G8 and G20 - it will be all about debt

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The Gazette, Wednesday, May 19, 2010

Maternal health in the developing world might be Canada's signature initiative for the G8 summit it's hosting next month, but the real issues before the G8 and G20 meetings are the sovereign debt crises that threatens the global economic recovery, and the question of whether the world's leading economies will adopt some kind of bank tax.

In an interview on March 9 for the April issue of Policy Options, Finance Minister Jim Flaherty made an eerily predictive comment on the debt crisis that was then below the radar.

"There isn't really room to move in some of the economies like the U.K. and the U.S.," he said, "or Japan or Italy, and then there are the worrisome countries such as Greece, but some others in the EU that have substantial sovereign debt problems, and this is a lesson to sovereign nations not to get themselves in a position where they are going to have to take drastic steps to stay afloat."

Two months later, Greece's deficit and debt predicaments have created a ripple effect in some other European nations, roiled global markets, shaken the euro, and resulted in a nearly $1-trillion rescue package that may or may not be enough to stabilize the situation.

And Greek Prime Minister George Papandreou, having endured the humiliation of going around Europe with a tin cup, is now threatening to sue his country's financial advisers, Goldman Sachs. For that, he might need to take a number.

Greece's deficit and net debt, respectively 10 per cent and 101 per cent of GDP, are a scary enough story on their own. Euro countries are supposed to limit their deficits to three per cent of national output, but Portugal, Spain and Ireland are also two and three times over their allowed deficits, which accounts for the ripple effect on the euro and the recent turmoil in global stock markets.

But even France and Germany, which essentially put up the euro bailout, are running current deficits of nine per cent and five per cent respectively.

And Britain, which wisely stayed outside the euro and retained monetary sovereignty in the pound sterling, has the biggest deficit crisis among the G7 countries. The new coalition government of David Cameron and Nick Clegg is inheriting a staggering $400-billion deficit or a frightening 13 per cent of GDP. Britain might have invented the nanny state, but it can no longer afford its culture of entitlement. While Britain's debt is now at a manageable 60 per cent of GDP, by next year it will be at 70 per cent, as borrowed money becomes owed money. Red lights are flashing, and the first coalition budget will be painful.

The United States is hardly in better shape. Its current federal deficit of 11 per cent comes out to $1.6 trillion - equivalent to the entire GDP of Canada. And by next year, the U.S. federal debt, now at 66 per cent of output, will reach 72 per cent of GDP, up from 42 per cent only three years ago.

In terms of deficit and debt, Canada has come out of the recession in better shape than any G7 country. The current deficit, projected at $53 billion, is only about four per cent of GDP, and the federal debt is only 33 per cent of output. Don't be surprised if the current deficit comes in smaller than forecast. The last two quarters have seen robust economic growth, and the whisper number for the deficit is closer to $48 billion. Japan, surprisingly, has the worst debt burden at 113 per cent of GDP, to go along with a deficit of eight per cent, while Italy's debt also exceeds 100 per cent of output.

When they get around the table of the G8 and G20 in Muskoka and Toronto next month, a conversation on deficits and debt is unavoidable. At the precipice of the financial crisis in November 2008, the G20 countries agreed to pump unprecedented liquidity into their economies to avoid the recession tipping into a depression. But now, on the cusp of a recovery, the bills for that economic stimulus are coming due.

The second conversation at the G20 will be about the financial-activities tax, hilariously known as the FAT tax, proposed by former British prime minister Gordon Brown as a levy on the banking and financial services sector. Brown is gone, but the ideas still has significant support among European G8 members, and surprisingly even in the Obama administration the United States.

As the host finance minister for both the G8 and G20, Flaherty has something to say about this, and he is dead set against it. Why, he asks, should Canadian banks be penalized for their success in weathering the financial storm. It is not for nothing that Canada's banking system is rated the best in the world by the World Economic Forum. And on CNBC yesterday, the ineffable Jim Cramer called Canada "perhaps the world's most stable financial system," and made a buy recommendation on Bank of Montreal.

It is also no coincidence that Flaherty was in India yesterday, drumming up support for a Canadian alternative to the FAT tax, one that would allow banks to convert debt into reserves when funds run low.

Here's another idea - increase loan loss provisions.

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