CANADA’S SEPTEMBER 2020 SPEECH FROM THE THRONE The Liberal Government’s Expected Fiscal Shift Keith Oland, Global Strategist IceCap Asset Management Limited September 21, 2020 Introduction ...................................................................................................................................................... 4 The Canadian Political System .......................................................................................................................... 5 Prorogation ....................................................................................................................................................... 6 WE Charity scandal and Bill Morneau .............................................................................................................. 7 The Speech from the Throne ............................................................................................................................ 9 The Liberal Party’s shift to the left ................................................................................................................. 11 How far will the shift be? ................................................................................................................................ 12 Reasons why the Liberal Party will significantly increase deficit spending ................................................... 13 Consequences of an increase in the national debt ........................................................................................ 15 Interest rates ............................................................................................................................................... 15 Canada’s credit rating ................................................................................................................................. 16 Credit spreads ............................................................................................................................................. 16 Provincial debt ............................................................................................................................................ 16 Canadian Dollar ........................................................................................................................................... 17 Canadian economic growth ........................................................................................................................ 17 Foreign government budgets ..................................................................................................................... 17 Conclusion ....................................................................................................................................................... 18 About the Author ............................................................................................................................................ 19 1 Disclaimer An investment in any strategy, including the strategy described herein, involves a high degree of risk. There is no guarantee that the investment objective will be achieved. Past performance of these strategies is not necessarily indicative of future results. There is the possibility of loss and all investment involves risk including the loss of principal. 2 It is our belief that the Liberal Government of Canada may introduce significant new spending programs in the upcoming Speech from the Throne, setting a precedent for other countries to implement similar programs. In the past few years there has been a major shift, particularly amongst western countries, towards expanded fiscal deficit spending. The current environment of historically low interest rates encourages borrowing to fund these programs. Canada has positioned itself to be one of the first major countries to rapidly expand spending, regardless of fiscal anchors such as the net national debt, and debt to GDP ratio. We could see the first indication of this shift in the Speech from the Throne on September 23rd, 2020. If major spending initiatives are announced without accompanying sources of income to fund them, we can infer that the national debt will surge. Markets will be watching closely, and if reactions to the anticipated shift are muted then this will give tacit permission for other comparable countries and sub sovereigns to do the same. This could also be a major step in bringing modern monetary theory (MMT) into the mainstream. 3 Introduction On August 18th, 2020, the Prime Minister of Canada Justin Trudeau asked Governor General Julie Payette to prorogue Parliament.1 This means all parliamentary activity stops until a new session of parliament is opened with what is called a Speech from the Throne. This also means that all business conducted by the House of Commons must be restarted in the new session. A Speech from the Throne is where the government introduces its direction and goals. This is currently scheduled for September 23rd, 2020. In our opinion, there is a financial market risk that Canada may announce programs in the upcoming Speech from the Throne that will lead to significantly greater than expected future deficits and debts. This has the potential to significantly change foreign investor perception of Canadian debt, equity, and currency markets. The Speech from the Throne is significant because we will hear in detail what the Liberal Government plans to do with their time in government. We believe there is a real possibility of a significant shift to the left in government policy, accompanied by increased deficit spending. The reasons for this are as follows: 1) The coronavirus pandemic, and the resultant need to stimulate the economy. 2) Low interest rates where the cost of money is essentially free (0.25% nominal interest rates, and negative real rates).2 3) The need to shift attention away from the WE Charity scandal. 4) The ability to displace the New Democratic Party on the political spectrum and position the Liberals in a place where they can expect to have success in the next election. 5) Leaks to the media demonstrating the Trudeau government’s preference for increased spending, although messaging from the Liberals has become more mixed in recent days. While it is difficult to predict with certainty exactly what new policies will be announced in the Speech from the Throne, we believe that there is a high probability that the new policies will increase fiscal spending and be funded with debt. On July 8th, 2020, former Finance Minister Bill Morneau announced an expected C$343 Billion deficit for 2020.3 It was also announced that the net federal debt would increase to $1.2 Trillion and that the federal debt to GDP would increase from 31% to 49%.4 This does not include Canadian corporate debt, household debt, municipal debt, or provincial debt, and clearly does not include new policy initiatives that will be announced during the Speech from the Throne. This constitutes a major shift in Canadian fiscal policy and the government’s attitudes towards the national debt and deficit. This paper will give a brief overview of how the Canadian system of government works, what we expect to happen with the Speech from the Throne, and what the impact on the national debt and the economy will be. What this paper will not do is give a critique of the Liberal government or assess the rightness or wrongness of potential policies. IceCap Asset Management is a non-partisan firm, and we have always taken pride in positioning our portfolios not based on what governments and central banks should do, but rather on what they are likely to do. The reason that this paper is important is that we may see a significant shift in policy that will be closely watched by other governments. If market reaction to the increased spending and debt is muted, then this will be viewed as implicit support for other governments to do the same. This will have an impact on debt and currency markets across the world. This could also be a major step in bringing modern monetary theory (MMT) into the mainstream. 1 Source: CBC News 2 Source: Bloomberg 3 Source: CBC News 4 Source: CBC News 4 The Canadian Political System The Canadian political system is based on the United Kingdom’s system of parliamentary democracy and is a constitutional monarchy. Parliament is composed of the Queen of Canada, Queen Elizabeth the Second who is represented by Governor General Julie Payette, the House of Commons whose members are elected by Canadian citizens, and the Senate whose members are appointed by the Governor General based on the recommendations of the Prime Minister. The Head of Government is the Prime Minister of Canada, Justin Trudeau. There are currently 338 members in the House of Commons and 105 senators. Elections are mandated to be held at least every five years. The five parties with representation in the House of Commons are as follows: The Liberal Party of Canada – Traditionally the most centrist party. They lost their majority government in the 2019 election recently. They are led by Prime Minister Justin Trudeau and currently hold 154 seats in the House of Commons. The Conservative Party of Canada – The most right-leaning party. They are currently the Official Opposition and are the only party (including Conservative predecessor parties) other than the Liberals to ever form a government at the federal level in Canada. They recently elected a new party leader, Erin O’Toole. The new leader plays better with centrists than the previous leader Andrew Scheer.