Canadians have never owed more and owned less. Our perception of the world around us is staggeringly rose-coloured, despite evidence to the contrary. We amassed more debt during the nasty (ongoing) recession of 2008-2009, the first time in history that consumers have gone further into debt during a recession. We sit at generational lows in terms of our savings rate. We have a consumer-driven economy that depends on the perpetual expansion of debt to continue with the charade. Interest rates have nowhere to go but up. We have let real estate comprise 20% of our GDP. We have watched in wonder as real estate prices have hit new levels, seldom asking why incomes, inflation, rents, or affordability have not kept pace. When we do wonder, we’re usually quite happy to accept the usual explanations: It’s different here….rich Asians…sound banks….more prudent….immigration….bla bla bla.
So how did we get here? We sit on the most unsustainable economy we have ever seen in Canada. If you’re a regular reader, you’ll know that I believe that the coming drop in real estate prices will lead to broad economic pain felt all across our great nation: Unemployment will be high. Consumer bankruptcies will be high. Pension issues will mount. Consumer spending and confidence will plummet. Real estate will not see these heights again for at least 5 years, likely longer.
With all this in the back of my mind, I sat down today to finally read the report issued in September by the Canadian Task Force on Financial Literacy. I’d like to highlight a few of the key quotes:
What has led to low financial literacy?
“widespread availability of on-demand credit with minimal qualifying requirements that encourage unsustainable borrowing habits”
This point cannot be stressed enough. Credit bubbles, which is what we have in Canada, are extremely damaging to the economy for several reasons. First, they pull demand forward. A case in point is housing. A great deal of demand has been pulled forward by loosening mortgage requirements and historically low interest rates. This is why sales are currently tanking, with prices set to follow. The second reason that credit bubbles are so damaging is because they create artificial demand in sectors of our economy that would not otherwise flourish. Because of this, employment is always low and economic growth high while a credit bubble is being created, but the opposite is true in the aftermath.
“widespread trends in advertising and popular culture that encourage individuals to consume rather than save, and the undermining effect of these trends on financial education efforts to teach people how to save.”
It’s interesting that there is usually at least a generation between bursting of asset bubbles since it typically takes that long for one generation to forget the pain caused by the reckless that led to the previous asset bubble. It explains why people who lived through the Great Depression never let go of that learned frugality and must have watched in amazement as our society slowly receded into the materialistic shell of its former self. The increasingly common bubbles we’ve seen in the past decade has been solely the result of miguided central bank policies, who think the best thing to do when faced with a recession is to kick the can down the road a little by stimulating consumers to go further into debt. Eventually they can’t take on more debt and the central bank pushes on a string while being exposed for the toothless tiger it is. This has been the experience of Japan and now the US, and will be our experience shortly.
Consequences of financial illiteracy:
This is perhaps the whole point of this blog: to explore the consequences of our shifting worldview here in Canada and try to protect from the fallout.
“A number of participants also suggested that a lack of financial literacy can have macroeconomic consequences that help explain, among other things, Canada’s
low (by historical standards) saving rate, a rising household debt–income ratio and increasing rates of personal insolvency.”
“As one participant noted, these outcomes are “symptoms of poor financial decision making in many cases exacerbated by inadequate financial literacy skills.” Another participant went even further: “The glaring truth from the financial crisis is that people who are not well informed do not make sound financial decisions and there is a price to pay for this in terms of our overall financial health as a country.”
Thoughts on borrowing behaviour and low savings:
“A number of participants told the Task Force that a lack of knowledge is often at the core of what they described as a growing problem of over-indebtedness, especially among young Canadians.“
I can attest to this. I can’t believe the amount of debt that younger generations (particularly those under 30) are now comfortable taking on. I think this is an acute problem, particularly for the housing market. The housing market is driven by first-time buyers. The market needs a steady stream of them in order to maintain high volume of sales and high prices over time. The pattern of younger and younger new home owners taking on larger and larger mortgages relative to their income and putting less and less down as down payment cannot continue forever. The implications for the housing market (and broader economy by extension) is not good.
“Many participants expressed concern about what they described as “Canada’s low personal saving rate” and a culture that does not appear to value saving. As one participant noted, “People don’t learn to save.” The presumed saving rate problem was attributed to a number of factors, including…a culture that tends to encourage consumption over saving.”
Let me repeat myself: None of this is sustainable!
In the aftermath of a busted credit bubble, several things are a given:
1) Consumer spending falls while savings rates rise, leading to deflationary pressures in the short term.
While our credit bubble has not reached the same excesses as seen in the US, ours is nevertheless extremely problematic. This is what that looks like in the US:
Note the rise in the savings rate in the US after their bubble burst in 2007. This trend will be intact until a reversal to the mean is complete. While necessary for the long-term health of the economy, the implications of this reversal for the US economy are not good.
2) Assets that require credit to purchase (i.e. real estate) get hammered.
3) Unemployment remains stubbornly high.
Our experience will not mirror that of the United States, but there will be more similarities than most want to acknowledge at this point. The era of consumerism, debt, pseudo growth, and housing as a means to riches are all behind us. The reversal will be painful but necessary. Position yourself accordingly.