BANK’S POLOZ STAYS CLEAR OF DOOMSDAY SCENARIOS

To talk of financial collapse would mean admitting defeat, says Kevin Carmichael.

If there is one thing that annoys a certain group of people in my Twitter bubble about Stephen Poloz, it’s the Bank of Canada governor’s perceived complacency in the face of what these people see as imminent economic disaster.

The reason for their frustration is Poloz’s unwillingness to raise interest rates to slow the accumulation of household debt, which now is about 170 per cent of disposable income. As you will have read many times, that’s a record. It’s also a number that compares with debt levels that preceded other financial disasters. As far as some of these well-informed critics are concerned, the moment Canada’s inflated house prices inevitably drop, we’re headed for a wave of bankruptcies that will drop the economy into recession.

Doomsday scenarios of that sort have been in the air since about 2009, when the Bank of Canada dropped its benchmark rate to 0.25 per cent to prevent a rerun of the Great Depression.

The doomsters predicted an inflation spiral, which never happened. But they were right when they warned that ultra-low interest rates would inflate housing bubbles. Whether the price surges in Vancouver and Toronto trigger crippling busts will be determined over the next couple of years because the Bank of Canada has stated definitively that interest rates will be moving higher.

On Tuesday, Poloz devoted an entire speech to household debt. He assured his audience in Yellowknife that he wouldn’t spend so much time on a single subject if he didn’t take it seriously. In fact, the credit burden of individuals ranks among the two or three things that worry policy-makers most. “Today’s record level of household borrowing reflects the evolution of the financial system and the comfort level of Canadians in taking on debt,” Poloz said. “But it also reflects a prolonged period of very low interest rates and rising house prices.”

It’s one thing for an anonymous Twitter avatar to talk frankly about housing bubbles, and quite another for the governor of the Bank of Canada to base his public remarks on worst-case scenarios. Even if Poloz thought we were on the verge of a financial meltdown, he would never say that, because doing so would be admitting defeat. Part of his job is avoiding the worst-case scenarios, and if he assumes he will be successful at doing so, he never will turn dark enough to satisfy the skeptics.

The reflexive answer to the debt problem is to say that interest rates must rise.

Poloz observed in Yellowknife that “aspiring to own a home is part of our culture.” When the global economy crashed in 2008, policy-makers knew they could harness that impulse to spark a rebound. A once-in-a-lifetime chance to get a mortgage for almost nothing would stoke demand for housing. The strategy worked, although few realized that the rest of the economy would be so slow to follow.

Poloz’s main argument for leaving interest rates low is that the damage from an extended period of weak economic growth outweighs the hypothetical risk of a housing bust. Rather than obsess over the headline figure, the Bank of Canada has dug deep into the lending data to understand whether the threat is as serious as it appears on the surface. The result has caused policy-makers to conclude that the answer is: probably not.

The governor noted in his latest speech that the debt-service ratio, or the amount we owe as percentage of our disposable income, has held steady at around five per cent since the early 1990s. That suggests households are able to manage their debts about as well as they ever were.

About eight per cent of households owe 350 per cent of gross income, representing about 20 per cent of all debt, Poloz said. These are the ones that most worry policy-makers, and is one of the reasons they have pledged to be cautious as they take interest rates higher; anyone so burdened will be extra sensitive to higher borrowing costs. “We are closely watching the vulnerability represented by that group,” Poloz said.

Talk of busts can obscure a bigger risk from elevated levels of debt.

Since the crisis, Canada’s economy has been unusually dependent on consumer spending as a driver of growth. When you buy something with debt, you are bringing forward a purchase you would have made in the future. Therefore, households can’t be an economy’s only growth engine, especially when income growth is stagnant, which was the case in Canada until relatively recently.

The data on whether domestic consumption is slowing is mixed. Statistics Canada said this week that retail trade rose 0.3 per cent in February, the first increase in three months. Moneris, which facilitates card payments for 220,000 Canadian merchants, said last month that its purchases over its systems increased by about five per cent in the first quarter from the same period a year ago, following the pattern that the company has observed for the past few years.

So no collapse, but maybe slightly weaker growth. Authorities also have taken steps to cool demand for houses by insisting that new buyers qualify for loans at rates that are two percentage points higher than current rates. Poloz said those rules appear to be making the system safer.

“There is good reason to think that we can continue to manage these risks successfully,” he said.

Let’s hope. Poloz’s usual critics will accuse him of denial, as they have been doing for years. For now, the central bank governor is winning the argument.