Polozonomics

SUPERDOG modified

Does Stephen Poloz know what he’s doing? The Bank of Canada head dude shocked markets last month when he dropped the bank’s key rate a quarter point. “Insurance,” he called it. “Poison” is more like it.

The signal he sent was unmistakeable. The guy had the patina of desperation about him. Immediately the dollar plunged, and has been barely above 80 cents US since. When it happened, I told you there’d be consequences.

The nation imports $45 billion worth of stuff every month, mostly machinery and equipment, motor vehicles and parts, electronics, chemicals, electricity and durable consumer goods. Yes, plus food. And Harleys. The bulk of this comes from the US, and we’re paying 20% more than we used to.

So thank Allah for cheap oil. Without a big drop in gas and energy costs, consumers would be shanked. As it is, families are still squeezed. Thanks to Poloz, it’s just started. I mean, have you bought lettuce lately?

Despite a massive 12% drop in energy prices in January, inflation was up 1%. Core inflation (after volatile energy is stripped out) is double that, at 2.2%. That number hasn’t changed in a long time, and sits within the central bank’s own target range. It would be lower, and living would be cheaper, if our central bankers had not sacrificed the dollar. As a consequence, seven of the eight categories of stuff StatsCan tracks cost more last month. Food alone was up 4.6%. Clothing shot ahead as well, along with all the crap from China that Wal-Mart sells.

Meanwhile, if you live in the GTA or YVR, you know what that quarter point cut did to housing. As predicted, it stirred the loins of moist Millennials, sending them into the streets to start bidding wars and force prices higher – even though mortgage rates were basically unchanged. Just as Poloz had telegraphed fear to the currency markets, he fed expectations that cheaper money would mean pricier houses. And so, it came to be.

In the first two weeks of February, say the realtors, sales in Toronto jumped 14% year/year, while prices were up 10.3%. The average detached house sprinted ahead to $1,056,238, the highest in almost a year, after trending lower through the second half of 2014. A similar story happened in Vancouver. Recall the photo I showed you the other day of a near-riot to buy 300-foot micro-boxes in unbuilt suburban towers.

POLOZ modified  So that’s Polozonomics. A rate cut. Collapse of the dollar. More expensive imports. Sustained inflation. Higher living costs. Real estate speculation. More consumer debt. All at the same time our export base is falling and jobs erasing, thanks to oil. What a combination.

How would it have been worse to leave interest rates alone, let the dollar down gradually, curtail inflation and suck some air out of the housing gasbag, giving hope to those priced out?

Clearly the bank was spooked about oil and deflation, plus what’s been happening in the prime minister’s home province. As you know, Alberta real estate is cratering. January sales crashed 45% in Llyodminster, 41% in Fort Mac, 35% in Calgary and 23% in Edmonton. This month to date, Calgary deals are down 34% and average prices have dipped 4%, with the expectation the decline will deepen significantly in the coming months. Once again we see human nature at play – when listings bloat, sellers sweat and values decline, the buyers disappear. When real estate is topping out and irrational, as in YVR, there are lineups to make offers. Nothing ever changes.

What happens now?

The betting is Poloz panics and reverses course. He already signaled that in a speech this week, saying the January cut was enough. Now he can see the immediate impact of his loonie-crushing move. With inflation rekindled even as a sagging economy punishes citizens, it’s highly unlikely another cut is in the cards – at least not next Wednesday, when the next rate announcement is scheduled.

Meanwhile we all know the US Fed will be raising its rate – likely June 17th, or July 29th. If that happens on the heels of another Bank of Canada rate reduction, just imagine where our currency is headed.

Well, now, aren’t you happy you took my advice years ago to put together a balanced portfolio with lots of diversification? More US, less Canada. A whack of fixed income and REITs. Bank preferreds. Inflation-indexed bonds. No stocks, no mutuals. Lots of love and a secret sauce.

Given what’s coming, you’ll be happier still.

The illusion

FLOWERS modified

Sadly, Tim’s dad just passed. Happily, he was a smart guy. “He bequeathed my mother, in her 70s, with his RRSP savings totaling almost $700,000,” says the son. “It’s growing rapidly and my frugal mother can’t take money out fast enough to touch the principal.”

So what’s the problem?

“When she passes on this RRSP money to her kids, the whole lump sum become instantly,” says Tim, “fully taxable (at the max possible rate). To avoid having the estate effectively cut in half we are looking for ways you can help “rescue” money from this ticking time bomb as quickly as possible. Are there ways of shifting RRSP money between non-spouse family members? Things other than the HBP which allow RRSP money to be extracted without penalty?

“No, this is not a greedy child counting his inheritance early. The whole family (Mother, son, daughter) just don’t want to see the government take half of my father’s hard-earned money in one foul swoop.”

I post Tim’s letter for a couple of reasons. Sure, it’s possible to move some of the money around and ‘rescue’ it from being fully taxed on mom’s demise – but the process is complicated and involves leverage. If mom borrows a big pile of cash, invests it, then takes RRIF income to pay the loan interest, over time capital will be moved from the shelter. (The RRSP income is taxable but the loan interest is tax-deductible.)

However, lenders aren’t keen on handing over big wads of leveraged cash to seventy-somethings with weensy incomes. So scratch that.

The real reason Tim is on this blog is to demonstrate the fallacy of RRSPs. They don’t eliminate tax. They defer it. Yet people come to think of all the money in a retirement plan as theirs. In this case the family – widowed spouse and kids – see the $700,000 pot as a family asset – their father’s ‘hard-earned money.’ But it’s not. It’s an illusion.

Dad got a tax break for putting money into the plan. He was allowed to grow it in a tax-free environment. He was even permitted to pass it on to his wife without being taxed. It was always intended to be withdrawn to pay for his or her retirement years, not to establish a tax-free legacy for hungry offspring. And a big whack of it was always the property of the government, which must be repaid.

It’s the covenant you make with the devil when you open an RRSP. In return for refunding the tax on your contributions now, you pledge to return it later, plus tax on the growth. You also agree to it being taxed as income (100%), not capital gains or dividends (50%). And if you die before this happens, the whole shebang is taxable – as if cashed in on the day of your passing.

This is the reality for every self-directed RRSP. Every group defined-contribution plan that your employer matches. Every registered pension plan. It’s all taxable. Same as money extracted from an RRSP for a condo down payment or to go back to school. In the end you’ve just kicked the tax can down the road. Better tell the kids now.

This is why TFSAs will come to be the retirement vehicle of choice. No, there’s not a tax refund when you contribute, but neither is there tax payable when you withdraw. All of the growth (like an RRSP) is not taxed. But that growth (unlike an RRSP) also flows into your hands in a taxless state. And TFSA money (on death) flows to a spouse or beneficiaries without triggering tax.

So, remember what I said yesterday about taxation on stupidity?

Here’s what I mean: these days only 15% of people make their full TFSA contribution – which would amount to a lousy hundred bucks a week. The participation rate has plunged dramatically since the thing was introduced back in 2009. That year two-thirds of people with a TFSA put in the max, but that was apparently because they just shifted their bank account into the next vehicle. Since then the savings rate has fallen off the map.

Worse (as I keep yelling ya) 60% of this money is in cash and another 20% is in GICs. People treat TFSAs like glorified savings accounts for Cuban holidays, new taps or liposuction. Even the government has produced ads telling you the tax-free account is a great way to finance a kitchen reno. (It’s in politicians’ interest to keep you stupid, by the way. The more growth a TFSA creates, the less tax that’s paid.)

No wonder the lefties are mobilizing to stop the doubling of the TFSA contribution limit. When 85% of the benefit is being squandered by the masses, they’re loath to see the rich (who all read this blog, of course) get even more of a break. Sure, they could participate. But it’s easier to buy a house they can’t afford, then moan about unfairness.

This is akin to thinking your father’s RRSP belongs to you, and asking Garth to rescue it.

What a waste that is.