In looking forward towards a post-pandemic recovery for Canada, an important player is the bond market. Over the last 20 years, Canadian provinces have borrowed heavily. Total provincial bonds now exceed federal government bonds – $650 billion outstanding for the provinces, $600 billion federal. Provincial bonds outstanding have grown by 325% over the 20 years, while federal bonds rose by 180%. And, now, for the future, more governmental borrowing at both the federal and provincial levels is a solid certainty.
Shockingly, Canada’s provinces – now in the midst of the COVID-19 pandemic – are expected to run an enormous aggregate deficit of $100 billion – $41 billion for Ontario, $20 billion for Alberta, and even $5 billion for Manitoba. The federal 2020-2021 deficit itself could exceed $250 billion for this year.
While no province has yet issued a new bond this year, nor have credit rating agencies been asked to provide a rating for them during this period of pandemic, new issues and changed credit ratings are coming. Many provinces will not be able to maintain their current investment grade, smitten with declining tax revenues and increased expenditures. There cannot be little doubt that most if not all new provincial bond issuances will be substantially downgraded.
The Government of Canada is now issuing 25-year bonds at rates of about 0.75%; compared to non-investment corporate grade bonds priced 10 times higher. With no province wanting to test the bond market without the support of the federal government, the expectation is that the federal government, through the Bank of Canada, will purchase hundreds of billions of dollars of provincial bonds at rates around 1%. This to finance both ongoing provincial deficits and to refinance any past issued provincial bonds which become due, and at rates below the current inflation rate.
Like any lender of last resort, the Bank of Canada will impose requirements on Provincial borrowers, and substantial political influence will be in play. There are generally two ways that this can go, either governments will adopt policies, designed to restore fiscally sound governments, both federal and provincial, or federal and provincial governments will continue to run massive deficits – leading to the issuance of more and more bonds.
If Canada and the provinces continue to issue $200-400 billion in new bonds every year, this would have a significant negative impact on the value of the Canadian dollar and increase inflation. Modern monetary theorists claim that governments which issue bonds in their own currency can never go broke. But, while that might be true, the reckoning comes by way of devaluation of currency and high levels of inflation.
Those of us who are old enough remember the financial mess (with massive deficits) left by the federal governments of Pierre Trudeau (Liberal) and Brian Mulroney (Progressive Conservative). Then, Canada was severely rebuked by the International Monetary Fund (IMF) over its debt level and the growth of the debt. At least two provinces (Saskatchewan and Newfoundland) required federal bailouts in the 1990s; this is after running massive deficits for over a decade. Jean Chretien had to, and did, make some very difficult choices, choices involving freezing and cutting programs, but brought the country back from the brink of financial disaster.
Our current Prime Minister inherited a strong federal fiscal position but weakened it by running annual deficits for the past 4 years of his party’s rule. Now, with spending to combat the economic collapse brought on by the pandemic, federal and provincial deficits will explode – leaving Justin Trudeau’s Liberal minority governments in a difficult place. Will he accept that his government is unable to introduce much of his left-of-centre policies without even worsening Canada’s financial situation? Will he have the toughness to hold post-pandemic spending down? Or, will he capitulate to special interest groups, and continue to run and facilitate large deficits and just print money?
Only time will tell. While it is easy to excuse governments’ spending and borrowing in a crisis, the needed hard part is to stop doing so when the crisis is over. There will be a truly defining moment for our country – far more than defeating the virus itself.
Will we be up for the challenge? Or, will our governments dither and accept further currency devaluation bringing on high rates of inflation, making all us poorer?
Randy Boldt is a senior fellow at the Frontier Centre for Public Policy.