A question many of you might have asked yourselves, and a question many Canadians are sure to be pondering. As many of us are aware, the federal government alone is set to spend almost $350 billion this year to manage the impact of COVID-19. The deficit could reach $400 billion in a worst case scenario of continued difficulties and unexpected negative surprises. The answer is very simple, but worth considering. Obviously, the federal government doesn’t have $400 billion sitting around. The deficit will be accommodated through the bond market and by the Bank of Canada. The federal government will issue bonds that will be sold on the open market to domestic, international, and institutional investors. Whatever people, businesses, pension funds, companies, and foreigners don’t want will be bought up by the Bank of Canada. The Bank will print money to buy the bonds issued to facilitate the borrowing. In this sense, the Bank of Canada’s importance to our country and economy will only grow. Not only are their low interest rates supporting cheap debt, a strong property market, and easy access to credit for most, but now their bond purchasing will be critical to the country in getting out of the COVID mess. As many of us are aware, the federal government alone is set to spend almost $350 billion this year to manage the impact of COVID-19.
One must keep in mind though, that the provinces and municipalities are also loading up on debt to get through COVID. Like Ottawa, the hope is that whatever bonds aren’t bought by people and investors will be purchased by the Central Bank. Ontario touched upon this in their 2020 budget. With the province projecting an over $35 billion deficit, the bond market’s appetite for the Ontario bonds was strong enough for the government to project no major difficulties in getting the funds it needs to operate. Provincial bonds are a well respected financial product that is usually in high demand. British Columbia’s provincial bonds are the most highly rated in the country, as that province has low debt, a strong economy, huge natural resources, and a geographical position and outlook that’s favourable (access to Asia). Provinces like Alberta and Saskatchewan, which traditionally had triple AAA provincial bonds, have seen their scores fall given the collapse of commodity prices. Overall, there have been no red flags on the issue of demand for provincial or federal bonds. They’re being bought up, one way or another.
The big risk is that with all of this activity from the Central Bank, inflation will begin to rise. We’re already seeing it for the price of many commodities – steel, cement, lumber, machine parts. The supply chain issues brought on by COVID haven’t helped in this regard. If inflation does begin to pick up, the central bank will be trapped, as it can’t raise rates (we all depend on cheap debt), and higher rates would simply squeeze government capacity to borrow as debt servicing costs would spiral out of control. Inflation in food and basic commodities generally perpetuates when the money supply (money velocity) picks up. This hasn’t happened as most of the inflation we’ve seen has been soaked up by businesses, governments, or through asset prices, and not in the day to day goods we consume, so it hasn’t been a problem. While inflation is beginning to pick up, the good news is that government’s understand that this deficit spending is unprecedented and will have to be reduced in the coming years.