The housing boom is the largest contributor to Canada’s economy, but it rests on growing household debt. And now it appears it may have reached its limit.
Real wages have stagnated for a decade and debt has grown to historic levels. Canadian households now spend 15% of their disposable income on debt obligations. Debt service payments are at an all-time high. Just a couple hundred dollars away from insolvency, half of working-class families can’t rub two pennies together.
While Bank of Canada interest rate hikes and new mortgage stress tests have helped slow down household borrowing, it is important to recognize the built-in limit to debt. Eventually, debt service payments just get too big.
People aren’t borrowing nearly as much these days. And fewer mortgages mean fewer sales. This has translated into falling house prices and waning profits in construction.
Debt-led growth is unwinding, and the economy-wide average profit rate is already at an historic low. When the housing boom turns to bust, there won’t be many investment opportunities for businesses to fall back on.
Canadian capitalism has become fragile. While the economy was robust enough to withstand the shock of the Great Recession in 2008-09, things have changed. Today, a large enough shock could push the country into financial and industrial turmoil.
And there are signs that a shock is coming.
You may have heard that US bond yields inverted earlier this year. This tends to happen before recessions. Investors dump money into long-term bonds, because they are pessimistic about the future of the economy. This pushes interest rates on long-term bonds below those on short-term bonds. The inversion is an important sign that the US economy may shrink this year or next.
If the US enters a recession, Ontario’s manufacturing industry will feel it most. Manufacturing contributes 12% to the province’s GDP and accounts for 40% of Canada’s exports. The clear majority of these are destined for US markets.
A recession in the US would decrease the demand for Ontario’s exports. So, manufacturing investment would follow profits down the tube. Employment and wages would contract throughout the economy.
As I have shown, however, the center of the housing boom is Ontario. Because households are already at their limit, job losses and shrinking real wages would invariably mean falling demand for new houses, missed mortgage payments, and rising consumer insolvency rates. The mindless blockhead leading Ontario’s public sector cuts will only make matters worse.
Moreover, Canada’s banks are highly leveraged. And their largest asset class is loans to households. The financial implications of this is a topic to which I will return in the future.
While an American recession is likely over the next year or two, its arrival could be hastened by the trade war between the US and China. The Trump administration has threatened to broaden tariffs to 90% of Chinese imports. China’s exports to the US far exceed its imports. And this means tariffs work to the advantage of the US. While China can’t wield tariffs in the same way, it could retaliate in other ways.
It could induce a recession.
China holds the world’s largest share of US Treasury securities. Recently, the Editor-in-Chief of the Communist Party’s newspaper, Global Times, and others in the upper echelons of the Chinese state suggested that Beijing dump some of these assets. This would push down their prices and increase their yields, resulting in higher interest rates in the US, bringing about a recession. While this scenario is unlikely, the US-China trade war — now a “people’s war” according to China’s CCTV — is rattling investor confidence.
In the context of weak profitability, household debt-driven growth has been one of the key drivers of the Canadian economy, especially in Ontario. Now it appears household debt has reached its limit, and state administrators have started to apply the breaks. If the American economy shrinks this year or next, Ontario’s manufacturing sector will take a hit, whose wide-ranging financial and industrial implications could signal the beginning of a deep crisis of Canadian capitalism.