Canada's Housing Bubble

Jan 16, 2010 Jonathan Tonge americacanada

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.