I think this is a well thought out view Brockm. However, if I accept what you say, and I have narrowed down my response to the items above: Is this not predicting virtually the end of the Canadian economy. If the driving force is housing, and it will mot only come to an end, but go negative, what will pick it up? What will happen to our Dollar, our stock market, bonds etc. I guess to protect oneself, you buy commodities or foreign based assets in a different currency (if so which?)
I am curious as to what you think the solution is. The reality is that if the housing market does implode, please explain to me where you are going to hide, i.e., what are the inflation-hedged investments you use/feel will survive.
Well, I never said we were headed for an economic collapse. And for the record, that's not my view.
The economy is not driven by the housing market. That's the illusion.
What is driven by the housing market is a false sense of collective wealth, however. People's wealth as reflected by the speculative sale value of a property based on the most recent comparables is nothing short of an illusion. That home equity can disappear faster than you can blink, is something the downturn in the US should have proven to everyone involved.
What's frightening, though, is how talk of improper regulation of mortgage eligibility rests on the assumption that the natural state of the market is to, in fact, rise faster than inflation. And prior to the final nail in the coffin of the gold standard, with Nixon's hail mary of the Bretton Woods consensus in 1971, there was virtually no appreciation in average home prices adjusted for inflation since 1859. What changed?
What changed was government's got in the business of subsidizing mortgages with artificially low interest rates as a matter of monetary policy. Over time, government incentives to home ownership, such as organizations like Fannie Mae and Freddie Mac which represented almost guaranteed buyers of home loans, and more recently in Canada, the Canadian Mortgage Housing Corporation, made it easier and easier for people of lower and lower incomes to qualify for mortgages. Not simply as a matter of credit rating, but as a matter of the actual cost of the money being cheaper.
But interest rates were/are not lower because real savings were high; a natural prerequisite in a free market. They were low because the government's were printing money to make them low. And ever since the Great Depression, the Keynesian orthodoxy against savings has reigned supreme. Keynesians believe in the "paradox of thrift"; that, if you save your money in a checking or savings account, you're depriving someone of a job. Instead, you should go out to Winners and buy a new golf shirt. This economic belief system lead to the rise of pro-growth economics, which made the stability of the entire economy dependent on ever expanding GDP through higher productivity and higher consumer spending, in order to offset the inflationary pressures caused by the fact that monetary bases were being expanded to continually extend more and more consumers credit to buy homes and other items like automobiles.
Ever since this policy has been in full-swing, government interest rates have been fighting a losing battle as they average lower and lower -- loosening access to new money -- in order to keep the economy growing and avoid deflation. Governments have started to run out of options on this front, since interest rates can't really go below zero. So now they are resorting to using open market operations, quantitative easement, and tighter lending standards to try and reign in the natural inflationary pressures that the monetary policy is precipitating.
The housing problem is a result of the perverse incentives that all this nearly-free money create; people are looking to increase their capital wealth they easiest way possible. So are businesses.
If you have interest rates below inflation, the market is sending a signal that there is excess savings in the market, and it's cheaper to expand material wealth through borrowing than through savings. And it is the rational choice! Which is why consumers keep doing it. But the problem is that the interest rates are not indicative of savings levels. Rather, they're artificially imposed rates by the government, and the worse the situation gets, the lower they push the rates, and encourage more and more borrowing. And people borrow. They take the greater and greater pools of money, and they get into bidding wars for property, which pushed asset prices up. But all the while, the whole market is built on a false foundation.
The effects are even more perverse, and these policies have had a direct contribution to the de-industrialization of the West, as access to real capital for investors is extremely difficult. Since the labour force is biased towards quality of life improvement through borrowing, rather than labour-intensive work. This drives the minimum industry can pay up, and in turn, incentivizes industry to export labour.
How bad is the situation in Canada? Well, I can tell you with a great degree of confidence it's not as bad as the United States. For one, we have a significant amount of natural resources. We often beat ourselves up about being a resource economy, but in reality, this is one of our most important saving graces. The other factor is the fact that government debt levels are so low, which will help keep our buying power, relative to the rest of the world in check.
But that shouldn't give you any real comfort. The US economy is not going to recover like most people think it's going to. The structural imbalances there are beyond insane. It's only a matter of time before China and Japan stop buying US treasuries completely, and there's a run on the dollar. When this happens, all bets are off for Canada. Our economy is not prepared to absorb that shock, as our industries are far too dependent on US export.
The real key to Canada's future is what the government does. Does it panic and go on a money printing binge? (Probably.). Or does it focus on short-term relief for the unemployed and allow the economy to restructure away from US dependence? (Not very likely.).
