Fiscal Fear Mongering in Quebec or Separatist Number’s Lunacy?

Independent Quebec’s greatest economist or numbers’ charlatan

Earlier this month Ed Devlin the head of Canadian portfolio management at Pacific Investment Management Company warned Quebec politicians to be careful in the upcoming elections. Devlin an expert in fixed income market and liability-driven investing wrote a research note¹ on Quebec’s debt dynamics and the possibility that talk of sovereignty had the potential to derail the province’s current virtuous debt dynamics as has been the case in parts of Europe in the last few years, most notably Italy.

The research note sparked indignation in French language media and in separatist circles. PQ economic critic Nicholas Marceau was ‘shocked’ by the scare tactics employed by Devlin and Martin Aussant head of the party Option National, an ex-economist himself, stated that the head of PIMCO Canada’s analysis wasn’t credible. Even the federalist Parti Liberal du Quebec felt the need to chip in, with finance Minister Raymond Bachand saying that Quebec and Italy were not comparable as they were not in the same ballpark.

It would seem that the lively reactions from the political sphere have proved Devlin right, Quebec politicians just don’t get it. The Liberals and the Option National seem to agree, Italy and Quebec cannot be compared. Martin Aussant actually went on record saying that Quebec was in the average of OECD debt to gross domestic product (GDP) percentages. The question now is whether Aussant wants to plead guilty to ignorance or deceit has he is wrong about Quebec’s relative average debt load.

If one were to take Quebec’s provincial ‘net debt’, which measures the provincial government’s debts minus the province’s assets, Aussant would be right, Quebec is just slightly below average in terms of debt to the size of the economy with a debt of 47% in 2010 versus 56% on average in the OECD. The conversation might have stopped there if Aussant had done his economic homework, but having been in politics for much too long it would seem that his professional due diligence might have slipped a little. Quebec’s net debt measure doesn’t use the same methodology as the OECD, one would have to add all provincially guaranteed debts to the equation to properly compare with the OECD’s numbers.

Thankfully the provincial Auditor General wrote a 2010 study attempting the exercise of comparison. He came up with another net debt number 53% of GDP. While this number is higher it remains squarely in the OECD average, this was surely the number that separatists like Aussant think about when talking debt dynamics. However it still isn’t the same number the OECD uses. The OECD calculates total debts not net debts. Using that number Quebec jumps straight to the top and comes in just shy of the podium in fifth place of most indebted jurisdictions in the OECD. Not really close to the average as certain like to claim.

But all this fails to take into account that separatist want to separate from Canada, hence the Canadian debt proportion that an independent Quebec would certainly have to assume. Adding today’s Quebec gross debt to its proportional share of the federal debt, an independent central Quebec government would have a whopping debt load of 135%. There you have it folks Quebec would take the bronze medal for national debts if independent, right behind gold winning dysfunctional Japan and bankrupt and bailed out Olympian Greece with silver.

Some might ask how is it that Quebec can be one of the most indebted jurisdictions in the world and not go bankrupt, while even the United States is quietly considering² State bankruptcy legislation for its lesser indebted local jurisdictions. The answer is hotly debated in Europe right now, and was correctly pointed out by Devlin in his research paper. Europe and even the US to a lesser extent are monetary unions without fiscal unions; they share currencies without sharing fiscal resources much to the contrary of the Canadian federation.

Through the equalization formula Quebec receives a fiscal top up (worth over 10% of its provincial budget), effectively buffering it against the reckoning of financial markets. While Europe dithers on the question of bailing out its member States, every year ‘have-not’ provinces get a mini bailout. Without assurances that this money stream is permanent international investors would drop Quebec debt securities so fast Spaniards would thank financial markets for having gone easy on them.

Another rationalization separatist economists like to use to explain why Quebec is much stronger than the rest of the worlds is that when looking at net debts Quebec’s finances are resilient. That could be true if there actually were assurances that those assets that can be sold off to pay debts were worth what Quebec’s balance sheet says they’re worth. Unfortunately, that never seems to be the case. Just before Iceland got into trouble and got bailed out by the IMF it had one of those on paper fortress like balance sheets. It actually had a much lower net debt ration than Quebec does today. Unfortunately when a country gets hit by a deep recession, increasingly likely nowadays, asset values tend to drop and net debt ratios tend to shoot up. Since the Caisse de Depot et Placement du Quebec (a huge chunk of Quebec’s assets) has already proved it’s capable of loosing 40 billion dollars in a single year, what assurances remain that those losses won’t repeat themselves. And If Quebec were to separate who exactly would like to swoop in and buy Quebec’s crown corporations? Greece has been selling its State owned enterprises for pennies on the dollar in its crisis, what assurances are there that Quebec’s assets will sell for much more? Using accounting valuation to describe the worth of a government’s assets is quite the precarious game and it takes a lot of optimism to believe those numbers as credible.

Another favourite retort against Devlin’s research note is that Quebec doesn’t have the fiscal evasion problems that Italy and its ilk have. While this is true, Quebec has a much lower proportion of taxable wealthy citizens than Italy does. Given wealthy anglos historical propensity to leave in times of separatist pressures, the issue in Quebec shouldn’t be whether we have a tax evasion issue come separation but rather will Quebec have a wealth migration issue if that time comes. All in all separatists may continue to find tricky accounting techniques to rationalize separation economically, but at the end of the day numbers and facts can only lie so much. The separatist project remains far from credible economically.

If separatist political parties want to head out the door of Confederation giving up equalization payments and accepting a whopping debt bill on the way out of the restaurant maybe a little more fear mongering is in order. Let’s hope that cooler heads prevail in this election campaign and that market rattling talk of separation can go back to were it’s been hiding for the past two decades: the dust bin.

A Montreal Manifesto

Yesterday I chose to walk home from school. It’s not an entirely short walk, walking from Guy street downtown to Monkland avenue and Girouard street in the Notre-Dame de Grâce neighbourghood will take the common walker an hour to cover the 5 kilometer distance. The walk wasn’t entirely unpleasant from a nationalist economic point of view. Signs of development abounded.

The very beginning of my walk began in the heart of Concordia University’s downtown campus. One is surrounded by the new glimmering Business School building, the slightly aged but just as freshly sophisticated Fine Art’s and Engineering building and the 70’s designed work of horror administrative building, being actively given a contemporary face lift. Walking westwards along Maisonneuve street one eventually reaches just north of the old Seville Theater block. Pausing for a moment I could not help but feel proud of seeing the old decrepit structure vanished, replaced with a massive hole in the ground from which a giant crane was erecting new 10 story condo development. Turning away from the Westmount city hall and walking past the illustrious Selwyn House school for boys I began the St-Antoine street climb. Halfway up the side of Mount Royal, the middle of the island historical mountain overlooking downtown, and peering south down one of Westmount’s steep streets, I caught a glimpse of an army of cranes in the distance.  The next street provided a better view of what is to be one of Montreal’s two Super Hospitals. Half a dozen tall cranes were churning and jostling in the air over the largest construction sight I’d ever laid eyes upon.

Finally reaching my own neighbourghood and the avenue us locals call Monkland Village, looking westwards along Monkland my gaze was met with the sight of not one, not two but three different developments of mixed residential and commercial use. This street which had not seen any change in the last decade, asides from a butchery moving and a store or two closing, was now alive with construction and development. Arriving at my house and picking up the day’s Gazette I hadn’t finished, I read an editorial of a popular and recurring idea in the Montreal media. Montreal is renewing! The editorial listed all the great developments of the city: Two Super Hospitals in the building, extension of the southern belt 30 highway, a new bridge linking Montreal and Laval islands (actually called Isle Jesus), announcement of a Champlain bridge replacement, refurbishing of the Montreal airport and surrounding highway circle, extension of the public transit systems, replacement of the Turcotte interchange, new skyscrapers in the works (none built since 1992) and a great many other examples of urban renewal. However, are these really the mark of a resurgent Montreal?

A few details escaped the description of my homeward walk, so banal they were to the average born and bred Montrealer that I am. The first was that while standing in the middle of Concordia’s campus, staring at its newer features my back was turned to its flagship buildings, the Hall and Library buildings. These buildings are of such a particular ugliness most of us stop looking up as we walk past them. Nor did I pay much attention to the multitude of grey apartment buildings surrounding the campus. It is actually hard not to draw parallels between this part of downtown and Beirut. That resemblance is further accentuated by the massive pot-holes lining the streets ad nauseam, reminding us of Lebanon circa 2006 (apologies to the Lebanese for the hyperbole). Another over looked detail is the neighbourghood hiding in the shadow of the old Seville Theater development, Shaughnessy Village. One of the more depressingly poor and socially ill quarters of town, with its streets strewn with drug users, aboriginal poor and its sad overcrowded women’s shelters. Even Westmount the richest neighbourghood in Montreal as decaying streets filled with cracks and pot-holes.

While the certain media gushes about urban renewal, most journalists and commentators know this to be superficial. Underneath the glimmer and hope of new construction, lays a deep corruption. Montreal’s construction industry is one of the most corrupt in the western world and openly so. Foreigners reading our press may be confused as to whether they are reading a Canadian daily or a southern Italian one on most days. Most city procurement or maintenance contracts are rigged. These problems are small in comparison to the larger issues facing the city. While once the most populous city in Canada and first to reach a million inhabitants, Montreal lost that title to Toronto in 1976. While Montreal used to be a commercially imperial city second in clout only to London in all of the British Empire, Montreal long ago relinquished those epithets to the likes of Toronto, Hong-Kong, Singapore, Sydney, Mumbai and Johannesburg. Montreal also used to be home to some of the greatest corporations in Canada, many of whom have left. Adding insult to injury some of the great names that left were named after the city: Bank of Montreal, The Sun Insurance Company of Montreal.

Although Montreal has been the subject of some renaissance of activity, undeniably the city endures a stagnant state of affairs when compared to thriving cities like Toronto, Vancouver or Calgary. The causes of Montreal’s ‘greatness’ demise are all documented and obvious. The advent of a separatist and anglophobic  mouvement in Quebec’s political life are the main culprit. Separatists have always believed that Quebec and Montreal by extension were great because they are francophone. Nothing could be further from the truth. What makes Montreal great is its bilingual and bi-cultural identities (now more multicultural than ever). The attempts by ethnocentrical separatists to preserve french or more exactly to enhance Montreal’s french heritage has been an attack on Montreal’s very soul. This situation has arisen because governments in Quebec are formed by constituencies outside of Montreal in its francophone heartland. The government’s vicious cultural and economic attacks on the city have been further compounded because the seat of governmental power resides outside of Montreal, where ignorance about the true strengths of the city are rife.

Montrealers need to wake up and understand that what plagues their fair city is the city’s lack of sovereignty. Quebeckers once led political and constitutional battles to become as they would say: “Maitre chez nous!”. Or master in their own house. It is high time Montreal embarked on such a quest for economic and cultural independence. As an anglophone friend of mine was telling me the other day, she is tired of our province’s petty and destructive language wars and she is considering moving to another province for better work and more ‘political peace of mind’. What I heard in her lament was disheartening to say the least. Many Montrealers feel the same, they are tired of having people in Saguenay or in Gaspésie telling them what language they need to work in and what culture they should be instilling in their children. Enough with the outside influence already.

What Montreal needs is to become a Chartered City. Like Hong-Kong being freed from China to pursue its own destiny Montreal needs to be free from the cultural dictatorship that strangles it. Montreal needs to be free from the petty politics of separation. Montreal needs to be free to work and grow in the language that bests suits its aspiration to rival some of the Worlds great metropolises. Montreal needs to free itself from the pervasive anti-business, anti-wealth mentality that corrupts this province. Montreal needs to stop waiting for a distant government to prosecute the criminals that daily rape the islands treasury and tax payers, she must do it herself. Montreal needs to be free from the ineptitude of its provincial political duopoly.

To move forward and become the great metropolis it was destined to become Montreal needs to take back the assets that make it great away from those that would have them be chains. French should have made Montreal greater than just another anglophone city in North America, instead, it has become its greatest drag, a secular dogma weighting it down and prohibiting enlightenment. Montreal must become a “Bill 101 free zone”, it must become a separatist free zone, it must invite the legions of hard working industrious anglos to come back to their native island. It must demand that all infrastructure building and conceptualizing be repatriated away from Quebec City. It must firmly but curtly ask the rest of Quebec to butt out of its affairs. Montreal needs to start thinking of itself as an aspiring city of Lights. Hope and ambition are the greatest fuels for change and progress. Let us together reclaim the spirit that made Montreal the center of the Universe in 1967.

Montrealers could not tell you why they believe their city is the greatest. Montrealers cannot describe why they have faith Montreal will some day erupt into one of the greatest urban cores of the World.  Montrealers wont even tell you about this faith so crazy the notion must seem to outsiders. It is time for us to grab our pride by the buckles, raise our heads and forge ahead to where our true destiny resides. Our mission should be: to never again let an off-islander impose their timidity or apathy on us and to never let one of us leave because the pastures are greening faster on the other side.

End of a Monopsony, Beginning of a New Era?

Canada is getting rid of one of its oldest market distorting institutions, the Canadian Wheat Board’s monopsony. Since its inception in 1935 the Canadian Wheat Board has been the only buyer of albertan, saskatchewan and manitoban barley and wheat. True to its electoral promise the conservative government is voting away the CWB’s market exclusivity. Western Canadian grain growers will now be free to market and sell their own products or choose their own intermediaries. While the move is not universally approved not least of which by a majority of the affected agricultures, it remains well worth celebrating.

Before moving to unilaterally de-monopolize the CWB the conservatives had organized a plebiscite of the farmers to seek political cover. The plebiscite was marginally defeated by wheat farmers and soundly defeated by barley farmers. Hence the wait for a majority government to move forward with the plan. Armed with a majority government the Conservatives have moved legislation to de-monopolize the Wheat Board by August 1st, 2012. Farmers will effectively be able to sell their produce on the open market or contract the grain marketer of their choice.

With the Conservatives 2010 move to block the hostile takeover of Potash Corp of Saskatchewan using the Investment Canada Act and the Conservatives public endorsements of Canada supply management schemes for poultry and dairy products, faith in Canada’ openness to foreign investment was on the skids. However, recent musings by ministers have been more encouraging. The governments bid to join the Trans Pacific Partnership is a case in point. Canada has seen its bid to enter the multilateral agreement  blocked based on its intransigence with regard to its agricultural policies. Prime Minister Stephen Harper has however indicated a willingness to put “everything on the table” in order to join negotiations. The file of Canadian-European free trade seems to be moving briskly as well with negotiations on the Comprehensive Economic and Trade Agreement. CETA is speculated to open up Canadian municipal procurement. While a few unions and entrenched interest will cry foul as they always do, it remains obvious to most that more trade only means more wealth on average.

The move to open up western Canadian agriculture to more competition was an easy move politically, as the conservative vote remains quite entrenched in the prairie provinces. Opening up poultry and dairy industries to more competition however is a much harder sell. Most of the poultry and dairy industries are concentrated in Ontario and Quebec, provinces containing ~60% of the Canadian population and vote. Political backlash from well organised farming syndicates from these provinces has turned discussion of liberalizing agriculture into a taboo. While Canada has traditionally been a positive element and proactive participant in international multilateralism, its stance on agricultural trade has prohibited it from helping the Doha round of trade talks escape collapse. On top of giving Canada a bad rap internationally, these two industries who’s members don’t even represent a single percent of the Canadian workforce, have been gouging consumers for decades without pity.

So it is time that the federal government brought down the gavel of justice on the heads of these special interest. It is time for Canada to liberalize its trade relationships. It’s time for Canadian entrepreneurs to start exporting increasingly competitive products to the rest of the World. It’s time Canadians began enjoying the fruits of trade which are higher quality products from home and abroad at cheaper prices. It’s time Canadian municipalities began running budget surpluses thanks to better priced procurement products and contracts. It’s time Canada did its part in alleviating World poverty not by splurging more resources on fruitless foreign aid development campaigns but rather by opening up its borders to the labour, services and goods of all nations and peoples of the World. It’s time for Conservatives to live up to the esteem that Canadians have bestowed upon them based on a fleeting impression that the CPC represent good economic stewardship! Riding Canada of an inefficient monopsony was a first step towards greater competitiveness and wealth, let CETA be the second but not the last.

Cius,

Many thanks to the readers of this blog from Vietnam!

Sonnez l’Alarme!

So I keep hearing that Quebec’s fiscal situation is not alarming, that austerity drives are not necessary and that the Jean Charest Liberal government is in the pocket of ‘Big Business’. So I did some snooping around and some number juggling to investigate whether the government’s current drive for a balanced budget is reasonable or just neo-conservative ideological pandering.

So I had to crunch some numbers a little and here is what I have found:

Often you hear people say our situation is not bad we are middle of the pack in the OECD in terms of net debt. Alright so having taken StatsCan’s number’s for Quebec’s net debt than adding on its proportional share of federal government net debt, Quebec indeed is middle of the pack. But who exactly is in the OECD you ask? Well out of 31 countries in the club of developed nations 5 have accepted IMF or EU bailouts (Greece, Hungary, Iceland, Ireland and Portugal). Another 4 countries (Belgium, France, Italy, Spain) have come close to being shut out of credit markets or seen the spead between their yields and comparable safe haven bonds increase to historical highs*. Many more OECD members have seen their long term credit ratings cut since 2007. All this to say that benchmarking ourselves against the OECD is just plain deceptively simplistic. Looking at the chart, one can see that Quebec is also middle of the pack of those that were bailed out. Bigger countries like the US, UK and Germany can get away with higher debt levels, it’s the nature of capital markets to respect bron over brain. However small countries need to be prudent. Ireland and Iceland had very small debt burdens before the crisis and look where they are now: bailed out and battered.

Now that we’ve established that Quebec is part of an unenviable club of high debt small countries, let’s look at its particular situation and find out why people still think things are okay. First sign is bond yields. Quebec’s 2 year bond is yielding ~1.35% or approximately 35 basis points above the Central Banks key rate. In the US the 2 year yield is roughly 27 basis points (at friday march 2nd close) or ~25 basis points above its target rate. So Quebec isn’t borrowing in real terms much more expensively than the US government, allegedly the safest debtor in the World (not that I believe they should be). Another indicator that would suggest no immediate problem is Quebec’s credit rating.

Moody’s	Aa2 (stable)	P-1
Fitch Ratings	AA – (stable)	F1 +
Standard and Poor’s	A + (stable)	A-1 +
Dominion Bond Rating Service	A high (stable)	R-1 (middle)

 None of Quebec’s credit ratings are Prime, meaning Quebec isn’t the safest bet possible but they remain in the High Grade to Upper Medium Grade categories. So one could be forgiven for believing that Quebec is fiscally alright given that large swaths of the financial and capital markets community still respects Quebec’s ability to service its debt. Now you are probably wondering why the ratings agencies are so kind to Quebec. There are many reasons why Quebec might be more financially than the European periphery or developing nations, I’ll focus on the three that seem most important to me (and probably the credit rating agencies):

   Firstly, according to the Canadian Constitution property rights and natural ressources are a Provincial jurisdiction. In essence the Quebec government can legislate any which way it wants with regards to natural ressources. Nationalisation, royalty regime changes and taxation are weapons the government can use to raise revenues or assets. These circumstances are what led the Quebec government to own one of the largest utilities in the World (Hydro Quebec). This coupled with the fact that the Province has a land masse of over 1.5 Million square kilometers containing an abundance of mineral and hydrocarbon ressources puts it a notch above the failing states of Europe in terms of natural wealth endowment.

   Secondly, the province’s government has a relatively high liability coverage ratio. That is for every dollar of debt the government owes it has 51.25 cents of assets as of 2008 compared to an OECD average of 44.91 cents in the same year. Now comparing to the OECD is once again very tricky since some of the members have coverage ratios in the triple digits while others have miserable ratios.

   Lastly, Quebec has an immense advantage over the PIIGS in that, it is part of a functioning monetary and fiscal union. Now functioning is very relative but it works great for Quebec. Quebec’s budget is partially immune to boom bust cycles because some of the automatic stabilizers are federal responsibility. For exemple Unemployment Insurance (called EI in Canada) is covered by the federal government. Quebec is also the recipient of fiscal adjustment transfers. Currently just above 10% of the Quebec budget expenditure is paid for through fiscal transfers from the federal level. This means very simplistically that the government can afford aheftier debt services payments oft least 10% more than its peers (if not much more).

The preceding points and the second graph would seem to imply that the province has the means to pay down its debt and that it has done so since the middle of the 1990’s. However from the third graph (Can & Qc Budget Balances) it is obvious that much, if not all of the heavy lifting in terms of debt consolidation has been done at the federal level. Another factor that has led to a decrease in the overal debt load is the shrinking share of the federal government debt. The data presented here takes into account a generational decrease in Quebec proportion of the debt do to a decreasing share of the population, from 26.38% in 1981 to 23.14% in 2011. The decreasing share of population indicates another problem is present. Quebecers are no longer making babies (okay they still are just not a lot). Quebec is well beneath the population replacement ratio of 2.1 children per woman (~1.5 last I checked, even though we are in the midst of a little echo boom). Which means that the labour participation rate is headed down way down in a near future.

Admittedly that problem isn’t quit immediate and can always be buffered by laxer immigration policy.

Remains the elephant in the room: the gross debt. Not a lot of countries can claim higher gross debts than Quebec without terrifying bond investors or having the IMF knocking on your door. I’ve explained above why this might be, now I’ll explain why it might not last. The bail out situations varied from country to country, but in Ireland and Iceland’s cases it was a question of nationalizing banks then watching the asset side of the balance sheets evaporate, net debt quickly rose towards the gross debt levels. While this isn’t likely to happen to Quebec (most Canadian banks are safe and headquartered in Ontario) it isn’t impossible either. A likelier problem would be a repeat of the Caisse de Depots et Placements 2008 kapoot, when it saw its assets shrink in value, creating a massive unfunded pension liability for the government (one is already present but most actuaires say it is manageable). Mis-management of state enterprises ‘a la Grecque’ or PDVSA style seems quite possible to me in the long run. With Hydro Quebec being the most indebted corporation in Canada (over 35 Billion $) and paying out a heavy dividend to the government its book value should be higher but isn’t. Also not to be neglected is secession from Canada. While politically unlikely now, it wasn’t so long ago that a referendum was won to preserve the confederation by a voting margin of less than 1%.

The bottom line is that Quebec is viewed as stable for a few good reasons, however neglecting the fact that Quebec is as financially precarious and politically unmanageable as some of the worst developed World debt offenders. Buy Quebec debt at your risk, within the next ten years austerity will become an obligation not a choice, I’m not hopeful that our politicians and the citizens they represent will show themselves more responsible than their Greek equivalents.

P.S. Thank you to all those who voted NO to seperation in 1980 and especially in 1995. Quebec would look like a colder version of Greece or Ireland right now if it wasn’t for your assiduousness.

* By “historical highs” I mean Euro era historical highs versus comparable German Bunds yields.