Picking our poison: The icy hand of austerity or the scorching rebuke of the bond market

As I’ve said a number of times before, all Western economies will endure austerity over the next few years.

Embracing the icy hand of fiscal restraint

Some countries, like the UK, will see the writing on the walls and take steps necessary to restore fiscal credibility.  The result will be a realignment of expectations; Entitlements will be slashed.  The public sector will see head counts drop (Britain is expecting to cut its public sector by half).  Promises made to many people will be reneged on.  Unions and near-retirees will be peeved.  It’s already starting!

We know how well that goes over!  Expect social unrest to follow on the heels of harsh austerity.

Here in Canada, in the traditionally liberal/socialist stronghold of Toronto, a very un-eloquent, loud-mouthed individual won the mayoral race on the back of a brilliant campaign that sought to “stop the gravy train”.

This is a sign of things to come!  People understand that things need to change.  They seem to get that the stimulus measures were a resounding failure.  People are starting to recognize that the only thing that separates this economy from the one back in early 2009 is the largest peace-time deficit spending in our history.  Coincidently, this spending tap is being turned off, and what do you know…..growth is slowing with it.

So it’s time to try a new plan.

Enduring the scorching rebuke of a seething bond market

People embrace austerity when all options are exhausted….but one.  No politician wants to run with a campaign of, “we’re going to cut entitlement programs…people will have to work harder….we’ll raise taxes to pay for our spending from years past….we’ll lay off a large number of public sector employees…”  Who want to be that guy?

So why do they do it?  Why don’t we keep partying like the money will never stop flowing?

The reality is that the bond market will eventually slap a country upside their head if they keep screwing around and don’t reign in their profligate spending.  For evidence of this, look no further than this past week as Ireland, Greece, and Portugall all took it on the chin.


“The yield on Irish 10-year bonds closed at (a record) 7.65 percent, while the extra yield investors demand to hold the debt instead of the benchmark German bunds reached 526 basis points.

The higher cost of borrowing by the State reflects mounting concerns that Ireland will struggle to reduce its budget deficit.”


“Yields on Greek 10-year bonds spiked to 11.34 per cent on Friday, approaching the historic highs of last May when the country had to be bailed out by the European Union and International Monetary Fund to avert a sovereign default.”


“Investors failed to respond to Portugal’s approval of a tough austerity budget as concern over European Union proposals to make bondholders share the cost of future state bail-outs pushed government borrowing rates to record levels.

The yield on Portugal’s 10-year year government bonds fell 9.1 basis points on Friday to 6.516 per cent. This was still close to the euro-era high of 6.655 per cent reached on Thursday, the day after parliament approved the country’s biggest spending cuts for 25 years.”

As a result, their bond yields soared this week.  If you live in that country, you would face the prospects of higher interest rates to service your debts.  Similarly, the government is looking at a higher portion of tax revenues being eaten by interest costs, meaning less money for other government spending.

What does it mean to us in Canada?

This weekend over at the Wall Street Journal, they ran an article about the looming borrowing needs for a number of countries, including Canada.

Here’s the kicker:  We are going to need to borrow about 18% of our GDP in 2010 and an estimated ~15% in 2011.  This is only marginally less than Portugal, Ireland, and Spain (another country with surging bond yields), and it is more than the UK will need to borrow, despite the fact that they are actively trying to deal with their spending and debt issues.

Finally, consider that the whole funding issues for Greece, Spain, Ireland, and Portugal all became an issue when their real estate bubbles burst, sending consumer spending, employment, and tax revenues down as well.  They’re in the midst of significant real estate carnage in all of those countries.  Their tax base is already suppressed, necessitating all the extra borrowing.  Canada, on the other hand, has a significant real estate bust to look forward to, as well as declining tax revenues and a renewed recession in 2011.  So, what will our REAL borrowing needs look like going forward?

More importantly, how will we respond to the austerity at hand?  Will we embrace it and recognize that we’ve sacrificed our future on the altar of government spending, and now it’s time to pay the piper?  Or will we fight to the bitter end to preserve a false standard of living, setting the stage for the ultimate smack down of higher interest rates on our historically high debt levels at all levels of society?  Either way, the next ten years will look VERY different from the past.


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14 Responses to Picking our poison: The icy hand of austerity or the scorching rebuke of the bond market

  1. jesse says:

    There’s another reason why austerity is popular: a large portion of the population, believe it or not, is actually living within its means and think others should too. The dirty underside, though, is how many of us depend on others’ debts for our incomes, directly or indirectly. Even the austere are in for a pound on this one.

  2. Michelle says:

    I agree that it is only matter of time when we ‘ Canadians’ will have to face much higher interest rates. The question is how high? Does anyone care to predict what the interest rates will look like in 5-10 years time?

  3. rp1 says:

    Sure in 5 years a 5-year mortgage be 7% and a big mac will cost $6.50. Median income up 10%.

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