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June 26, 2017 | The unwind

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

This pathetic blog is not actually about real estate, house lust and your tormented spouse. Rather it’s all about financial security. Sometimes owning a property gives you that. Lately, not so much. Let’s dive off the deep end for a few paragraphs, and yak about what could go wrong. Not just with a home, but everything.

To assist us in this miserable, depressing and scary task we have an outfit called the BIS. Whazzat, you ask? Why should I care?

The Bank for International Settlements is essentially the central bank for the world. Birthed during the darkest moments of the Great Depression, it’s owned by 60 central banks (including the Bank of Canada) accounting for 95% of the economic activity of the planet. Therefore it’s more influential than Justin and the Trivago guy combined!

The BIS has one goal: keep things from getting too screwed up. It wants central banks to coordinate stuff like interest rates and money supply. It also serves as kind of a ER doc to the international economy, diagnosing current conditions and doing interventions as necessary. Right now the BIS says its patient weighs 620 pounds, is grossing out on a super-carb diet, with high blood pressure, diabetes, gout, heart disease and a badass attitude. Only a matter of time, it concludes.

Here’s the scenario. We never really solved the 2008 credit crisis, just papered it over with cheap money. After ten years the amount of new cash created by central banks to buy up bonds and try to stimulate growth is epic. The only way these banks – like families with giant mortgages and nations with big debts – can keep rolling along is if rates (and payments) stay low. Meanwhile all this debt has encouraged humans to borrow massively, which in turn wildly inflated the price of assets – like houses.

Rates have to rise, or ‘normalize’, or the problem grows continually worse. And that’s what the Fed has also concluded. So up she goes. Three pops in the last six months. That makes the over-indebted very vulnerable to ending up in a serious mess as rates across the world move in response. Near the top of the list of looming victims is Canada, where debt ratios are 70% higher than a decade ago (the US, in contrast, is up 29%).

Why a rate hike of 2.5% would mean 'serious trouble'

This is called the “great unwinding.” It’ll come as shocking news to millions of Millennials who have grown up believing they deserve 2% mortgages and the government will never let the cost of money rise.

So what happens if the BIS s right? A new crisis, it says. Serious one. “Unprecedented challenges.” Credit growth in Canada is at red-flag levels, along with Hong Kong, China, Thailand, Mexico and Turkey. If rates eventually rise by 2.5%, then the BIS says we’ll be “in serious trouble.” That would take the Bank of Canada rate from its current 0.5% right up to 3%. For some context, the rate was 4.5% back in 2007, 21% in 1980 and 10% in 1990. So three percent would still be well below the long-term average.

The consequences of a rate-tightening cycle that lasts for three, four or five years are predictable. Debt service costs would march higher, economic activity would fall, stocks would lose value, employment would get harder and houses would tank. Among the places with most damage, the BIS suggests, would be Canada – largely thanks to the property boom which has reshaped society, driven family debt to $2 trillion, wiped out personal savings and concentrated net worth in a single asset.

Meanwhile two billion more people around the world have entered the workforce, keeping wages depressed, while free trade – essential to economic growth – has allowed them to directly compete with workers who live in expensive places, like here. So the response has been predictable on the part of many voters. Build walls of concrete and tariffs. Keep rates low and elect guys like Trump.

How credible is all this doomer talk?

Very. But that doesn’t mean it’s going to happen soon. No central bank wants to destroy its economy, even if this leads to a better place. Having stated that, swelling rates will be with us for years to come. In 2020 nobody will be renewing mortgages at 3%. House prices will be lower down, not higher. People with a one-horse portfolio will regret that in 2017 they didn’t start dealing with the great unwind.

So, sell assets and lighten up on debt. Have a balanced and diversified portfolio of the kind described here so often – which saved people’s butts back in 2008-9. When the TSX dropped 55% and took seven years to recover, that portfolio declined less than half and recovered within twelve months. Over the worst three years of our financial lives (to date) it averaged a positive 5% average annual return.

If you believe the storm will return, prepare. If you don’t, wrong blog.

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June 26th, 2017

Posted In: The Greater Fool

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