OTTAWA — The warning shot fired by ratings agency Standard & Poor’s across the bow of the U.S. Congress and White House on Monday over their inability to rein in spending is reminiscent of the debt crisis that faced Ottawa in the mid-1990s.
At that time, S&P, joined by Moody’s, did not just warn Canada, they took action by actually downgrading the country’s credit rating, thereby hiking interest rates.
This time it is America’s century-old AAA credit rating that is being threatened with a downgrade because of run-away deficits.
Canada is in no danger of such an outcome today, say analysts, even though both countries are dealing with similar mountains of national debt.
In fact, Canadians may experience a bit of schadenfreude from the misfortunes south of the border — particularly since American commentators took such glee in mocking the “Canadian peso” at the time, and particularly since S&P took care this time to praise Canada’s current stability.
There are also some minor positives for Canada from the U.S. woes, said economist Douglas Porter of BMO Capital Markets.
“The financial market implications of S&P’s move are a bit different from prompting pure risk aversion, since (U.S.) treasuries and the U.S. dollar are normally the safe havens,” he explained in a note.
“Alternatives such as gold, the Swiss franc, Canadian bonds, will instead benefit as investors move away from long treasuries.”
As things currently stand, the two countries’ government debt to gross domestic product ratio is similar in size at slightly above 60 per cent, with the proviso that north of the border, provincial debt is also counted.
But where the two countries radically diverge is that in Canada most governments have put in place reasonably credible plans to eliminate deficits, whereas the United States is in the middle of an ideological war between a Republican Congress and Democratic White House.
“We wouldn’t be bullet proof if we did nothing about our deficits indefinitely, but we are clearly on a much better fiscal track than the U.S.,” said CIBC chief economist Craig Alexander.
The more profound impact on Canada from Monday’s shocker, say analysts, is what the credit warning and subsequent reaction from U.S. policy-makers means for the economy, both short term and long term.
In the short term, any austerity action by the U.S. in response will necessarily lead to slower economic growth and higher unemployment. This will have negative spin-off effects for Canada’s economy, particularly the export sector.
The short-term negative implications accounted for the immediate sell-offs on both Toronto and New York stock exchanges Monday, along with a setback for commodity prices.
Down the road, however, a more fundamentally sound U.S. economy, assuming the government is able to tackle its problem, will be a benefit for Canada, analysts believe.
The very fact of S&P’s warning is a good start, said TD Bank chief economist Craig Alexander, who noted that the “Canadian peso” embarrassment helped galvanize public opinion in support of government action.
“This is why the S&P announcement today is a positive because it drives home the point that the U.S. fiscal problem is a very serious concern and it needs to be dealt with,” he said.
That’s still a tough sell when the unemployment rate hovers around nine per cent, but Alexander believes the U.S. government will have no choice but to act in the next few years.
It was a tough sell in Canada as well in 1994, when total government debt peaked at 100 per cent of GDP, where the U.S. is currently headed.
Ottawa responded by cutting spending, including transfers to the provinces, and increasing taxes. The result was what became known as the jobless recovery.
The payoff came four years later. Ottawa eliminated the deficit and began a period of about a dozen years of surplus budgets allowing it to pay down about $100 billion on the national debt.
In turn, the sound fiscal underpinning has enabled governments in Canada to hike spending during the recent recession, without triggering a new debt crisis.
But while a shift in public opinion made austerity possible in Canada in the 1990s, the U.S. faces a deeper challenge, Alexander said.
“The U.S. is in quite a bind. The U.S. government cannot apply enormous fiscal austerity to deal with its deficit right now because the economy couldn’t cope with it,” he said.
At the minimum, however, he said the credit agencies are expecting Washington to table a plan that points to a more sustainable fiscal outlook, with actual austerity understood to have to wait until following the next presidential election and a more entrenched recovery.