Canadian Investors Should Be Looking Over Their Neighbor’s Fence

I know it’s not polite to stare, and I know people should mind their own business… But, when a neighbor nurses a shaggy front lawn, driving the property values on the street down or when a car dealer tells you your brand new and overpriced vehicle’s melted head gasket is not his problem, well, darn the politeness. This is also how I feel about what’s going on south of the border — I know I shouldn’t stare; it’s not polite. But, when two economies are so closely intertwined, as is the case with Canada and the U.S., I need help minding my own business.

Macroeconomics uses a nice little equation to measure gross domestic product (GDP) based on the expenditures approach. It states that a country’s GDP is equal to its aggregate consumption, plus investment, plus government spending, plus net exports. From the fiscal point of view, one variable in this equation that seems to hold the key to the others is government spending.

You see, when government increases its spending, cuts taxes and runs a deficit, the country’s consumption, investment and net exports decline, pushing interest rates higher. The opposite happens when the government cuts its spending and increases taxes.

So far, things appear simple enough. All an economy needs is a little tweaking here and there. But, what happens when things get horribly out of hand, leading to exorbitant government spending, frightening budget and trade account deficits, and, worst of all, the national indebtedness of staggering proportions, totaling $8,745,173,811,441.98? (Just in case you have trouble reading this number, we are talking about $8.75 trillion in debt!)

How did the U.S. economy manage to bury itself so deeply and is there a way out? I’m afraid there isn’t anyone who can provide a simple or easy answer to the second question, but in lieu of an answer to the first one, I can offer an illustration of why and how things got so bad.

A few days ago, an alarming, although expected, piece of news hit the media. In it, the Senate voted to send more troops to Iraq; 21,500 new soldiers to be exact. So far, the war in Iraq has cost 3,133 precious American lives and almost $60.0 billion in taxpayers’ money. Of course, the only way for the U.S. government to keep up with an expensive war like this is to keep on spending.

Remember the little equation of measuring GDP through the country’s expenditures? Well, if the government is spending like crazy, it creates a deficit. As a result, consumer and business spending, as well as net exports should go down in response, while interest rates increase. Unfortunately for our good neighbors, consumer and business spending are not showing signs of a slowdown, while net exports are definitely hurting, considering the size of the trade account deficit.

All the while, the Fed seems so overwhelmed, not knowing what to do with interest rates. You see, one of the biggest problems of successful fiscal policy is its timing. If interest rates are raised too soon, by the time the economy fully absorbs it, the country may overshoot the landing and vice versa. I wish there were other words to describe it, but it seems the U.S. has been sucked into a fiscally disastrous vortex of historic proportions.

Let me give you an example of an economy run in a different manner. Canada is a heavily taxed country. Tax revenues are used to keep engines of a number of social and other kinds of government programs running smoothly.

As a result of fiscally prudent government spending, for fiscal 2005 to 2006, Canada’s budget surplus has reached CDN$13.2 billion, while the country’s federal debt level is the lowest among G7, totaling CDN$561.00 per each Canadian. In aggregate terms, since peaking in 1996 to 1997, when the federal debt totaled CDN$562.9 billion, the country’s current debt level stands at $481.5 billion.

It is scary when the government loses its head — and there are no other words to describe actions of the Bush administration. But honestly, I neither want to nor can I imagine a world of shifted

economic powers. If the United Kingdom had not been severely impoverished during WWII, it would have had the economic strength to take the lead role on the world stage instead of the U.S.

These days, it appears it’s America’s turn to head to the poorhouse. Since the U.S. has traditionally been Canada’s main and largest trade partner, if it came to be that the U.S. is no longer the world’s superpower, Canadians might not exactly like whichever country takes up the torch next. And this is precisely why I cannot stop peeking at the goings on behind our good neighbor’s fence.

Now, readers of Profit Confidential might think that my interest in macroeconomic trends in the U.S. and Canada is not exactly going to tell them much about what to do with their own investments. But, nothing could be further from the truth.

You see, in this day and age, no man, country, economy or company is an island. Economic trends and events tend to filter down and up as part of a perpetual economic flow. So, if, for example, things are shaky on the macroeconomic level, they cannot be much better on the microeconomic level either. And, it is precisely on the microeconomic level where faiths of companies you might be invested in are often decided.

So, my advice is not to turn the blind eye to the “goings-on” on the macroeconomic level. If nothing else, macroeconomics can serve as an early warning system you should be taking a full advantage of.