Canada's debt binge is a drag on the future of the economy

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Canada's debt binge is a drag on the future of the economy

The Canadians continued to pile on debt at an alarming rate throughout COVID -19 pandemic, exacerbating the financial vulnerabilities associated with an overburdened economy. We apologize, but this video is not loading.

Tap here to see more video from our team. Canada's debt binge is not good for the economy's future or loonie Indeed, despite being among the most indebted of their peers pre-pandemic, Canadian households expanded their liabilities at the fastest rate in nearly a decade — primarily driven by a huge uptick in demand for mortgages as low interest rates prompted a surge in house prices — leading to a surge in household debt-to - GDP ratio to 119.6 per cent by mid 2020 from 10 The household debt ratio has declined since the crises peak, but the reality is that the population's excessive borrowing habits leading up to and during the pandemic will likely act as a drag on future consumption — and, thus, economic growth — over the long term.

As mentioned above, the debt bulge was predominantly fueled by the boom in mortgage loans that accompanied rapid house price acceleration witnessed since the beginning of the pandemic. As interest rates soared lower and residential real estate prices in the country skyrocketed by around 40 per cent year over year at their peak in April 2021, mortgage growth followed suit leaping 9.2 per cent in second quarter — the fastest pace since 2007 housing bubble.

Meanwhile, other forms of consumer credit and non-mortgage loans have actually seen fairly tepid growth. On balance, Canadians exercised some financial prudence as limited government aid and generous spending opportunities joined forces to boost disposable income, giving households the opportunity to pay off more expensive types of debt including unsecured debt The ratio between consumer credit and mortgage liabilities to disposable income fell to its lowest point since 2008, as households cut credit-card spending at the same time that the federal government was beefing up their wallets. Some relief does come from falling debt servicing costs, expanding the ability of Canadians to pay for their loans, but the danger here is that this encourages accumulation of more debt. Consumer credit contracted for four quarters in a row as credit card debt hit a six-year low, according to Equifax Inc. However, it has begun to rise once again 1.3 per cent year over year as of Q 2 2021 from -2.2 per cent year over year in Q 1 After some brief signs of improvement, overall debt growth appears to be returning to its unstable pre-pandemic trend.

The trade-off between the short-term benefits and long-term costs of high debt levels is well documented: while spending and economic growth can get a short boost typically within one year from the debt burden increase, any potential benefits in the short run are typically reversed and some within three to five years. According to a study by the International Monetary Fund, higher debt tends to stimulate long term GDP growth, is associated with high unemployment levels and considerably increases the odds of a future financial crisis as slower growth could trigger a wave of credit defaults. Similarly, a separate study by the Bank for International Settlements estimates that an increase of one percentage point in the household debt-to-GDP ratio leads to shorter growth in the long run by 0.1 percentage points. What's even more unsettling, from the perspective of the Canadian economy, is that BIS found that the negative long-run effects on consumption tend to intensify when the household debt ratio exceeds 60 per cent of GDP. At more than 103 per cent, Canada s household debt-to-GDP ratio exceeds this intensification ratio and hasn't been above 60 per cent threshold since 2001.

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Why the debt crisis is important for investors here Ultimately, while the debt boom may have some positive effects in the short run, the unsustainable household debt levels across Canada are expected to act as a drag on long term consumption spending, hindering real GDP growth and leaving the economy more susceptible to future financial crisis. Even though balance sheets somewhat improved throughout the pandemic, especially at the lower end of the income strata as government aid boosted disposable income and Canadians attempted to pay down expensive non-mortgage debt even as mortgage debt boomed the unsustainable trend of rapidly rising overall debt that existed pre-pandemic seems to have taken hold once again.

With mortgage debt accounting for more than two-thirds of liabilities and Canadian real estate as a share of disposable income reaching at a record high 501 per cent, most Canadians are exceptionally vulnerable to any correction in the housing market, which has already shown signs that it is cooling off. All in, the long term fundamentals of the Canadian economy are on shaky footing, further crippled by excess debt, and we fully anticipate future economic growth to remain subdued — safe to say we remain highly skeptical of the loonie in the longer term. Julia Wendling is the founder of independent research firm Rosenberg Research Associates Inc. David Rosenberg is an economist there.