"Happiness is wanting what you have and not
wanting what you don't have" – Chinese proverb
Canada
was once a prudent nation that shunned debt and embraced saving and frugality.
Over the past 15 years or so, our nation’s psyche has dramatically
changed. Where we once shunned debt, we
now embrace it. Where we once frowned
upon extreme leverage, we now consider it a badge of honour. Where we once paid
our debts in full at the end of the month, we now carry multiple balances
across multiple lines of credit. Debt is
hip, cool, and fresh. Saving and investing is old, boring, and unsexy.
We
are just not happy with what we have now. If we live in a condo, we want a
townhouse. If we live in a townhouse, we want a house. And if we have a house
already, we want a bigger one. If we have a Honda Civic, we want a BMW 330xi. IPhone6, we need the new IPhone7. And so on
and so forth. I won’t go into a whole
philosophical discussion about consumerism and consumption as that is not the
point of this blog; however, we are just not happy with what’s in front of us
and we continually lust for more in the futile hope that it will bring us that
elusive happiness. Money won’t buy you happiness, but it will allow you to buy
a nice granite countertop.
As
we learned in our previous post, our incomes have barely budged
in the last 30 years, yet our basic living expenses have increased faster than
inflation. In other words, we make the
same but everything costs more. On top
of increasing basic expenses, we want more stuff and we will not wait for it.
We want all and we want it now and damnit we are going to get it no matter
what.
The
monster
Monsters
come in all different shapes in sizes. When we think of a monster, the first
things that usually come to mind is some type of malformed, ugly, grotesque
creature. A monster is evil and inflicts harm for its own amusement. We must
avoid monsters, especially those that want to do us harm.
There
is a monster lurking in most people’s homes.
It’s in the walls and closets of our bedrooms. Sometimes it’s in the clothes we wear or the
filet mignon we eat at night. It can remain silent for years as it spreads like
a cancer. If left unchecked, it will consume everything in it’s path. It has ruined families. It has destroyed
cities. It has brought countries to its
knees. This is the debt monster.
Debt
is simply money borrowed from another party under the agreement that it be paid
back at some point in the future, with interest. People go into debt for various and sometimes
legitimate reasons. Perhaps you want to start a business and need some money to
get it going or you want to go to school to learn a profession or trade so you
can increase your earning potential. In
the circumstances just mentioned, perhaps it would be a rational choice to take
on some debt.
In
most cases today, we go into debt because we just want a nicer and bigger place
to live even though the current living arrangement is just fine. We go out and buy houses even though we can
rent the exact same house down the street for 30% less per month. We want fancy
cars; we want to travel overseas twice a year; we want to eat out 5x a week; we
want to wear Louboutin shoes at work; we want nice furniture for our houses;
and, we want to have the latest cell-phone.
When
you go into debt, you are bringing future consumption into the present. Therefore,
you are negotiating a future pay cut with yourself. Why? Because the future
debt repayment will cut out future consumption.
For example: if you borrow $1000 today and pay it back over 2 years at
$50/month, you will have $50 less a month to spend every month for 2 years. In
the end, you would have spent $1200 in total for just $1000 of consumption
today. I cannot stress this enough, debt is a future pay cut.
In
addition to negotiating a future pay cut, the goods we buy using debt are usually
non-productive perishable products. When
was the last time either you, a family member or a friend borrowed money to
acquire ETF shares tracking the S & P 500, bonds, preferred shares or some
other investment? Likely never. We don’t borrow money to buy assets with the
expectation that they will increase in value over time, we borrow money to buy
things that decrease in value exponentially.
Today,
when you borrow money you are reducing your future consumption and the stuff
you buy today likely will fall in value very quickly after its purchased,
including those Louboutin shoes (unless they are made of gold).
How
much do we owe?
Canadian
household debt is now over $2 trillion dollars.
Most our debt, 65%, is mortgage debt.
Our collective debt was only $1 trillion just 11 years ago. The
acceleration of our debts is unprecedented since the creation of this country. In fact, our current debt is larger than the
entire Canadian economy.
As
you can see from the above graph, the yellow bars represent mortgage debt and
the blue bars represent consumer debt. We should expect to see a gradual rise
in debt over time via inflation (increase in the money supply) and population
growth. However, around 2005-2006, mortgage debt and consumer debt has been
accelerating fast and furious. It should
come to no surprise that since 2005-2006, residential property prices broke from
its long term moving average and began increasing rapidly. Since we are not
earning more, as house prices go up so do our debt loads to finance it.
What
is the household to debt ratio?
This
is an estimate of the ratio of debt payments to disposable personal income.
Debt payments consist of the estimated required payments on outstanding
mortgage and consumer debt. The lower
the number, the better.
The
household debt-to-income ratio now stands at 169.15% which is up 23% in the
last 10 years.
We
tend to follow the same spending patterns as our good friends in the United
States as our economies are thoroughly connected. Let’s look at a graph comparing the debt-to-income
ratio between Canada and the U.S.:
Our
peers in the United States, who are not exactly the best role models when it
comes to spending and saving, had an debt-to-income ratio of just 128% in 2007
before they entered a debt deleveraging cycle (credit becomes scarce and people
begin to pay down their debts). They
reduce debt day by day while we pile it on.
We seem to continue borrowing without limit. Can there be a limit? What would happen if we
enter a debt leveraging cycle?
Is
the economy keeping up with the increasing debt load?
Our
politicians tell us religiously that the debt loads are just fine as the
economy is growing and keeping pace. Everything is sunshine and lollipops and
any discussion of debt is ridiculed. Let’s examine their sunshine and lollipops
theory more closely.
From
December 2015 to the end of December 2016 the Canadian economy grew by about
1.4% - meaning the economy grew by $28.9
billion. In this same one year period, the total debt outstanding in
Canada grew by $309 billion.
In
other words, for each $1.00 the economy expanded in this one year period,
the total debt outstanding increased by $10.69.
As
I indicated in a previous blog post, math is not my speciality. But it does not take a mathematician to
figure out that for every $1.00 in growth resulted in a $10.69 increase in
debt, something is seriously, seriously wrong.
By the end of 2016, the total debt
outstanding in Canada was 3.5 times greater than our annual gross domestic
product.
Tell
me with a straight face that our economy is “healthy” and not addicted to debt.
Are
Canadians having trouble with their debt obligations?
1
in 2 Canadian families would face serious financial difficulty if their paycheque
was late by just one week. In other words, they would default on their
obligations within days. This statistic alone should be an alarming wakeup call
for our politicians and banking sector; nevertheless, we will continue
pretending everything is sunshine and lollipops.
Over
the past year, bankruptcies have decreased by 2% but credit proposals (where a
deal is made to offer creditors a % owing rather than declaring bankruptcy) has
increased by 6.3%. With the
explosion in credit growth it is only a matter of time before many people are
in over their heads as wages are simply not keeping pace.
Bankruptcy
trustees are now seeing more and more clients who earn fat incomes yet have
multiple lines of credit, multiples mortgages, maxed on credit cards and zero
ability to pay back their debts. Yes, they will likely end up losing their
homes.
Turn
on the TV and you’ll likely see a glut of ads for debt consolidation services,
bankruptcy services and sketchy jewellery buyers offering to either buy your
home for cash or lend you money against your home no questions asked. There is
one commercial on CP24 right now where a father talks about all his expenses
and states “we can’t afford it”. Instead of reducing his expenses and/or
increasing his income, he takes out a second mortgage against the house. Why
make sacrifices when you can just borrow more?
The
average Canadian family is hanging on by a thread. Is this the sign of a
healthy economy or one that is overburdened by debt?
The
bottom line
The
media and politicians keep telling us that Canadians are richer than ever. As
property values have skyrocketed, so has our collective wealth they claim. How can real-estate increase so quickly if we
are not earning more? The answer is not complicated – we simply borrowed our way to a false sense of prosperity. Compare
any graph of rising house prices with debt loads and you will see an
exceptionally strong correlation – increases in house prices results in an
increase in corresponding debt.
All debts must
be repaid with interest at the agreed upon terms. Don’t believe
me? Go to your bank or lending institution tomorrow and tell them you will no
longer pay your line of credit and mortgage. Their team of expert debt
collectors and lawyers will move faster than a fat kid who dropped a chocolate
bar. The banking laws were created to protect banks, not you.
Canadians have
been engaged in a debt fueled orgy over the past 15 years and it is only a
matter of time before the lube bottle runs dry. The day will come when it runs
dry, and if another bottle isn’t found quickly, things will get rather, rough.
We, too, will have a painful debt deleveraging cycle where the tsunami tide
will quickly reveal those who have been swimming without a bathing suit.
It’s
not just me that shares this view, the Organisation for Economic Co-operation
and Development (OECD) stated the following last month: "As past
experience has shown, a rapid rise of house prices can be a precursor of an
economic downturn”. A few weeks ago, The
Bank of International Settlement, the mother of all central banks, stated that Canada has one of the highest credit-to-GDP
ratios in the developed world which posed an “unusual” elevated threat to our
banking system. Maybe we should ignore them as we’re superior and immune to the
laws of math, right?
Or
maybe that red bank should change their slogan from “you’re richer than you
think” to “we’re poorer than we think”.
When
can we go back to wanting what we have and not wanting what we don’t have?
