Infomail June 16, 2014

Objects in Mirror Are Closer Than They Appear

“The best argument against democracy is a five minute conversation with an average voter. ” Sir Winston Churchill

There is no sugar coating it.

The provincial election held in Ontario on June 12 th was very much a referendum on fiscal conservatism. On one side (The Liberals) was a platform which had presented a budget a few weeks ago which promised more of the same: taxing and spending; lots of spending in fact. On the other (The Conservatives) was a platform which basically ran on the Drummond report, which was a set of recommendations from a commissioned panel by the incumbent Liberal government on how to get the budget under control.

Despite what the negative ads implied, Mr. Hudak would have cut a mere $4 billion out of a $120 billion budget, hardly the slash and burn the opposition claimed.

In the end, democracy voted, and fiscal conservatism lost……and big.

And yet, not only was a government which had declined the standard of living for its residents, turned the province from a “have” to a “have not” province which now receives welfare-like transfers from Ottawa, has one of the highest unemployment rates in the country, the highest hydro rates in the country, and at best has been an incompetent (if not corrupt) steward of its citizen’s funds……no, they are not simply rewarded with another majority mandate……they are rewarded by the citizens of the province, who are both in denial and entitled, with a majority. And the beauty is when one looks at an electoral coloured map of the election, it went something like this: • Toronto, Ottawa, and a few seats elsewhere – Red (Liberal) • The border towns – Niagara, Sarnia, Windsor, The Soo – Orange (NDP) • Rest of the Province (Definitely all of the agriculture centers) – Blue (Conservative)

With just about 40% of the popular vote, the Liberals were able to score a big majority and now pretty well have carte blanche to do more of the same without any impunity for several years.

No doubt Mr. Hudak ran a terrible campaign, making several gross mistakes and never being able to bond even with supporters who are normally blue to the bone. Given the Liberals track record the past 11 years, this election should have been a lay-up.

Buy before looking ahead, one must look back to get a bit of history. I will focus on one point, and one point only, and that is the provincial debt. Regular readers will know where I stand on fiscal conservatism, but these numbers tell the story without much narrative:

From 1943 to 1985 (42+ years) the Conservatives ruled Ontario with a dynasty rarely seen in politics at any level. After all that time, the provincial debt ended 1985 at $31.5 billion.

In 1986, the Liberals under David Petersen broke the streak and rules until 1990, leaving the debt at a docile $35 billion.

The NDP under took over, introduced pay equity, affirmative action, rent controls and introduced casinos to Ontario. The provincial debt in 4.5 years went from $35 billion to approximately $100 billion.

So to recap quickly: • 42 years of Conservatives = $31 billion in debt • 4.5 years of NDP = $65 billion in debt

The ’ Conservatives took over for two terms from 1995 to 2003 (If you include Ernie Eve’s short tenure) and the debt went to about $132 billion.

Then in 2003, Dalton McGuinty brought the Liberals back into charge and took our debt to a whopping $288 billion or about 120% of where it was when they took over, and despite all the spending, our province went to a “have not” entity.

Total Ontario Debt by Ruling Party Time Period Ruling Party Total Ontario Debt 1943 – 1985 Conservatives $31.5B 1985 – 1990 Liberals $35.4B 1990 – 1995 NDP $101.9B 1995 – 2003 Conservatives $132.6B 2003 - 2014 Liberals $288.1B (Source: Wikipedia – Ontario Government Debt)

So the math works out to something like this: Every single resident of this once fine province owes approximately $21,000. The esteemed Fraser Institute recently did a comparison in March of 2014 entitled “Lessons from the Past and Solutions for the Future” which compared California, which is generally acknowledged to be the poster child of fiscal ineptness, to Ontario. The highlights are as follow:

California Ontario Total Residents 38.3 million 13.6 million Gross Debt $144.8 billion $267.5 billion Gross Debt in Bonds 7.6% 40.9% Per Capita Debt $3844 $20,166 Percentage of Budget 2.8% 9.2% to Pay Debt

By any measurement, Ontario is a fiscal disaster when compared to California, and with only 1/3 of the population, no Silicon Valley, and with a much less diversified economy.

The accumulated debt may have happened in the past and is in the rear view mirror, but it will catch up to us very quickly.

Although governments differ from households in many ways, when it comes to debt they are quite similar. Borrowing money may be a sensible way to cover short term shortfalls, however the bigger a governments debt becomes the bigger drag it imposes on the economy, as a larger fraction of government revenues must be devoted to simply service the interest on the debt. This leaves government with fewer options in the event of a financial emergency.

The solution to a government debt problem is the same as it would be for a household: spending must be brought into line with income. Tax hikes are simply self defeating because they stifle economic growth which results in further revenue declines.

Ontario’s current financial trajectory is unsustainable. Serious curbs on spending are uncomfortable short term but avert the possibility of a much worse budget crunch down the road. From what we heard from Premier Wynne during the campaign, I can’t see it happening.

At the Federal level, Canada itself provides an excellent example on how to quickly turn around a deteriorating debt situation without hurting the economy. In the mid 1990’s, Canada had been running a deficit for two decades, and it had resulted in one-third of all federal revenue being absorbed by interest payments. For every $1 in tax increases, $7 of spending was cut and the Federal government went on to run 11 consecutive budget surpluses causing the debt to GDP ratio to drop sharply from 71% in 1996-97 to 33% by 2007-08.

But here’s the beauty of capitalism and free markets. Even if Ms Wynne is unwilling to make the hard choices needed, the markets may do it for her. I would guess in the very near future, Ontario’s credit rating will be cut. And the current cost of about $10 billion annually to service all that debt will rise to $12-14 billion, and where will those billions come from when the province is out of money? Ironically, it could be who is forced to downsize the provincial government (where reportedly 1 of 7 Ontarians is now employed) by 100,000 employees, turning her on the very unions who helped her get re-elected.

The templates on what will happen when governments spend recklessly and waste taxpayers dollars are out there, they are called Detroit, or Greece, or Spain, etc……While the rest of the world has in recent elections turned to fiscal conservatism, it seems North America, with its growing entitlement mentality, has gone the other way.

The Liberals campaigned on more of the same, big-spending policies and they will continue on them. Sure it will end ugly, but that’s democracy. They were given a mandate, a big one at that, to avoid the hard choices and to go back on it otherwise, would be a kick in the crotch to those who elected them.

This is what Ontario voted for, and this is what they will get.

They deserve no less.

Stay tuned,

Vito Finucci Vice President and Director Investment Advisor

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