It’s a Political World

By David Dittman • August 16, 2011 • Canadian Edge Weekly

In October1992 Standard & Poor’s downgraded Canada’s credit rating from AAA to AA+. S&P had rated Canada AAA since 1951. Moody’s cut its rating on Canada from Aaa to Aa1 in June 1994, then to Aa2 in April 1995. In January 1995 The Wall Street Journal editorialized that Canada was an “honorary member of the Third World.”

But the 1995 Canadian federal government budget included cuts of over 10 percent in total spending phased in over the 1995-96 and 1996-97 fiscal years. The federal government cut national defense and customs and immigration spending and reduced the size of its civil service.

The Dept of Finance prominently reduced its workforce. Transfers to provinces that funded health care, post-secondary education and social services were also cut. Transfers to persons were largely spared, though some, notably unemployment insurance benefits, were restrained in subsequent years.

Through a combination of spending cuts and tax increases–7-to-1, cuts to increases–by 1998 Canada had a balanced budget. In May 2002 Moody’s boosted the country to Aaa again, though S&P took until July 2002 to announce that the Great White North was worthy of its AAA.

The federal government posted a fiscal surplus every year until 2008, when the global financial/credit/economic crisis forced Prime Minister Stephen Harper and his minority Conservative government to reverse with countercyclical deficit spending a decade’s worth of balanced budgets.

The point of the foregoing history–apart from the fact that it provides nice background to Canada’s current prominence in the income investing universe–is that it’s possible to right a listing fiscal ship rather quickly, though it takes time to reestablish credibility and demonstrate systemic bias toward budget balance.

By “systemic” in this context is meant too the will of the people. In Canada, perhaps because transfers to individuals were relatively unscathed, at first Liberal and then Conservative governments enjoyed popular support for measures undertaken to make sure what went out matched revenue coming in.

Primarily, though, two decades after its downgrades Canada is a model of fiscal rectitude because credit raters recognize that parties across the political spectrum are committed to long-term budget balance. The difference with S&P’s recent downgrade of the US is that it took a prospective look at domestic politics rather than acting on, well, action.

Moody’s, for its part, will wait until the “Super Committee” created by the US Congress in recent debt-ceiling legislation has at least had its opportunity to fail before it moves on America’s credit rating. For the time being, Moody’s as well as Fitch have affirmed triple-A ratings and “stable” outlooks for the US.

To say it can be done is not to say it will, and the present state of American politics–taking into account the fact that this great experiment in democracy has always been marked by nasty, brutish and colorful struggles for domestic power–certainly provides little reason for comfort.

Professor Paul Kennedy observed the following about the US in his 1987 book The Rise and Fall of the Great Powers:

The task facing American statesmen over the next decades, therefore, is to recognize that broad trends are under way, and that there is a need to “manage” affairs so that the relative erosion of the United States’ position takes place slowly and smoothly, and is not accelerated by policies which bring merely short-term advantage but longer-term disadvantage.

Though he missed the timing, crediting the durability of the Evil Empire more than the spirit of the Russian people, Professor Kennedy, writing ahead of the collapse of the Berlin Wall in 1989 and the events that followed, accurately predicted the demise of the Soviet Union.

We’re about two and a half decades along in the process Professor Kennedy describes for the US. The 1990s, though fraught with intense political battles, were a period of prosperity like no other during the post-war boom. Bipartisan efforts on the revenue as well as the spending side of the equation provided a stable foundation that seemed to extend the safe harbor President Roosevelt’s New Deal established for American-style capitalism.

But the first decade of the 21st century, punctuated by unfunded domestic and foreign policy choices that contribute, along with the revenue-killing Great Recession, to the massive debt and deficit staring us in the face today–undid all that. I and my co-authors Elliott Gue and Yiannis Mostrous pick up this theme of “the relative erosion of the United States’ position” in The Rise of the State: Profitable Investing and Geopolitics in the 21st Century, which was published a year ago by FT Press.

Our thesis does not contemplate the ruin of the US, nor even its displacement as the primary global economic and political power Rather, what we discuss is the diminution of power relative to emerging–or reemerging, as in the case of China–nations on the global scene. We pick up, in a sense, and with proper humility, a small piece of the puzzle that Professor Kennedy described.

For the record, it’s my view that a reordering of global power relationships that sees the US anywhere but at the top of the structure entails circumstances that render any investment advice superfluous. In other words, it’ll take more than gold bullion to get you through such a nightmare. We provide actionable answers in The Rise of the State.

And we provide answers on a regular basis in Canadian Edge, which includes in-depth coverage of more than 100 companies that together pay among the highest yields in the world. Soon we’ll do the same thing in Australia.

Its financial system described as the strongest in the world by multiple entities that track such matters. It’s among a dwindling number of sovereign credits with a AAA rating, its political consensus on budget matters–it was a Liberal government in the early and mid 1990s that started Canada off on the policy course of spending cuts and tax increases–is one reason why.

Growth in the developed world, constrained by excessive debt and sclerotic political systems, is inadequate. Threats to the continuity of the current European structure could cripple the global economy as well. Meanwhile, emerging markets must continue to accommodate the expanding appetites of their ascendant middle classes.

Canada, peculiar among its developed peers, stands to benefit in relative terms from this shift. Canada is home to abundant natural resources, in huge proportion to its approximately 30 million people. It entered the global financial/credit/economic crisis with a decade’s worth of bipartisan fiscal discipline and balanced budgets under its belt.

Continuity at the federal level was guaranteed this spring, as Canadians finally rewarded Prime Minister Harper with his long-coveted majority in Parliament for his Conservative Party.

The big-picture view is favorable if your mind is open to the opportunity Canada–and other similarly situated countries, such as Australia–offers the US-based self-directed investor. More than eight months into the era of trust taxation–the post-trust era, if you insist–Canada is still the place to find among the best companies in the world for high current income and stable long-term growth.

Collecting dividends helps you build wealth through secular and cyclical bulls as well as secular and cyclical bears. If you run your own investment ship, there’s no better way to establish ballast than with high-yielding Canadian stocks.

The Roundup

Here are links to summaries of second-quarter earnings reports for Canadian Edge Portfolio Holdings. Look for a complete review and a look at how numbers for individual companies fit within the current investing climate in the September Canadian Edge.

Conservative Holdings

Aggressive Holdings

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