Minister on the GO worries about Europe

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The Gazette, Wednesday, June 22, 2011

Jim Flaherty had a speech on his schedule in Toronto first thing Monday morning. His staff offered to send a car up to his home in Whitby to pick him up.

"No, I'll take the GO train," he told them. "I can catch the 7:45 and be down at Union Station by 8:30 and just walk across the street to the Royal York."

Total cost to taxpayers, assuming he kept his ticket as a receipt: $7.50.

There isn't another G7 or G20 country where the finance minister, outside an election campaign, would take a commuter train to an event.

But that's Flaherty, and it might be that staying connected with the voters of his Whitby-Oshawa riding is one of the reasons he was reelected last month by a margin of 36 points.

But make no mistake - he understands that the economy of his suburban riding is also connected to the wider world of those other countries. And it's what keeps him up at night, starting with the United States and eurozone countries. In the U.S., the recovery has stalled, while in Europe a financial crisis looms over bailouts to basket cases like Greece.

The Canadian narrative is different, a conspicuous success story in contrast to the struggling U.S. economy.

In New York last week, Flaherty didn't have to pitch the Canadian story to banks, funds and senior media such as the New York Times and Wall Street Journal editorial boards. They were very much aware of it.

"There's lots of foreign direct investment in Canada," Flaherty says, "and lots of people are buying the Canadian dollar." The highflying loonie might be a problem for Canadian exporters, but Flaherty has called it "the price of success."

Yet, as Flaherty also likes to say, "we are not an island," and that's part of what keeps him up at night.

The Canadian deficit, at 2.6 per cent of GDP, is cyclic, and due to return to balance by 2015, with surpluses after that. As for the federal debt, it will then be at 35 per cent of GDP, lowest by far in the G7. With unemployment at 7.4 per cent, Canada has created 560,000 new jobs since May 2009, more than all the jobs lost in the Great Recession and then some.

In the U.S., it's different. The deficit, at 10 per cent of GDP, is structural, with no forecast of a balanced budget in this decade. The U.S. debt ceiling of $14.3 trillion is about to be raised, and the debt is forecast to be 77 per cent of GDP next year. Unemployment crept back up to 9.1 per cent last month.

Sitting on the front porch of his restored Whitby farmhouse on Father's Day, Flaherty saw plenty to be concerned about in the U.S. fiscal-framework and employment picture.

"Ben Bernanke," he was saying of the head of the U.S. Federal Reserve, "is talking about the dangers of structural unemployment. Youth unemployment is something like 18 per cent. There's a situation of factory jobs not being filled because people don't have the necessary computer skills. The gap between rich and poor is widening."

And in terms of stimulus, Bernanke doesn't have much left in his tool kit. The U.S. central bank rate of 0.25 per cent could hardly go lower. And his second round of quantitative easing, in which he's bought back $600 billion of bonds, is about to run out at month's end, with no third round in sight.

And then, as Flaherty notes, "the U.S. political system is already in campaign mode for the next presidential cycle, with the prospect that nothing will get done until after the election in November 2012."

No wonder, as he says, that "Wall Street is hedging again." The finance minister doesn't comment on the stock market any more than exchange rates, but he's certainly aware that the TSX is in correction territory, off more than 10 per cent in the last two months, driven down by worries about the U.S. and Europe.

In Greece, for example, where they are rioting over austerity measures, the public debt is close to 150 per cent of GDP. Greek bonds are trading as junk. The prospect of its defaulting on its sovereign debt cannot be excluded, except, as Flaherty says, "the German banks are reluctant to take a haircut."

The European Central Bank, European Union countries led by Germany and France, and the International Monetary Fund already stepped in last year to help failing countries such as Greece and Ireland with a $1-trillion rescue package.

Flaherty thinks they might need to do so again, "to do a TARP with the European banks." It worked in the U.S. - the $700-billion Temporary Asset Relief Program in the fall of 2008 saved Wall St. and prevented the collapse of the U.S. financial system.

While the bailout of Wall St. was unpopular on Main St., it worked, and the banks have repaid the money with interest.

"The thing is to overwhelm the problem, and create confidence," Flaherty says.

He's now the ranking finance minister in the G7, and Canada will have something to say about this in the inner councils of the IMF.

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