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The federal government, if suitably motivated, could double GDP growth in 2014 and 2015 without too much inconvenience in the short term. How this would happen, and the reason it shouldn't, gets to the heart of the slow-motion train wreck that is China's midterm economic future.
It's a wreck that is going to be felt in the portfolios of Canadian investors. Any nation's GDP equals private consumption, plus investment, plus net exports – plus government spending. So, everything else being equal, increases in public-sector expenditures flow through directly to GDP (although the relationship isn't one-to-one for all sorts of complicated reasons).
Canadian GDP is approximately $1.7-trillion (U.S.). To boost economic growth by a large amount, the increase in government spending would have to be monumental – tens of billions of dollars.
But the government could do it. Federal finances are healthy and global demand for highly rated sovereign debt remains high. So Ottawa could borrow the funds, initially at rates between 2.5 and 3.0 per cent.
The actual increase in government spending could take any number of forms. The Gordie Howe International Airport could be built in Floral, Saskatchewan. A high-speed rail (HSR) line could connect Vancouver to Halifax. Dated public housing could be demolished and rebuilt to the delight of construction companies and cement producers nationwide.
This strategy, which would resemble much of what China is doing right now, would generate a short-term boom – but end in economic disaster. The HSR line would run at a massive loss. Gordie Howe Airport would operate at 20-per-cent capacity.
The feds, after borrowing the funds at 3 per cent and higher, would see no increase in government revenue to offset the added interest costs. The added debt burden would be sitting there for our grandkids.
In China, the signs of this type of malinvestment are well documented. At a recent conference, the head of China's Civil Aviation Administration, Li Jiaxiang, noted that 134 of China's 175 regional airports are operating at a loss. Despite that, the plan is to build 55 more airports by 2015.
Money is also being spilled with abandon on high-speed rail projects. Beijing-based Caixin Media pointed out that "two months after its February 2010 opening, the high-speed Beijing-Fuzhou line quietly closed for a lack of passengers. Reports said not a single seat was booked during the 10 days before the decision to scrap the 2,058-kilometer line."
In the Chinese economy, the debt taken on to build this infrastructure is not always held at the government level. The loans are held on corporate balance sheets, on off-balance sheet vehicles run by local governments and within the short-term savings vehicles known as wealth management products. In the latter case, the country's own central bank chairman Xiao Gang has admitted that the asset class is "fundamentally a Ponzi scheme."
China's non-government, non-bank debt has climbed to over 200 per cent of GDP – from less than 140 per cent in 2008 – just as overall economic growth is slowing. This is a sure sign that investment is becoming less efficient and non-performing loans are piling up.
Problems are being swept under the rug. In many cases bad loans are hidden in the off-balance sheet government investment vehicles. In others, corporations unable to make payments on debt receive government-ordered extensions on the terms of the loans. They still won't make payments.
The Chinese economy is still on track to become the world's largest by 2030. But the country has built scores of unprofitable airports, underutilized high-speed rail lines and bridges to nowhere. A financial reckoning, and a slower pace of growth, is all but inevitable.
Canadians have benefited from China's amazing expansion and the resource demand it has generated. But domestic investors can no longer depend on Chinese growth to support their resource-based investment returns. The sooner they reallocate their portfolios, the better.
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Scott Barlow