Canada's Housing Bubble

Jun 01, 2010 Garth Turner greaterfool.ca

Here’s the easy part: the Bank of Canada will raise interest rates. Likely today. I’ve told you for months to expect as much, and besides, I’m wearing my lucky shorts.

Mark Carney has no real choice. Not after the latest GDP numbers showing fast growth in the first three months of the year, and a drop in the value of the dollar. The central bank’s key job is to fiddle with rates in order to quell inflation, maintain a steady supply of capital and keep the dollar in a predictable trading range. So far, he’s flunked. He knows it.

So this is a chance to normalize the price of money after a year of emergency rates, and hope it quells the debt storm that’s swept the nation. Ironically, it’s now debt (personal, corporate, government) that constitutes the greatest threat, and central bankers like Carney have nailed this monster together.

So, here’s the scenario – and the more difficult part of this post.

Raising interest rates, even a tad, will shock the few Canadians who fail to read this blog each morning with their Cap’n Crunch. Already sitting on a steaming pile of mortgage, LOC, car and credit card debt, they will ask of Mark, with irony, a rhetorical flourish and a few flying flakes, “WTF is he thinking?” Coming just four weeks before the HST raises the cost of everything for 16 million cash-strapped people, the last thing needed are higher debt servicing costs, since floating rate VRMs and lines of credit will increase in an instant.

This is why higher rates look inflationary, when the opposite’s true.

More costly loans will help stop real estate in its tracks. They’ll fuel the perception there’s now danger in borrowing. Ultimately, they’ll do what they’ve just done in Australia – reduce mortgage borrowing by a staggering 25%. And after that, they’ll be the catalyst for a real estate correction potentially as biblical as the American one. But nobody will know that for a year or two.

So as the cost of money jumps, so does the cost of living. But simultaneously the price of the biggest asset everyone owns decreases. That means families have less disposable income while their net worth falls. Yes, debt is a cruel mistress.

This is sad, but predictable.

And it’s not the worst news. Debt itself is deflationary, since it sucks off huge amounts of money that would normally build stuff and employ people. Today Europe, America, Canada – everybody is swimming in record amounts of borrowed money. Competition for money is creating a new credit crunch, which is raising rates in the bond market (remember, Greek bonds achieved ‘junk’ status). And just as higher rates inflate a family’s costs while deflating their net worth, the same’s happening to countries.

This is why commodity prices are tanking. And I am sure most people have no idea what it means when steel, cattle hides, tallow and burlap plunge in value as they did in May – down a withering 57%. The last time this happened was just before the lights went out in the final months of 2008. In fact, in October of that year the decline was almost exactly the same – 56%, the worst dip in sixty years.

Markets are sending you a message. The debt binge of the past year, fuelled by absurd interest rates engineered by Mr. Carney and his buds, is about to eat us. Anyone with an appointment to arrange a $560,000 mortgage on a teardown in North Toronto or a deteriorating Vancouver Special needs to pay attention. The next year or two could be déjà vu all over again.

Do you recall the housing market in, say, November of 2008? Hope so.

But here’s the thing. BP.

Oil may be under pressure with all other commodity prices, but that doesn’t mean we’re any less dependent upon it. What’s happening in the Gulf of Mexico is not just a crime against the planet, but also a potential global economic hit. New regs restricting deep water drilling at a time when most of the easy land-based oil has been sucked out threaten to raise costs and curtail supplies. Another reason families will be in the vise – paying more for their energy, as well as more taxes and interest.

This is a bit depressing. Which is why I didn’t mention Korea, Thailand or Gaza.

What to do?

Dump real assets. Flee debt. Grab yield. Diversify. Be liquid.

And give thanks you’re only a man, a woman. Not a brown pelican.