Here we go again

Spring is typically budget season for the world's major economies. One of the first out of the blocks will be UK Chancellor of the Exchequer Rishi Sunak, who will be introducing his first full pandemic era budget next week.

Right on cue, the bad advice is starting to surface.  Here is former Chancellor Philip (now Lord) Hammond, warning that the Chancellor (and by implication PM Boris Johnson) have become "addicted to spending", making them unlikely even to consider the steps needed to rein in spending as the pandemic eases.  (And here is an alternative viewpoint). To be fair to his Lordship, he is not suggesting that Sunak start cutting back on pandemic support programs next week; he seems to accept that digging out of the fiscal hole the pandemic has created will take years or even decades. Still, you might hope that Hammond would think back to the austerity that the Cameron/Osborne government imposed on the UK in response to the global financial crisis. That austerity weighed on growth for much of the following decade, ensuring that targets for eliminating the budget deficit were never attained.

We are likely to see the same thing here in Canada, where a firm date for the Federal Budget has not yet been announced. The opposition Tories have been very critical of the scale of the pandemic support programs the Trudeau government has launched, which have indeed been about the most generous of any developed country. However, to be fair once again to a former Tory (a habit I do not intend to get into), at the time of the global financial crisis PM Stephen Harper listened to advice and eschewed austerity measures that would have tipped the economy deeper into recession. As a result the Canadian economy and financial system came through the crisis in better shape than the rest of the G7.

The Tories recently demoted their attack dog finance critic, Pierre Poilievre, to the lesser role of labour critic. It is not clear whether party leader Erin O'Toole found Poilievre's ranting a bit too much, but there is little likelihood that the Tories will tone down their fiscal rhetoric in the coming weeks. History suggests that it's not a winning approach to take with the Canadian electorate, but that's obviously O'Toole's call.

For Canada, the UK and just about every other country, the scale of deficit financing undertaken in the past year is not sustainable. This is true not because of the old canard about leaving unpayable debts to our grandchildren, but because excessive financial stimulus must eventually heighten inflation risks. Governments certainly need to be cautious about keeping the spending going as economies recover, a message that may not yet have got through to Justin Trudeau and his rookie Finance Minister, Chrystia Freeland. That said, history is replete with examples of governments discovering that outright austerity only reduces growth and never reduces debt. More such history is not what we need right now. 

What, me worry?

Inflation fears are starting to make themselves felt across global markets. Commodity prices are rising, as are bond yields, as investors become nervous that ever-expanding government stimulus may cause economies to overheat as and when the coronavirus pandemic starts to ebb.

The Bank of Canada has been saying for some time that it expects to keep its policy settings very accommodative until it sees inflation rise sustainably to its 2 percent policy target, which it does not expect to happen until 2023. Are the current alarm bells in financial markets leading the Bank to change its thinking? Not yet, if this speech, delivered virtually today by Governor Tiff Macklem to the two largest chambers commerce in Alberta, is anything to go by. 

Early in his remarks Macklem stated that "The Bank's latest forecast doesn't anticipate economic slack being fully absorbed until into 2023", a clear indication that the expected timetable for tightening remains unchanged. The Bank expects "an even more protracted recuperation period while the economic potential that was lost over the course of the pandemic is rebuilt."

The bulk of the speech looks at this period of recuperation mainly from the perspective of the labour market. As Macklem notes, the impact of the pandemic has varied widely across sectors, income groups and genders. Industries where physical distancing is impossible -- hospitality, the arts, air travel --  have been "hammered", while industries where physical distancing or remote work is possible have fared much better.  Far more low-wage jobs have been lost than higher-paying positions and, because women hold a disproportionate share of jobs in the hardest-hit sectors,  they have suffered far worse job losses than men. 

As COVID restrictions ease in line with the vaccination rollout, the Bank expects "some bounceback in employment in the near term. And, as with the first reopening, we should also see some reversal of the pandemic’s uneven impact in the labour market." However, the Bank does not expect to see "the same economy we had before".  The COVID pandemic has accelerated what Macklem refers to as the Fourth Industrial Revolution, based on technology, automation and e-commerce. This will create new opportunities for many workers, but also means that  "some of the jobs that have been lost during the pandemic will not return. And the workers who have already borne the brunt of the pandemic may be especially affected." 

Macklem concluded his remarks by looking at the policy implications of the scenario he had outlined, for the private sector, for Government and for the Bank itself. He reiterated yet again the commitment to a long period of policy stimulus: "We have committed to keeping our policy interest rate at the effective lower bound until economic slack is absorbed so that our inflation target is sustainably achieved. And we have backed up this commitment with our program of large-scale government bond purchases." And at the very end, he directly addressed the inflation concerns that are keeping investors awake at night:

"I began this speech by highlighting the health of Canada’s labour market before the pandemic. Unemployment had been around 40-year lows for a couple of years. Based on past economic cycles, we would have expected inflationary pressure to begin to rise. But inflation wasn’t threatening to take off. As the pandemic recedes and the recovery continues, we will keep that experience in mind. Monetary policy can continue to support demand in order to minimize scarring and bring as many people into the work force as possible."

It's said that the most dangerous phrase in the investment lexicon is "this time it's different", but for now, that's the bet that the Bank of Canada seems willing to make. 

Fuelling inflation

Statistics Canada reported this morning that the consumer price index (CPI) rose 1.0 percent year-on-year in January.  This compared to a 0.7 percent increase in December and was slightly above the consensus expectation. The principal factor driving the increase was the price of gasoline,  which rose 6.1 percent month-over-month as global energy prices moved higher. Gasoline prices have continued to rise through February, which strongly suggests that overall CPI will also continue to edge upwards.

The Bank of Canada's three preferred measures of core inflation were little changed in the month, averaging 1.5 percent. Thus both headline CPI and the core measures remain well below the Bank's 3 percent inflation mandate. Still, concerns are starting to emerge that the Bank's confidence that low inflation will allow it to keep rates on hold until 2023 may be misplaced.

Global commodity prices are rising, led by energy, metals and lumber, as optimism about the rebound from the COVID pandemic continues to build. This is excellent news for Canada's terms of trade, but could presage more generalized inflation pressures to come. Government pandemic relief programs remain in place. Indeed the Biden administration is determined to add massively to its own stimulus efforts, even as the pandemic seems to be easing and vaccination efforts ramp up. Finance Minister  Chrystia Freeland, has described Canada's pandemic relief plans as "pre-loaded stimulus"; if Canadians stop saving and start spending as vaccinations roll out, pressure on consumer prices could soon follow.

Fixed income markets are certainly paying attention. US 10-year Treasury yields this week hit their highest levels in a year, and Canadian 10-year yields, though below year-ago levels (and still remarkably low in historical terms at 1.12 percent) are also moving higher. Definitely not anything to panic about, but definitely something to watch. 

Updating the model

I blogged back on January 13 about the latest "modelling data" from the Ontario Science Table, the expert group that has been providing advice to Ontario Premier Doug Ford about how to combat the pandemic.  Ford had said ahead of a report from that august body that the fresh projections would make Ontarians "fall of their chair", and the numbers were indeed scary: 20,000 cases of COVID per day in the Province by mid-February.

I felt at the time that the numbers represented extrapolation rather than modelling.  Here's part of what I wrote:

I don't intend to disparage the Science Panel here, but this kind of modelling can produce some very weird results. One member of the Panel commented that a faster growth rate would potentially lead to a 40,000 per day case rate, as indeed it would. Then again, it happens that the number of new cases reported this week has actually been slightly below the levels seen a week ago. Is that a new trend? Maybe, maybe not, but simply projecting it forward would lead to a much different outcome from the one the Province is using to justify its decisions.   

Well, here we are in mid-February, so let's have a mini-inquest. There are some issues with data collection, but in round terms the number of daily cases in Ontario seems to be close to 1000, which means the Science Table's scary projection was off by a factor of twenty! I'm not saying this just to have some finger-pointing fun: after all, as the man said, forecasting is difficult, especially when it's about the future. But being this wrong can be damaging. Ford and his team constantly claim to be guided by the science, and here's a piece of that science that has been spectacularly wrong. It makes much harder for the Government to justify its policies -- you were dead wrong last time, Doug, so why should we believe you now?  

On Thursday the Science Table produced its updated modelling results.  They seem to have learned some lessons. The report now looks at two elements of the scenario going forward: the future of the original  COVID strain, which seems to be under reasonable control, and the risks posed by the so-called UK variant. It looks as though infections from the original strain will continue to fade across the Province, but the overall outbreak could start to ramp up again if the UK strain gets out of control. Keeping it under control means getting the R-number, which is currently around 0.9, down to about 0.7. If that does not happen, the overall case count could head towards 5-6,000 per day by the end of March.

That all looks a whole lot more like actual modelling and less like extrapolation. It's also not fall-off-your-chair scary, and it requires a little time and thought to understand. So, needless to say, it has hardly been reported in the media at all. 

The Digital Loonie

It's literally true that some of the $20 bills moldering in my wallet have been there for the past year.  Almost all my financial transactions have moved to online or contactless payment, and I'm surely not alone. Today Bank of Canada Deputy Governor Timothy Lane delivered a lengthy speech to the Instiute for Data Valorization (what dat??) in Montreal on the subject of "Payments Innovation beyond the Pandemic". Let's take a look.

Lane began his remarks by describing the rapid growth in digital transactions since the pandemic began:

A survey of Canadian retailers shows that e-commerce has nearly doubled from pre-pandemic levels.

.....In our most recent Business Outlook Survey, nearly two-thirds of participating firms reported that they are making some kind of digital investment. 

.....Among these developments is a shift toward the increasing use of digital payments. For example, a November 2020 survey found that two-thirds of small businesses now accept payments online—and half of them started doing so only recently.

Even when Canadians pay for goods in person, contactless options appear to be gaining traction. Interac reports that the volume of Interac Flash transactions grew by two-thirds in July 2020 compared with April.  Consumer surveys also report that contactless payments have increased.

Most of the technologies Lane is describing here are well-established. Indeed, it is almost a surprise that it has taken the pandemic to get so many businesses and consumers to embrace them more fully. Still, it is very clear that there is no longer any way back to the old cash-in-hand world.

Lane then went on to talk about changes in the Bank of Canada's physical bank notes, before musing about the possibility of a government-issued digital currency -- a "digital loonie":

.....for the past decade or so .....and we’ve been asking ourselves: could Canada and Canadians benefit from a digital form of cash?

.....In a speech in Montréal a year ago, I gave our preliminary view: we did not see a need for a central bank digital currency at that time, but we could imagine scenarios that could make a central bank digital currency beneficial in Canada. 

.....A year later, our view remains unchanged: a digital currency is by no means a foregone conclusion.

.....That said, the world has been changing even faster than we expected.....  And so our work to prepare for the day when Canada might want to launch a digital loonie—backed by the Bank—has also accelerated.

....We are not alone. In a recent survey, almost 60 percent of central banks reported the possibility that they will issue a central bank digital currency within six years. This is up from less than 40 percent only a year ago.

Having said that, Lane was quick to point out that he is not a fan of the existing digital currencies:

The other scenario I raised in my speech last year is the increasing use of digital currencies created by the private sector, including cryptocurrencies and so-called stablecoins. While these products have existed for several years, some could see a boost from the acceleration of digitalization in the midst of the pandemic.

Even in this increasingly digital economy, though, cryptocurrencies such as bitcoin do not have a plausible claim to become the money of the future. They are deeply flawed as methods of payment—except for illicit transactions like money laundering, where anonymity trumps all other features—because they rely on costly verification methods and their purchasing power is wildly unstable. The recent spike in their prices looks less like a trend and more like a speculative mania—an atmosphere in which one high-profile tweet is enough to trigger a sudden jump in price.

Lane then poses two fundamental questions: 

.....Are there benefits to issuing a digital form of money? And if yes, who should do so?

In response to the first question, we don’t yet know whether many Canadians will actually want to use a stablecoin or any other kind of digital currency when they have alternatives available—cash, debit, credit and electronic transfer. 

.....In response to the second question, if the public does want a digital cash-like currency, some good reasons illustrate why a central bank—a trusted public institution—should issue it.

Currency is a core part of the Bank’s mandate, and the integrity of our currency is a public good that all Canadians benefit from. Only a central bank can guarantee complete safety and universal access, and with public interest—not profits—as the top priority.

Lane goes on to speak at length about modernizing payments systems and specific issues relating to cross-border transactions, but let's stop at this point and consider the truly fundamental question: what would a central bank-issued digital currency even look like?  The "stablecoins" that he refers to already exist -- Facebook mused about issuing one last year -- but the differ from the more prominent digital coins such as Bitcoin and ethereum in that they are asset-backed in order to provide greater stability and utility as a payment mechanism. 

Today's Canadian dollars, like other currencies, are in effect backed by the full credit of the Government, whether we are talking about notes and coins or digital money. Would a digital loonie have that same backing, or rather, would anyone accept a digital loonie that did not have such backing in preference to the  existing government-backed loonie that can already be widely used for digital transactions? It is hard to see why anyone would want to do that, and so it's not obvious why issuing a specific digital loonie would add much, if anything, to the range of payments alternatives that Canadians already use. 

Canadian employment -- an unsurprising setback

Canada lost 213,000 jobs in January, according to data published today by Statistics Canada. Adding in a 53,000 job loss in December (a smaller loss than originally reported), , today's numbers bring the total level of employment to its lowest level since August 2020. Correspondingly, the unemployment rate is up 0.6 percentage points at 9.4 percent, the highest level since that same month.

The loss of jobs can be entirely blamed on the COVID pandemic and the restrictions imposed by Provinces to combat the second wave.  It's striking to note that the two most populous Provinces, Ontario and Quebec, more than fully accounted for the losses, shedding 251,000 jobs between them. Outside those Provinces, only Newfoundland and Labrador lost jobs in January: the seven remaining Provinces all saw modest job gains. 

The job losses were entirely concentrated in part-time work, with 225,000 such positions lost in the month, with a startling 153,000 such positions lost in Ontario and a further 93,000 in Quebec.  This reflects the prevalence of this type of employment in the sectors most affected by the latest COVID restrictions: accommodation and food services and retail trade both saw significant job losses.

Outside the sectors hardest hit by COVID restrictions, there were some surprisingly positive elements to the report. Despite the sharp fall in part-time employment, total hours worked across the economy actually rose 0.9 percent in January.  The construction industry gained 39,000 jobs in the month, mainly in Alberta and Quebec. This may reflect seasonal adjustment issues, with the winter weather across Canada much gentler than usual so far this winter. More broadly, StatsCan notes that in a number of sectors characterized mainly by full-time employment, including professional services, finance and leasing, employment has now recovered to its pre-pandemic level. 

Today's data point to a very weak economy at the start of the year. Indeed, the drop in employment in December must cast doubt on StatsCan's preliminary estimate that GDP actually edged higher in that month.  With new COVID cases declining across the country, Provinces are starting to talk about cautious re-opening of their economies, but the excruciatingly slow rollout of vaccines means that this process will have to be undertaken with great caution. Both employment and GDP are likely to remain stagnant at best until well into the Spring.