Canada's Housing Bubble

Sep 22, 2011 Ben Rabidoux theeconomicanalyst.com

There was a slew of revisions to Canada's economic growth prospects today.

IMF warns of slower economic growth:

The International Monetary Fund has released their latest World Economic Outlook publication.  Although the IMF has been notoriously 'behind the eight ball' in their forecasting, it's nonetheless worth hearing what they have to say.  The document is extensive, but here are just a couple key snippets:

In Canada, downdrafts from its southern neighbor will be offset in part by relatively healthy economic fundamentals and still supportive commodity prices.

I’ve made it no secret that I think Canada’s current debt dynamics and over-reliance on consumer spending and real estate-related industries to generate economic and labour market growth makes the Canadian economy fully capable of wilting under domestic pressures alone, a fact lost on economists who ignore private sector debt, as evidently the IMF does.  For more on that, check out the following posts:  'Why a housing correction would CAUSE a recession' and 'The confidence economy'.

That being said, the fact that our largest trading partners are reeling is certainly of concern.

In Canada, growth is forecast to moderate from 3¼ percent in 2010 to 2 percent during 2011–12, reflecting ongoing fiscal withdrawal and downdrafts from the U.S. slowdown.

This new outlook for 2011 is nearly a full percentage point lower than in their last outlook and creeping towards my unchanged estimate of 1-1.5% GDP growth in 2011.

Although jobs have rebounded at a faster pace than in the United States, a slower pace of recovery over the near term is expected to keep unemployment at 7½ to 7¾ percent during 2011–12.

For Canada, which is in a sounder fiscal and financial position than the United States, ongoing fiscal tightening can continue, but there is policy room to pause if downside risks to growth keep rising.

Of course, we need to delineate between ‘sounder’ fiscal position and ‘sound’ fiscal position.  While most economists are happy to look at Canada’s national debt and pat ourselves on the back since it’s barely over 50% of GDP (compared to 100% in the US), once we combine federal and provincial debt and compare it to federal and state debt in the US, we find that we’re not as angelic as often portrayed.

canada debt to gdp federal provincial total

US state federal debt total GDP

Total US public sector debt is 120% of GDP as of mid 2011.  In Canada, it’s 110% as of the end of 2010.  ‘Sounder’, but not necessarily ‘sound’, though we have made significant efforts to reduce the combined debt levels from 135% of GDP in the mid 90s.  Canada’s national balance sheet is in good shape relative to many Western nations, but again I’m concerned at the self-congratulatory tone in our mainstream media when it comes to our debt levels, and I’m equally concerned that most international economists who look at our debt situation don’t seem to understand (or care?) that our combined provincial debt burdens are greater than our federal debt.

BMO reevaluates Canadian growth prospects

Meanwhile, the folks at BMO were busy modifying their own outlook.  Some key quotes from their latest assessment:

A weak currency and improving household finances will support the U.S. economy, while firm commodity prices will continue to drive investment in Canada’s resources sector.

BMO entirely misses the reality that a flight to the perceived safety of the US dollar is a distinct possibility as Euro zone problems intensify and European banks become increasingly unstable.  The flight from risk assets suppresses commodity prices while at the same time buoying the US dollar.

Canada will remain challenged by a strong currency and high household debt, with the latter likely to restrain consumer spending and home sales even as interest rates remain low.

There is about a one-in-three chance of recession in the year ahead. The U.S. economic recovery remains fragile amid depressed consumer confidence and high foreclosures. An adverse shock—stemming from a worsening European debt crisis—could unhinge the recovery. Canada’s close trade ties with the U.S. suggest it would not be immune to a U.S. downturn, though greater flexibility in monetary and fiscal policies could cushion the weakness.

Due to the strong Canadian dollar and weak global economy, the Bank of Canada is unlikely to raise interest rates until next summer.

Economic growth is expected to improve modestly in the second half of the year...Business investment should remain healthy amid strong demand for commodities from the developing economies. China, in particular, continues to grow strongly despite policies designed to restrain inflation.

The perpetual China growth story is one that I don't buy at all.  The possibility of a hard landing in China, in which growth slows to 5%, would destroy demand for industrial commodities and lop an estimated 40% off current commodity prices....and the TSX, which is 50% energy and materials, would get whipped like a bad mule.

However, Canada’s economy will be held back by the strong loonie and more restrictive fiscal policy. After expanding a solid 3.2% in 2010, the economy looks to grow a modest 2.2% this year and to repeat this middling performance next year.

Existing house prices, which rose sharply in the past year, have stabilized in recent months, and are expected to decline slightly in 2012 as demand moderates in response to tighter mortgage rules. Should the economy slip back into recession, high-priced Vancouver would likely suffer a sharp correction.

News flash for BMO:  Vancouver's screwed, regardless.

Bank of Canada discusses risks to Canadian economy:

Mark Carney was in Saint John, New Brunswick today to give a speech to the Board of Trade. The speech amounted to nothing more than a reaffirmation of the risks discussed in the Bank's July Monetary Policy Report.

Canadians entered the summer brimming with confidence. Expecting strong sales, our businesses were full of plans to add jobs and invest in plant and equipment. Canadians themselves had a very positive view of their economic prospects. Now, in the face of alarming events abroad, some are less sure. What happened? And how should the public and private sectors respond?

The direct impact of weaker European growth on Canada is relatively modest. However, the financial and confidence effects could be considerable. In response to uncertainties in Europe, global equity and commodity prices have fallen significantly, and financial market volatility has increased markedly.

The spillovers to Canadian financial markets have been less pronounced but are still notable. Overall financial conditions have tightened in Canada, largely due to declines in equity values. Importantly, our financial system continues to work well. Our banks have virtually unmatched access to funding and capital; credit to Canadian households and businesses remains widely available at historically low rates.

The Bank expects that growth will resume in the second half of this year, led by business investment and household expenditures, although lower wealth and incomes will likely moderate the pace of investment and consumption growth.

Slower global economic momentum will dampen domestic resource utilization and inflationary pressures. The Bank expects total CPI inflation to continue to moderate as temporary factors, such as significantly higher food and energy prices, unwind. Core inflation is expected to remain well contained as the growth of labour compensation stays modest, productivity recovers, and inflation expectations remain well anchored.

The risks to our economy remain largely external and are skewed to the downside.

I wouldn't be surprised if GDP growth posted a very modest gain in Q3, although I think the deciding factor will be the strength of inventory restocking.  I'm still of the belief that a technical recession is a 50% chance in Q3.  Regarding the notion that risks to the economy are largely external, well, that's a topic I've discussed to death.  I think it's a ridiculous statement, but the suggestion that risks are skewed to the downside is hard to disagree with.

Cheers

Ben