Canada's Housing Bubble

Jonathan Tonge October 2, 2009 http://americacanada.blogspot.com

If you speak to most Canadians you get the impression that it's different here than it is in the rest of the world. We are rich in commodities, spend more wisely, less indebted, strict bank regulations and our housing market is strong.

Yet I have said numerous times that Canada’s economy has been built on a house of cards. Growth of debt for the past thirty years, and especially in the past ten, has provided Canadians with a heightened sense of future well-being, a sense of solidarity and economic stability. I have also said many times that the fundamentals of our economy are not sound. If it was not for leverage than home prices and incomes may actually be lower today than they were ten years ago.

So it is only fair that I respond to my fellow Canadian bulls.

Commodities

Well rich in commodities we are. Canada is a vast country. So it may come as a surprise to many to find out that the ‘mining and oil and gas extraction’ industry only accounts for 4.5% of the Canadian economy. Furthermore, in the five years from 2004 to 2008 this industry’s output grew by only 1% in total. That’s less than 0.2% growth per year.

Click for a larger image of the matrix.

In 2009 mining and oil and gas extraction shrunk by 15% YOY. It is now a smaller industry than it was in 2000. Please see Canadian Economy shrinks 5% YOY.

Furthermore, the output of 'Agriculture, Forestry, Fishing & Hunting" industry actually shrunk 1% between 2002 and 2008. By mid-2009, this industry was 13% smaller than it was in 2008, erasing well over a decade of gains.

Canadian’s perception of these industries certainly does not meet economic reality.

Spend thrift

Canada has a gross national savings totaling 24% of GDP. This is in line with other export based nations like Germany (25%) and Japan (27%). The United States has a gross national savings rate of 13%. This is in line with other import nations like the UK (12.7%).

However consider Uh oh Canada! Americans are out-saving us:

“The percentage of disposable income saved by U.S. consumers shot to 6.9% in May, the highest level since December 1993. The rapid increase in the rate, which stood at zero in April 2008, has caused an historical anomaly by surging ahead of the savings rate of cautious Canadians. Canada's savings rate stood at 4.7% in the first quarter.”

Gross national savings rates have more to do with trade imbalances then they do with being culturally 'cautious'. This explains the difference between the savings rates in designated 'import' and 'export' nations. Please see Obama G20 – Trade Imbalances to get an understanding of why this competitive advantage will soon disappear.

It is important to distinguish between personal savings and gross national savings. Gross national savings are the sum of government AND private savings. Therefore CPP's 187 billion (2007) nest egg and Alberta's Heritage Savings fund of 17 billion (2007) account for a large portion of our gross savings.

Furthermore is it also important to note that each country has a different definition of a gross national savings rate. For instance in 1995 Japan had a savings rate of 13.4% and United States had a savings rate of 4.7%. However the calculations depend on the treatment of consumer durables, private pensions and life insurance payments, social security, household interest payments, capital transfers and depreciation. Adjusting for such factors brings the gap in savings rates down to just 3%. Please read EUI's definitions of savings and income for more information.

Note that Alberta is now dipping in to its savings to fund its 6.9 billion dollar deficit and CPP's savings was down to $117 billion after the 2008 crash.

BLOG UPDATE - OCTOBER 9, 2009

Scotiabank, Statistics Canada: National Savings Collapses

Less Government Debt

Total government debt in Canada in the good old days of 2007 was 1.2 trillion. This was offset by financial assets, for a net debt of 759 billion. That’s a burden of $42,402 for each worker in Canada’s labour force.

Please click for a larger image of the chart.

According to the World Bank, net US government debt totaled 5.96 trillion dollars in 2007. That’s $38,928 for every worker in the US labour force. Download WB spreadsheet here.

It’s important to separate 2008/2009 record US budget deficits from this comparison, since the United States asset bubbles have popped. My argument is that this asset bubble is yet to pop in Canada and when it does, it will drive budget deficits much higher in the coming years creating more of a comparison.

Nevertheless, provincial deficits in Canada are much higher than state deficits in the US. The provinces plan to borrow up to 30 billion in what will probably end up as a rosy forecast. This leads a total of 85 billion in provincial and federal deficits. That’s the equivalent of a $736 billion deficit in the US on a per capita basis and brings us in line with the actual US deficit between Q2-2007 to Q2-2008.

Keep in mind that private credit in Canada is growing at a record rate. These deficits will surely rise when Canadians lust for debt gets tapped out within the next year and a half and consumer spending drops as a result.

Strict Bank regulations:

Please read CMHC – Canada’s Breaking Point.

“While many banks were flogging that it was a great time to buy a home, not one of them increased their mortgage holdings. Between the beginning of 2007 and 2009 Canadian Banks increased their total mortgage credit oustanding listed on their books by only 0.01% (see CMHC chart below). One has to question if real estate was such a great investment, why didn't they want to touch it?”

Click for a larger image of the chart above.

Housing Market is Strong

Canada and Australia are the only two real estate markets in the world that think they are fundamentally different. But they are not. They both have the advantage of credit expansion.

Mortgage debt has been growing at increasing rates year after year in line with home price appreciations. In mid 2008 the mortgage credit growth rate fell to annual rate of 9% (from 13% in 2007.5-2008.5). The housing market in Canada tanked. Home prices fell 10%.

In February of this year, mortgage credit expanded at a rapid rate. The market immediately recovered. Why do you think that was?

Now that mortgage credit is growing at 12%+ house prices are back on the rise. The fact is home prices require an ever increasing amount of debt to keep them rising. Next year mortgage credit will have to grow by at least 13% to keep home prices stable. Note that all this growth is compounded year after year. It’s not sustainable.

Click for a larger image of the chart.

Note in the graph that it should read millions on the y axis – not billions.

Nominally speaking, average Canadian home prices have increased 4.16 times since 1985. Comparatively, between 1987 and 2006, the US housing bubble managed to grow nominal home prices only 3.3 times their original price.

Interestingly, now that we have deflation (-0.8% in August), the inflation adjustment on home prices should now revise real prices upwards.

Also consider"when herds collide on the yellow brick road" from Australian economist Steve Keen:

“Australian house prices rose by a factor of five since the 1987 Stock Market Crash, far more than even US house prices. Even adjusted for inflation, Australian house prices increased by over 250 percent from 1987 levels. The best the US’s housing bubble could manage, before it burst in 2006, was a meagre 180 percent rise.”

Productivity

Consider long term trends in Canada's productivity performance from Statistics Canada's Daily publication:

Over the past 50 years, productivity in the Canadian business sector has increased at a slightly slower rate on average than it has in the United States. Between 1961 and 2008, productivity in Canada rose 2.0% a year on average, compared with 2.3% in the United States.

However, in recent years, the gap in productivity growth between the two countries has steadily widened. From 2000 to 2008, labour productivity in Canada's business sector increased at less than one-third of the pace in the United States.

During this period, productivity in Canada rose at an annual average rate of 0.7%. In contrast, it increased by 2.6% a year in the US.

American businesses have not always had the advantage. Before the mid-1980s, productivity growth in Canada was actually faster than in the United States. Between 1961 and 1980, productivity in Canada increased 2.9% a year on average, faster than the rate of 2.5% in the United States.

Subsequently, productivity growth in Canada became slower. In the mid-1980s, Canada's productivity was 10% below the US level. By 2008, it was three-quarters of the level in the United States.

This needs to be repeated: “By 2008 productivity was three quarters the level of that in the United States”!

THE REALITY

The four industries that saw the largest economic growth between 2002-2008 were the following:

Retail trade: 20% growth
Wholesale trade: 17.8% growth
Construction Industries: 17% growth
Finance, ins., real estate…: 14.6% growth

Click for a larger image of the graph on the right.

These four industries were the biggest beneficiaries in the growth of debt and the resulting wealth effect of Canadian home price appreciations.

So I ask once again. How are we so different than the rest of the world?

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