Unless you are Buffett-level rich or living off the land up in the Yukon, you’ve seen a big hit to your wallet in the last year. The inflation which certain people were predicting for decades - and been completely wrong about – has arrived. In June it reached 8.1 percent year over year, the highest number since 1983. Food prices are even worse, going up almost 10 percent, while gasoline across Canada has gone up by a ridiculous 48 percent. These are scary numbers, made worse by the fact that wages have only gone up by 3.9 percent. This is all bad news for low- and middle-income working people. A lot of Canadians are struggling to make ends meet.
What’s causing inflation? You’ll hear some dim bulbs whining about Trudeau and blaming it on the government’s spending but that’s complete garbage; this is a global problem as inflation is high all over the world; the US is at 9.1 percent, while the Eurozone is at 8.6 percent. There are three actual causes. First, demand was supressed during the pandemic as everyone stayed home and watched Game of Thrones on Netflix. Now people want to put on pants and leave the house, which means they are going to spend money, and this is driving up demand for many products and services. Secondly, the pandemic broke supply chains because work stopped or slowed down, meaning key components like semiconductors aren’t available now in anywhere near the amounts required. This is an ongoing problem because China, where most everything is now made, is again implementing a series of total lockdowns due to Covid. Lastly, the war in Ukraine and the resultant sanctions on Russia have severely curtailed the supply of crucial commodities like wheat, fertilizer, and most importantly, oil. Since all products must move at some point, high oil prices lead to higher prices for almost everything else.
Inflation is dangerous because it is insidious; the longer it goes on, the more likely it is that people will expect it to go on and then adjust their behavior accordingly. This is called inflation expectations. For example, say you want to buy a car in a year. If you see prices rising, you buy it now because you think if you wait, it will cost more. But by buying now, you are contributing to increased inflation today. Now multiply that transaction millions of times and it should be clear how inflation can become entrenched. It’s a self-fulfilling prophecy. Once inflation expectations rise, so do wage demands and this further feeds the cycle, as more money is chasing the same goods.
But as I mentioned above, wages aren’t keeping up with inflation at all, and this tells us that high inflation probably won’t become entrenched. At some point the pent-up demand from the shutdowns goes back to what it was beforehand. With interest rates and prices rising, the cost to consumers of additional consumption gets prohibitive. You can’t spend what you don’t have or what the banks won’t give you. The economy recovered exceptionally quickly after the pandemic, but that growth was simply a return to normal economic activity. Remember that before Covid we were stuck in a prolonged deflationary cycle: decades of anemic growth and declining wages in real terms. None of the structural pre-pandemic problems that caused this – wealth concentration, tax unfairness, lack of competition, offshoring, and environmental costs – have gone away.
Which brings me to Pierre Poilievre, the likely next leader of the Conservative Party. Poilievre mouths a lot of the sound money, deficits-are-evil nonsense that you hear from the goldbug crowd. He has said he will fire the head of the Bank of Canada (BOC), Tiff Macklem, for…well, I don’t know why exactly. Poilievre said he needed to fire Macklem “to get inflation under control”, which is akin to a starving man thinking that burning down a deli will get him a sandwich. He also said that the BOC has been acting like“Trudeau’s ATM", which I take to mean he thinks that by having ultra-low interest rates the BOC allowed the Liberal government to spend too much during the pandemic.
The BOC is responsible for monetary policy, the main component of which is setting interest rates through the overnight rate. This is the rate the BOC charges commercial banks to borrow money from it. Other interest rates are priced from this rate. The BOC has no control over the federal government’s spending. Zero. Zilch. And the government has no control over the BOC’s setting of interest rates. The BOC is completely independent, which is exactly the way it should be.
You know who did benefit from ultra-low interest rates? About 95 percent of the Canadian population - everyone who had a job, held stocks, owned real estate or had debt during these last 15 years. If you live in a Canadian city, the value of your home has at least doubled since the financial crisis. During the pandemic alone, housing prices went up 62 percent Canada-wide. Following the Keynesian blueprint, the government saved the economy during Covid by essentially transferring the burdens of its citizens to itself. That’s what every government did, even conservative ones, and it was one hundred percent the right thing to do. Government finances easily recover, but businesses and individuals who go bust do not, which has huge negative economic and social impacts.
But there is no free lunch; we were always going to have to pay for the pandemic, one way or another. Inflation is the bill coming due, as are the resultant higher interest rates. The rising rates worldwide will throw cold water on inflation and likely usher in at least a moderate recession here in Canada, for this simple reason: it’s not the federal government that’s over-indebted, it’s Canadian consumers and businesses. Higher interest costs will shrink demand, bring down housing prices (something that is absolutely needed) and force banks to cut back their loan books. This washout is necessary because Canadians are amongst the most indebted people in the world. All of this is certainly bad news but it still beats the hell out of the deflationary death spiral that would have occurred if the Liberals just sat by and did nothing during the pandemic, which is what Poilievre was advocating. The Keynesian remedy has now worked twice, during both the financial crisis and Covid, but the Right still can't admit they were wrong.
It's not surprising that the Conservatives would use the deficit to scare people because they never change their playbook. While running a deficit during a period of high inflation is certainly not ideal, it's doubtful that it's contributing much to inflation given all the global causes I listed at the beginning. The deficit for 2022-23 is $53 billion, which is about 2 percent of GDP; compare that to the UK (with a conservative government) at 4.3 percent or the US at 3.9 percent. But Poilievre has stated emphatically that if he were PM he would balance the budget immediately. Let’s pretend he’s in charge right now. The total budget for 2022-23 is $462 billion, broken down as follows:
Pensions, EI, child benefits, fuel subsidies – $133 billion
Transfers to provinces - $177 billion
Operating Expenses – all government departments, including the military – $116 billion
Interest on national debt and actuarial adjustments – $36 billion
Will he take $53 billion out of the hands of families, the unemployed and retirees? That would be devastating to the economy and to his popularity. Will he try to cut the transfers to the provinces, which pay for health care, education, infrastructure, etc.? This would be stupid, as our health care system is already struggling and things like infrastructure and education are investments that will benefit our economy in the future. So that leaves operational expenses, which is where the Conservatives always look for waste – you know, those ‘useless’ civil servants they’re always yelping about. Out of that $116 billion, the military accounts for about $25 billion, leaving roughly $91 billion. Poilievre would have to cut about half of this to get anywhere near a balanced budget, which means most departments would be crippled and unable to fulfil their basic duties. He would have to throw 100,000-plus people out of work, which again would be horrendous for the economy.
So it's not feasible to quickly eliminate the deficit without causing more economic damage. In fact, Poilievre's remedy is actually the perfect recipe for stagflation-negative growth with price inflation-which is the worst of all economic scenarios. This leads to one inescapable conclusion: Poilievre is either stupid or he’s being dishonest. I’ll leave it up to Conservative voters to decide which one they feel better about.
I get that people are scared and angry about rising prices, and they want a quick solution. But in reality, those often don’t exist. Everything comes with a price. Poilievre won’t magically solve inflation or save our economy by eliminating the deficit and firing the head of the BOC. When a politician offers simple solutions to complex problems, it's proof that he or she is either unwilling or unable to deal with the real world. All they will do is make everything worse.
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