Benjamin Felix

August 6, 2020

Economics, Inflation

Episode 110: Craig Alexander: No Crisis Should Ever go to Waste

Benjamin Felix

August 6, 2020

Economics, Inflation

Craig Alexander is the first Chief Economist at Deloitte Canada. He has over twenty years of experience in the private sector as a senior executive and leading economist in applied economics and forecasting. He performed macroeconomic research, regional and sector analysis, and fiscal market forecasting and modelling.

Craig is a passionate public speaker and holds a graduate degree in Economics from the University of Toronto.

Often called a ‘once in one hundred years event’, the COVID-19 pandemic is having a profound impact on the economy. Today’s guest is Craig Alexander, Deloitte’s Chief Economist, who brings his 29 years of experience analyzing the economy to answer our questions about the marketplace. We start the conversation by exploring how the pandemic is affecting small businesses, with Craig adding insights into what the government should be doing to help. Craig discusses how the pandemic has revealed inadequacies with Canada’s employment insurance and why Canada needs to improve both its income support and its skills frameworks. A key theme in the episode, Chris presents the idea that businesses “Shouldn’t let a crisis go to waste.” As such, Chris thinks that this crisis is a chance for businesses to reassess their models, especially as certain pre-pandemic trends will continue to disrupt business. Chris also highlights the importance of high-quality childcare services to ensure both long and short-term economic recovery. From childcare, we leap to real estate before Chris provides his perspective on the interplay between the stock market and the economy. After the hosts question the value of economic forecasts, Chris makes a strong case for them, showing how they help organizations to develop plans based on several best and worst-case scenarios. Next, we ask Chris about investing in these times of economic uncertainty and if there is a risk of increased inflation in the future. Near the end of the episode, Chris talks about which industries will most likely grow in the future. Tune in to learn more from Chris’s incredible economic perspective.

Key Points From This Episode:

Presenting Craig Alexander’s bona fides and the insights gained from this episode. [0:00:39]
How the pandemic has impacted the economy, especially small businesses. [0:03:10]
Craig talks about inadequacies in the current employment insurance system. [0:05:06]
The challenge of repurposing the job market to fit the recovery landscape. [0:06:37]
Reassessing business models as a way for businesses to exit the recession stronger than before. [0:07:44]
Trends disrupting business that have been accelerated by the pandemic [0:08:55]
Why high-quality childcare services are so important to the economy. [0:11:16]
How the real estate market is faring and why Ottawa is not a good benchmark. [0:14:31]
How bank policies and mortgage deferrals have impacted real estate. [0:18:40]
Making a distinction between COVID-19 and post-vaccine trends [0:22:22]
Why consumer debt is increasing but that the debt-to-income ratio is a poor metric [0:24:42]
How the interaction between the economy and the stock market has played out. [0:28:37]
What government and banks did that stabilized the stock market. [0:29:45]
How economic recovery hinges on managing health risks. [0:32:04]
The case for economic forecasts and their role in simulation analysis. [0:34:23]
Craig highlights the level of uncertainty regarding economic futures. [00:39:15]
Why uncertainty shouldn’t prevent you from making investments. [0:41:19]
How the government response is geared towards preventing deflation. [00:42:52]
Hear why the government's strategy won’t decrease the appetite for Canadian bonds. [0:48:03]
How the pandemic is affecting some industries and which markets will see growth. [0:51:12]
Chris explains why macroeconomic theories evolve based on circumstance. [0:58:06]
Chris shares how he defines success and what brings him satisfaction. [1:03:43]

What effects do you anticipate from the pandemic on small and medium sized businesses in Canada, and in a broader sense, what does it mean for the Canadian economy?

The Canadian economy is in the worst economic contraction that we've seen since The Great Depression. And small businesses in Canada actually make up the vast majority of business enterprises in the country. So, as one might expect, if you're having a terrible recession, many small businesses are going to be bearing a lot of the brunt of the downturn. There has been unprecedented fiscal stimulus and support for businesses in this environment. But regrettably, we are still going to lose a lot of small businesses here. And this shouldn't actually come as a surprise to anybody, because of the number of local announcements regarding restaurants closing, or retailers closing. The vast majority will weather the storm, but we are going to see an increase in bankruptcies and insolvencies associated with the downturn.

And as an economist, what worries me about that, predominantly, is what it also means for the recovery, because small businesses are the job creation engine of the economy. So, if we lose a lot of small businesses here, it could actually slow the labor market recovery when we get to the other side. That's one of the reasons why I think governments need to put a priority on helping put in place policies that are going to encourage new startups and entrepreneurs during this economic recovery.

Now, it does look like the peak impact of the pandemic was in April. Statistics Canada is now tracking that in May, the economy likely grew by about 3%, that's after contracting 18% in the prior two months. So, we do look like the peak is behind us. But as we're going through that gradual reopening, I think it's going to still be a very challenging time for small businesses.

You mentioned like new startups, is there a way to align the workforce to take advantage of what these new startups can be like? How do you re-purpose effectively a large part of the workforce?

Well, we are going to have significant unemployment, even with the reopening. There's going to be a situation where businesses don't require as much labor. And then you're going to have businesses that fail. And so the question is, as the economy recovers, do workers have the skills the businesses need? And I think that there's two elements to this. Number one, the pandemic has shown us how inadequate our income support framework was. With the fact that the government had to announce that it was launching an Employment Insurance equivalent program for non-EI eligible workers immediately when the recession to hold. It actually told you that our existing EI system is actually not adequate to deal with the current labor market.

You have a lot of self employed workers, part time workers, full time contract workers that wouldn't be eligible for EI. And so, as a consequence, as we've seen the changing nature of work, our income support framework hasn't kept pace. So, I think one of the things we are going to see is, when we get into September, October, the government will wind down the CERB Program. This is the program that gives unemployed workers, $500 a week, $2,000 a month. That program is eventually going to be wound down and unemployed workers will be transferred to another program. And the question is, is it going to be EI? I suspect that sometime between now and the end of CERB, the government will unveil a new income support framework for workers. And so, that's something I'm watching for.

The second part is up-skilling or re-skilling. The fact of the matter is the jobs that get created during the recovery are not necessarily going to be in the industries where the jobs were lost. And that actually means that you have to, on the one hand, give workers the income they need to support them, so that then they can go do the training and re-skilling. But we also need to do a better job on the training programs. And we also need to do a better job of matching the skills that unemployed workers are developing with what the labor market needs.

So, anyone who has actually experienced a period of unemployment would know that when you go and you talk to, when you go into the EI office and have a conversation, they often ask you, "What skills would you like to train for?" What they don't ask is actually, what is their job for that skillset, right? And so, we actually need to improve both our income supports and our skills framework.

What do you think businesses can be doing to come out on the other side of this thing stronger than they were when they went in?

When you think of a crisis, there's three stages to any crisis. The first is respond. The second is to recover. And then the third stage is the thrive. And so, when the crisis hit in February, March, everyone shifted, all businesses shifted into respond phase. Like what do they have to do to survive the economic valley and still be operational at the other side? But then very quickly you actually had to pivot to recovery. Because as I said, the economy collapsed in March, April, but it's already starting to grow again, which actually meant that businesses had to figure out how to survive, but they also immediately had this shift into, "Okay, how do we recover?"

I think ultimately it's about looking at the current business models and reassessing them. And I'll say one thing in terms of my position at Deloitte, I have the opportunity to interact with a lot of businesses across this country. And I'm really impressed by the number of management teams that are actually making really significant changes to their business models, are really thinking through how to transform their businesses. So, if you think about it, the current environment is being shaped by, there's a whole bunch of trends that are impacting businesses in this current environment. So, there's the perpetual trends. These are the things that were already disrupting business before the crisis, but are still in place. And that's things like aging population or government efforts to address climate change. These were present before and they're still present.

But then there's trends that were disrupting businesses before the pandemic and economic lockdown that have now been dramatically accelerated. And one of the big ones is the shift to digital. Like what you're seeing in the current environment is businesses that were... If you think about retailers, right? Businesses that had a good eCommerce platform before the pandemic hit are actually doing much better in this environment than businesses that have had to suddenly figure out how to do eCommerce. So, there's been a huge shift toward digital. There's been an acceleration in the trend towards more flexible and more remote work, obviously, right? With the economic lockdown.

But once you've actually figured out how to run your business from a digital point of view, how to run your business with a more remote and flexible work place, once the genie is out of the bottle, it's not going to go back, right? This is an environment that's very transformative. Similarly, we're seeing in manufacturing, shift towards AI and automation taking place in the current environment. If you have to physically distance workers, one of the ways you can physically distance them is by giving a worker more machinery and equipment to work with as opposed to a co-worker. And so this can, again, all of these things have an impact in terms of the shape of the recovery, because the skills that you need with a more digital business, with a more remote and flexible workplace, the skills you need with more AI and automation, those skill sets are changing.

In the current environment, the not letting the crisis go to waste, a lot of it has to do with businesses actually, transforming their business models and making strategic investments that are actually going to pay off, not just during the recovery, but actually in years to come.

What you think the economic impact might be when we come back this fall for partial reopening of schools and a, hopefully, post pandemic world, what will the impact look like?

If we think about early childhood education, there's a bunch of dimensions to it. The big one is that childcare basically increases female labor participation in a very significant way. And pre-COVID when we had very tight labor markets. When we were trying to think about how do we get the most from our workforce or the most from our people, one of the things that a lot of the modeling I did showed, was that even though women labor participation has increased a lot in recent years, it could still be increased even further, if affordable accessible high quality childcare was actually available.

And so, in an environment post-COVID where you have more labor markets slack, the labor market shortages aren't going to be as big of an issue. But that doesn't mean the importance of child care isn't there. First of all, it's really in the long run, it's really about up-skilling the kids and making sure that the kids are going to be resilient workers in the future. As we're finding out in this environment, there's a lot of workers that they're going to have to pivot their skills. And if you have weak literacy and numeracy skills, it's going to be enormously difficult for you to retrain or adjust to changes in the labor market.

In the long run, we need high quality childcare for the kids. But we also need the childcare for the parents. And one of the things many parents have experienced during the last few months is the fact that, if you suddenly shut the schools and shut the childcare and the kids are at home, this can be very disruptive and it can be actually very hard to be a productive worker.

And one of the interesting things around the research around being a flexible or remote worker is most of the academic reports show that remote workers are actually more productive. That you actually, by reducing things like transit times, commuting times, and they're like, you actually get big productivity gains from workers. And I think that's still true, but I think that when it was government imposed and workers didn't actually have their home office spaces set up. And then, when you had the schools being closed, I actually worry that actually it caused a very significant drop in labor productivity.

I wouldn't be surprised if in 2020 the shift to remote work being so abrupt actually caused a big drop in labor productivity. So, when we think about the economic recovery, the reopening of schools and reopening of childcare, is going to be very important if we want to get some parents back into the labor market or back to work.

How long can Canadian house prices hang on to the levels that they're at?

Real estate has been surprisingly resilient during this downturn. But I'm not sure the resilience that we're seeing at the moment will necessarily translate to a complete avoidance of any real estate cycle in response to the recession. And I think the reason for this is, so home prices are all about supply and demand, right? And so, your demand is the actual sales, right? Buyers that are actually making purchases. And your supply is listings. And so, with the economic lockdown, what effectively happened was, economic activity just stopped. And the thing about it is, if you have an equal drop in listings and sales, then you don't get any price effect. And so, I think that's actually underscoring why... And it happened so suddenly, everybody just went on hold. And because both supply and demand went on hold, roughly equivalently, you didn't get any price effects.

Now, CMHC is calling for about a, I think it was 8% to 18% decline in national average home prices. And I suspect that the argument that they're giving is that, as we go through the reopening and particularly as the government income support programs, eventually start to diminish, you're going to see more of the impact on demand a little further down the road, right? And so, as the economy reopens and economic activity picks up, if you see an increase in listings from their depressed rate, if listings come back faster than sales, you're going to get a price effect. And so, that's I think the argument for a decline in home prices.

Now, what's interesting is economic forecasters are deeply divided about this. There's CMHC forecast of the 18% decline, but some of the Canadian banks aren't forecasting any decline at all. And it basically comes down to the significant uncertainty related to supply. Your comment about anecdotally using Ottawa, don't use Ottawa as a benchmark. And the reason not to use Ottawa, is Ottawa actually, real estate market in Ottawa often is not on the same cycle that other cities are, because of the presence of the large scale presence of the federal government.

So, when you have economic recessions, governments spend more and they actually go out and they hire and they have to deliver more programs. And so, this supports the public service. And so, in a government town, you're going to see that helps support local real estate. But then often what happens is, whereas the rest of the market, so if you think about like say, Toronto, Montreal, Vancouver, these cities likely seeing the home price decline in response to the unemployment shock and the income shock on the households. They'll have a price decline. And then when they're recovering, Ottawa home prices will stop them. And invariably, what it's related to is the fiscal cycle. So, Ottawa probably is not the same risk at the moment, but it's probably more at risk when the federal government starts to try to reign in its deficit.

What might the impact be of Canada's monetary policy? And is there a chance of that policy to counterbalance on the supply side effect on housing prices and push prices even higher?

So, let me just be clear, the uncertainty is more on the supply side, right? So, on the demand side, we know what the demand fundamentals are. When I build a model for Canadian home prices and home sales, right? The things that go into it are things like what's happening to employment and what is happening to income and what is happening to mortgage rates. And these are all the typical things that drive your demand. And in a normal cycle, you do get shifts in supply, but typically demand is more cyclical. And that's why when we have recessions, you get home price corrections, and then you get recoveries.

What I'm suggesting is at the moment, we have less confidence in the outlook on supply. We already know that the demand situation is bad. On the mortgage rates side of things, yes, The Bank of Canada cut rates. But if you've actually paid attention to what's happened to mortgage rates, they haven't dropped as much as The Bank of Canada cut rates. And part of the reason for that, I think is the reflection of the fact that, if you look at the spread between variable mortgage rates and The Bank of Canada opening rates, the spread has actually widened.

And I think what's taking place is, the banks are being very supportive to workers who lost their jobs, and they have offered, if you're in financial distress, that you can get a mortgage deferral for up to six months. But in response to that, I think that the interest rate spreads have shifted in a way that's a little more favorable to the banks, because they're trying to make up some of the difference in terms of the financial hit they're going to take. Right? Just keep in mind that the banks have basically set aside in the last quarterly earnings reports, the big major banks basically put aside loan loss provisions for $11 billion in loan losses, right? So, this is something where the spreads are not going to be quite as attractive to the buyers because the banks are trying to improve their financials on that spread.

Now, rates have still come down. And back in 2009, the drop in interest rates was hugely supportive to real estate and really fueled a lot of activity. And it helped the economic recovery. And it was very bizarre because at the time you had rapidly rising unemployment, we had rapidly rising home sales, and you don't normally see those two things going together. This time around, I'm not as convinced that the low rate environment is going to provide as much impetus. And partly because, we've been in such a low rate environment for such a long period of time. And yes, I think that mortgage rates are lower than they were pre-COVID. But I still think that the income shock and the employment shock is going to be the bigger impact.

With this new work from home environment, should people move out to suburban or rural areas to take advantage of prices in those environments?

There's a bunch of moving parts there, right? So, the shift to remote work, if yeah, so there was a recent, I think it was the Angus Reid poll, that showed one third of workers that are currently working remotely, don't expect to go back into the office. And so, there is going to be some persistence to this. And of course, that then could actually change, in a sense, that can actually change your real estate demand, because individuals that might have then thinking of buying a condo downtown might suddenly say, "Well, if I'm going to work remotely, maybe I'll work remotely from one of the suburbs."

And so, there could be not urban-rural, but within urban centers there could be an increase in preference for the suburbs. I'm always a little careful about these things, right? Because I remember back in '08-'09, when I was deputy chief economist of the TD Bank, everybody said, "Wow, after this global financial crisis, this banking crisis, banking will never be the same again." Yeah. And then you went a few years down the road and other than holding more capital and employing more lawyers, it pretty much went back to normal. So, I think we have to be a little careful in terms of how we interpret the longevity of some of these trends.

If we think about, right now there's enormously disrupted supply chains, right now consumers are behaving in a very different way than consumers have ever behaved before. They don't want to go to stores. They don't want to touch products on shelves. If they go, they make more purchases per trip, but in aggregate, they purchase less. And this is something, the shift towards the e-sales.

Now, that you've gotten a lot of Canadians more comfortable with e-sales, which by the way are up like 120% year over year, you're not going to necessarily go 100% of the way back. You probably should go some of the way back. But that's all during a period when you have the virus still in circulation. So, I differentiate between trends that are happening post lockdown and trends that are going to take place post vaccine.

In the near term, I would agree with your assessment on preferences for real estate. I just don't know whether that preference will stick indefinitely because I think our urban centers are going to continue to be very attractive destinations to live in. But right now, during when the virus is circulating, maybe condos look less attractive.

The other real estate dimension that I've thought a lot about, but it's really hard to model, is the possibility that you get a big increase in supply of properties coming from investment properties that aren't generating the rental income that the owner was anticipating, because of the pandemic and because of the decline in tourism and travel. And you sit there and you think, well, with a lot of the condos that have been bought in some of our major urban centers were for things like Airbnb, and all of a sudden those properties aren't generating the income that was anticipated. Could they end up on the market? And if that happens, that actually could increase supply significantly. And that would be another component of a price correction in terms of, if you see a price correction, I suspect that single detached homes are going to have less price volatility, than say, condos.

How do you think that the distribution of mortgage debt across the country affects the house price risks, and maybe broader financial risks in the Canadian economy?

Yes. So, you remember when I was saying that there's trends that were taking place before, but then have been accelerated, one of the big ones is debt. And so, in the current environment, you're going to see consumers who take on more debt through lines of credit to help support their incomes during this employment shock. You're also going to see that that financing becomes more challenging because you're taking a hit to income. One of the financial stats that people love to quote is the debt to income ratio. And the debt to income ratio pre-pandemic had climbed up to around 172%. It's now up to around 177%. When the income shock shows up in the data, I think that debt to income ratio is going to be 230%.

But the other thing I would stress is that is a lousy metric for financial risk, because you're basically comparing a stock to a flow. You're comparing the stock of debt that somebody has to their annual flow of income. And anybody that knows or anything about working with financial statistics, you don't compare stocks to flows. The right way to look at this is the interest and principal payments relative to after tax income. And that number doesn't look nearly as worrying as the debt to income ratio.

The other thing I'd highlight is, and people are often surprised by this, but the numerator is all the debt people have, but the denominator is all the income of people with debt, but also the income of people that don't have debt. So, if you actually strip out the people that don't have debt, the ratio goes from like 177% up to something like 300%, right? And so, the debt to income ratio is a terrible metric. I suspect what's going to happen here is when we think about the at risk population, what we knew pre-COVID was that it was about 10%, between 8% and 10% of the Canadian households were carrying debt ratios that put them in the camp of being financially strained, like really strained, where if they have any disruption to income, they could really have a problem here.

What you really have to ask yourself is, okay, so what fraction of that 10% of households just got impacted by the employment shock? And so, if you think about it and you start working through, just if you did this as a back of the envelope exercise, right? The unemployment rate, if you include all the workers who not only had lost their jobs and are looking for work and count them as unemployed, but all the workers that lost their jobs, but didn't look because of the pandemic, the unemployment rate right now is about 20%. So, if we just said that the distribution of debt, or the shock to labor was equal across the population, then you're looking at maybe 10% of households that are at risk, and of them, 20% of them are now going to be really financially strained and it could be in jeopardy. So, do the math, right? Turns out it's around 2% of households.

The thing I would stress about that is it sounds low, but keep in mind that if you're at 10%, you're talking to like two million households, right? So, you're still talking about a big hit. And this is again, why banks are taking loan loss provisions, right? That's why they are anticipating that there is going to be a significant increase in insolvencies and bankruptcies here. But understand it's not going to be like United States in 2008, 2009.

How do you describe to someone the relationship now between the stock market and the economy?

From an economist perspective, the stock market is one of our best leading economic indicators. So, if you look at what happened this year, there was the outbreak in China and the markets started to weaken in January because they were anticipating the slowdown in the global economy. But then once it started to show signs that this had the potential to turn into a global pandemic, the stock market plunged. And the drop was unprecedented in terms of the speed of the decline. And it was basically falling like a knife. And because the market was actually correctly anticipating that this was going to be the worst recession that we could imagine, and many times worse than '08, '09, but then you had a few things happen.

Oh, and I should stress, the drop, most of the drop came before governments announced lockdowns. Right? So, the market was ahead of governments. So, then what happened was, you had this litany of every day governments were announcing new programs and central banks were doing unprecedented things, providing stimulus. And at first, I was really surprised because at first it was as if the market was just ignoring everything governments and central banks were saying, because the market was still dropping and dropping and dropping. And then, I think it got to a point where the barest sentiment had peaked. But also, you also had signs that the lockdown in China was proving effective. And I think the market basically, again, looks forward and says, "Gee, China went into a lockdown, the health risks diminished. They're going to be able to reopen. This is what's going to happen in Europe. And with the delay, this is what's going to happen in North America." So, the market rally really strongly as actually the economies were in lockdown, and as the terrible economic numbers were coming in.

The other thing is a lot of investors pay attention to economics statistics. But when Stats Can does a survey, it reports the results of that survey one to two months after the survey was done. And so, a lot of the time, the data you're looking at, even the high frequency data, is actually in a sense telling you where you were, not where you are. And so, the market rebounded.

Now, again, with the caveat that I can't predict the market, it did look like the market got way too complacent. It did feel like the market didn't quite appreciate the fact that as we went through the reopening, the health risks would actually increase. And there's also the distinct possibility, that as we get into the upcoming flu season, we could have a second wave. And what we're seeing right now in the United States in terms of the rise of infection rates, particularly in the US South, this is actually showing you exactly, this is showing you the health risks have not disappeared, right? And I mean, this is a big topic.

But in my mind, one of the things that a lot of people are missing, is that the economic lockdown was never actually designed to stomp out the virus. That what it was meant to do, if anything, the right way to think about it, is that economic lockdown was to prevent the health system from being overwhelmed with cases. And as we go through the reopening, that's the key issue. As you reopen, we're going to have more cases. The question is going to be whether the number of cases are manageable from a healthcare point of view. And if you start to get numbers that suggest that it could become unmanageable, then governments are going to either stop the reopening or actually reverse direction. And we're seeing that in some US states. And I think that that's why you're currently getting the volatility in the market, because if the health risks are managed, then I think the economic recovery proceeds and the market will continue to make up the ground it lost.

If on the other hand, it looks like the reopening is going to be very protracted or we're going to have setbacks, or there's going to be a second round of infection. These are all the things that are going to cause the market to reevaluate valuations for stocks, right? Because the stock is nothing but the discounted present value of all the future earnings of the company. And actually what the market is trying to do is figure out what that earnings forecast looks like. And so, right now it's all about the health risks. Mind you, I'm also worried about things like protectionism, right? I'm worried that in a post pandemic world, we could have even more protectionist sentiment that the EI... I think what we've seen globally is an expanded role for government. We have government meddling in business all over the place right now. And I don't think that role of government is going to suddenly go back to where it was pre-COVID.

So, from an investor point of view, I think there's the health risks. And then I also think that there are elevated political risks that we need to monitor and be sensitive to.

How do you think that economic forecast should be used in decision making?

Nobody actually has an accurate crystal ball that's going to tell you what's going to happen. Right? What economic forecasts are, is a best guess as to what might take place. And economic forecasts are not only sort of the best guess, but they're also internally consistent, where a good forecast is internally consistent. So, in other words, if you have a view of an economic recovery, the economic recovery, the components of what you're forecasting should be consistent in terms of the behavior of the consumer and the behavior of business investment, the behavior of government spending and government investment and the like.

And while nobody has an accurate crystal ball, businesses still need forecasts to develop business plans. And in the current environment, in normal times, we do, here's our base case forecast for businesses to use for planning exercises. And then we do stress testing and we come up with bad scenarios. And businesses will often stress test their business. The issue is we're currently living through stress test, right? If you think of the magnitude of the shock that we've just experienced, it's as bad as the worst stress test I ever generated for the bank I worked for. And given that we're in that environment, you have to think about scenarios.

So, yeah, right now, one of the strongest themes I have in our economic commentary, is the fact that we need to think about things as scenarios. And the way, conceptually, you think about it like a tree diagram and with probabilities associated with each branch of the tree. And what you're trying to predict is which path your economy is going to take. So, right now, we run a base case, which has the Canadian economy contracting this year by 6% and then rising next year by 5.5%. But we also do a scenario where, in point of fact, things that turn out better than we anticipated.

But then we also run scenarios around things like a second round of infections, a second wave that causes a renewed lockdown. We do a worst case scenario, where another wave exceeds the ability of governments to respond. And we run global scenarios, so for example, we run the scenarios where the Western economies are still experiencing extraordinary economic weakness for a period of time. But China's economy comes back and you have the rise of Asia. So, conceptually, you could think of a whole bunch of different scenarios here as to what could actually transpire.

And I think that's how businesses need to use economic forecasts, right? It's not just one forecast. It's, "Here's what we think is most likely, but here's three other cases." And how would your business respond to these potential scenarios? And that's something we do. We do labs with businesses where we spend a couple of days or a few days with businesses going through different scenarios and helping them think about how they might be impacted.

It's business sensitivity, right? So, what would happen to your business if this happened? Okay, what would happen if this other set of assumptions happened? And often it isn't just about the planning. It's also about getting businesses or governments, it could be policy makers, what policies would you respond if this was to occur? Right? If the recovery just continues, policymakers might focus on doing more infrastructure investment. But maybe this time the infrastructure is different than the past. Maybe it's not roads and bridges, maybe it's healthcare and childcare and the schools, right? So, the policy response could be different depending on the environment we're in. Whereas, if it's a second wave, maybe the money you would put in the infrastructure, doesn't go into infrastructure, maybe it actually goes into the healthcare system to basically address the second wave and the income shock on workers.

Well, similarly for businesses, if the world has shifted to digital and you need to make digital investments, you have to put that into your capital plan. And if you put it in your capital plan, you might want to think about different scenarios in terms of, what is actually affordable in terms of new capital outwards.

Even if you hear a data point about economic forecast usually being wrong, that doesn't necessarily matter if the range of forecast that were given to a business helped them prepare for a bunch of potential outcomes.

Yeah. Just to highlight the degree of uncertainty at the moment, right? When the Bank of Canada published their last economic forecast, they said in the second quarter of the Canadian economy would contract between 10% and 20%. We usually debate about things like 0.2, right? Is the economy going to grow at 2% or 2.2%? If the Bank of Canada is half a point off of consensus, you start to get people talking about them being unrealistic. At the moment, the range of uncertainty, it's 10 percentage points, right? So, this is actually why the Government of Canada was a bit resistant when the opposition was calling for a fiscal update, which we're going to now get on July 8th. But initially the government had pushed back and said, "Any fiscal numbers we present right now would be speculative because of the high degree of uncertainty that's present at the moment." And you know what? They're absolutely right.

Now, I think that you still want your government to be accountable and the government's running massive deficit. So, I don't actually think there's harm with the government coming out and saying, "Hey, here's our current tracking of the size of the deficit." But just so you understand, there is an enormous amount of uncertainty here, both in terms of how the economy is going to perform, but also what actions governments need to take. And this is also why from an investor point of view, there's so much uncertainty, right? Because if the Bank of Canada can't get their head around how the overall economy is going to perform, how is an investor going to necessary be able to evaluate the earnings prospect of a company. This is a very difficult and challenging environment from an uncertainty point of view.

Nevertheless, you can't let uncertainty stop you. I'd love for someone to tell me when we... Since 2008, I don't remember an environment without high degree of uncertainty.

Do you have concerns about inflation given all of the governments around the world have done in terms of their response to the pandemic?

Yeah. I get that question a lot because between central banks and governments, they're throwing billions and billions of dollars at the economy. The Canadian government deficit this year is going to be somewhere around probably two... The deficit was going to be $28 billion. That's what the projection was in December. Now, it's going to be somewhere between $250 and $280 billion. The Bank of Canada is running an asset buying programs. So, they're buying corporate debt, provincial debt and federal debt. And that means that you're injecting money into the system. And anybody who suffered through first year economics, which I apologize for, because man, that's a brutally boring course. But anybody that suffered through first year economics was told if you increase the money supply, you eventually end up with an inflation problem. Well, in secondary economics, they tell you that's actually not quite true.

And the way it works is, if you inject additional money in the economy, as that money circulates through the hands of businesses and investors and consumers, it will be used to buy products. And if that happens and you don't increase the supply of the products, you will bid up prices and that's what we call inflation. So, there's several steps to that. Well, the important part here is, if you increase the money supply, as it circulates through the hands of investors, businesses and consumers, well, it's not circulating normally right now, that's actually got an economic expression to it. It's called velocity. So, what's happened is the amount of money supply has increased, but the velocity of money has collapsed. Yeah. You could see this in things like the spike in the personal savings rate, right?

And so, at the moment, it's not inflationary. And in fact I'd argue quite the opposite. Right? Right now what's happening is the reason you're getting these policies is because governments and central banks are doing everything in their power to prevent deflation. And this is really important because if you end up in deflation, it's enormously hard to get out of it. When Japan experienced deflation in the early nineties, it's never been able to pull itself fully out of it. And the reason is, it's very simple, right? Why buy today what will be cheaper tomorrow? Right? So, central banks actually know how to fight inflation, but fighting deflation is enormously hard. So, right now the balance of risks is towards the inflation. I don't think it's going to happen because of the policy response, but the inflation risks are actually very, very low.

Now, if we go out a couple of years from now and said, okay, is all that money still circulating in the economy after the recovery has gotten well underway? And maybe the vaccine has been deployed. Okay. At that point, yes. Yes, now we could definitely have an inflation problem. But what that also you is there's time for governments to shut down the programs. Right? So, the CERB, which is the $500 a week, the government is paying people. That program is going to end in September, October, right? The government wage subsidy for businesses is going to end by the time we get to the end of the summer, right? A lot of the programs that are currently in place are going to be shut down. That will bring down the deficit and reduce the inflation risk.

Similarly, the Bank of Canada will have to scale back its asset buying program and end it. And then eventually down the road, they will have to basically work those assets off their balance sheet. Although, what we've seen in the United States with the US Federal Reserve, is man, they can carry a lot on their balance sheet for a long period of time. So, I don't think the Bank of Canada will be doing that aggressively. But my point is, there's no inflation risk in 2020. I think the inflation risks in 2021 are very low. I think inflation risks start to rise in 2022, 2023. And it's all dependent on what governments are doing with the programs, whether the money that they've increased, as the velocity of money improves, they need to re restrain the money supply.

Is there a risk on the fiscal policy side that the appetite for Canadian government bonds dries up, the market dries up and then rates get higher and it becomes harder to borrow. Is that a risk for Canada?

The simple answer is no. The longer answer is yes, the Bank of Canada is buying some of the debt that's being issued. But you actually hit the nail on the head in terms of the fact that, the question I often get is, how can governments possibly afford what they're currently doing, right? If you look the deficit is going to be upwards of $280 billion, right? How can we possibly afford this? Well, if you look at debt as a share of the economy, when we had a fiscal crisis in the mid nineties, the debt to income ratio in Canada was around 67%. I think the government, when they released the fiscal numbers, their fiscal snapshot on July 8th, I think they're going to probably say it's going to be around 44%. So, we are way below the levels that were a fiscal crisis in the past.

Moreover, when we had a debt to income ratio of 67%, the government was, in the nineties, the government was borrowing at 9.6% on 10 year government bonds. Right now they're paying about 60 basis points, right? And so, this isn't just a Canadian story. This is a global story. This is why governments around the world can afford to do what they're currently doing. And it's important, right? Because if you didn't have it, then governments wouldn't be able to offset a lot of the economic weakness and provide a lot of support to businesses and households. And we would run the risks of... If you actually did the lockdown without the fiscal response and the monetary response, you would have a depression, right? If you look at the magnitude of the drop in activity and the increase in unemployment, we haven't seen things like this outside of depression.

The reason why we're going to be able to dig ourselves out of this is because governments and central banks are addressing the income shock on households and businesses. It still means we're going to have high unemployment, and there's going to be business losses, but man, they're doing a lot to offset it. So, the big risk would be down the road.

Go back to the last question. If in 2022, 2023, suddenly there was an inflation problem, well, then bond yields would rise significantly, debt service costs would balloon. And now, actually we've got a fiscal problem on our hands. Again, I don't think that's probably the most likely scenario. I suspect that what's actually going to happen is interest rates are going to remain exceptional low like they did after '08, '09. Because during the last recession, there was so much damage done. Rates remained at exceptionally low levels for years. And I expect the same thing to happen this time around. And that's why what's happening right now is currently affordable. And so, it's not so much about the Bank of Canada buying the bonds, it's more actually about the cost of borrowing for government.

Do you see any particular economic opportunity for new businesses in Canada going forward?

Yeah, I think well there's a few dimensions, like most questions are. You ask big questions, right? So, first of all, I think the Canadian economy is more diversified than people actually think it is. Yeah. The entire commodity sector is probably about 20% of the Canadian economy. But if you ask people what share do they think... And I'm talking about agriculture, mining, energy, I'm talking all commodities, right? I suspect people would think it's a dramatically larger share than that.

So, we actually are a more diversified economy than often made out. What is true is the TSX is not a diversified index, right? The TSX is dominated by what you just described. It's energy, it's mining, it's financials, right? So, our stock market is not diversified, but our economy is more diversified than people think.

I think what you're going to find is, when I do my forecast for the economic recovery, regrettably, one of the things is that while countries seem to be the first in, the first out. So, China was the first into the pandemic. It was the first out of the pandemic. And then it was Europe. And then North America. From an industry point of view, it's almost the opposite. It's almost first in, last out. So, the industries that have been hit hardest here, like the energy sector, like retail, like accommodation and food services or transportation. These sectors are probably going to have, it's going to take them the longest to recover from the current environment. In contrast, where we're actually likely to see more growth are in industries that have been more resilient in the current environment. So, like information communication technologies, the digital companies, professional type services, financial services. I think financial services will have a cycle here.

But I think, yeah, financial services are going to continue to be one of Canada's leading growth segments. And what does that mean? If you're thinking about advanced services being your fastest growing sectors, what that tells you is, the Canadian economy is shifting into being a more diversified, more services oriented, particularly advanced services oriented type businesses. Yeah. I think what we're going to find is energy and manufacturing are going to be a declining share of the economy. And that doesn't mean they aren't going to grow. Right? We're still talking about during the recovery, energy, mining, manufacturing, these sectors will all grow. But the point is that as a share of the economy, they will diminish.

The other thing I'd say, from an investor point of view, is we tend to think about the market in terms of the Canadian market, the US market, the European market, but that's not the way companies behave. So, from an investor point of view, yeah, you might want geographic diversification in your portfolio, but understand that it's really, if you have a telecom company or a digital company, it's probably operating on a global basis. Right? And it isn't just about what's happening to the Canadian economy. It's actually what's happening to the market that they sell to.

And we have some great examples in Canada of businesses that are actually thriving in the current environment. Right? Great example, actually, it almost ends us on where we started on entrepreneurism, is Shopify, right? Shopify is doing very well because It's a company that's got... it's a digital platform. And e-commerce is ballooning here. And so, other companies that aren't getting the same headlines, but there are companies in Canada that are actually thriving in the current environment.

Likewise, there's businesses that are rapidly transforming themselves and are likely to have a lot of growth down the road. One example of this, was there was a large grocery chain store that I talked to on one of our webinars. And it was fascinating. They said that they knew they were going to have to do more e-grocery in the future. They knew that they needed a plot. They needed to develop the capacity to do more online grocery shopping. And so, the company actually came up with a five year plan. So, they had a vision of where they wanted to be five years from now. They did it in three weeks.

They had actually thought about where they wanted to be five years from now. So, they actually had a notion of a plan, like a path, but from a deployment point of view, they did five years of work in three weeks. And now, that company has that platform going forward. Right? And you think about Shopify, what is Shopify? You can describe it many ways, but one of the ways I like to think of it, is that it is a catalytic engine for entrepreneurs. Because what Shopify does is that, you have small businesses that might not know how to do the online sales and tap the global market. But Shopify comes and says, "Here's a package, deploy this. Now, you can tap." The Canadian economy is like 2% in the world economy. There's 98% of the opportunity is outside of our country. Right? And so, it fosters entrepreneurs and help small businesses.

Going back to where we started, we're going to need entrepreneurs. We're going to need business startups. We're going to need growth, with more growth, probably coming from industries that in the past were not what we considered to be the main engines. Right? If we think about Ontario, it was a manufacturing... The Ontario economic growth was driven by manufacturing, a lot of it autos. The future of Ontario is not in autos, right? There's going to be businesses in that segment that thrive. There's going to be great companies in that segment. But as the primary driver of economic growth, I don't see the auto sector being the primary driver of growth in Ontario.

Well, similarly for Canada or say for Alberta, the energy sector probably is not going to be as big a driver of growth as it has been in the past. But again, they're still going to be some awesome investment opportunities in the sector. There's going to be some great companies in the sector, but in terms of the actual contribution to economic growth, we're probably going to see the commodity sectors declining as a relative share.

Could you touch on the history of macro economic thinking and where we are today?

Yeah, it is interesting. Every time, back in '08, '09, I remember going to a meeting with department of finance and it was with all the chief economists and we walked into the room and said, "You know what? We're all Keynesians now." Right? Because Keynes, basically wrote his economic thesis as treatise in response to The Great Depression. Right? And so, then when you get into periods, like say the early 2000s or pre 2008 where the economy is doing really well, Keynesian economics is not actually as relevant, but you still have Keynesian economists out there that are promoting Keynesian ideals. But they're often making what I would consider bad recommendations, because the recommendations don't reflect the fact that the theory was designed for periods of economic difficulty.

So, your neoclassical economics is actually far more relevant in periods of strong growth, low unemployment, et cetera. And your Keynesian economics becomes highly relevant when you're in very bad economic downturns. And you're trying to think about, okay, so what happens when supply and demand don't actually clear, right? So, you have the assumption when you do economics is, your supply and demand curve are always crossing. Right? Well, what Keynes said is, sometimes they don't, right? And with the disrupted supply chains that we've had, that was a perfect example, right? All of a sudden the supply just isn't there, like essential medical supplies.

If you look at the history of economics from its start, from Adam Smith to Ricardo, what's interesting is when you go through that theory, when you go through it, right? So, there was Adam Smith and then you had Ricardian economics after that. And then, Marx was writing at that point. And Marx took Ricardian Theory and developed his economic thesis and overlayed his political ideology on it. Right? But at the end of his life, Ricardo actually recognized that his work was a dead end, that he hadn't got it right. But all of Marx is based on Ricardo. And then you go from Ricardo, to Mill, to Marshall, and that's where you're getting, you have more cohesive economic theory. But that economic theory always assumed supply and demand, that supply would equal demand.

But then you had The Great Depression. And Keynes looked at it and went, "What the hell? My economic theory doesn't explain this." Right? So, he came up with his theories, his general economic theories, such that you could have supply and demand not clear, which then ended up creating a role for government, what governments need to do.

But then we had, after the Second World War, we ended up in a world, where in the sixties, the seventies, the eighties, we ended up with a hyperinflation environment. But Keynes didn't tell you anything about how to deal with that, not at all. Right? And so, it shouldn't be surprising that every economist that's written economic theory is somewhat shaped by the environment in which they're living in the times in which they're living. And that means that the economic theory evolves as you go through experiences.

And so, in '08, '09, one of the big findings was, none of our economic models... You're going to laugh, right? And non-economist always laugh at this sort of thing. But we didn't have financial linkages in the models. Right? It was always just assumed that if there was a demand for credit, there'd be a supply of credit.

Just like Keynes had this solve for how can you have supply and demand not equal. Post '08, '09, central banks and economists had developed theories around what happens when supply and demand of credit doesn't equal. And then that has real economy effects. Right? I'm not sure what we're learning out of this one, because the current environment is more of like an act of God. And all of a sudden, you just have governments that shut down the economy. So, I'm not sure that, from an economic theory point of view, I don't think we've got a new theory, but I think there's a huge opportunity for, if governments actually got this right and they probably won't. But if governments actually got this right, there'd be a huge opportunity to rate basically, fundamentally change a lot of our policies and programs. Right? Like I said, about building a better income support program for workers, right? That's an example of that.

There's a huge opportunity for businesses here to suddenly become more productive, if they're willing to completely go outside their safe zone and really overhaul their business model. Because right now, boards of directors would give you approval.

How do you define success in your life?

If my wife's happy, happy wife, happy life. No. I mean, I love what I do. I love talking about the things that we were just talking about. I'm passionate about economics. And back in '08, '09 we characterized it as a one on a hundred year type of event. I think it's unfair to have two, one in a hundred year events inside my lifetime. But I will say that during these terrible times, from an economist point of view, we actually learn an awful lot. It's when the economy is strained, that we are actually, we learn a lot.

I also get a lot of personal satisfaction out of having conversations with businesses and governments, because it gives you a lot of satisfaction when you're trying to help companies, particularly when times are hard, right? I created a Deloitte economic recovery dashboard that's on the external website that would allow people to track what's happening to health statistics and economic financial statistics. And when we did that project, there was a number of clients that when we showcased the dashboard to them, they said, "Hey, we've got data. We'd actually like to contribute. We're not going to charge you. We just... You're trying to help people during a terrible economic time. And we want to help too."

And so, all of a sudden we got all this high-frequency data, company specific things that they track, or they have access to that we could put in the dashboard. So, if you go on our external deloitte.ca website, you can find the dashboard. And you can see all the indicators. But it was hugely, it was a great experience, because you had all these companies that were saying, "Normally we charge for something like this, but you know what? No, we just want to help."

So, at the moment, we're doing a lot with AI and big data in ways that we've never done before because of how lag the economic statistics are. So, we're actually learning a lot, right? I mean, if you're passionate about something and mentally stimulated, it's going to be a really positive. So, even though this is a terrible time, from an economist point of view, it's a period where we're doing, I'm doing more to help governments and businesses. And that gives you a lot of personal satisfaction. Although, it's sad that we're doing this in such a terrible environment.

There's businesses that I'm talking to that are going to thrive. And then there's businesses I'm talking to that are going to go through a very painful merger or acquisition in order to stay alive.