For some time now I’ve been making a number of predictions on the state of the economy and housing. These predictions are archived mostly over at my brother’s blog and date back as far as 2008. I’d like to reiterate a few of these predictions and add some interesting charts to support these predictions. These charts are courtesy of a great report by Wolfe Trahan, which was highlighted over at Zero Hedge. The report is titled, “Slow and Methodical March Towards a Double Dip”. It’s a great read.
Here is a brief list of what I see as the macro themes affecting Canada over the near to mid-term.
1) Deflation driven by a secular shift away from debt-based consumerism and towards frugality and savings. It’s no secret that Canadians are more indebted relative to their incomes than ever before. When mass psychology kicks in and people embrace debt en masse while few save, a debt boom occurs. If you’ve read the primer on deflation, you’ll know that debt such as mortgages, lines of credit, credit cards, etc. all spend the same way as minted currency. Yet they’ve been generated out of thin air by banks in our fractional reserve banking system. This has the effect of flooding markets with money. All that money sloshing around looks for a home. For the past 10 years, and in particular the last 5, that home has been real estate. As that debt is repaid and as people inevitably begin saving again, the result is two-fold: 1) A reduced money supply; 2) A collapsing velocity of money (I explain all of this in the primer mentioned above).
Here’s how that process looks in the US:
Note the savings rate in the US is rising. Ours will begin to rise again in early to mid 2011.
Note that the US consumer has finally begun paying off their debt. This is the exact process described above and is coming here to Canada. Soon! Lest you doubt that, have a look at our current debt levels, which are now above where the US debt levels stood when their bubble popped….
2) We have a housing bubble in Canada, aided and abetted by erroneous government policies via CMHC. This housing bubble is currently deflating. We will see a peak-to-trough decline in the ballpark of 30% nationally, with certain centres seeing +50% declines.
The effect of this is two-fold: 1) It will choke off consumer spending, the ‘life blood’ of our dysfunctional economy; 2) It will lead to stubbornly high unemployment and a ‘new’ recession in Canada by Q3 2011.
As I’ve explained before, people are very willing to tap home equity to buy stuff they don’t need, provided that home equity is expected to increase over time. This mindset has led to the astonishing increase in lines of credit depicted below.
As people realize that their home is not worth what they thought it was, they will stop tapping their equity and begin paying it off instead (see point #1). In an economy that is largely driven by debtor consumer spending, this is bad news.
The second important point is that this will lead to stubbornly high unemployment. There are a number of spin-off effects of high house prices. David Rosenberg calculated that for every dollar of home equity increase, it generated 9 cents in spin-off spending. This has benefited a variety of other industries: travel and tourism, some manufacturing, construction and real estate just to name a few. As homes drop in value and people stop buying them in the frenzied levels of the past few years, it has very negative side effects.
Here’s an interesting chart from the Trahan piece. What is shows is the connection between home sales and unemployment. The author took home sales data, flipped the line graph upside down, and then compared it to unemployment rates a year later. The result?
(Image removed at the request of Wolfe Trahan & Company)
These are the dangerous side effects of debt bubbles. Human psychology makes us prone to extrapolate recent trends into the indefinite future. They cause people to allocate their monetary and human capital to take advantage of these ‘trends’. As such, we see industries thrive where in a normal economy they would not. And these very industries will struggle to survive as the economy undergoes the painful process of normalization.
There you have it. A quick review of my main predictions: A housing price correction, a new paradigm in consumer frugality, a recession in Canada by Q3 2011.
Take these predictions for what they’re worth. I’m happy to help you prepare for the days to come, as great opportunities will follow them.