The recession of 2015

If the economy drops off, Canadians can lay the blame on the Bank of Canada and irresponsible politicians, says columnist Michael Hlinka

March 3, 2015
by Michael Hlinka

From the February 2015 print edition

I believe that the Canadian economy is going to suffer a sharp recession this year. I believe that unemployment, which ended 2014 at 6.6 percent, will likely be 8 percent or even higher 12 months from now. I believe that the job losses will be concentrated in construction and finance, two of the most important private sector employment classifications.

Then the ripple effects will be felt throughout many different service occupations. And if I’m right, the responsibility should fall squarely on the shoulders of the Bank of Canada and irresponsible politicians who should have anticipated the consequences of cheap money.

There is usually a precipitating event that causes any economy to go into recession, some sort of unanticipated shock. In this case, it will be the sudden drop in the price of oil. Just this past July, West Texas crude was more than US$100 per barrel.

Then, in fewer than six months, its price was slashed in half. This has already led many oil and gas companies to scale back capital projects for this year, and some significant job cuts have already been announced. During more normal times, this would not be disastrous…but it’s anything but normal in Canada right now.

In these pages, I have previously commented about the build-up of private debt. What we have seen in the past 25 years is a persistent increase in household debt to gross domestic product. In 1990, for every dollar we owed, we earned one dollar.  Twelve years later, the ratio of debt to earnings was 1.1:1. Since then, the ratio has climbed steadily and as of writing, it’s now about 1.6:1. That is, for every dollar we’ll make this year, we’ll owe $1.60! This is unchartered territory and it’s an ominous burden to be carrying at any time.

We know that people are more likely to take on debt when they feel confident about the future. And that makes sense. If I’m making $50,000 this year and I believe that next year my earnings will be bumped up to $75,000, I’m not worried about borrowing.

I anticipate having a lot more disposable income to make my interest payments and retire principal. So I leverage myself. But what if next year, instead of making $75,000, I actually bring home $30,000. Then I’ve got a serious problem. Either I must scale back my spending drastically or default on what I owe.

Let me speculate how the Canadian economy will play out in the next 12 months. After lay-offs occur in the oil and gas sector, there will be a pullback in construction. For several years, spurred by low interest rates, new housing starts across the country have greatly exceeded what is needed to match population growth. I live in Toronto and have a bird’s eye view of the condo development happening all across the city. It doesn’t feel right. And even the Bank of Canada recently warned that housing across the country may be over-valued anywhere from 10 to 30 percent.

If construction employment dropped to levels seen at the end of 2012, unemployment in the country would exceed 7 percent. The Canadian banks—all of which are huge employers—have already announced that “cost containment” is their priority. Even cutting payrolls by 2 percent would bump up the unemployment rate that much more. Then the ripple effects would really start to be felt: The airline industry would be hit hard, with less money spent on discretionary travel. Ditto for hospitality. A weakening Canadian dollar would mean that prices for imported goods would edge that much higher, cutting into discretionary income just oh-so that much more.

Let’s assume that I’m right. What can you do to best weather the storm? First, start reducing debt if this is a personal issue for you. If I were in the market for a new home, I would seriously consider waiting because I think the Bank of Canada is right—there will be a pullback in prices this year. And if the slowdown occurs, then interest rates have nowhere to go but down.

Should your mortgage be coming up for renewal, if you’ve got a variable rate, stay with it, and if it’s fixed, think seriously about assuming a bit of interest rate risk and going variable.

I truly hope I’m wrong on this macroeconomic call. I am very lucky. My labour income (I’m a tenured professor in the Ontario community college system) is very safe, almost as safe as Bank of Canada Governor Stephen Poloz. He and his predecessor, Mark Carney, have overseen an era where interest rates were slashed almost to zero.

It was inevitable that sort of asset bubble would develop. One did. The only thing that kept the ship afloat this long was high resource prices. And by the time they recover later this year, which I think they will, the country will be in recession, and the people who suffer won’t be the ones that deserve to.
Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC Network.