Blog

With the prospect of a PQ Government in Quebec after next Tuesday’s election and a third referendum (a syndrome called the “neverendum”) on the horizon, I will reflect a bit on how global capital markets – the bond vigilantes – might respond.

There is some relevant historical precedent. In the run-up to the too-close-to-call 1995 referendum, international capital markets refused to buy new Canadian public sector debt. At the time, I was on the board of the Ontario Transportation Capital Corporation, then responsible for building Highway 407. We wanted to replace the provincial treasury bills that were funding the project with long term debt, and were given that alarming news by the Ontario Ministry of Finance.

Since 1995, Canada’s fiscal position has become much more secure relative to that of other countries. On the other hand, the bond vigilantes are much faster to pounce on countries whose finances are at all suspect.

Quebec’s public sector debt now stands at about 50 percent of gross provincial product. Debt service costs approximately $10 billion and consumes 11 percent of the government budget. The critical question is what will happen to the federal debt in the event Quebeckers were to vote for sovereignty in a future referendum. Sovereigntists will ignore the question or obfuscate. The federal government will argue that the debt was incurred by the entire nation, that federal assets in Quebec (the St. Lawrence Seaway, airports, federal buildings, national parks) will remain in situ and would thus become the property of a sovereign state of Quebec, and that therefore an independent Quebec must assume its fair share of the federal debt.

If we assume that a fair division of federal debt results in Quebec assuming its per capita share of the debt (24 percent, based on the 2011 Census), then an independent Quebec’s debt would increase to approximately 90 percent of gross domestic product (as shown in a recent briefing note entitled Quebec Election: Handle with Care posted on the Pimco Canada website). If we then assume that Quebec would be able to pay the same interest rate on its additional debt as on its current debt, then debt service costs would increase to close to 20 percent of the government budget.

Enter the bond vigilantes. Public debt of 90 percent of GDP is close to the situation in Greece, Italy, or Spain. If the bond vigilantes are skeptical about the long-term viability of the public finances of a sovereign Quebec, they would demand a substantially greater risk premium for debt issued by a sovereign Quebec than by the Canadian province of Quebec. The downward financial spiral faced by Greece or Italy could become a reality for Quebec. So virtually the first action of a sovereign Quebec government would be to seek a bailout.

If the sovereigntists’ Achilles heel is therefore public debt, then the federal government could exploit it. As soon as a sovereigntist government begins to prepare for a referendum, the federal government should enact a Fiscal Responsibility Act that would be parallel to the Clarity Act. (Recall that the latter requires a clear referendum question passed by a supermajority as a prerequisite for negotiating Quebec sovereignty.) The Fiscal Responsibility Act would stipulate that a sovereign Quebec would have to accept its per capita share of the federal debt. The Fiscal Responsibility Act would be intended to so substantially increase the economic cost of sovereignty for Quebeckers that it would dissuade them from voting for it in a referendum.

What I have outlined here is one of the key sticks the Harper Government could use to keep Quebec in confederation. But what carrots could it provide? It is a majority government with minimal representation from Quebec. Prime Minister Harper, to his credit, has achieved a level of fluency in French that, unfortunately, few members of his Cabinet or caucus can match. On a host of issues – for example social policy, cultural policy, and the long-gun registry – the Conservatives are completely out of step with Quebec. The Harper Government will have to do some serious thinking about how it can present a more welcoming face to Quebeckers if it is still in power during another referendum. Threatening to saddle Quebec with an unsustainable debt burden may be necessary to preserving the Canadian confederation, but it will not be sufficient.

After some vacation time, I’m now back to the blog. The latest round in advertising for the US presidential campaign features attack ads by the Obama campaign and by Americans for Prosperity, a conservative superpac.

The Obama campaign’s attack ad starts with Barack Obama’s affirmation – in his voice accompanied by his physical presence – that he approved the ad. With Romney’s off-key rendition of “America the Beautiful” in the background it reminds us that Romney’s firms outsourced private sector jobs to Mexico and China, and that as Governor of Massachusetts, he outsourced public sector jobs to India. It continues that Romney personally has millions in Swiss bank accounts and tax havens like Bermuda and the Cayman Islands. It ends with the text message “Mitt Romney’s not the solution. He’s the problem.”

The Americans for Prosperity ad starts with a clip of Obama pledging to cut the deficit in half by the end of his term in office and then shows clips of a “national debt clock,” in which the national debt increases from $10 trillion at the start of his term of office to the current level of $15.9 trillion – the latter displayed with a cacophony of background voices talking about the debt crisis and government spending. The ad ends with another clip of Obama saying that “I will be held accountable. If I don’t have this done in three years, then there’s gonna be a one term proposition.” The ad’s punch-line is the text message: “let’s make this a one-term proposition.” The ad concludes with a narrator stating that “Americans for Prosperity is responsible for the content of this advertising.”

What stories is each ad telling? Who is the narrator? Which ad is more convincing?

Obama’s voice and the accompanying clip of him in the White House at the outset proclaim his status as a metanarrator, the person with authority to set in motion the attack on Romney. The attack is waged on two levels, first public policy, namely that Romney has outsourced both private and public sector jobs in the past and can be expected to do so in the future; and second, personal probity, the implication that, through bank accounts in Switzerland, Bermuda, and the Cayman Islands, Romney has been aggressively, and perhaps illegally, minimizing his tax obligations. Contrasting Romney’s public display of patriotism with his policy decisions and personal conduct as taxpayer suggests hypocrisy and an absence of integrity.

The Americans for Prosperity ad has a much less authoritative metanarrator. Who or what is Americans for Prosperity? The conflation of the deficit with the national debt is unexplained and the cacophony of voices hides a fuzziness of thinking. In the second clip of Obama, in which he says “if I don’t have this done in three years,” it isn’t even clear that the “this” he refers to is the same “this” (cutting the deficit in half by the end of his first term) he was referring to in the first clip. The ad’s implicit message is that Obama is a promise-breaker. But is breaking a promise a sufficient reason to throw an incumbent out of office? There are plenty of instances of incumbents being reelected even if they broke their promises. What incumbents must argue is that they made a sincere attempt to keep their promises, but circumstances changed, and changing circumstances required a changed response. Obama hasn’t yet made that argument, but he could, and he could certainly blame the Congressional Republicans for their role in the US Government’s inability to halve the deficit.

To summarize: the Obama campaign’s attack ad tells a more coherent and convincing story than does the Americans for Prosperity ad, it hits at more serious personal failings on Romney’s part, and it uses a more authoritative metanarrator. Advantage in round two to the Obama campaign.