Entries from January 2015 ↓

Guess what?

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Europe’s now deflationary. We’re on the way. This doesn’t suggest your lettuce gets cheaper (it’ll actually cost more), but it does mean many other prices will fall (cars, laptops, houses). Sadly, it also guarantees profits and wages go along for the ride.

There are a few rules of deflation we should all understand:

First, falling prices are not cool, unless you’re an old retired snort on fixed-income government dole. But even so, it’s unlikely you’ll be buying big-ticket items with declining pricetags, as opposed to food and crap from China. So, this is still not a good gig.

Falling prices, as with houses now in Calgary, make reasonable people delay their buying decisions. Consumer spending goes down, and the economy along with it. Recall that 65% of the Canadian GDP is based on consumers, and almost a quarter is directly tied to residential real estate.

Second, when people spend less, businesses make less. They cut back on their own spending. They lay people off (Bombardier, Suncor, Tim Horton) or they give up (Target, Mexx, Sony, Jones New York). Or they tell people their wages and salaries will be decreased, as is now happening in the oil patch. Or they make employees become contractors, without benefits.

Third, when prices fall so do profits. Margins are squeezed. Look at the banks, several of which were downgraded this week by analysts who understand what lower mortgage rates and less consumer spending means. In a recessionary/deflationary environment (and we learned yesterday that our economy is actually shrinking. Fast.) companies lose the ability to raise fees or prices. So they have to cut overhead. Like CIBC, which trashed its IT department and punted 500 employees.

As a result, and the fourth component of deflation, employment falls and consumer spending follows. We’re living this now, as you saw this week with a revision of Stats Canada numbers showing job losses in December were three times worse, and our track record for all of 2014 was piteous. Now with the oil contagion spreading, things will only deteriorate. I would hate to be selling truck nutz in Alberta these days. (Actually I’d hate it any day.)

The last (and worst) part of deflation is what it does to people with debt. As profits, incomes, jobs and prices fall, money gets more valuable, which means debts are harder to pay. Canada is pickled in debt. People on your street have never owed as much. A growing number of families – over four in ten – live paycheque-to-paycheque. Savings and investments are being concentrated more in the hands of the 1%, while debts are accumulating in the lives of the 99%.

The IMF warned again this week that “domestic vulnerabilities in the housing sector and the household sector are elevated,” saying our real estate is inflated by 20%, and destined to fall. And yet, the sheeple do not learn, as evidenced from new bidding wars in Vancouver and some parts of Toronto in the wake of the Bank of Canada’s regrettable little nip in interest rates. As you might expect, this is being egged on by a voracious and irresponsible real estate industry.

So what happens now?

More of it. Few people alive today have any real experience in fighting deflation. So far central bankers have printed money, flooded economies with liquidity, supported banks, eased credit restrictions, paid people to buy cars and build decks and slashed interest rates. Governments have gone deeply into debt running deficits so they can keep social spending high even as tax revenues crater.

These things have been happening for up to six years. In the US, they worked. Elsewhere, including here, not so much. But the collapse in oil is a net positive for Americans, the world’s biggest consumers of it, while it is negative for Canada, one of the largest producers. Now the Bank of Canada has dropped its rate to .75%, and there may be more coming. The US is on track to raise its central bank rate by the summer. If so, it suggests a far weaker Canadian dollar and higher consumer prices even as deflationary pressures mount.

Sadly, there’s nothing much to be done for the house-lusty and the debt-infused masses surrounding us. Nor for the struggling retailers, oil guys or idled engineers. This week US banker JPMorgan said “there will be blood” in Canada because of the oil collapse. Despite this warning, the lousy GDP numbers, the layoffs, store closures, we can see how people respond to the notion of cheaper debt – they want more.

So, I give up. There’s no point trying to change things. Human frailty wins.

This blog will henceforth allow only astute, prescient, unhorny people to read it. Govern yourself accordingly.

Help me

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Are you fed up with global macroeconomics, hairdressers who parse monetary policy better than the Fed and old retired snorts who surf all day and then tell you why the government is lying about Labour Participation Rates?

Me too. Sucks.

Instead, let’s mess with some of the silly people who write me for advice.

Here’s Alan, in Calgary, where one of the major banks has forecast a 3.5% decline in house prices this year (stop laughing):

I read your blog this evening and want to ask – what if I just want to buy a place to live? So house prices are going to be down 3.5% – so what? In the grand scheme of things, that doesn’t seem like a lot.

Our rental house (we have an amazing $1500/month utilities included) went on the market today. While we certainly WOULDN’T buy it for the $409K asking price, or the $344K that it was assessed at (fine to rent, pain to buy), we are considering buying. We’ll never get a rental at the same price that we’re getting now. What’s the problem of buying a house and just living in it for a few decades? We don’t want to go crazy with debt, but we’d like something around the $300K number – we make $105K annually. Two kids, though – money is tight for sure.

Anyways, I was just wondering about buying for the long-term. Good time for buyers?

Great example of thinking with your pants, Alan. First, buying a house because your rental is coming to an end and you hate moving is hardly justification for what could be a debilitating, long-term action. I know nothing about your finances, other than ‘money is tight for sure.’ But that’s enough. Without a substantial downpayment (let’s assume 10% on a $350,000 house) owning will cost you several hundred dollars more a month – in financing, taxes and insurance alone – than renting. So money will get tighter.

The only reason you might want to pay more now to live in a lesser place is if you believe you’re building equity in the future. But forget that. You’ve chosen what is possibly the worst time in decades to consider buying in Cowtown. As of Thursday, listings had swollen by 87% over this time last year while sales were down 38%. Almost 1,500 families who bought in the last eight weeks without previously selling their houses are now freaking. We’re on the cusp of serious price deflation, given the collapse in oil and the layoffs that will materialize this spring.

So, Alan, you can buy a crappy house, penalize your family with less cash flow and lose all your equity in the next year. Or you can move. Duh.

So much angst in Alberta. Here’s Alicia. Poor, horny, soul.

Hi Garth: My family is moving to Fort Saskatchewan, AB for my husband’s job.  He’s getting transferred in the next couple months, and works in the agriculture industry.  We expect to stay there for the long term.

I really want to buy a house.  I’m house horny.  We have 2 kids under 3 years. I want to pay down 20% on a house.  We have about $150k.

My husband wants to rent.  He’s wanted to keep renting for the last 5 years but I feel I need to settle down. Also, my parents are pressuring me to buy a house and not rent.  They think renting is throwing away ones money. However, it’s difficult to find anything to rent for under $2000/month.  Probably be looking upwards of $2500/mth. Buying a place implies our monthly payments will be $1500/month. Is it better to rent or buy?

Sounds like Alicia wants a $700,000 house, and to buy it without paying the pirates at CMHC. Fair enough. But this also means a mortgage of almost $600,000, and a monthly of $2,700, plus property tax and the usual gaggle of other costs. Then there’s $850 a month in lost gains on an uninvested downpayment. So, owning will mean at least a thousand dollars more a month than renting.

Add to that all of the unbridled risk now extant in the Alberta market (see Alan, above), and the awesome chance you will diddle away most of your downpayment buying at the pre-correction peak. So why are you even having this debate? Ah yes, your parents. Two more Boomer know-it-alls? Meddling in your marriage? Imposing their values on you?

They’re wrong to comment. You’re weak to listen. Do what’s best for your family.

Finally, here’s confused Clarence, to prove the Kool-Aid’s just as potent in Toronto.

Love the blog. I’ve been reading it for the last year or so. I come to you in need of advice.

My girlfriend (age 31) and I (just shy of age 29) just signed a purchase agreement for a townhouse in downtown Toronto. Asking was $799k, we bought for $765k. Our combined base salary is $141k. We currently live together in a condo she owns, which we now plan to sell. It’s also in downtown Toronto. We figure we could get about $330-$340k for it, mortgage on it is $260k. The net amount we make will wipe out our existing debt (mainly from school). Our down payment is $165k, which we have liquid. The payments would be about $2400/month. We currently pay about $1400 a month on the condo’s mortgage, plus $335 in monthly maintenance fees.

Despite the gloom and doom, I think it’s still a good idea. This is a 5-15 year house for us, we aren’t looking to get out of it quickly. It’s got hardwood, a built in garage, granite counters…it’s not exactly a shack. We have no plans to have children. I personally don’t think a $600k mortgage is too bad at this point in our lives. That’s $300k each, which we both did on condos (I sold mine last year). Single people have $300k mortgages on sub 600 square foot boxes, so why not combine and get an actual house instead for essentially the same obligation per person? We’ve run the numbers and we feel fine about what income we’ve got leftover after all the fixed expenses are accounted. She’s a CA, I’m a CFP, we’ve been following the market for years…we’re not total idiots when it comes to this stuff.

We have until Friday to walk away. The girlfriend is getting seriously cold feet (it isn’t her dream house, she isn’t in “love” with it) and as I said I want to go through with it (I don’t think her dream house exists. Not for our price range and desired neighbourhood, at least). Any thoughts?

The most terrifying part of this, of course, is that he’s a financial advisor and she’s an accountant, which basically means we’re all screwed. Oh, and unmarried, so the mortgage could be a lot more durable than the relationship.

Seriously, think about it. The monthly finance bill plus property tax will be $12,000 more a year than the condo now costs, in after-tax dollars. The lost income on the downpayment will double that – so you have to devote about $40,000 more in gross earned income to afford the move. Then you will have zero liquid assets, no financial portfolio and $600,000 in variable-rate debt.

Oh yeah, and your GF still doesn’t love it because it’s not her dream house? Guess what comes next.

Hope you’ve had an excellent 29 years, Clarence. Your life. It’s over.