Europe should do 'whatever it takes,' Flaherty says

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The Gazette, Wednesday, November 2, 2011

For months, Jim Flaherty has been saying the Europeans need to "overwhelm the problem" of their sovereign debt crisis. They took two important steps last week in raising their bailout fund to ?1 trillion and forcing European commercial banks to take a 50-per-cent writedown on their Greek debt.

Further measures may be announced at the G20 summit in France Thursday and Friday. Flaherty certainly hopes so.

"The answer they should give is, 'We'll do whatever it takes to overwhelm the problem,' " the finance minister was saying the other day as he sat in the living room of the Flaherty family's restored farmhouse in Whitby, Ont. "The proof will be in the implementation, but it's certainly a move in the right direction, including the bank haircuts."

The final size of the bailout package for financially beleaguered nations such as Greece and Italy could be as high as 1.5 trillion euros. Whatever it takes, says Flaherty, in terms of pumping liquidity into the system. He's also concerned about European banks being overleveraged. "We don't know what's in the black boxes of those banks," he said. "The stress tests for the European banks are not as severe as they are in North America."

Overall, says Flaherty, the eurozone crisis "is the No. 1 worry right now. And the No. 2 concern is the U.S. deficit and debt." For months, these concerns have been reflected in global stock markets, with daily triple-digit moves above or below the norm rather than the exception.

"I'd like to see more resolution in Europe before we proceed with the fall economic update," Flaherty said.

Which may be one of the reasons he's put it off until now. It won't be next week, with the House of Commons out for the Remembrance Day break. A reasonable guess would be the week after next, perhaps on Tuesday, Nov. 15.

Flaherty will be staying the course, with his narrative that the recovery is fragile, that Canada has come out of the recession in better shape than anyone else, and that Ottawa is on track to return to a balanced budget by 2014. That's his story and, barring a European collapse, he's sticking to it.

The recovery is, indeed, fragile. Flaherty's independent panel of outside economists has just revised its consensus growth forecast for 2012 down to 2 per cent. "That's not so bad," Flaherty says. "It's not the end of the world." But it's not 3 per cent, either.

After slightly negative growth in the second quarter, Canada's economy grew by 2.2 per cent in the third quarter, thus avoiding two consecutive quarters of negative growth, which technically would have been a recession. U.S. growth of 2.5 per cent is also reassuring, as we export one-third of everything we produce and three-quarters of it goes to the U.S.

Flaherty remains confident the goal of a balanced budget by 2014 is achievable. For one thing, government revenues are growing again. For another, emergency stimulus spending is winding down. Furthermore, Ottawa plans to cut operating spending by at least $4 billion over the next three years. That would be a 5-per-cent cut, but all departments have also been asked to submit scenarios of 10-per-cent cuts as part of the government's expenditure review. In the private sector, they do this all the time. Only in government would this be seen as a big deal.

Meantime, Flaherty is confident he can balance the books on schedule.

"We will get to balance in the mid-term, even with the more modest growth assumptions," he says. "It's totally manageable." Especially if the expenditure review comes in at the higher end.

He also waves off the suggestion that Canada's deficit, only 2 per cent of gross domestic product, is structural rather than cyclical. Canada was in a surplus before the economic crisis, and will be in a surplus again in three years, once again paying down the federal debt, which will be only one-third of GDP.

The U.S. deficit of $1.5 trillion, nearly 10 per cent of GDP - now that's a structural deficit, with no prospect of it being reduced even by half by 2020. The U.S. debt of nearly $15 trillion is approaching 100 per cent of national output.

After last May's federal election, Flaherty went to Washington, where he conveyed a message to Republican congressional leaders that the Americans need to get a grip on their deficit and debt. He gets an audience for this message because Canada has a story to tell, one of leading by example, resulting in the lowest deficit and debt in the G7, and the strongest job growth coming out of the recession. While the Republican leaders congratulated him on the re-election of a Conservative government, they were taken aback when he sketched out the extent of Canada's massive stimulus program.

Flaherty allowed himself a chuckle.

"For a while there," he said, "we were all Keynesians."

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