In a speech delivered to the Economic Club of Canada on December 13, Bank of Canada Governor Mark Carney pointedly warns that the economic crisis that swept in waves through economies around the world in the last two years, leveling some major banks and disrupting markets, is not yet over.
Mr. Carney’s remarks make it clear that while the economic monkey may be off Canadians’ backs, it appears that the circus is still in town. The ongoing “turbulence in Europe,” he suggests, “is a reminder that the crisis is not over, but has merely entered a new phase.” Moreover, he notes, the budget sheets of both governments and the governed across the industrialized world are weighted down with debt levels that are not sustainable in the long term.
Canadians “Must Adapt” to a World Awash in Debt
With “the pace, pattern and variability of global economic grow” still in a state of flux, Mr. Carney warns that Canadians “must adapt” to the changed circumstances. “In a world awash with debt,” he cautions, “repairing the balance sheets of banks, households and countries will take years.”
While Canadian banks and markets were “well-positioned” and fared better than any other G7 country – more particularly, having fared far better than the U.S., where the collapse of housing markets triggered the economic storm – the overarching theme of his speech is that, “”these are extraordinary times.”
Financial institutions, insurance companies, pension funds and individual Canadians should note he suggests that, “(a) massive deleveraging (of debt) has barely begun across the industrialized world.” He points out that “(h)ousehold expenditures can be expected to recover only slowly [which] implies a gradual absorption of the large excess capacity in many advanced economies.”
Low Interest Rate Will Not Last Forever
While governments, particularly the U.S. government can be expected to keep interest rates at extraordinarily low levels until economic growth picks up the slack in excess capacity, Mr. Carney warns that Canadian banks, businesses and households should be prepared for an inevitable rise in borrowing costs. Those who exhibit complacency about debt levels, or are irrationally exuberant and take on more debt with the presumption that low rates are here to stay for the foreseeable future, will do so at their own peril.
Mr. Carney notes that “(h)story suggests that recessions involving financial crises tend to be deeper and have recoveries that take twice as long.” We are seeing the effects of this in the U.S., he suggests, where economic growth remains low and unemployment high. “(F)ollowing severe financial crises, ” he observes, “growth rates tend to be one percentage point lower and unemployment rates five percentage points higher.” As a result, he suggests, “very low policy rates in the major advanced economies could be in place for a prolonged period – a possibility underscored by the recent extensions of unconventional monetary policies in the United States, Japan and Europe.”
This accommodative low rate environment will not, however, be permanent Mr. Carney warns. Canadians should therefore prepare for higher rates by avoiding taken on new excessive debts, paying down or consolidating their current debts and boosting their savings levels. Homeowners, in particular, should be cognizant that rates will inevitably rise.
Canadian Households Cautioned about Debt Levels “Canadian authorities,” he cautions, “will need to remain as vigilant as they have been in the past to the possibility of financial imbalances developing in an environment of still-low interest rates and relative price stability.” Further, he points out, “(h)ouseholds [will] need to be prudent in their borrowing, recognizing that over the life of a mortgage, interest rates will often be much higher.”
Yet, over the course of the last several years – even in the midst of the waves of economic shocks that reverbated around the globe – Canadian household debt has increased to a level that will be very difficult to carry in a higher interest rate environment.
“While there are welcome signs of moderation in the pace of debt accumulation by households, credit continues to grow faster than income,” Mr. Carney points out. Moreover, he notes that, “(i)n some regions, lower house prices have begun to weigh on personal net worth.”
“Without a significant change in behaviour,” he warns, “the proportion of households that would be susceptible to serious financial stress from an adverse shock will continue to grow.” Canadians should be cognizant of these dangers and should position themselves, in terms of how their current debts and home mortgages are financed, so that they are prepared for any pronounced spike in interest rates when the inevitable fiscal adjustment occurs.
In closing his speech, Mr. Carney remarked: “The Bank’s advice to Canadians has been consistent. We have weathered a severe crisis-one that required extraordinary fiscal and monetary measures. Extraordinary measures are only a means to an end. Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households to ensure that in the future, they can service the debts they take on today.”
After these remarks, we can’t say that we haven’t been warned.
