Monday, 23 July 2012

The vote split risk - Peter Brown's analysis

Readers of this blog will know that I am concerned about the potential impact of a centre-right, or free enterprise vote split on the outcome of next May's general election. A couple of weeks ago Peter Brown, founder of Canaccord Capital, and one of the province's business leaders, wrote a letter to the BC Conservative Party's executive council on the subject.  The letter received a fair bit of media coverage, but the accounts I saw (naturally) reproduced extracts only.  I was curious to see the whole document, and Mr. Brown very kindly agreed to provide it to me, and has allowed me to print it in full.  As might be expected, given the author's half a century of experience working in capital markets, it's a careful analysis of the fiscal challenges faced by governments here and abroad.  He's not optimistic about the economic world that lies ahead.  He's also not shy about what, in his view, needs to happen in B.C. if we want to maximize our political chances of navigating the continuing stormy seas of economic uncertainty.  Here's the letter, all of it:


I have been in the investment business for over fifty years and founded Canaccord Financial, Canada’s largest independent investment dealer forty-four years ago.  In addition, I serve on the Economic Advisory Council to the Federal Government, Chair the Fraser Institute am Vice Chair of the Investment Industry Association of Canada as well as sit on the Board of Governors for the Business Council of British Columbia.  This variety of experiences gives me an exposure to the global, geopolitical and economic forces that are currently at play and they cause me to agree with the Governor of the Bank of England when he said in October, 2011 that “The world is facing the worst financial crisis since at least the 1930’s if not ever.  I believe it is generally true that there are more problems in more places with less leadership than anytime in my lifetime. 



The purpose of this letter is to suggest that we are in a very troubled global economic condition that is more serious and likely to be longer in duration than the normal relatively short term post war recessions and that will, in my opinion, impact on global growth, investment and job creation for some time to come.  It is a time that responsible British Columbians need to get past their partisan beliefs to hopefully ensure that our politics don’t add another level of uncertainty in an uncertain and economically dangerous world.



The media focus is rightly on the European Union which represents more than 25% of world GDP and 30% of consumption – about twice as large as China.  Currently about half of the 17 European countries are in recession, the average unemployment rate is 11% and the GDP has fallen 0.4% from 2007 through 2012.  Issues include sovereign debt crises, banking crises and a great deal of social instability, but Europe, while significant, is only part of the problem.



Developed world growth forecast for 2012 is 1.4% down from 3.2% in 2010 and the emerging economies will grow at a rate of 5.7% down from 7.5% in 2010.  The US GDP is projected to grow less than 2% which will be the worst recovery of all post World War II recessions.  The Canadian government has projected a 2.1% GDP growth which is weakening.  Japan in the same 2007 – 2011 period suffered a decline in GDP of 3.5% aggravated by a natural disaster and now China is experiencing weaker growth as its manufacturing activity is slipping along with that of the U.S.



Many parts of the developed world have been on a borrowing binge to maintain unsustainable entitlements that now require the pain of deleveraging and austerity.  This is accompanied with the unfortunate demographics of aging populations who tend to consume more government services as they live longer and, out of necessity, hold on to their jobs.  The receding economies will cause relatively high unemployment over the intermediate term and unfair and unsustainable youth unemployment.



It would appear that a substantial issue going forward will be intergenerational fairness where we could pass to the next generation an economic opportunity that is substantially diminished from the one we inherited.  I could develop the case that the next generation will have lower incomes, higher taxes, less services, higher rates of youth unemployment, significantly larger amounts of per capita government debt, higher cost of secondary education and lower pensions.  The signs are there for the potential of higher levels of social unrest among the connected youth that rightly feel disadvantaged by their predecessors. 



There are so many other problems in so many parts of the world, with the potential to generate other crises and a steady stream of negative news going forward – for example: the instability of the Middle East, several important elections in the developed world, including the unfortunate socialist electoral results in France, the behavior of the casinos on Wall Street that have lost sight of the purpose of capital markets and risk management and the potential expiry of the Bush tax cuts which could impact the US economy by over 3% of the GDP.  There are already forty-eight million Americans now collecting food stamps while social security and healthcare programs are massively underfunded and therefore uncertain.



There is a current smugness amongst Canadians who have come to believe that our banks and economic management are somehow superior – but the truth is, while we may be the tallest of the pygmies, we are in the process of building our own debt and fiscal crises in spite of more responsible federal fiscal management. 

  • The truth is the federal debt will grow from $457 billion in 2007 to $671 billion by 2016 as federal debt, as a percentage of GDP, has risen from 29% to close to 35%.
  • Provincial debt will rise from $319 billion in 2007 to approximately $600 billion in 2016 with Ontario’s provincial debt, in the same period, increasing by over $150 billion as it doubles from $156 billion to $310 billion.  Tragically Ontario’s financial condition impacts on the rest of Canada as it represents 46% of the Canadian economy.
  • Program spending is up 60% in a decade from $130 billion and will reach $268 billion by 2016.



And that is not all . . . in the current year the combined federal and provincial deficits will be $41 billion which is shared equally between them but the provinces are faced with a greater problem as healthcare costs on average are going through 50% of the provincial budgets with the baby boomers not yet at their peak healthcare spending.  In addition, our personal debt levels average at 150% of annual income, higher than both the U.S. and U.K., with B.C. being the highest in Canada.



Clearly Canada’s fiscal regime is unsustainable and needs to be addressed particularly at the provincial level which will require diligent fiscal management. 



Scott Baker of Stanford University recently commented on the U.S. economy.  “Current levels of economic policy uncertainty are at extremely

 elevated levels compared to recent history.”



“We find that an increase in economic policy uncertainty...

foreshadows a decline in economic growth and employment.”



The American economy is receding as the rules are unclear and investors are facing too many uncertainties such as future tax policy, the cost of Obamacare, the impact of deficits and entitlements and unfunded programs and liabilities with many states and municipalities near bankruptcy.  These uncertainties are compounding the unstable economic conditions with the result that the American economy is again drifting towards recession following an extremely weak recovery in spite of their unprecedented massive stimulus and many other governments in the developed world as well as China.



In B.C. investment decisions are starting to be deferred for fear that the change to a left of centre government would create similar uncertainties in respect to a very similar list of issues that is proving to be so detrimental to the U.S. economy.  If the NDP were elected it would most likely be a two term government and the investors remember all too well the lost decade of the 90’s when our province was ranked 9th in Canada for economic growth.  We all know that there is a direct link between investment and employment, particularly employment for our youth and we also need to consider the fact that all or part of the $35 billion of capital projects that are in various stages of planning in Northern B.C. could well be jeopardized.  



It is clear to me that in this uncertain world and with these economic conditions, we all ought to put petty partisan issues behind us to ensure we elect a stable free enterprise government.  It is not the time for B.C. to take the risk of another failed experiment with the left by letting them back into power by way of a split of the centre right vote. 



It should be obvious that it is very important to keep the free enterprise forces in B.C. aligned under one political umbrella going into the next election as political fragmentation, in my view, will serve to aggravate the negative business community and investor reaction to a possible NDP win in 2013.  Fragmentation of the centre-right will cause many people in the business world to attach a higher likelihood to the prospect that the NDP can last for more than a single term.  It is critical that those on the centre-right remain committed, coherent and robust and that those who contribute to fragmentation of the centre right vote come to realize that they are an unintended political ally of the left.  In the world we live in today fragmentation on the right could be a disastrous scenario for our province and its economic opportunities.



The studies of the Fraser Institute show there is a measurable, positive correlation between free market approaches to public policy and certain outcomes that are economically and socially desirable.  We owe the next generation the opportunities and jobs that can only be developed in a free enterprise environment.

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