A key decision made by the Bank of Canada head, Stephen Poloz, to keep the Overnight Interest Rate at 0.50% for another quarter continues to affect regular Canadians in key ways. This rate is essentially the fixed cost for much public & private borrowing that occurs in Canada; whether it be borrowing for a mortgage or an auto loan; maybe even government parties borrowing to finance an annual deficit. When this rate increases, borrowing is made more expensive and when this rate is kept low, then borrowing is made cheaper. How this affects housing prices is if borrowing is made more expensive, people are unable to overleverage themselves or take out big mortgages, so prices stay low. Interest is a tax (inefficiency) on not having full payment today. That much is obvious to some, but to the new generation of Canadians we had to learn the hard way.
Inefficiency Currently Present in Society
Untold millions of dollars of profits have been made in the credit industry in the last decade due to Financial Illiteracy. These are ‘Beginner mistakes’ occurring to a class of people who were not aware of the penalties because no one taught them the basics of that industry. Imagine going scuba diving or even starting at a new job, you must sit through some form of mandatory training where the basics of the activity, and risks associated with the activity are explained. But when getting a credit card, you’re just thrown in the deep end right away. I would argue this is why blame for financial malfeasance lays only partially on end user behavior, since there’s no mandatory kind of personal finance/credit class that can currently be taken in the public school sector. This directly hurts end users. Public education is supposed to be a chance for people who don’t always have the means to pay for that level of training and it’s getting squandered. People are spending 12-15 years of their life in public education and are graduating these public schools not knowing the basics behind credit.
The Bank of Canada might be complicit in not fostering this ideal of Financial Literacy because more people find out about Economics and the faster they’ll realize how having such low interest rates is not necessarily a good thing. We’ve had 0-1% interest rates for 8 years now, (since the US Housing Recession of 2007) and this is training my entire generation of people that cash is forever cheap & it is driving more people to over-leverage themselves. Fancy way of saying that since the cost of carrying cash is so cheap (<1%) bake that into your business plan. Low interest rates are also doing away with training my generation that saving is the way to future wealth. So what happens when rates finally do rise? What’s going to happen to an untold percentage of market players, especially those that bought in late? They will be forced to liquidate (or eat the loss of the value of their properties) and that’s when the bubble bursts. There’s evidence of this in the Canadian Market as of late with the high-ratio mortgages increasing in the Toronto/Vancouver real estate markets. Once interest rates start to rise what will become of housing?
So every month that Stephen Poloz sits back and let’s money stay cheap he’s fueling this addiction to cheap credit, one that has led to Housing accounting for a $7.4 billion increase in GDP — about half of Canada’s economic growth in 2015. This could be described as political football since the Bank of Canada is supposed to make monetary policy decisions that ensure long term Canadian Economic Growth. But it could also be looked at as Stephen Poloz setting up the CDN economy for failure. By setting up this generation for a bubble to pop, he did not ensure growth was unsustainable. The reason I say this is because housing has had such a dramatic growth, and brought in so many tax dollars, a fall in housing activity will lead to a fall in tax revenue and would force tax rates up on those who can still pay. Inadvertently this will kill a lot of private industry because the private industry who’s still making money will end up paying a higher tax bill. This is the series of activities that has occurred in Greece over the last few years and has decimated their private sector leading to a lot of long term unemployment. Now Greece also doesn’t control their own currency so Canada might just see our currency debased by a further 20-30%. Stephen Poloz may be setting the stage for either one of two things to occur in 2017:
1) Keep rate the same which will see the CDN dollar fall so the real estate sector can continue to grow
2) Increase rates and raise the fixed costs for debt penalizing people with high-ratio mortgages disproportionately
Damned if you do and damned if you don’t, I guess that’s why you don’t base your monetary policy on perpetuating a bubble.
Now we switch gears to discuss Public Debt. All levels of government will be affected by this increase in the Overnight Rate as this increases borrowing costs for governments financing of deficits. I bet that the Ontario Liberal Party is not accounting for this risk of increasing debt service costs in their deficit projections even though it’s likely to happen in 2017. The reason I say this is because the US just decided to raise their Interest Rate to the %0.75 level as well, thereby increasing pressure on our dollar to depreciate relative to theirs. We usually try to mimic US interest rate behaviour but this time we may not. Now this will be good for Canadian Export driven corps but if the USA increases their corporate tax rate to 15% (from 35%) and provide a one time amnesty clause to corps holding foreign funds, this may lead to further long term structural currency depreciation.
Economist’s Moment – the Carbon Tax
I’ve spoken to how Free Trade can affect a nation’s Economy before and I will use this Economist’s Moment to further add on to this.
Free trade benefits:
- Comparative advantage allows for net consumption to increase because individual countries are specializing in what they’re good at
- Consumers can afford more with less
- Supposed to lead to a net increase in people working
Free trade negatives:
- Since countries are now specializing in the production of goods and services, entire technology skillsets get outsourced
- Domestic production will not be allowed to innovate on current designs out on the market because the opportunity will not be there
- Costs and labour practices are hidden since they happen in a different country (how can we send food inspectors half way across the world if that’s where our food is made)
- Allows for corporations to pick up and move operations easier
- Labour mobility is clearly hampered because corps can move but the labour cannot
- Countries have to give up sovereignty to be signatories to many free trade agreements
I’m not a fan of free trade. I believe that perfect competition can lead to the lowest prices for consumers and the only reason Western societies are more pro-Free Trade (until Trump was elected) is because the costs to start up a business in the West are so high. I would argue government regulation has a big part to play in this but I cannot pinpoint an exact percent cost attributed to government. Governments are careful to not audit themselves, or show cost transparency and implement a series of measures to ensure secrecy so they can hide the costs they pass on to their citizens. For these reasons, perfect competition is impossible to attain in the West and that’s why Free Trade is such an easy thing for bureaucrats to campaign on.
But here’s the part where they don’t like to talk about and that is once all the auto jobs are outsourced, what happens to the supporting infrastructure (engineering, skilled trade & post secondary education jobs) for that industry? They leave too. All the future innovation that would have happened in Canada disappears as well. This is the reason why free trade does not make sense for countries like Canada. Once we outsource an industry completely, we not only lose the ability to innovate on that industry but all of a sudden we are also dependent on foreign countries. Kind of like how Trudeau cannot risk to damage Chinese-Canadian ties. He cannot bring up Human Rights Abuses carried out by the Chinese. They control his purse strings and the ability to deliver product to our domestic industry. When dealing with a country like China, it’s important to understand that unfair government subsidies are also a temporary way for Chinese goods to gain a foothold in the Canadian market. Deceptively tricking the Canadian Market into believing that cost savings are greater than they would be if those subsidies did not exist. Again disadvantages of free trade.
Now we get to the carbon tax, that the Trudeau government has advocated for. This will kill Canadian jobs because he’s pursuing a policy to tax dirty industry and chase it from Canada. Again he’s not focused on utilizing information to educate Canadians to change consumption habits (e.g. discussing the impact of carbon intensive food manufacturing). I get the overall point, which is he’s hoping for corporations to invest in green energy so that carbon footprints can be minimized. But again that’s discounting free trade. Let’s look at the example of Chyna selling phone cases at the local mall. She has a successful business where she sells 200 cases a month and sources all her phone cases from a Canadian manufacturer. She pays $1 a case in costs and this happens to be the same cost as Chinese producers. Now with the incoming carbon tax, costs will rise to $1.3 per case from the Canadian manufacturer but because China does not have an equivalent tax, those cases will remain at $1. Who is going to lose out? This is going to happen all across the economy because we don’t tax incoming product the same way. We unfairly penalize Canadian manufacturing then wonder why manufacturing is moving overseas. I understand why free trade exists and why it’s important to foster free trade relationships worldwide, but politicians too often don’t know when to strike a balance with free trade partners. If free trade partners are using child labour, or 16 hour working days to churn out cheap product, how is that fair to Canadian workers? This is where I don’t understand how only 1 Canadian Premier stands against the incoming Carbon tax. You can’t just ship ALL industry out of Canada. There will be no jobs left. Time has come where we need to stand up on our own two feet and see domestic manufacturing flourish.