Tuesday, January 19, 2010

Update on Canadian Credit - Not Good News

According to the latest release by the Bank of Canada, the outstanding balances of various credit types held by Chartered Banks (only) have expanded by the following amounts during the period of February 2008 - November 2009 (1 year, 9 months):
  • personal loans have increased 19%
  • balances on credit cards have increased 14%
  • 'other' types of loans have expanded by 14%.
  • personal lines of credit have grown 39%


In the period of April 2008-October 2009 (1 year , 6 months)
  • NHA securtized loans (government insured and securitized mortgages) has increased by 67%.
  • total household credit (consumer credit and residential mortgages) grew 14% or by $165 billion.
Reflect on the economy over 2008-9:
  • According to the Conference Board of Canada, Canada’s income per capita fell in 2008—the first time this has happened since the 1990–91 recession.
  • The income gap between Canada and the U.S.—$6,400 per person in 2008—is double what it was in 1984.
  • At $6,400 per person Americans earn more than 20.2% per person than Canadians.
  • Canada's economy shrunk 5% from Q3 2008 to Q3 2009.
  • Average home prices are up 20% in 2009
Conclusion

The $56 billion increase in outstanding personal lines of credit is the equivalent of a 4% increase in Canadian disposable income over the 21 month period. It has been a massive stimulus on the domestic economy. This credit can not inflate at this rate forever and therefore will be a huge hit on retailers and contractors when the expansion ceases (or possibly even contracts). A modest drop in outstanding personal lines of credit could provide the equivalent drop of 6% of disposable income.

But that's just one type of credit. Total household credit expanded by $164.6 billion over the 1.5 year period from April 2008 to October 2009. This credit inflation represents a 13% increase in disposable income over the period. Almost all of this inflation was consumed in residential mortgages and home equity lines of credit. The rest was spent on consumption.

A housing bust would effectively stop this credit expansion and possibly shrink outstanding credit balances. When that happens, it will feel as though disposable income had just dropped by well over 13%. The result on the domestic economy and the circular effect of a credit deflation on house prices is predictable.

Interesting to see what happens when the Home Renovation Tax Credit (HRTC) expires on February 1st 2010. Without argument, the HRTC pulled demand forward encouraging the rise in personal lines of credit.



Jonathan Tonge
www.americacanada.blogspot.com

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Sunday, January 17, 2010

Housing Bubbles around the World

Mish Shedlock has a great post up on his blog discussing housing bubbles around the world. Take a look at Canada and one would conclude that we are a "bastion of common sense."

Below is a sample of his post, but I recommend clicking the link above and reading the full article. There is an interactive graph created by The Economist that he has embedded. Note that he put some of my comments up as an addenum.
Mish: Canada is the surprising country. Here are charts that show what I mean.

House Price Index



Prices vs. Average Income



Those charts makes Canada housing prices look like a bastion of common sense. I assure you that is not the case.




Jonathan Tonge
www.americacanada.blogspot.com

Comments are open to the public. Please share your opinions, links and ideas with other readers.

Saturday, January 16, 2010

Recession to Continue in Q3 2010?

Canadian mortgage credit has grown 132% since 2000. A $1 in 2000 now costs $1.19 according to the Bank of Canada. With that in mind, CPI inflation has accounted for only 14% of the total growth in mortgage debt in the past ten years.

Debt was by no means low in 2000. The debt-to-income ratio was almost double what was present after the recessions of the early 80's.

In real terms wages certainly haven't increased since the 1980s. Wages in real terms are less than 10% higher than in 2000. The lower and middle incomes are in real terms, lower than in 1980.

The reason for this growth in credit was lower interest rates. In the early 1980s, central banks around the world switched their monetary policy strategy. Instead of focusing on the money supply, they would instead focus on interest rates. Interest rates provided them with the ability to surgically control CPI.

CPI fell year after year. By the 1990s it was well under 3%. By controlling interest rates, the bank lowered inflation, which allowed them to drop interest rates further. The process was incredibly accurate.

Unfortunately the definition of CPI did not change when the banks changed monetary policies. CPI was no longer relevant yet was still completely relied upon when setting interest rates. A change from controlling money supply to interest rates should have changed the focus from consumer prices to credit growth. This didn't happen.

Which gets us to where we are today. In a situation of massive credit growth during a period of low inflation.

You'd be blind if you didn't know what we are heading into. This will be a period that in fifty years, will still be reflected upon. We are hitting a secular peak in credit growth. Interest rates are 0%. As interest rates can't go any lower, the speculators will soon clock out. Their won't be any more gains left to be had. Any inflation that entirely depended upon credit growth, will disappear.

The banks models will be revised, after this pending crash. Don't believe me? Wait ten years and check back in. CPI won't be used by the central bank. It will be termed Consumer Price and Credit Inflation Rate (CPCIR). It will be weighted by the present value of assumed future income allocated to each.

Recession in Q3.

So here is my instinct. This reality check could happen now, or in a couple years. But my gut says at the end of Q2 2010.

Inventory levels have adjusted in the world, allowing a Q3 and Q4 adjustment to growth. The stimulus packages have taken full effect, and will begin to be a drag on economic growth in Q2 2010. Credit has expanded at astronomical rates, causing bubbles as far as China and as close as the New York Stock Exchange. I can't see any more room for growth, and as such, the speculators should cash in any day now.

Sovereign debt will begin to be an issue. Is this massive credit expansion based on a reality - that the countries around the world will be able to grow beyond this debt? Debt afterall is a drag on growth once it stops expanding. With a lack of real business investment over the past ten years, I don't forsee this happening.

What if Paulson or Geithner get kicked out? Noting the public outrage and subpeonas issued against central banks, such actions would change the ball game. Investors have been investing based on a zero risk environment. This environment would be ditched if the individuals responsible for such policy choices were held accountable. Similar individuals would simply not risk their careers or reputation by crossing this boundary again (which in my opinion is a good thing).

Look, if policy makers want to grow the economy, they're going to have to face an adjustment period. Policy has been completely wrong. You have to fess up now. It's going to hurt. But dragging the world economy further into this abysmal pit of nothing isn't helping.

A real economy depends on most importantly on PIDS. Productivity, Investment, Debt and Savings. It's so incredibly simplistic that you don't even need a high school education to understand it.

Productivity is the amount of goods or services you produce while you work; investment reflects the value of the goods and services you produce; debt reflects the amount you can borrow or that you have to pay back; savings tells you how much other's owe you. That's pretty much what it comes down to.

In Canada our productivity has dropped from at par with the US to 25% below its rate. Investment in the oil sands has been good. RIM, EA and a few other companies have made solid investments. But outside that it's been in real estate. Real Estate doesn't provide any future benefit to the economy, so you are effectively been borrowing against nothing. This choice of investment (which is really an expense) has of course forced debt to unheard of levels, despite economic growth. Savings in Canada have followed suit with the US, recently being lower than the savings rate down south.

What can you expect? Canada is completely misguided thanks to bad policy.

Don't get me wrong. Canada is stunning. It is a beautiful country possibly ummatched by any other. We have tons of resources, and can secure future energy supply for our citizens hundreds of years into our future. Of course we're not doing that. We're selling our childrens stake off now so some miner can earn a six digit salary.

Yet despite the commodity handicap, we're not growing like we should. Despite the massive credit growth, we're not growing.

So what happens when these handicaps disappear? We need to get our heads on straight here. Our expectations are completely out of whack.

My guess is Q3. I don't have a crystal ball. I've been wrong before. But it will happen. The sooner the better in my opinion.



Jonathan Tonge
www.americacanada.blogspot.com

Comments are open to the public. Please share your opinions, links and ideas with other readers.

Thursday, January 14, 2010

A Little About Me

Officially I started this blog in June 2009. So that really doesn't give you any history of my predictions. I was searching through my email yesterday and I found a couple informal emails sent to a close friend. Both were written in July of 2008 when oil peaked at over $140 a barrel and US Q2 GDP was reported at 3.8%. A little later in this post I reflect on democracy, capitalism and government. Please note that I'm not a financial adviser. The information below was a matter of opinion and not intended as financial advice:

Email sent July 24, 2008:

“Edmonton real estate sales are already falling at 24% annualized and this hasn’t even started. Vancouver, Victoria and Kelowna will crash even harder – especially in their detached residential sector. Victoria is currently falling at 7% a year, and Vancouver just flatlined and just started its fall at 3.6% annualized. In the coming months these annualized percentages will begin to accelerate, turning in some markets to 50 or 60%.

And as far as work goes, stay away from employment or investments in the banks. Keep your money out of shares in the financial sector. The world is about to go into a global credit meltdown as this real estate bubble is about to deflate internationally. Also, think of possibly investing in gold to hedge your risk.

From my research it shows that the Canadian government promoted 30, then 35, then 40 year amortizations, interest only loans, zero downs and allowing RRSP contributions to down payments just a month after the US housing bubble popped in the beginning of 2006. This allowed Canadian real estate to inflate to unheard of values even in the face of a real estate meltdown south of the border. So why did the Canadian government do this risking young people’s retirements, their savings and putting them in debt that for some will require bankruptcy of at least take over a decade to get out of?

Well I can only guess that the US knew right away that this was a bubble, not only when it popped but a year before, that it was going to create a global credit crisis since the real estate bubble was international. The leaders of all the countries may have possibly met and discussed this issue behind closed doors (have no evidence of this, but it would appear to be orchestrated with England, Australia, Japan, Spain, Canada, G8 etc.), about how they could soften the landing for residential real estate and the impact it would have on the worlds financial system which stands a chance right now of completely melting down.  So they increased loose lending practices in the rest of the world while the US took the first big blow – thereby softening the landing for the world’s financial system which would go completely belly up if global real estate fell at the same time.

The Banks in the US won’t be able to survive this same issue around the world, as lending will dry up and interest rates will skyrocket, further adding to the number of defaults in the mortgage industry. This is bad news. Real estate may never approach the values you see today – possibly never again. The result of deflating assets may actually destroy the middle class in the industrialized world leading us to a depression not seen since the Great Depression. This is due to many factors including the income affect, whereby if you owe more than your worth, you stop spending on everything but the bare necessities of survival. This final blow to "wealth", which was merely created out of thin air by artificially inflating asset values, will be one of the big blows of comparable wealth between the east and the west industrialized nations."

I wonder if my hunch about the G8 trying to prevent a global meltdown was true? When I wrote this letter it would have sounded reminiscent of conspiracy theory, which I actively try not to subscribe to. But given the unprecedented cooperation amongst the G8 starting in October 2008, it would not be that hard to believe.

Sent July 21, 2008

* China has enough production capacity to make every product consumed by every person around the world. There is too much manufacturing capacity in the world. Manufacturing is about to go belly up.

* Both dot.com and the Real estate bubble were created by Alan Greenspan. The bubbles gave wealth, which meant people had something to borrow against. This allowed them to continue to spend. Now these people are bankrupt.

*This could quite possibly be the beginning of the end of the US empire. My guess is you will see them start to sell their resources and crown corporations in the next couple years. Believe it or not, but Washington is currently filled with lobbyists arguing for them to create the next bubble in order to save the American economy. What do you think it will be?

* America owes 44 trillion dollars. Including debts that will become due in the next ten years, that figure is 88 trillion. At the same time over 80 million Americans will retire in the next ten years putting that debt onto fewer tax payers, who by all measures will see their salaries drop. With the bubbles deflated, most of these Americans will have negative wealth going into retirement.

* America has no choice but to print more money."

I like the last prediction there. Ok Ok most of you are saying "duh".

Some other predictions:

By January of 2009 I was banking on a housing rebound. One only needed to look at a mortgage calculator to know what was about to happen (and that's exactly how I made the prediction). Canada's was too aggressive with their interest rate reductions - they did not let the market move into a more severe but necessary corrective phase. Therefore they dumped cheap money on a population who was still bullish on housing - a recipe for disaster.

In December of 2008 I explained to a Vice President at RBC Investments that in my opinion stocks had not hit bottom. He had been advising his clients to get in (not necessarily bad advice in hindsight). I told him that there were still severe issues with credit, trade was collapsing, that people were optimistic because of Obama, and that colder weather was on its way to the North East (where TSX and NYSE are based). Those factors were sure to weigh in on stock valuations. I explained to him that there would be a bottom within a few months and I was going to buy back in then.

I also informed him that the only stock I was interested in was Petro Canada since it was severely undervalued (at the time around $22 a share) and now that the Teacher's Pension Plan was involved, they were going to shake up the 'crown' style management. It's amazing how soft the teacher's expect taxpayers to be on them, yet when the ball is in their court and it is their money, they are amazingly ruthless. I think the VP took that advice to heart as he was really interested in hearing about it. Petro Canada ended up getting merged with Suncor in March, providing a 3 month return of 50%.

Believe it or not I ended up moving back into stocks the day the market bottomed (within hours). That probably was good luck. I didn't  have the balls to stay in the market though and ended up selling about a week into the market rally. Honestly I didn't think the fundamentals supported it.

Enough bragging you say. True. But I made some good calls. More importantly I've learned some lessons.

Lessons:

Since then I've learned a great lesson. In a speculative market, don't take actions based on fundamentals. You take actions based on short term decisions. Everything is just a ponzi scheme so don't try to make sense of anything. Just don't be the last one in, or the last one out. Emotions rule. Reality is meaningless until the day the market corrects itself.

And of course this last paragraph sums up what I now write most often about. It's why lax monetary policy not only fails, but creates the problem in the first place. It's why capitalism is a victim of a fascist system. How dare it be blamed for the financial collapse.

Before I get further into this, it will help if I define what democracy is to me:

 "A transparent system that fosters the freedom of each citizen, unborn and alive, to come to their own conclusions, and make choices how their resources are spent, have equal influence over their environment, and to be protected by laws that ensure honesty and fairness."

Capitalism thrives in democracy. Unfortunately we do not live in a democracy.

Our system works to make the citizen docile. They accept the world around them because they feel they have no influence. This allows special interest groups, most notably government, unions (especially government unions), corporations, minority groups, and crown businesses to lobby the government and take control.

The biggest threat to democracy is government itself. At one point in time, perhaps a couple centuries ago, this would have sounded like an oxymoron. Today most would accept that statement as true, however. Without the government, these special interest groups would have noone to lobby to, but well you. They'd have to earn their influence one citizen at a time.

Conclusion

If 2008 didn't prove how worthless money really is, then I'm sure we'll learn it soon enough. Real wealth is tangible. It can be described. It provides real benefits that improve our lifestyle. Capitalism, operating under good laws that enforce transparity, competition along with a non discriminatory minimal tax structure can provide the wealth that we seek.

Minimal government fosters democracy, which fosters honest capitalism. By keeping money in the taxpayers hands, we get to decide what is of value to us. We permit a level of wealth that encourages a lifestyle of recreation, time with family, the arts and music, and a passion for unique interests. Taxing people and then treating culture as a government affair is not democratic or effective. It in fact destroys culture.

None of this means turning our back on those that are incapable of providing for themselves or their families. But it does mean that we force those who are "capable" to make their own decisions and pave their own path. It also means that that those who are incapable are forced to go to their community for help, at least as a first resort, not some distant government. Decisions made by millions are far better than those made by a few men.

The actions the government has taken for the past thirty years, and for that matter since the Great Depression, has severely injured democracy. Whatever the casualties, we should not be scared to reclaim democracy. We should only be scared of slipping further away from that ideal.


Jonathan Tonge
www.americacanada.blogspot.com

Comments are open to the public. Please share your opinions, links and ideas with other readers.