Economics: Mackenzie On Why Canada Was Hit

TORONTO, ONTARIO - As fate would have it, the Education Committee of the local Parkdale-High Park New Democratic Party happened to schedule weeks in advance a session about the economy on a night when Prime Minister Stephen Harper and opposition leader Stéphane Dion both appeared on television to make their cases to the Canadian people. Neither of leaders gave a memorable speech or said anything new. The NDP event, on the other hand, featured economist Hugh Mackenzie's views on the current situation, some of which were very informative.

One thing I had never understood about the financial crisis was why, if Canada had a sound banking system unlike the US, there had been (and to some extent, continues to be) a liquidity problem for businesses. Mackenzie pointed that businesses in Canada, like their US counterparts, had long ago stopped relying on lines of credit from their banks for their day-to-day cash needs, and were also participating in the short-term paper market, in which they effectively traded short-term bonds as required overnight to maintain liquidity.

A compelling (at least at the time) reason to use the short-term paper market was that those loaning money could invest in structured investments--which contained other paper assets, which had come to include the bundled bad mortgages from the United States that have played such a central role in the crisis--in order to earn another 1%. When the crisis hit, nobody would buy the structured investments, not knowing what they might hold, and that meant money was no longer being exchanged; the liquidity had run right out of the market.

While the smoke has cleared somewhat, Mackenzie pointed out that the difference between the interbank rate--what banks charge each other for overnight loans--and the corporate loan rate has gone from 20 basis points before the crisis to 1600 points today. That's right, it used to be a 0.2% difference and now it's 16%! It's not hard to imagine how that makes things tough on businesses.

Probably the most amusing story of the night was Mackenzie's recounting of his encounter with the Quebec travel agent who gave away trips to the Caribbean if it snowed on a given day. It had snowed, so he had to provide the trips, but Mackenzie found out that the travel agent didn't care, since he had purchased insurance. What kind? A weather derivative. Mackenzie felt that pretty much proved the case that derivatives are not different than gambling.

People at the meeting were mostly looking for answers of what should be done now, and while Mackenzie did have some suggestions, his real bottom line was not reassuring. Fundamentally, the Canadian economy is too integrated with China's resource needs and the industrial needs of the US to recover on its own. The best that can be done in Canada is to try to be ready to capitalize on the next uptick in the economy when it eventually occurs. He pointed out that the 1981 recession, while deep, was recovered from in about four years because plants were largely kept intact and people laid off. The 1991 recession was not nearly as deep, but recovery took longer. Mackenzie believes that is in large part because plants were shutdown and dismantled. The 2008 recession may be deeper than the 1981 recession, and again plants are being permanently shut down.

In Hugh Mackenzie's opinion, it might be a very long path to recovery.