“The challenges we face have only just begun”

Reality bites!

The sobering reality of our economic situation has bitten Mark Carney like an angry terrier.  Just a few months after raising interest rates while citing an improving economy, Carney has been on a media whirlwind tour discussing the significant challenges we now face.

He discussed some of his concerns with the Toronto Star:

The hard part of recovery is just starting, says Carney

“This is going to be a different form of recovery globally, and that has real implications for Canada…These are extraordinary times—the challenges we face have only just begun.”

I agree it is a VERY different global recovery.  This one is almost entirely sustained by emergency interest rates and government stimulus.  Tack on to that a collapsing demand for imports from the US, a Chinese economic miracle that is anything but, and our own home grown challenges and you have a ‘recovery’ unlike any other.  Were it not for the strong bounce in equity markets and a gravity-defying housing market, the populace would have a hard time believing there’s any recovery at all.

“Canada’s economy, which appeared to be roaring back to life a year ago, has already slowed markedly and is likely to experience a prolonged period of modest to sluggish growth.”

“With conditions looking up last spring, Carney felt it necessary to begin raising the Bank’s overnight rate by 0.25 per cent in June as a hedge against a possible burst of inflation. And by early September, it had reached 1 per cent, where it still sits.”

“I think it’s clear that the Bank was overly optimistic about the economic outlook when they started raising rates,” says Canadian Labour Congress economist Andrew Jackson. “Probably if he knew then what he knows now, Carney wouldn’t have been raising them as he did.”

Vindication?  Here’s a snippet from a blog entry on this site from September:

“I’ve been wondering lately if perhaps the Bank of Canada is going to try to orchestrate another ‘shock and awe’ emergency rate cut in order to spur credit demand.  I just cannot fathom why Mark Carney would raise interest rates in the face of what is so obviously a smoke and mirror recovery.  An article out today in the Grope and Flail suggests that Carney’s rate decision tomorrow is a tough one.”

“I disagree.  From a Keynesian monetary perspective (which Carney adheres to and I despise) it’s a clear-cut decision:  Hold the line.  However, I’m starting to grow suspicious that perhaps the idea here is that they will let interest rates rise incrementally for a period of time and let it garner a lot of media attention….(then) they can slam rates back down to emergency levels….I can’t help but wonder if they aren’t trying to set us up for a similar rush to capitalize on ‘record low interest rates’.”

Back to the article:

“Now, we are out of that easy bit,”…Federal and provincial stimulus programs, which together are pumping nearly $60 billion into the economy, are coming to an end.  And the boom in the housing sector “can’t go on forever,” Carney said.”

No kidding!

“Private debts are very quickly becoming public debts,” he explained, referring to the huge deficit financings mounted by governments to sustain economic demand when business and household spending slumped in 2008.”

Indeed.  Therein lies one of the great structural issues in our economy.  Our economic recovery was built upon the ephemeral effects of stimulus spending and wealth effect-induced consumer spending.  As the government is forced to embrace austerity, consumers will need to step up their spending from its already lofty levels of 65% of GDP.  Yet with consumer debt at unprecedented levels and home prices at lofty valuations and set for a decline, I can’t see them pulling providing the growth necessary to avert significant economic pain.

“With an eye toward Ireland, Portugal and Spain, he added that the result (of government stimulus spending) is “putting a number of countries in fiscal difficulty.”

Not just countries….

Are some provinces facing a European style debt smackdown?

Some people seem to think so:

The Europe of North America

“Under a scenario he assembled…he discovered New Brunswick’s deficit in 2016 would hit $2.1-billion, up from the projected $818-million shortfall this fiscal year. To avoid a deficit that large, Mr. Drummond estimated, New Brunswick would have to raise taxes across the board by 42%.”

That will go over real well.  It’s not just New Brunswick!

“The downgrade may be just the beginning for New Brunswick as well as for other provinces such as Ontario and Quebec whose balance sheets and economies bear a closer resemblance to troubled peripheral Europe than they do with the rest of Canada. These problem provinces can’t solely blame the deep recession for their fiscal woes, either. Years of robust spending growth ahead of the crisis — done despite repeated warnings that such expenditures were unsustainable — have exacerbated matters.”

Ontario’s fiscal issues are well documented.  Earlier this year, Mike Shedlock ran a great piece comparing Ontario to California.  If you know anything about California, you’ll know that it is often criticized for its massive debt levels relative to other states.

As also noted by Business Week earlier this year, the bond market won’t tolerate Ontario’s massive growing debt levels indefinitely without asking for a significant risk premium, which would make funding deficits significantly more burdensome.

Indeed, the nation and the provinces continue to play Russian roulette with the bond market.  The end game here is predictable:  Austerity in future budgets.  The only question is whether it will come voluntarily or in the form of a bond market whoopin’.

Either way, the next decade will look nothing like the past 50 years.

-Ben

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16 Responses to “The challenges we face have only just begun”

  1. Pingback:   Bankers & Economists sound the alarm on loans by Lend Me Money

  2. rp1 says:

    Carney raised rates because every indicator said he had to. Inflation was nearing high end of the target range, the economy was quickly adding jobs, and super low rates were feeding a debt bubble which continues to this day.

    Sadly, our economy runs on debt growth. There is probably no way to rein it in without a lot of job losses and a “reckoning”. Carney has been buying time and trying to spread out the shock, but every year the debt gets bigger. I don’t think it is mathematically possible for him to fix it, and that’s why he’s warning people. The warnings are getting more dire because the problem is getting worse.

    Someone must address the issue or a crisis will occur. Carney is trying to get Canadians to do it, but after what has happened many are now blind to risk. The only other thing he can do is raise interest rates, which is guaranteed to reverse the “recovery”. He just threatened to do that if the debt situation gets too far out of control.

    The government really should rein in lending. Banks are now giving them political cover, so they’ll do something in the new year. I suspect they’ll lower max amortizations to 30 years. Either way they’ll continue to take small steps hoping to avoid a crisis.

    But looking the big picture, a crisis seems inevitable. As soon as we reach the tipping point more houses will start coming onto the market and finding fewer and fewer buyers. Too many people own multiple properties. There have been massive speculative investments in real estate. Can the government really make all of them good? The only lever left to pull is immigration. I think they’ll do it.

    In short, it only pays to be contrarian in a free market. “Buy now or be priced out forever” was probably good advice.

  3. Severus says:

    Rates were raised because they had to. The problem is not rate hiking. The problem is the Keynesian madness and meddling going on instead of letting markets sort things out. What we needed was Creative Destruction. Governments decided to meddle and kick the can down the road. What they are doing is just creating new bubbles.

    My bet is that we will have stagflation.

  4. jesse says:

    Make funding future deficits more burdensome? Yes but it also makes rolling over current debt more burdensome too, a 1-2 punch. Look what’s happening to the PIIGS and Japan. Rolling over existing obligations is a significant portion of new debt issuance.

  5. Fish10 says:

    No offense Ben, but this is NOT Keynesian. Calling this Keynesian is the way the Right hides what it has done, which is to corrupt Capitalism.

    They went for free-market capitalism for a decade and then when it hit the fan they intervened to save the Big banks and Investment banks, bond holders and big money.

    That is NOT what Keynes suggested. He wanted managed growth (ie cut the hands of speculation) and managed busts. He was NOT in favour of allowing the free-for-all we had for the Greenspan era and then the shameless bail-out of Goldman and Wall Street that followed.

    • I actually agree with your statement. Central banks actions we see today are an abomination of Keynes’ theory. I get that. But it is the flag flown by the meatheads like Krugman, so I’ll happily attack their economic theory, whatever they want to call it.

      • JimmyHat says:

        Personally, I find value in b0th this blog and Paul Krugman’s and the two are the only financial blogs that I visit daily. If mud is to be slung at Krugman, fair enough, but it should be at the substance of his arguments (it is the internet and we can link to posts and articles afterall).

      • jesse says:

        If mud is to be slung at Krugman there should be some concomitant alternative policies offered.

        I think his advice to concentrate policies on increasing employment is correct, as is his (hardly unique) understanding that private investment is needed to begin raising rates.

        Interestingly Canada has been successful at regaining jobs quickly, though given recent soaring personal debt levels we have a clue as to why. Private investment needs to step up and to some degree I think this is happening, though I think government policy should be giving it a bit more of a nudge. In my line of work government grants for private sector R&D are slated to increase in 2011. That tells me the government understands and agrees with what Krugman also sees as the problem.

  6. Sam says:

    Do you people actually believe that people who hold paper from the US, Japan, PIIGS, etc don’t know what they are holding? A chance may get restructured? CMHC paper as well? The market is setting a price in the free markets every single day for this stuff.

    Yes Wall Street was bailed out, but did you want to see – all your savings and financial holdings wiped out? Banks are now booming, they have payed back the governments with interest and dividends.

    Let’s try to focus on something positive, the world is changing, the epicenter is shifting from the developed world to the developing world – How are you preparing for this shift? I want to hear some real “financial insight”

  7. jesse says:

    Sam that sounds like EMT to me. Bonds are fairly priced given all expected outcomes? I can think of more than a few exeptions that disprove the rule, not least CDS changes in 2008.

    If all you read on this blog is complaints, step up to the plate and provide some “insight” of your own. (Wasn’t that last comment of yours a complaint, actually?) Otherwise join the rest of us also rans.

    The floor is yours.

  8. Sam says:

    Forgive me, what is EMT?

    • jesse says:

      efficient market theory

      • Sam says:

        Thanks – and thank for the “floor” – it’s hard to provide a thesis for something that is tied to this blog. My comments are simply saying that the blog says” financial insight” “Preserving and enhancing your wealth in the tumultuous times ahead”

        Instead the bloggers are focused on EMT, Economic Theory and doomsday – which is fine, however why not talk about what trades people are doing to exercise this view?

        For example, my view is Canada is fine and home prices will be stable and continue to go higher in the future, deflation will be around for sometime, and commodity super cycle will take the markets higher.

        I prefer being long loonie, long Canada bonds (5y) and Long Cad real estate on floating rates. I also would add some VIX calls and short a touch of gold to help when that portfolio gets stressed.

        What does your book say? Where is your money?

      • jesse says:

        It may sound a cliche but I see rates trending higher over the next 5-6 years. I observe the US has begun to de-leverage itself with a few more years to come. However private investment looks to be picking up, though slowly. I don’t know about the direction of the stock market but P/Es look above trend.

        I’ll be picking at equities from cash over the next 5 years if values fall.

        Unlike you I’m not sanguine on property prices. There is close to no risk premium on owner-occupied condo units. That’s a warning sign for me. I can get a better return on a diversified REIT or utility after management expenses that enjoy the same supposed capital gains and more control over their holdings. The only way condos compete on this is if owners assume their time and management expenses are free. While that may be a viable business model for some, they are effectively working for nothing. When things really turn around that will be untenable, wrought through higher financing rates.

        I’m actually bullish for the economic outlook over the next 10 years and that means higher rates. The last credit-fueled recession in the ’30s saw several years of deflation but once that was cleared out of the system — and I think they didn’t understand this until it was too late — interest rates and money velocity started increasing, fast, in a very short amount of time. I think Carney is a student of history and understands how fast economies can start booming again. His recent warnings are not some con job; he gets it. JMHO.

        Thanks for the discussion.

  9. John in Ottawa says:

    Is it a bubble?

    I have a serious problem with any banker that suggests that rising debt is acceptable as long as asset prices are rising as well. It is too general. If liquid assets are rising with debt, they are interchangeable. Simply sell the assets and eliminate the debt.

    Housing is a special class of asset. It is where people live, develop relations, find work, and raise families. It can also become very illiquid. In a healthy market, there is generally about six months of resale housing supply.

    The bankers are beginning to tell us we are in a debt bubble. I would argue they are correct. But are we in a housing bubble? With the exception of some jurisdictions, I’m far from convinced.

    About a year ago, The Economist published an interactive housing price index flash gizmo. They have kept it up to date since. You can find it at The Economist — Clicks and Mortar. I urge you to take it for a spin. You can look at several country’s housing indexes simultaneously, but I suggest you concentrate on the US (Case Schiller), Australia, and Canada.

    I often read that Canada and Australia are in a bubble. If you use data starting in 2005 to the present you can almost make a convincing case that Canada is in a bubble similar to Australia. But that is just fun with numbers.

    Canada had a significant housing price boom from 1987 to 1990. Then prices collapsed and didn’t recover until the first quarter of 1991. That’s a long time. Set the slide bar at 1991 Q1 to the present. You can look at %price increases, price index, price/rent ratios, and price/income ratios. Keep making sure as you change modes that you are still looking at the US, Australia, and Canada.

    I think you will be very surprised to find that, nationally, Canada is far from being in a bubble. In fact, prices have dropped, in real terms, since 1991.

    At no time prior to 2005 did our prices rise further or faster than in the US. Compared to 1991, our index is still lower than the deflated US housing index. At no time since 1987 has any measure of a Canadian index been remotely comparable with Australia.

    What hasn’t dropped is real debt. Debt is bubbling right along, but our key asset is not going anywhere over the long run (leaving aside specific regional markets).

    So we have seen a bit of improvement in house prices only recently, we feel wealthier in spite of stagnant wages, and we go into debt. In reality, we are not any wealthier (from our house asset) than in 1991, we are just more in debt. Oh, and that means we are poorer.

    The banks are justified to be worried about a debt bubble. Nationally, there isn’t a housing bubble to support the debt.

    • John in Ottawa says:

      It is too bad we can’t edit these comments.

      I meant to state that house prices collapsed in 1990 and didn’t recover until 2001.

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