Housing and the future of Canada’s economy

Why are you here?

This is far from a philosophical question.  This lowly blog is not yet three months old, yet readership continues to grow at a rate that has me pleasantly surprised.  This site now frequently receives 2500 daily page views, nearly double from a month ago.

While I’d like to believe that people are simply enthralled by my witty and thoughtful insights, I know it’s more likely a reflection of the lack of insight and integrity from more traditional media sources, which seem increasingly satisfied to simply tow the line fed to them by sources of questionable credibility. I’ve been hard on the mainstream media on this blog.  For that I don’t apologize.  I’ve also been hard on the bank-employed economists, realtor groups, and politicians of all stripes.  Again, I’m not sorry.

Ours is a very different world from the pre-credit crisis world of just a few years ago.  We have entire nations being bailed out and having their debts guaranteed.  For who’s benefit?  The citizens?  No….it’s to the benefit of the big foreign and domestic banks holding those bonds.  The citizens will be stuck with the legacy of unrepayable debt and lower living standards so the banks don’t take hits to their capitalization ratios and can therefore continue to make risky bets so their top employees can make multi million dollar bonuses.  It’s certainly not politicians or bankers looking out for us.

Similarly, anyone who understands the immensly important role that real estate and the associated wealth effect spending has had on buoying our economy here in Canada can not help but question the credibility of  any politician declaring that there is no basis for fears of a housing bubble, particularly when that politician is the one person most responsible for inflating it.  Given the ‘not on my watch’ mentality of politicians who are quite happy kicking a problem can down the road for someone else to deal with, I have a hard time trusting them too.

Likewise, any entity that requires a perpetual expansion in credit to maintain maximum profitability is questionably biased on this same question.  Given that mortgages and HELOCs are by far the two largest generators of credit, and both are dependent on strong house price appreciation, it calls into question the ability of bank-employed economists to be entirely truthful about the potential for a significant housing correction.

And so people increasingly flock to independent finance and economics blogs like this one.  You may not like what I have to say, but you’ll have a hard time questioning my motives.  I don’t make a penny off this web site.  You won’t find advertisements anywhere.  That may change if it consumes an increasingly large amount of my free time, but for now, I receive no remuneration whatsoever for maintaining this lowly blog.

If you’re new to this site, let me welcome you.  I hope that at the very least you will see that I try to provide an insightful counter view to the prevailing ‘wisdom’ of our times.  We may disagree, but I promise you two things:  1)  I will never censor criticisms of my views….2)  I am happy to post guest posts that disagree with my position and aim to debunk some of my macro views using facts, stats, and strong logic.

The Financial Insights one-stop primer

If you are new to this blog, please check out the 6 primers.  They are required reading if you’re going to understand what we’re talking about on this blog.

Sometimes we just need things said several times before they finally sink in.  So while none of this is new to anyone who has read this blog, I will take a moment and highlight what I feel are the structural issues with our Canadian economy and how I feel these will resolve themselves over the next few years.

1)  Housing and GDP growth:

Our economy is too reliant on housing to generate growth. At present, housing constitutes 20% of our GDP and was one of the driving forces behind the great Canadian economic miracle of 2009-2010.  The last time that 20% of GDP was derived from real estate was in the early 90s, before real estate across Canada declined in real term for nearly 10 years and declined substantially in several major centres.

2)  Consumer spending and GDP growth

Our economy is also far too reliant on consumer spending, which makes up approximately 65% of total GDP.

3)  Debt and savings

Normally a high percentage of consumer spending is not an issue in an economy, unless it is financed by a perpetually increasing debt load and is coming at the expense of consumer savings, as is the case.  This implies that demand is being artificially pulled forward as this debt must at some point be repaid.

It’s difficult to know exactly when this ‘gap’ in consumer demand will hit, but when it does, it will have significant impacts on the broader economy.  If you understand that credit = money in our fractional reserve banking system and that spending money more often = inflationary pressure via increased velocity of money, then you’ll understand that the paying off of outstanding credit = shrinking the aggregate money supply and saving money = decreasing the velocity of money.  This will create deflationary pressures that will be felt particularly acutely by any asset market that is predominantly financed via debt…….namely real estate.

4) Present real estate valuations

Now I said that it is extremely difficult to know exactly when the gap in demand will hit, but two things give us clues.  One is the fact that our housing market is extremely pricey by any measure of fundamental value.  On a national level, we have a housing bubble.  As in the case of the US housing bubble, this simply means that some areas will be hit harder than others.  Perhaps you live in an area where real estate prices are still in line with historic measures of fundamental value.  If you live on the West Coast or in T.O, don’t count on it.  While our housing market has not yet reached the same levels of irrational exuberance experienced by our American cousins, it is nonetheless problematic.

Whether you fall in line with the bank economists who are predicting a mild 10% correction, or whether you fall in line with other economists who see substantially greater overvaluation, one thing is for certain:  You are a fool if you think that real estate can continue to substantially outpace inflation and wage growth into the indefinite future.  Mark my words: The next 10 years in the Canadian real estate landscape will look nothing like the last.

5)  The wealth effect

One of the blessed side effects of real estate appreciation is what is called the ‘wealth effect’.  It’s basically where people feel richer, therefore they spend more money on stuff that they wouldn’t have bought otherwise.  The wealth effect associated with real estate is often calculated at 6-10%, meaning that for every dollar in real estate appreciation, consumers are likely to spend an additional 6 to 10 cents.

Nowhere is this more evident than in the latest CAAMP report which was discussed at length on this blog.  Basically, it revealed that home equity withdrawals were goosing household spending to the tune of 8.5% annually.

This provides a glorious feedback mechanism whereby increased house prices create increased consumer spending and increased demand for houses, which creates the appearance of an economic boom as unemployment becomes a distant memory and good times roll.  As the good times roll, people feel good about the economy and their job security and project those feelings into the infinite future, bid up the price of houses, and the process repeats itself.

But when real estate corrects even mildly, this mechanism goes into reverse.


Timing the exact start of a secular shift and a mean reversion is virtually impossible given the fact that there is an element of human psychology involved.  If humans were perfectly rational creatures, we wouldn’t be in this predicament in the first place, now would we?

That being said, it’s fairly obvious that all of the points above are tied to the strength of the real estate market.  Therefore it is highly likely that the whole mean reversion will begin about the same time that people realize that they are not as rich as they think they are, and maybe they should pay off interest rates before they rise and consume even more of their income, and maybe they should have saved for a rainy day.

Given the weakness in home resales, which have been registering at some of the lowest sales volumes in the past decade in most big boards, I think that the first hints of year-over-year price declines will be any time.  I’ve been predicting a drop of 5 to 10% by the new year, with another 10 to 20% off in 2011.

That being the case, we should see housing starts weaken even further in 2011 as well as consumer spending significantly muzzled.

If I’m right about this, we should see negative GDP readings by Q3 or earlier, with an outright recession by Q3 or Q4.

In addition, unemployment is set to march steadily higher and remain stubbornly high, perhaps above 10% for several years.

Deflationary forces and a secular shift back towards frugality will ensure that real estate prices don’t see their highs again for at least 5 years, and more likely a decade.

The caveat

2008 and 2009 were interesting years for me.  I’ve never been so right and so wrong at the same time.  I was one of only a few people I know of who was warning about a global debt issue before the credit crisis hit.  I also warned that house prices in Canada were set to correct….and they did.  Where I was dead wrong is that I had no idea to what lengths the government would go to ward off a depression.  In the process, they reignited a housing market that would still be dead today.

Could the same thing happen again?  Well, certainly the shock and awe factor of historically low interest rates is now gone.  I don’t expect much of a jump in demand even if they cratered them again, which wouldn’t surprise me.

However, there is nothing stopping the government from introducing zero down, interest only mortgages, 50 or 100 year amotizations.  All of these are terrible ideas, particularly when backed using taxpayer dollars.  The further down the road of irrationality we travel, the greater the fallout.  But that doesn’t mean they won’t try.

And so I will add this caveat:  My economic predictions are useful only as far as governments will allow free markets to roam.  At the end of the day, the free markets will win out.  But that’s not to say that government intervention won’t necessitate an extra inning or two.

In conclusion, welcome to this lowly blog.  I hope you find it worth at least the price of admission.



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8 Responses to Housing and the future of Canada’s economy

  1. Ray says:

    hehe, that’s a long post to get to your segue of being able to back out of your economic prediction under excuse of government intervention! It was a bold prediction nonetheless and I was wondering how close to xmas you would get before this post would appear 🙂

    Anyways, I agree with everything you say on this blog, except I think BoC will actually raise rates especially in light of the Oct increase CPI/inflation readings and the overheating RE prices of late. We may not see it Dec.7 but if Nov comes in hot then we should see it in the early new year.

    • Hi Ray. What part of my prediction have I changed, exactly? My predictions haven’t changed, and I still think I’ll be proven right. We’ll see how close I am to the timing, but the macro picture is all but a given. The government can at best only change the timing….the outcome is assured.

      As for interest rates, I’d love to believe that Carney will have the balls to continue increasing even as the economic growth illusion comes apart at the seams. You obviously believe that our central banker has the integrity necessary to do what’s best for the long-term health of the economy. I’m not so convinced. But in fairness, I have been wrong about the last couple rate hikes, so who knows…

  2. John in Ottawa says:

    The issue isn’t “if,” but “when.” The burning question is, “What will it look like?”

    It probably won’t look like the US with its sudden drop off a cliff and it certainly won’t look like Ireland, but that still leaves a lot of room for hurt.

    What is a “soft landing?” On a national scale I guess it looks like a gradual slope downward that the economy can adjust to slowly. Given what is happening almost every where else, I guess we could count our lucky stars if we have a soft landing.

    It is extremely frustrating that it is so difficult to get timely, hard data on Canada. In the US, every time someone sneezes there is someone over his shoulder counting it, sorting it into quality of sneeze, possible cause, age factors, seasonality, seasonally adjusted, income, and ethnic background. Two days after the month ends it is published online, and then “adjusted” twice more. A little “black box” math is always included in the stats, but we know that and can at least attempt to reverse engineer the black box. Even lying statistics are better than the seeming dirth of information available to Canadians.

    How are our banks really doing? They offload debt to Special Purpose Entities (SIVs). What’s in those SPEs? Is it marked to market? Can it be put back? Questions without answers.

    A friend of mine called last week looking for advice. He has come upon hard times and hasn’t paid his mortgage in six months. The house has been up for sale for almost as long. The bank called last week for the first time, saying they had “just noticed” that he isn’t paying. How is that statistic recorded in Canada? Where is the “We just noticed you are six months delinquent.” statistic? How is that marked to market?

    We read economic tea leaves here in Canada. Stale, moldy tea leaves.

  3. MarKoz says:

    Thanks for all your posts – I really appreciate your analysis. I spent 6 years in uni but never took any courses in economics. Too bad, because it really fascinates me. Your articles are some of the best I have read (and I read a lot) and go a long way to assist my understanding.

    One of the most striking things about the world economy is its (to me) lack of rationality. Back in late 2007 I decided to take my RRSPs out of mutual funds and put them in a savings account. My banker warned me it was a bad idea and pointed out that even if the US economy tanked there were plenty of places in the world that would still be going gangbusters (he cited China). I said that China primarily manufactured products for the US so who would they sell to? We agreed to disagree. Come 2008 and I’m feeling like a genius. Come 2010 and I’m feeling like a dummy because my money is still earning 2% (I hope) and the markets have recouped all their losses.

    Economies all over the world are running on stimulus money that will have to be paid back which, I presume, means higher taxes and less consumer spending. Unemployment is high. There are property bubbles in China, Australia and here. There is fallout from property bubbles in the Eurozone and the US. When people feel uncertain they rush into gold and bid its price up to $1400 per ounce even though it has limited functionality for anything other than jewellery (according to the Gold Council’s own website gold “exists primarily as a decorative material”).

    Somehow in the face of all this the markets have made a miraculous rebound. I’m not getting it and that fact is costing me money in lost interest. I’d like to move my funds but have no idea where and have no trust for the same guys that in 2007 were telling me not to move my money out of mutual funds. I hope to gain some insight from reading your blog and others.

    Keep up the great work.

  4. LRM says:

    Keep up the great posts. Someone has to get unbiased info to the public and I hope your blog will be one of the “go to” sites for honest, credible, and timely financial information for the Canadian investor. Your work is appreciated .

  5. RJH says:

    Thanks for a great blog and the insightful postings. I am a daily reader. I hope you are wrong with your predictions but I am afraid that you are dead on.

  6. Kevin says:

    I believe your site is the definitely among the ” go to” blogs for Canadian real estate. Well written, well researched. If I am doing some research, your blog is one of the first I hit. Thanks.

  7. mac says:


    Really? What you’re describing is someone who needs to go on a journey. A journey of self-discovery where you take responsibility for your future and your money and you go about interviewing different financial planners, stock brokers, etc., who have access to myriad financial products that go well beyond mutual funds. And then that journey leads right back to …. you!

    I’ve done pretty well since 2008 and that’s including that awful dip in the stock market, thanks to my own interpretations of where I thought the RE market was going and my great stock broker. And he’s great, not because he’s always right. He’s great because he has my best interests at heart and takes the time to discuss both sides of any trade with me. Both of us have been right and wrong too many times to count. And from those calls I have made and lost money. So what? That’s investing.

    You can’t just make one move and say that’s it. You’ve got to move the ball down to the end zone and once you score, you don’t go home, you start again.

    Please don’t be one of those guys I see in focus groups. Embarrassed by what they don’t know about finances who have abdicated a lifetime’s worth of financial responsibility either to their wives or to “some guy at the bank”. Your banker dude wasn’t wrong forever, he was just wrong for those 6 months. Get over it and start exploring your financial future.

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