Canada’s bet with debt.
Back in 2008, the world was knocked into one of the worst recessions we had seen in decades. Canada was by no means immune. Over-leveraged Canadians lost property and businesses, retirement investments tanked and consumer confidence plummeted. History tells us this kind of downward spiral is very dangerous. To introduce some control into the system, governments will often take many measures to help, “right the ship”. One of those levers of control is borrowing rates. To give you an example of the way the Bank of Canada used interest rates to stabilize our economy, on December 5, 2007 Canada’s prime borrowing rate was 6.00%. Just one year and one month later, on January 9, 2009, it was 2.75%. Conversely, as a sign that the Bank is now feeling more optimistic about Canada’s economic recovery, we’ve seen the country’s leading interest rate rise three times so far this year.
“Easy money”?
There has been a lot of talk lately about how low borrowing rates have created a sense of “easy money” among the Canadian public. For nearly a decade, the cost of living beyond our means was relatively cheap. And while that may be true, I believe it is more accurate to say that low interest rates allowed most Canadians to stay afloat rather than live large. Since 2008, the price of gas has increased significantly, which exacts its toll at the pumps but filters down to just about every cost we incur. Rent and housing prices in many markets skyrocketed, particularly as supply has stagnated. The cost of university and college educations has risen and as many young people learned, an expensive degree doesn’t always translate into a stable, good paying job. The rise of precarious employment only exacerbates the challenge because while you may be counted as being employed, your job isn’t paying the bills. So was borrowing money easy? Yes. Was it “easy money”? I don’t see that being the case for most.
Fiscal policy for the times?
Back in October when the Bank of Canada last raised its rates, it was reported that a full one-third of Canadians feared bankruptcy in the face of rising interest rates. Why then, given the near record-high consumer debt-to-income ratio is the Bank of Canada so keen to keep pushing the prime interest rate higher? At one point in our past, before the Great Depression, our central bank was guided by monetary policy aimed at trying to protect our country’s exchange rate. This direction was abandoned as it pushed us deeper into recession. Here it is important to remember that today, the Bank of Canada monetary policy is guided by inflation – to gradually and safely raise the standard of living for Canadians. As Romana King writes in MoneySense, “ [the] 2% inflation target is the theorized equilibrium point between economic growth and a higher cost of living.” While rate increases represent another challenge to those carrying high debt, rising interest rates are also good news for savers, future homeowners and a growing cohort of seniors who depend on interest income to help fund their retirement expenses. The Bank of Canada has demonstrated it is well aware of the tension between bringing interest rates up while balancing the situation of hundreds of thousands of Canadians still carrying backbreaking debt loads.
Betting on futures.
Last month the Canadian Association of Insolvency and Restructuring Professionals (CAIRP), released its analysis of historical trends that shows that consumer insolvencies typically rise about two years after interest rates start rising. The Bank of Canada appears to be betting on the idea that a gradual approach to rising interest rates might encourage more Canadians to pay down the debt they have. Indeed, there is some merit to this strategy. In September, Statistics Canada stated that rising rates appeared to be bringing, “a halt to relentlessly rising debt levels”. Notwithstanding, in a country when nearly 1 in four are feeling crushed by debt, particularly those who are younger and earning less, I believe the time has arrived to consider less chancy approach. Indebtedness and defaults have bring their own perils to the equation. As Kevin Carmichael, national business columnist, wrote last year when rates began to rise: “There is a broader recognition that there is more to economic policy than managing inflation and balancing the budget.” At least in part, Canadians will need a higher priority placed on financial literacy and debt rehabilitation if we hope to truly get back on our feet as a country.
Reg Rocha
President
4 Pillars Consulting
