Tuesday, January 18, 2011

Canadian debt levels ... what is really going on?

The Canadian government is worried about personal debt levels of Canadians.  They have changed mortgage qualification rules twice in the past year to "tighten" the lending practices.  The top issue we are told is consumer debt. 

Mortgages are not consumer debt, consumer debt is credit cards, car loans, etc.  How many Canadians have a Visa, a Mastercard, two car loans and a store credit card from Home Depot, the Brick and the Bay?  These are all charging clients between 7 and 22% interest.  Mortgage debt is currently 2.25% to 4%.  I ask, "Which one is worse"?

I do not think the current mortgage tightening has anything to do with Canadian debt levels.  I think that the current changes are gear directly towards the Canadian Dollar.  At this point, this morning, the Canadian dollar sits at $1.01 USD, meaning we are above par.  Historically, the Canadian government has held the policy of keeping the Canadian dollar lower than the USD.  This is to protect many Canadian economic sectors, including tourism, import/export and manufactoring.

Usually, when the Canadian dollar climbs, the government will lower interest rates, making Canada a less attractive place for investors to "park" their money.  For instance, a high Canadian dollar, compared to the world reserve currency, the USD, investors would hold Canadian dollars to lend them to back to Canadians at a higher rate of interest than they can achieve in the United States.  But in a low interest environment, investors are not going to want to hold Canadian dollars are there is little return in lending money in Canada.

Currently, we are in an environment where we cannot lower rates to lower the value of the Canadian dollar.  Core inflation in Canada is on the rise, meaning the value of goods is rising compared to the value of our dollar.  To combat this, the usual method is to raise interest rates, but currently, we cannot raise interest rates.

What do we do?

The economic engine that usually pushes a country out of recession is the housing industry.  The housing industry is the single largest employer in Canada if you consider all the off-shoot businesses that are dependant on housing - real estate agents, trades people, lumber yards, mortgage brokers, surveyors, indirectly the auto industry (pick up trucks), etc.

I would argue that Canada is not in a recession, but that the effect of the US economy on Canada has caused a slowdown in the Canadian economy.  It is a funny thing right now, as our banking system, our economy is strong but we are being directly influenced  by the problems in the USA.  With over 80% of our trade going South of the border, it is easy to see why Canada is feeling the hangover from the US financial meltdown.  With 80% of our trade going to the US, it is pretty easy to ascertain why the Canadian/USD exchange rate is so important to our exporting sector.     

What do the new mortgage rules do to the exchange rate?  A slow down in the Canadian economy, means inflation should drop.  A slowdown in the Canadian economy also means that the Canadian dollar should drop.  The Federal Government is attempting to push the dollar lower by slowing down the housing market.  This slowdown will keep both the dollar and inflation in line. 

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