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I’m not sure how many of you have been following Canadian politics lately (or ever) but there are some interesting developments that are even rarer than what we are currently seeing with this global financial crisis. We had an election not more than seven weeks ago within our country, and we had the lowest voter turnout on record. After the election, the party that emerged victories was the Conservative Party of Canada, with 37% of the popular vote. They were granted a minority government, as they do not hold more than half of the seats in the House of Commons.  The Liberal party of Canada on the other hand suffered an embarrassing loss, gaining the lowest percentage of the popular vote in Canadian history. Their leader, Stephane Dion, was ridiculed as being a massive failure.

The steps that the Conservative government took in helping our country overcome this financial crisis were exactly the ones that I would have taken. Trim spending, try to balance the budget, and do nothing else. You might be saying “Well Bri, this isn’t very Keynesian; the government should be intervening in markets to help bring stability.” I would have to agree that it isn’t a Keynesian approach, but it is the approach that I think makes the most sense for our country (and other countries as well for that matter). Why would a policy of non-intervention be the best for us? Wouldn’t it result in massive chaos, high job losses, an extreme loss of wealth, and civil unrest?

A non-interventionist policy would indeed result in a massive amount of chaos, thousands of job losses, extreme losses of (artificial) wealth, and potentially civil unrest. But it is the optimal solution as it is the only one that will refresh these stagnant countries and bring about renewed innovation and growth. The problem with our current society is that we are satisfied with the status quo. Yes, we would like to do more to help x, y and z, but we really can’t be bothered to change our lifestyles to do so. We have been spending outside of our means for years now. We have maintained an artificially high standard of living. Real incomes have actually dropped since the mid 1980’s. Debt has soared.

I challenge anyone to present me with a reason why any person should have more debt than they do equity. Wait, shouldn’t I be comparing debt to assets? I suppose that would be the proper methodology given our current situation, but it is often very difficult to assess what the value of those assets would be. There are accounting firms that make billions of dollars per year assessing the value of our assets. Mostly on the basis of ‘fair market value’…

What most people don’t understand is that when your purchasing power is artificially inflated, those with less are now able to purchase more. When there are constraints on supply (such as the number of beach homes in Florida) then demand is sure to drive up prices. This leads to the ‘fair market value’ of such things to skyrocket. Because we have borrowed on the equity (or asset value) of this new home, we have effectively balanced out our debt to our assets. We have reached an equilibrium that most people would be fairly comfortable with.

Yet what this does not consider is that your asset-backed debt is valuated on something that was erroneously postulated to ever increase in value. The presumption was that your house value (asset value) would rise while your debt load remained consistent and that if the need ever arose, you could sell your house to cover your debt and still have money left over to buy a new house (albeit a smaller one).

Unfortunately, this debt-fuelled craze finally came to a halt as these peoples’ debt repayment schedules began to reset at higher interest rates, and others realized that they didn’t really want to pay such high prices for such a house. On several hundred thousand dollars, a few interest points increase is definitely not negligible. While things may have been in balance when the house was first purchased, because the values of houses had stagnated, these homeowners now had more total debt than total assets. Their total worth was negative.

In order to make an attempt at solvency, people tried to sell their homes into the market to downgrade and hopefully repay their debts. Yet there were so many people in the same situation, that all this did was further increase the supply of houses which decreased the prices even more (closer to their real fair market value). This caused more people to become underwater (negative total worth) and the cycle continued. Being unable to sell their homes, people were then confronted with payments that they could not afford, and they had to default or declare bankruptcy. With more than $1.4 trillion worth of mortgages in the USA, this was a massive hit to the banks.

The banks really should have calculated for these possibilities, but they were too highly leveraged and making massive returns besides, that they couldn’t be bothered to care about their mortgage holdings. This came back to bite them in the ass, as first Bear Stearns, and then Lehman Brothers collapsed. Interestingly enough, the week after Bear collapsed, major news sites listed that Lehman was on the verge of collapse due to a lack of liquidity. The then CEO countered that Lehman was just fine, and so the markets continued chugging along. I suppose he was lying.

Following the collapse of Lehman and the resulting turmoil, as other banks lost billions of dollars on their now worthless investments, the major economies of the world turned to Keynesian policy for dealing with recessions; stimulus. The basic premise is that the government should take money from its coffers to help smooth over any problems and help the country ease out of a recession. This is extremely effective behaviour and is a very good method for easing out a recession. What none of the policymakers bothered to consider is that as originally published, this stimulus was meant to come from the governments coffers (oh, did I say that already?). This means the government should have the money on hand. Running with more than a trillion dollar deficit was not exactly what Keynesianism had in mind.

In order to affect a stimulus while you have already insurmountable debt, you need to turn to your central banks to print money. Print up a few more trillion dollars to dole out, and problem solved, right? No, not right. Because by increasing the supply of money, you effectively decrease the value of each dollar. Suppose we have an auction with three bidders who are looking for a 1935 Dodge Shadow. We only have one such car in existence. As is the fashion with auctions, the price will be bid up to unbelievable sums of money until one of the three emerges as the victor and drives away in his car. This car has a lot of demand and little supply, so the price is high. Now, if we have three of these cars, it is possible for each man to simply bid a reasonable sum of money for each, and drive away happily. This is because demand is equal to supply. We are at equilibrium where if you want the car, you can have it, and so you only pay how much it is worth to you.  Now, if you have four of these cars, the price for each will decrease because now the auctioneer desperately needs to get rid of his excess and the buyers really have no need for more than one of the cars.

Hopefully that made sense. Essentially, when you have more buyers than sellers, the price is high. More sellers than buyers, and the price is low. An equal amount, and we have a fair market price. Emphasis on that last point, as that is where our economy should be heading. By letting the markets collapse and reset, we are essentially letting things fall to their fair market value. Anything unsustainable will be cleaned out of the system and we would be left with a far more lean and mean economy… eventually. The problem is that this will result in a much needed depression as these things reset and re-align. We would have high levels of unemployment and peoples’ wealth dropping to zero.

I advocate this solution as our countries would then be once again competitive on a global stage, and we can really start bringing some innovation and change to the world.

Back to the impact of the current political situation in Canada. The opposition parties are trying to form a majority government to oust the current one. They will work together in coalition to lead decision-making. Their first task is to put forth a motion to bail out the auto industry and forestry sectors so they can please the unions. The next task is to give the rest of the nation a stimulus package.

Anything that Canada does will be ineffective if our largest trading partner has problems. I say we let them bear the costs and we can just sit back and enjoy the ride. By the way, I hope the unions all collapse. They are the biggest drain on our competitive prowess over in the West.

Oh, I’m not a Keynesian (if you couldn’t tell).

[I apologize if this seems a little disconnected, I’ve written it over a span of 5 hours while at work]