The new Prime Minister of Canada, Justin Trudeau, promised in his winning electoral platform to run reasonable deficits in order to stimulate the economy. This is the first time in recent memory that a G7 country is openly advocating running public deficits. Other countries have incurred deficits but have excused them as temporary. In this case the advocacy is explicit.
When I was Canada’s ambassador to the OECD in the late nineties, Canada had the worst deficit in the G7 Club, which prompted the Wall Street Journal at the time to label Canada “an honorary member of the Third World.” But in a few short years, under the Liberal Government of Jean Chretien, the deficit was transformed into a surplus and Canada became a world model of successful deficit management.
Are we now witnessing a return to the ‘bad old days’? Should we be afraid of deficits and their accumulation over time? Is Canada behind the times or, on the contrary, ahead of the pack?
At stake is a simple question, which has been obfuscated by a priori ideology: is debt always bad or sometimes just what is most needed?
On the one side, there is the so-called ‘German’ school of thought — unreservedly against deficits. It is instructive to note that the German word for debt is ‘schuld.’ Interestingly, the German word for ‘guilt’ is also ‘schuld.’ Hence, an indebted person or organization must be ‘guilty.’ The German aversion to debt explains in part the Eurozone espousal of austerity and its opposition to deficits. Live within your means is the supreme motto.
In contrast, the ‘Anglo Saxon’ concept of debt is different and predates Keynes. Modern capitalism has been built on a philosophy of borrowing and lending. Cheap loans for investment and consumption and the use of ‘OPM’ (Other People’s Money) to build fortunes have been the rule, not the exception. In fact, very few of today’s billionaires have reached their high wealth by using only their own money. The leveraging potential of OPM is awesome and both individuals and governments in the Western World want to jealously preserve a good credit rating in order to borrow even more. In case things go bad, there are bankruptcy laws to protect the borrower. Presidential candidate Donald Trump has freely admitted that he has used U.S. bankruptcy laws four times to restructure his companies and increase their profitability. No guilt there.
Given a possible new acceptance of deficit-spending in the G7 countries, which may result from Canada’s example, here is a proposed four-point checklist, free from ideological beliefs, to try and allay irrational fears regarding indebtedness while reinforcing the rational ones.
1. What is the purpose of debt?
Debt creation to build infrastructure or, for that matter, to invest in general, makes a lot of sense. This is what the Trudeau government intends to do. In fact, even borrowing to stimulate private sector consumption may make sense when the economy is dragged down by high unemployment and unused capacity.
But there are two negatives to be avoided like the plague: borrowing to meet current public expenses and even worse, borrowing to pay back old debt with new debt. This was the trap that Canada was in in the nineties but managed to escape from. This is also the trap that Greece has been in for many years. A losing strategy.
2. What is the rate of interest?
In the stagflation of the seventies when governments were borrowing at above 15 percent, debt accumulation became very dangerous. Today the situation is quite different. Borrowing can be done at absurdly low interest rates of less than two percent, something that was unimaginable just a few years ago.
Furthermore, the advent of negative interest rates, where lenders actually pay to lend, is a game changer. There is presently a huge amount of capital in the world, disproving the popular perception of capital scarcity. Monetary capital can be created not just by central banks but by many other formal and informal organizations (credit cards, bitcoins, coupons etc.). Some lenders now consider it is best to park their money for a fee, as you would be willing to pay to park your expensive car in a safe garage.
3. How has the maturity date changed?
The advent of super abundant capital has also led to another counter-intuitive phenomenon: distant maturity dates for loans. We now see the emergence of hundred-year loans. Surprisingly lenders are willing to wait that long before repayment – another example of the plethora of capital. These loans are spreading both in the public and private sectors. We are very far from the Mafia loan to be repaid by the end of the week at 10 percent interest.
4. Who owes the money, and to whom?
This is one of the most important and most overlooked questions. When you hear statements like ‘the whole world is indebted’ the absurdity of this proposition should be obvious: if the whole world is indebted, to whom do we owe the money? The planet Mars? For every debtor there must be a creditor. If we are all debtors we must all be creditors – by definition.
The only exception is ecological debt. If we destroy our environment and ignore climate change, then Homo Sapiens incurs serious debt and there are no creditors. But in the case of financial debt the identity of the debtors and creditors is most important.
For example, the Greek public debt is owed to external creditors. It represents 175 percent of GSP and is causing legitimate alarm. But Japanese public debt is over 200 percent of GDP and does not inspire fear at all, because it is owed to the Japanese people. It is an intra-family arrangement and as such, constitutes a form of internal transfer mechanism, which is accepted by the people of that country and is of little interest to foreigners. In addition, a debt denominated in a country’s own money rather than a foreign one is less dangerous, even if held by foreigners. The country cannot go bankrupt since it can just print more money.
Of course, inflation is a possibility but Japan has suffered no inflation in spite of its very high debt/GDP ratio. In fact it is suffering from acute deflation, which is the opposite of inflation, as is Europe. When an economy operates well below its production possibility, more capital stimulates more production not more inflation.
What should we conclude regarding Canada’s return to deficits? After the 2008 crash, governments first spent a lot, mainly to refloat ailing banks, then went into an austerity and debt-reduction mode with alarm bells sounding about debt ceilings, the debt apocalypse, etc.
Today and tomorrow, if the four conditions mentioned above are met, it would be almost masochistic not to borrow. If we reject the irrational feelings of guilt and impending doom, intelligent deficit spending, via public borrowing, may well swing the pendulum back to the economic centre and offer a cure for the ‘nearest’ enemies of the Western World which are now not inflation but low growth and deflation.
In this sense, Canada will have once again acted as a pioneer.