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Saturday, November 5, 2016 12:42
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RYAN  By Guest Blogger Ryan Lewenza

For deficit hawks like us, the late 1990s and 2000s were a great period with the Canadian Federal government posting surpluses for 11 consecutive years. However this ended with the 2008/09 financial crisis, and we now expect a sea of red for years to come under the Trudeau Liberals. While weaker economic growth is definitely a factor behind the deficits, the main driver is the massive increase in infrastructure spending. Is this the right direction for Canada to be taking?

We believe it is, as we see a number of supports for a major investment in our aging infrastructure.

First, we believe that the monetary policies of global central banks have largely run their course, and are beginning to lose their efficacy in stimulating economic growth.

To help combat the effects of the worst financial downturn since the Great Depression, central banks around the world responded by lowering interest rates to record low levels. When this failed to engender a robust recovery, central banks resorted to new “unconventional” monetary policies by purchasing massive sums of bonds in an effort to drive interest rates even lower. Known as Quantitative Easing (QE), this has become the go-to tool for central banks to help stimulate growth.

Below we illustrate the result of these policies with the combined balance sheets of the US Federal Reserve (Fed), European Central Bank (ECB), and Bank of Japan (BoJ) increasing by US$9 trillion since 2007 to a staggering US$12.7 trillion today. That’s trillion with a T!

And what have do we have to show for this central bank largesse?

Central Bank Balance Sheets At Historic Levels


Source: Bloomberg, Turner Investments

Yes the equity markets have clearly benefited from these monetary policies, but the impact on the global economy has been much more muted. Take a look at Canadian GDP growth for example. In the decade before the financial crisis, the Canadian economy grew at an average rate of 3.2% Y/Y. In the years following the financial crisis, when central banks threw everything but the kitchen sink at the global economy, our economy has averaged only 1.4% Y/Y.

Quite frankly if we want to see the Canadian (and global) economy strengthen then something different will have to be done to achieve this. Quoting Albert Einstein “Insanity is doing the same thing over and over and expecting different results.” If monetary policy is losing its effectiveness then maybe we should try something else.

Canada’s Economy Has Downshifted into Second Gear


Source: Bloomberg, Turner Investments

At the same time that our economy remains stuck in second gear, there is a large need to invest in our aging infrastructure. Following WW2, there were large investments in infrastructure but this slowed during the 1970s and 1980s as the Federal and Provincial governments deferred spending on much needed investment. According to the Federation of Canadian Municipalities, the cost of this deferred investment is a major infrastructure deficit that they estimate at $123 billion. And according to the Canadian Infrastructure Report Card, roughly 37% of our roads and 43% of our public transit are rated “fair” to “very poor”. Anyone driving the streets of Toronto or on the crumbling Gardiner Expressway can attest to this.

Condition Ratings by Replacement Value of Canadian Roads


Source: Canadian Infrastructure Report Card

Finally, I believe current conditions are ideal for a major investment spend in our economy. Our Federal debt is relatively low at roughly $600 billion, equating to a debt-to-GDP level of just over 30%. Compare that to the US at over 100%, Germany at 80%, Italy at 130% or Japan at 220% for example. While it’s paramount that the Federal government has a plan to get us back to a balanced budget following this period of investment, we do currently have the room to increase debt as we make these much needed investments. Moreover, with interest rates at historic lows, now is the time to issue debt and make these investments. The question then is, where to invest?

We believe the focus has to be on stimulating economic growth and increasing productivity. A bridge to nowhere is not the solution. The government should be focusing its efforts on improving roads, public transit, communications and utilities and water which help lower business costs and increase corporate profits.

If you’re not already asleep by now, I recognize this is not the most exciting of topics, but this is probably one of the most important issues facing Canada today. By investing in smart infrastructure programs that stimulate economic growth (Conference Board of Canada estimates that every $1 billion spent creates 16,700 jobs) and improve productivity, this is how we can get our economy humming again and get back to those good old days of 3%+ GDP growth.

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.


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