4 hours ago
Monday, February 22, 2010
National Bank says that "Canada is in Decent Shape"
Posted on 9:20 PM by Email:
Well then that says it. National Bank tells us that there might be a little shock if interest rates rise, but overall we still have less debt than the USA. So why worry then?
Here is the chart that backs their point:
Courtesy of the Globe and Mail. Read article in full here.
Well that is a significant growth if you look back to 1990 when our debt was only 90% of disposable income, whereas USA had nearly 110%. It does make sense that mortgage debt would be higher in the USA as it is tax deductible.
But certainly Canada's debt growth doesn't look as scary as the growth in US debt. Or does it?
Well to answer that you need to forecast the next three years. Let's assume two different situations. Feel free to add a third.
The first situation is that Canada experiences a USA style housing collapse starting in Q3 2010. At first the contraction is mild, just like it was in the US. By early 2011 home sales and price declines accelerate. For arguments sake, assume that by 2012 housing loses 20% of its value and a further 20% by 2014-5.
The second situation is that Canada doesn't experience a collapse. Housing continues to grow "modestly", at roughly 8% per year just as it has prior to 2008. Fueled by lower interest rates, housing by mid-2012 is 20% more costly then it is today. Nice!
What effect would both of these situations have on the debt-to-disposable income ratio?
First let's talk about the middle black line that falls on 2010. That's us right now. We are in the midst of passing the USA in debt-to-disposable income.
The horizontal yellow line marks what level of debt the USA was at when their credit crisis began. Canada will pass this point by mid 2010.
Our assumption with the green line is that for one reason or another, most likely rising interest rates, a housing bust or a recession, Canada begins the same journey as the USA did but four years later. To make it a similar contraction it would have to materialize primarily in residential mortgages and HELOC's as they make up 86% of household debt (just like the US by the way). That means that a housing bust would either be the cause or the victim of the credit contraction. Regardless, the result would be the same.
The government actively tries to douse the markets with more credit, but eventually by 2012 the market gives. It can no longer afford it. Credit begins its long descent and as it does, the sound of air rushing out the economy can be heard as an inflation of roughly 13% of disposable incomes is replaced by a contraction of 5%. The economy enters recession, unemployment rises by roughly 5-10% and incomes fall by around 5% per year.
The second assumption is that we do not experience the same fate in 2010. Instead, thanks to low interest rates and an absence of a recession, homes continue to appreciate (up 20% by 2012) and home sales remain strong. By mid 2012 Canada's debt to disposable income reaches 180%. The economy then experiences a Japanese style collapse and deflation ensues.
It is important to note that even if credit continues to rise steadily at 10% per year (higher than disposable income growth), we would still experience a parabolic rise in the ratio in the second example. This occurs as the growth is compounded. So as a 10% marginal increase in credit would send the ratio from 100% to 110%, it would similarly take the ratio from 150% to 165%, and then from 165% to 181.5%. You simply multiply the ratio by 110% each time. That's why you would expect a curve. That curve is also why you get a bust.
Credit contracts in both situations. The drop sure does look scary. But in both situations the debt ratio does not return to mid-nineties levels until 2025 (which was still high by historical standards).
Either way, despite National Bank's optimism, Canada is not in decent shape. We are headed towards a bust, one way or another. It's just a matter of time.
Jonathan Tonge
www.americacanada.blogspot.com
Comments are open to the public. Please share your opinions, links and ideas with other readers.
Here is the chart that backs their point:
Click for a larger image.
Courtesy of the Globe and Mail. Read article in full here.
Well that is a significant growth if you look back to 1990 when our debt was only 90% of disposable income, whereas USA had nearly 110%. It does make sense that mortgage debt would be higher in the USA as it is tax deductible.
But certainly Canada's debt growth doesn't look as scary as the growth in US debt. Or does it?
Well to answer that you need to forecast the next three years. Let's assume two different situations. Feel free to add a third.
The first situation is that Canada experiences a USA style housing collapse starting in Q3 2010. At first the contraction is mild, just like it was in the US. By early 2011 home sales and price declines accelerate. For arguments sake, assume that by 2012 housing loses 20% of its value and a further 20% by 2014-5.
The second situation is that Canada doesn't experience a collapse. Housing continues to grow "modestly", at roughly 8% per year just as it has prior to 2008. Fueled by lower interest rates, housing by mid-2012 is 20% more costly then it is today. Nice!
What effect would both of these situations have on the debt-to-disposable income ratio?
Click for a larger image.
First let's talk about the middle black line that falls on 2010. That's us right now. We are in the midst of passing the USA in debt-to-disposable income.
The horizontal yellow line marks what level of debt the USA was at when their credit crisis began. Canada will pass this point by mid 2010.
Our assumption with the green line is that for one reason or another, most likely rising interest rates, a housing bust or a recession, Canada begins the same journey as the USA did but four years later. To make it a similar contraction it would have to materialize primarily in residential mortgages and HELOC's as they make up 86% of household debt (just like the US by the way). That means that a housing bust would either be the cause or the victim of the credit contraction. Regardless, the result would be the same.
The government actively tries to douse the markets with more credit, but eventually by 2012 the market gives. It can no longer afford it. Credit begins its long descent and as it does, the sound of air rushing out the economy can be heard as an inflation of roughly 13% of disposable incomes is replaced by a contraction of 5%. The economy enters recession, unemployment rises by roughly 5-10% and incomes fall by around 5% per year.
The second assumption is that we do not experience the same fate in 2010. Instead, thanks to low interest rates and an absence of a recession, homes continue to appreciate (up 20% by 2012) and home sales remain strong. By mid 2012 Canada's debt to disposable income reaches 180%. The economy then experiences a Japanese style collapse and deflation ensues.
It is important to note that even if credit continues to rise steadily at 10% per year (higher than disposable income growth), we would still experience a parabolic rise in the ratio in the second example. This occurs as the growth is compounded. So as a 10% marginal increase in credit would send the ratio from 100% to 110%, it would similarly take the ratio from 150% to 165%, and then from 165% to 181.5%. You simply multiply the ratio by 110% each time. That's why you would expect a curve. That curve is also why you get a bust.
Credit contracts in both situations. The drop sure does look scary. But in both situations the debt ratio does not return to mid-nineties levels until 2025 (which was still high by historical standards).
Either way, despite National Bank's optimism, Canada is not in decent shape. We are headed towards a bust, one way or another. It's just a matter of time.
Jonathan Tonge
www.americacanada.blogspot.com
Comments are open to the public. Please share your opinions, links and ideas with other readers.
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14 Response to "National Bank says that "Canada is in Decent Shape""
I see a chinese bubble burst first, which will crash the comodities and the canadain dollar will loose 30 to 40% of it s value to the USD. That alone will bring RE prices in line with the states and at the same time will jump start the canadian economy. So maybe RE will not crash or increase steadly as you suggest but just stagnate with the CAD taking the brunt of adjustment and lots of inflation at 3 to 6% with interest rates at 1 to 3%, bond vigilantes are dead already, it is all goverment and CB controlled economy, evth is possible, we have reached a permanent high plateau!
I agree with the above, possible slow growth or even crash in China leading to commoditie crash and loss of value in Can$, with loss of commod jobs. Although not sure this will lead to strong exports, demand is much lower now world wide and all coutries pushing for exports with protectionists measures rising.
Imports will be higher with low Can$, putting more pressure on jobs, retail sector jobs.
I don't see low can$ as good.
Best scenaro for Canada is China does not slow to much, but that maybe wishful thinking.
We are 90% of the debt loading that the US was when the financial crisis took hold. 90%! And that's something to brag about? I think the National Bank is nuts.
This entire country, especially Vancouver, are one cuckoo away from the cuckoo's nest.
Frankly this country deserves what it is going to happen to it. When people are crying in street homeless, and starving because they lost all their money on a stupidly outrageously priced house, they deserve no sympathy other than being kicked in the teeth with one's boot.
This is one depression that is coming where you can't blame the over stuffed aristocracy, or incompetent government. This monster that is coming is entirely the fault of the greedy, selfish, spend-hog boomers. They were born fat like pigs, the were raised indulged like fat pigs, and they are going into retirement like super-sized overgrown hogs. Soon they will die just like all hogs do, in the slaughter house.
Only problem is, the rest of the planet is going to have to pay a huge price too.
Ok so if we are going to have a financial blood bath, let it be a good one! Maybe we should recall the French's solution to these financial messes, I do believe they invented the guillotine just for this occasion...yes, indeed, that is something to think about.
Question for you Johnathan: You have for quite sometime have been warning of the coming financial collapse. As for me, I am a believer. But do you really believe that all this effort on your part is doing any bit of good? People in general (especially in North America - and that includes Canada too) do not want to know about this kind of trouble. They are like the proverbial ostrich with its head in the ground. Personally, I think sir, with all due respect, that you are opening yourself up for some really bad attacks, for when all hell breaks lose, it is the messengers (like you), that get killed off first.
Don't you think it is time to lay low? This baby is going implode very soon, you really want to be around and risk being seen as the sanctimonious know it all? Believe me, there will be no rewards, on the contrary, people in bad times know only how to spit venom unto those others who make them know, that they themselves, are to blame for what has happened.
#1,
Would that situation not crash the bond market? The Bond market, worth roughly $100 trillion worldwide, would lose half its value.
First bond yields would need to at least double to compensate.
Of course everyone would retire their debt and take out a variable loan. The bubble would grow, malinvestment would go to a new level, and the world economy would enter into a inescapable depression within years of such an event.
I personally see deflation. It's incredibly hard to kick start inflation expectations after 20 years of low inflation. There is too much excess capacity. Playing with inflation just makes the bond market more nervous, jacking up interest rates.
Anon 11:25,
Well I'm not alone blaming individuals. My biggest gripe is with government. They have provided the policies that have caused this event to happen.
If they let the free market clean up this mess it would never have become such a serious issue. But every policy they implement adds to debt and depletes savings, rather than encouraging the economy to be more innovative or productive.
That's because only the free market can do the latter, whereas monetary policy is very effective at the former. Why would anyone want to save cash at 0.5% below inflation when they can borrow at inflation?
Individuals and realtors are to blame as well. But you can't blame people for being greedy. That's innate.
But you can blame a government for trying to be the answer to all woes. They are not the answer. They have to stop pretending that they know what the economy is or how to improve it. They can only do the latter.
And voters have to stop asking the government to fix things. They need to understand that the economy is a fabric that is best weaved by their own democratic and free hands, not by a socialist or facist government. The choices of millions is far superior to the answers of a few men who do not know, what they claim to know.
So can you suggest any way for a first time home buyer to hedge against this risk?
Once the US collapse started, is the Debt ratio increasing due to the loss of asset value as home prices decreased? Or is it a blended effect as people continued to expand credit while asset values declined as well?
Thanks,
TT
Excellent site Jonathan!
Once the commodity/china bubble bursts the cdn dollar will tumble as it is seen as a commodity currency. Since will import everything inflation will jump. Last I look inflation was at the top end of Carney's range. That means he will have to RAISE rates. Manufacturing has been gutted so there will be a long lag between the drop in the currency and a pick up in employment. So the pick up in interest rates also completely pushes the real estate bubble over the edge. This causes a large contraction in public spending. Since we have a consumption based economy, personal trainers for everyone, a lot of jobs disappear. Public finances get real bad and foreigners realize that they have been lied to by our economists, media and government as to the soundness of Canadian finances. . So Carney gets in trouble for promising the average Joe that he is going to keep their rates on their mortgage low. Canada is not a reserve currency that has a huge manufacturing base like the US, Germany or Japan. International capital will leave. I wish I had better news about the economy. What amazes me is that we have seen bubble blow up in real estate in the US, Spain and other place but somehow we are special???
Does anyone know if foreigners have been taking CMHC up on 5% down on spec properties? Was wondering how much Chinese money could be driving Vancouver and Toronto real estate. Both cities have huge Chinese populations.
#6, yes. Stay out of RE til' it fully corrects (about 6 years is my guess assuming there are no fundamental changes to mortgage terms). Or simply rent until it is no longer cheaper than it is to buy.
#7 Dropping RE values affect only those homeowners who have bought in after the bubble collapse, so it is a blend but one that is a slow starter, taking time for falling RE values to noticably drop national disposable income expenditures impacted by changes in reduced debt levels.
#5
I agree, Jonathan. I believe the government has gone well out of its way to create a RE bubble designed to create a wealth effect in a bid to try to win a majority government.
Everything they have done points to it. 40 year nothing down insured mortgages through CMHC from June 2006 on til' Oct 2008 coupled with major deregulation of CMHC standards and regs, combined with the 35/5 year mortgages CMHC insures today in the face of record low interest rates, taking all the risk away from banks through CMHC, reducing lending restrictions, there is no other time in history where one can borrow so cheaply as there is right now. Unfortuately, it gets priced in and with RE values in bubble territory eroding mortage affordability as we speak, we have nowhere to go but down.
There are too many things going against Canadian RE past this summer. Rising inflation, GDP growth near 5% in the U.S. and Japan, record levels of government debt forcing record foreign debt, trade deficits, higher taxes with HST and higher federal/provincial taxes inevidably coming in an effort to get budgets under control, and finally rising rates which are likely to be flirting with double digits 5 years from now... this is the greatest concern going forward. So too, just as RE values fall with rising interest rates, so will the wealth effect bolstering retail, wholesale, realtors, construction, insurance, financials and GDP (CMHC proudly brags about RE being nearly 20% of GDP on their website), suddenly become a poverty effect leading to higher unemployment, shrinking credit and reduced income.
RE values that climb for reasons outside of earnings (government meddling) are destined to fall back to earnings support as other outside variables (long amortizations with little down, low interest rates) return to normality. What we are witnessing with the unprecidented credit expansion in Canada that is created mainly by buyers of used homes is... the recipe for a recession. The only question is when (I like you see it starting in the 3rd quarter of this year). HST, provincial/municipal (and later federal) tax increases, rising rates, falling RE equity and reduced borrowing power... all will combine to reduce disposable income creating a recession.
Sadly, its the government that claims to be "smaller" with the so called goal of not getting in the way of a free market economy that is doing the most damage with the creation of a wealth effect that is unjustifiable, unsustainable and unprecidented. For all that debt... what did we truly buy? Again, what did this government try to buy from us with our own borrowed money?
Just about everything I read these days is tinged with inflation fear (JT is among a minority club who are refreshingly excepted). I guess it's going to take a while to break 90 years of conditioning - at least 20 years by my reckoning, during which time all assets will be in decline (see Japan since 1990 superimposed on the World). They will then essentially lie there in a most un V-like manner for another 20 years while people die off and forget the economic absurdities engendered by our late 20th century fascination with greed, entitlement and something for nothing attitude. The more egregiously overvalued assets (housing, stocks) will decline the most. The Rodney Dangerfield(s) of our present economically dysfunctional world, cash and a good old fashioned work ethic, will be surprisingly coveted and yes, eventually respected.
High real estate prices also raises the overall cost of hiring employees. If you were going to locate a plant to this part of the world, it would likely be a lot cheaper in Michigan or Ohio. Based purely on real estate there being so much cheaper than the GTA. Paying someone there $50k would allow them to afford decent housing here it does not. High priced real estate is hollowing out our economy. Not only have we lost jobs to China, but we will get cleaned out by the US also.
I too tend to fall in the deflation low interest rate side of things. Sky high debt not sky high interest rates will be the real problem. Where I'm not sure on if where house prices will go, sideways or a real collapse. A Las Vegas style collapse I think not.
Great site, and I fully agree. So here's the question: How does one short the coming disaster and make money off of it? Seriously, any ideas? In the USA it was done with CDSs. Here?
This site will now be a regular read, great, good work Jonathan!
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