Saving the US Economy - the Canadian Way

[Barrister]

David Frum: Saving the U.S. economy — the Canadian way
Posted: December 05, 2009, 9:30 AM by NP Editor
David Frum
Barack Obama this week convened a jobs summit to discuss the awful U.S. unemployment numbers. Should the federal government hire unemployed workers directly? Pay money to states so that they can hire people?

If I'd been invited, here's what I would have advised: Learn from Canada.

America's situation today resembles Canada's in 1992-93: a horrific recession, terrifying indebtedness, and gathering doubts about the country's future.

Fifteen years ago, Canadian authorities made one crucial decision: They allowed the currency to depreciate. The Canadian dollar dwindled to as little as U.S. ¢62.

It was as if all of Canada had been put on clearance sale. Every asset within Canada was devalued, every wage was cut. Median hourly wages in wealthy Ontario tumbled below wages in Mississippi. Canadian purchasing power was slashed. Canadians suddenly had to pay more for almost every internationally traded good and service, from orange juice to software programs to foreign holidays.

Canadians were compelled to consume less. By discounting Canadian assets, they sold more. And because their labor suddenly cost less, they were employed more.

Nobody enjoyed this policy. The policy's inherent pain was aggravated by the Chrétien government's simultaneous decision to maintain taxes at very high levels — the government rescued its own finances first, and left Canadians' personal finances for second.

Whatever one thinks of the Chrétien government's tax policies, however, the currency policy did its job. Exports jumped, the Canadian growth rate accelerated, and Canadian living standards recovered.

Meanwhile, the Americans were conducting a very different kind of economic policy — a policy that emphasized debt and consumption rather than work and export.

The United States may run the most pro-borrowing public policy on Earth. An American home mortgage is tax deductible, as Canadians know. Americans use this subsidy from the government to buy more house for their money: On the eve of the recession, the average new home in the United States contained more than 2,300 square feet of space, as compared to about 1,850 square feet for the average new Canadian home.

Two other pro-borrower policies may matter even more than home deductibility. An American mortgage is almost always non-recourse. If a home owner does not pay his or mortgage, the lender can repossess — but cannot usually reach the home-owner's other assets. The home-owner may have a million dollars in the very same bank that holds the mortgage, but the bank account is as unreachable as if it were located in the Cayman Islands.

Non-recourse loans create a one-way option for borrowers. They borrow to buy an asset they expect to increase in value. If the borrower guesses right, he or she gains a windfall. If wrong, he or she walks away, leaving the loss to the lender.

It gets better! Suppose a buyer accepts a fixed-rate mortgage at 5% and mortgage rates rise to 6%. Too bad for the lender: The rate is fixed, the buyer is protected.

Suppose, however, that mortgage rates decline to 4%. The lender is not protected. The buyer has the right to pay off his high-rate loan, usually without penalty, and refinance at the lower rate.

One more thing. Capital gains on the sale of a principal residence are untaxed, so long as the buyer reinvests in another residential property.

Altogether, the incentives combine to invite borrowing, speculation, and property flipping. Supercharge those incentives with no-down-payment, no-paperwork mortgages — and a crisis is made.

Step two after a Canadian-style currency depreciation should be a shift to a Canadian-style approach to home finance. The first shift will encourage work; the second shift will encourage saving.

Unfortunately, the ideas President Obama seems eager to import from Canada are not these right lessons, but instead two wrong lessons: the need for higher taxes and more government control of the health care system.

It's as your children's teachers tell you: You can only teach those who want to learn.

http://network.nationalpost.com/np/blogs/fullcomment/archive/2009/12/05/david-frum-saving-the-u-s-economy-the-canadian-way.aspx

[Jacob]

Government control of the health care system is the wrong lesson?  I guess I shouldn't be surprised by this from Frum, but it's still pretty dumb.

[grumbler]

I am confused about some things.

First of all, in Canada, can banks cancel mortgages at will?  The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this).  The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).

Secondly, in Canada, are fixed-rate mortgages illegal?  the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.

I am rather astonished that someone would share such a shoddy article with us.  It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! 

I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar.  Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would.

I am calling shenanigans.

[Razgovory]

Government control of the health care system is the wrong lesson?  I guess I shouldn't be surprised by this from Frum, but it's still pretty dumb.

He's a God out in the South Pacific.

[Admiral Yi]

I wonder what Frum means when he says Canada "allowed" the currency to depreciate.  AFAIK the looney has been floating ever since the end of Bretton Woods.  Did Canada stop selling reserves to prop up the value?

I also don't see the connection between the exchange rate and real estate markets.

[Jacob]

I am confused about some things.

First of all, in Canada, can banks cancel mortgages at will?  The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this).  The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).

Secondly, in Canada, are fixed-rate mortgages illegal?  the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.

I am rather astonished that someone would share such a shoddy article with us.  It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! 

I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar.  Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would.

I am calling shenanigans.

Yeah, I'm thinking that's the right call.

As for mortgages, here's how it works up here (AFAIK) compared to what I'm guessing is the way it is in the US (making no claims here, so feel free to point out where I'm wrong):

Mortgage payments are not tax-deductible.

If I get a fixed rate mortgage, which I usually do, I can refinance before the term is up to take advantage of lower interest rates but I may well pay a penalty for doing so as that's written into the terms of the mortgage.  There's usually a limit to how much you can pre-pay and you cannot pay more than that.  I believe it's commonly something like 15-25% of the original principal per year plus maybe double monthly payments.  In most cases you can't just show up with half a million cash and pay off your balance if you have it, unless you pay some penalties too.

I don't believe houses are protected in general bankruptcies, nor do I believe that I can go bust on my mortgage without my other assets being on the line.

[Zanza]

Canadians suddenly had to pay more for almost every internationally traded good and service, from orange juice to software programs to foreign holidays.

Canadians were compelled to consume less. By discounting Canadian assets, they sold more. And because their labor suddenly cost less, they were employed more.

[...] however, the currency policy did its job. Exports jumped, the Canadian growth rate accelerated, and Canadian living standards recovered.

Unlike Canada, the US is using the currency that virtually all international trade is denominated in anyway. Depreciating the dollar will only cause a recession in the countries that let their currency float against the dollar, whereas it doesn't solve the real imbalance, namely the massively undervalued renminbi. Causing a recession in those countries means that there is no one to buy more US exports, so what the policy will do is lessening US imports, but not increasing US exports much. That will close the trade gap a bit, but at the price of less wealth for everyone involved.

[Neil]

So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses?  Problem solved.

[Admiral Yi]

So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses?  Problem solved.

Against the law, for starters.

[Neil]

So why doesn't Obama just ban all Chinese goods until they adjust their currency, and confiscate all property owned by Chinese-owned businesses?  Problem solved.

Against the law, for starters.

Why would that stop him?  I seem to recall another president during tough economic times who didn't care about the law.  He was also a raving egomaniac with excellent PR skills.

[BuddhaRhubarb]

I am confused about some things.

First of all, in Canada, can banks cancel mortgages at will?  The article implies that they can (since it claims that a problem is that, in the US, only the borrower can do this).  The other possibility is that in Canada, loans are permanent (or, at least, one must pay a penalty for paying back a loan early).

Secondly, in Canada, are fixed-rate mortgages illegal?  the article implies that they are, by making note of the fact that fixed-rate mortgages are legal in the US.

I am rather astonished that someone would share such a shoddy article with us.  It says "lets do these things like Canada does them" and then doesn't bother to tell us how Canada does things! 

I guess the depreciation of the US dollar has not been deliberate enough for the author, but it is unclear to me exactly how he wants the US to sabotage its dollar.  Looking at the US-Canadian dollar exchange rate, the massive drop he claims happened 15 years ago is not apparent; the $C didn't hit US$0.62 until 2002, and that (my math tells me) is much more recent than 1992. The decline of the $US in 2007 had none of the miraculous effects that Frum said it would.

I am calling shenanigans.

ya. Hilarious that Frum is pushing for Chretien like policies. also.

actually the CAD dropped to similarly low (but not quite 62 cents) in the late 90s  as the  link below shows. the late 90's was just as crappy jobs wise as the early 90's. maybe worse.

http://www.cbc.ca/news/interactives/map-history-dollar/

[DGuller]

Devaluing the currency doesn't work well when your currency is also the world's currency.

[Ed Anger]

I favor screwing the entire world over as we go down in flames.

[The Minsky Moment]

This is pretty silly, for reasons already pointed out.  The US can't really control its exchange rate, and the dollar occupies a fundamentally different position in international finance than the loonie.  With respect to the critical bilateral relationship with China, it should be obvious that the US can't simply devalue the dollar.  The article also ignores other relevant fundamentals driving the Canadian economy, such as the commodities super-cycle.

[alfred russel]

The dollar has been getting its ass kicked recently anyway.