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Beware the pain-for-no-gain economic scenario

Gwyn Morgan, Globe and Mail – Jan 19, 2009

VICTORIA — It's only been six months since Japan hosted the G8
leaders' summit in Hokkaido Toyako, but the issues discussed then
stand in sharp contrast to those of today. Topping the Hokkaido
agenda was the economic impact of skyrocketing oil prices and the
resulting transfer of economic power from the West to East, along with
the dangerous supply dependency on countries such as bellicose Iran,
Hugo Chavez-led Venezuela and geopolitically ambitious Russia. Food
prices were escalating at the time and the devastating prospect of food
shortages loomed for the world's poorest people. On another front,
enormous U.S. fiscal and trade deficits were battering confidence in
the world's benchmark currency.

In Canada, robust revenues from the export of high-priced oil, base


metals and grain had driven the loonie from 85 cents (U.S.) to par in
only fifteen months, allowing little time for struggling manufacturers to
adjust. The commodities boom fuelled high steel, concrete and
transportation prices, resulting in huge cost overruns, labour and
materials shortages, as well as severe project delays. For first-time
buyers, years of escalating housing prices and the prospect of inflation-
driven increases in mortgage rates made buying a home increasingly
difficult.

In the midst of today's gloom we might wish to turn the clock back, but
could we have lived with ever-increasing food and energy prices and
yielding the West's economic sovereignty to Russia and the Middle
East? I think not. This financial crisis is painful, but we'll get through it
and the fortuitous gain from this shorter-term pain is the avoidance of
a more dangerous outcome. That is, unless ill-considered reactionary
attempts by Western governments to soften the crises brings back
those same problems, as well as saddling taxpayers with enormous
public debts and deficits. What are the signs that this pain-but-no-gain
scenario may well happen?
BAILOUTS OF THE DOOMED

Private sector enterprises survive by constantly adapting to a changing


environment, but even corporate great-grandfathers eventually die.
Governments of successful countries strive to create an enterprise
ecosystem populated by companies at all stages in their life cycle.
Artificially interfering with this birth-growth-death cycle by subsidizing
dying businesses wastes taxpayer dollars and pollutes the enterprise
ecosystem. The longer-term outlook for Western countries, Canada
included, is for a shortage of trained workers. A far better choice for
public expenditures is in transitioning and retraining workers for the
new jobs being created by the growing enterprises that are crucial to
our country's prosperity.

ILL-CONCEIVED SPENDING

Global governments seem to be in a race to spend trillions of dollars


trying to get their economies moving again. Panicky politicians are
unlikely to make choices that both optimize value for the public dollars
spent and have real-time impact. The danger is that lead times
associated with new projects cause these huge public expenditures to
occur after the economic crisis has passed, thereby competing for
labour and materials with private-sector projects. This may well bring
back labour and material shortages, driving cost overruns for both
public and private projects.

PRINTING TOO MUCH MONEY

In an effort to head off a perceived threat of depression-style deflation,


central banks are using all traditional tools, and an unprecedented
array of new ones, to add "liquidity" to financial markets.

Since the supply of assets, goods and services is finite, more money
circulating in the economy necessarily means that the value of each
unit of a nation's currency will decrease, causing the nominal cost of
almost everything to increase. Zimbabwe is the extreme case in point.
The global economic crisis has reduced the cost of fuel, food, housing
and most other things. Given where costs were going, that is a good
thing.

However, printing too much money would put us back into the
inflationary spiral we entered only six months ago.

DEFLATING INVESTMENTS

The collapse of stock markets has hammered the value of both


personal investments and pension funds.

The value of most stocks will likely recover, restoring the nominal
value of investments and pension funds. However, if the combination
of government stimulus programs and money-printing creates an
inflationary spiral, the buying power of those apparently recovered
investments and pensions may be drastically lower than before the
crisis.

The fact is, inflation is great for debtors, including governments which
have deficit spent their way into un-repayable debt, and individuals
who have done the same. But for savers and pensioners, high inflation
is a crippling plague. The cruel irony of high inflation for savers and
pensioners is pain when the markets collapse, while being little no
better off when they recover.

STRUCTURAL DEFICIT DISEASE

Experience has demonstrated that "temporary" government spending


programs result in dependencies that spawn special interests who
lobby to delay ending their taxpayer-funded largess. The so-called
temporary transition program implemented after the collapse of the
East Coast cod fishery is a sad case in point. The perceptions and
realities that make new spending programs good politics and their
demise bad politics means inflationary government deficits will likely
continue long after the financial market meltdown ends. The result -
higher taxes and inflation, which prevents our country from fulfilling its
economic potential.

We must not forget that the real cause of this economic crisis is
imprudent lending practices and the handoff of bad loans, disguised
and rated as quality investments, to unsuspecting investors. The pain
is great, but many of the dangers discussed by G8 leaders only six
months ago have faded. Let's hope government actions don't negate
the gains, resulting in greater long-term pain.