America is headed for a debt crisis like Canada's in the '90s, warn veteran politicians

David Dodge and John Manley, who helped steer this country back to safety, say U.S. must act fast, even if it’s politically risky

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Two former heavyweights in Canadian politics say the United States is staring down a fiscal crisis reminiscent of the one Canada endured in the 1990s, and could learn a thing or two from the difficult decisions its northern neighbour took to remedy it.

David Dodge, who as deputy finance minister helped Jean Chretien’s government steer the country out of a crisis fuelled by soaring deficits and debt-rating downgrades by using aggressive spending cuts and policy fixes beginning in 1995, said the U.S. must act quickly and decisively, even if it’s politically risky or requires shaking up sacrosanct social programs.

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John Manley, who was in the Liberal cabinet at that time, agrees that U.S. lawmakers should act well before borrowing money becomes more difficult and expensive.

The cost of servicing the U.S. national debt has already soared to the point where it outstrips hefty annual spending allocated to defence. Rising interest rates have helped push the debt-servicing cost to US$879 billion, a 23 per cent increase from a year ago, according to the Conference Board Inc. The situation signals to some that the country is facing a sovereign debt crunch such as the one Canada weathered in the mid-1990s.

Markets were losing faith, and so we were in real trouble

David Dodge

“We had the crisis,” Manley said in a Jan. 8 interview after discussing the likelihood of a U.S. debt crunch and Canada’s experience on a webcast with Dodge and economist David Rosenberg of Rosenberg Research & Associates Inc. “Once you’ve on a burning platform, it’s best to get off it and we had a burning platform in 1994-95.”

A ratings downgrade on Canada’s national debt in 1992, coupled with continued large deficits over the next couple of years, raised the spectre that the International Monetary Fund might need to intervene in the country’s fiscal affairs as it had in the 1960s.

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Chretien’s government, in which Manley served as industry minister, tabled a budget in 1995 that ushered in drastic steps to reduce both the deficits and the debt by scrutinizing whether government programs were affordable, efficient and necessary. It resulted in a significant downsizing of the public sector and spending cuts that affected most federal departments and programs, from transport and natural resources to defence, as well as transfer payments to the provinces.

“We did things that not everybody in the Chretien government wanted to do,” he said. “We had more opposition in our caucus than we had in Parliament (where the opposition Reform party was in favour of cuts).”

At the same time, Dodge said, Canada moved to address demographic-related funding issues with the Canada Pension Plan. It was unpopular, but put Canada ahead of the U.S., which is still dealing with politically contentious but necessary social security reform.

“In about 12 or 13 years, it’ll run out of money, so they’ve got to fix that element,” he said. “And no one wants to touch it.”

Dodge said there are few signs the U.S. is prepared to address any of its debt and deficit issues.

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“The first lesson is, you really don’t want to let it go on at the rate it’s going; you’ve got to move really quickly and when you move, you’ve got to move decisively,” the former governor of the Bank of Canada said.

Hard lesson

That lesson was learned the hard way in Canada, with deficits growing even after Standard & Poor’s Corp. downgraded the country’s credit rating in 1992. Moody’s followed suit, lowering its rating in 1994 and again in 1995.

“That fundamentally was our problem,” Dodge said. “By the 1990s, we had interest costs that were eating up about 30 per cent of our revenues and that was just not sustainable. Markets were losing faith, and so we were in real trouble.”

A chunk of Canada’s spending cuts that were eventually imposed came from defence, a tactic that is unlikely to be copied in the U.S., particularly as geopolitical tensions rise, said Manley, who had a stint as foreign affairs minister as well as finance minister and deputy prime minister during his 16 years in politics.

“If they get their arms around that and begin to reduce it, that imposes a burden on the rest of us in the western alliance to start to spend even more,” he said. “And, of course, we know how that’s gone so far in Canada where we are seen as kind of a laggard within NATO and without much will to spend and pick up our part of what seems to be required in a world in which geopolitical tensions don’t seem to be abating at all.”

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World-wide impact

What concerns Manley most if the U.S. doesn’t make some hard choices to address the rising cost burden of its national debt is that a sovereign crisis there would extend well beyond the country’s borders.

“The trouble is, when Canada has a crisis, it’s rough for Canadians; when the U.S. has a crisis, we’re all being buffeted on those waves,” said Manley, now a senior business adviser to law firm Bennett Jones LLP. “When I was minister of finance (in the early 2000s), I asked one time: Could we model what a sovereign debt failure in the United States would look like? And we couldn’t. We really don’t know what it would be like.”

Repeated stalemates over U.S. government spending and its debt ceiling — the most recent tenuous agreement reached on Jan. 7 still requires Congress to pass a series of appropriation bills to avoid a shutdown — provide him little comfort.

“The fact that they flirt with it, with these debt-ceiling limits, doesn’t give you a lot of confidence that there is behind the scenes a plan for how to act coherently and quickly when the crisis actually does hit,” Manley said.

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Canada had a quick reversal of fortune in the 1990s, partly as a result of hard spending choices and policy reform, and partly due to luck, according to Manley and Dodge. The country went from running deficits of nearly $45 billion in 1995, or six per cent of gross domestic product, to a balanced budget in 1997 and surpluses by the end of the decade. Net public-debt-to-GDP fell to around 80 per cent from 104 per cent.

One thing Canada had going for it then that the U.S. does not now is that the Conservative government of Brian Mulroney introduced the controversial Goods and Services Tax (GST), which the Liberals pledged to get rid of but ended up leaning on as they sought to balance the budget without raising taxes.

“We had a revenue system that was more robust with the GST in place than the Americans do, so we weren’t relying on having to raise income taxes,” Dodge said, adding that the U.S. would probably have to raise taxes and cut spending to balance its books.

Canada was also in a period of stable inflation and falling interest rates in the last half of the 1990s, which both Manley and Dodge said helped improve the country’s books more quickly than anticipated.

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Canada not immune

But despite the lessons learned nearly 30 years ago, Manley said he’s concerned the current Canadian government has forgotten the importance of keeping the debt and deficits under control, since the ramped-up spending to deal with the COVID-19 pandemic has not been reined in.

“Memory fades. The problem from my point of view is the credibility that the government needs to have in order to really discipline markets and manage expectations,” he said. “It’s so hard to gain credibility around these things so that global markets believe you, and it’s so easy to lose that credibility, and I think we’re on the edge of losing it.”

Complicating matters in the U.S., Manley said, is the failure of the two major political parties to agree on much of anything, regardless of whether the president is Republican or Democrat. He said the divided caucus he was part of in the 1990s pales in comparison to the deep divisions in U.S. politics.

“Getting consensus with other parties was not something that we really worried about; we worried about getting re-elected, which we were in 1997,” he said. “But I think in the U.S. context, where getting an agreement on the day of the week is almost impossible — it seems to be divided on partisan grounds — finding the ability to do some of the very hard things that will be necessary in order to bring their situation in hand is what really concerns me.”

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Dodge said there are ways for the U.S. to “postpone the day of reckoning,” and that lawmakers will likely use them. This could include putting pressure on the U.S. Federal Reserve to ease inflation targets or reintroduce a program of buying government bonds.

“I suspect we’re going to get one of those sorts of reactions before we actually see Congress come to the conclusion that they have to both raise taxes and cut spending,” he said, adding that the U.S. dollar’s status as a reserve currency held by central banks around the world may provide some assurance that the bond market won’t “give up” on the country in the meantime.

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