New Year's report card

I told you so
January 2, 2001

Some newspaper columnists in Canada follow a New Year's tradition of acknowledging in print the most glaringly inaccurate predictions they made during the preceding year. This peculiar form of self-flagellation is the journalistic equivalent of a New Year's Day polar bear swim, or vowing (yet again) to lose 10 pounds. There's something about the morning of January 1 that forces people to face up to their limitations.

Not me. I never swim in cold water, and I don't even try to lose weight. And as a left-wing economist (a vocation that many consider a contradiction in terms), I spend 364 days of each year listening to people tell me why I am wrong. It seems perfectly fair to take a single day to celebrate my good calls. My regular hecklers can have at me again tomorrow.

So presented for the record forthwith are my most perfectly prescient predictions of the past year. (Web links direct the diligent reader to on-line evidence that I actually said what I say I said, as opposed to rewriting history after the fact.)

The Loonie: Canada's economy strengthened notably relative to the U.S. in 2000, and world commodity prices bounced back. By all reckoning, the Canadian dollar should have ascended, yet it continues to languish well below 70 cents (U.S.). Why?

I warned a year ago that the federal government's decision to allow more foreign content in tax-subsidized pension and RRSP funds (up from 20 percent to 30 percent) would put sustained downward pressure on the dollar. Following this change, Canada experienced a net capital outflow of $18 billion in just the first nine months of 2000--the biggest capital flight ever. Ironically, all this occurred just as Canadian markets were outperforming their U.S. and European counterparts for the first time in years. Many investors now wish they'd stayed home.

Fiscal Alchemy: Before the federal election, I estimated how much of the budget surplus had been spent by the Liberals on the competing goals of tax cuts, public programs, and debt reduction. To correctly measure the surplus, I argued, taxes should be adjusted for ongoing economic growth, and program spending should be adjusted for inflation and population. By this standard, the Liberals allocated virtually nothing to public programs; 98 percent of the surplus went to tax cuts and debt reduction.

Unnamed federal Finance officials told reporters that these adjustments were akin to "alchemy;" my numbers weren't to be trusted. Then in a draft paper at a December conference, Don Drummond, Chief Economist at the TD Bank, presented his own idea of how to measure the surplus: tax revenue should be adjusted for economic growth, and program spending should be adjusted for inflation and population. What is interesting is that until June Drummond was the Associate Deputy Minister of Finance in Ottawa, in charge of federal budget planning--and the boss of those "unnamed Finance officials." As far as I know, none has yet referred to their former superior as an alchemist--at least not to his face.

Air Canada: In late 1999 I participated in a tense meeting at Air Canada's Montreal head office. Paul Brotto, Senior Vice-President of the company, was trying to convince representatives of Air Canada's various unions to publicly denounce the Onex takeover bid, and profess their support for the existing management. Instead of trying to enlist workers in a phony show of corporate loyalty, I asked, why didn't Air Canada launch its own bid to take over Canadian Airlines? Impossible, Brotto replied. He debunked the cost savings that could result from a merger, and argued that financial markets would not tolerate the resulting debt load. Nonsense, I rebutted: investors would love an airline unencumbered by the competitive bloodletting that dragged down the industry for over a decade.

As we all know, Air Canada eventually did take over its weaker competitor. Its stated plan to run the two companies as separate airlines lasted as long as a Nunavut summer. By July 5 Canadian was a full subsidiary of Air Canada, and their schedules were merged in the fall. Air Canada earned all-time record operating income of $478 million in the first nine months, despite higher fuel prices and restructuring costs. The company's stock peaked at $21.50; it has since fallen back in the wake of further fuel price hikes and winter weather, but still closed out the year at $13.50--more than twice its level prior to the Onex bid.

As for Mr. Brotto? He is now the President and CEO of Canadian Airlines.

Social Assistance for Investors: I have often argued that the various tax loopholes available to financial investors constitute a bizarre form of welfare for the coupon-clipping elite of sociaty. This year the federal government officially agreed with me. In the pre-election mini-budget delivered by Paul Martin on October 18, the most recent giveaway to financial investors--a big reduction in capital gains taxes--was actually defined as a government social program. This maneouvre helped the "compassionate" Liberals to claim that they had fulfilled their promise to reinvest future surpluses in new social measures. Come to think of it, in the wake of last year's $4 trillion meltdown in technology stocks, perhaps those financial investors really do need a little social assistance.

Tech Stocks: Speaking of technology stocks, the mother of all correct predictions was my uncanny unmasking of the mass hysteria fueling the high-tech run-up. On March 13, I wrote in the Globe and Mail that the spectacular rise in high-tech valuations had everything to do with self-fulfilling bubble-chasing, and nothing to do with fundamentals. Incentives like capital gains loopholes and RRSP credits were only throwing gasoline on this speculative fire.

Within days, the NASDAQ composite had begun its precipitous slide, as the greed of investors transformed rapidly into fear. By year-end the NASDAQ was down 51 percent from its March peak. In other words, tech stocks could now fall completely to zero, and investors would lose less money than they already have. Throwing salt in the wound for Canadian investors: the much-heralded expansion of the capital gains exemption now simply means that they'll have to bear more of that loss in real, after-tax dollars. I guess poetic justice lives, after all.

Of course, not everything I said last year came true. I seem to recall arguing that Canadian voters would not support deep tax cuts, because of the steep price they would exact in foregone social programs. I also put $25 on the Maple Leafs finally advancing to the semi-finals. Oh, well, there's always next year.