the G7. Since the debt ratio will drop anyway simply by the growth in the GDP and the ratio is already below 30 % on a national accounts basis there is lots of room for moving some of the funds from debt reduction to program spending investments in health care, education, infrastructure and refurbishing the military over the coming years.
Program spending despite the increase in spending that is announced in the statement of an additional 10 billion dollars is still at the lowest it has been as a share of the GDP since the 1950s. If the Government wanted to lower the unemployment rate further down to below 6 % and repair more of the damage to the health care system and infrastructure the opportunity is definitely there.
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