“When you combine ignorance and leverage, you get some pretty interesting results.” …Warren Buffett

Canada’s ratio of household debt to disposable income rose to 165.4 per cent in the final quarter of the year.  For all of 2015, household debt rose 4.9 per cent, the fastest pace in four years, to a record $1.92-trillion. That included a 6.3-per-cent surge in mortgage debt, also the fastest since 2011.  The bulk of this debt has floating rates. As a result, once rates start climbing, so will the burden.  As touched on last issue, a survey conducted by BDO in Canada found that 62% of respondents would not be able to afford a $300 monthly increase in their debt payment, or anything for that matter.  All this would take is the interest rates to go from 3% to 4.25% on a $250k mortgage.  This will likely take place over the next few years.  In fact, we are betting it will.

Ipsos Reid found that during the second quarter of 2015, 17% of those surveyed had debt equal to no less than 350-times household income, with the bulk of it being a mortgage.  This is an insane amount of debt to carry and 17% of the population to do so is not normal, no matter how good the economy is.  It’s harsh to say, but these consumers are toast no matter what happens to interest rates.   What is worrisome was that 23% of respondents were on the borderline.  These are the people on the fence who cannot afford the $300 monthly increase in their debt payment.  Thankfully, 57% of the households surveyed in the report are fine with very manageable debt levels.  Plus, a third have a paid off mortgage and have savings that are growing. 

A country who borrows is pledging the consumer’s future income tax.  The higher the debt climbs the more income tax the government will require, equating to less disposable income down the road.  This is why government debt continues to be the concerning issue for us.  Within a few days the U.S. debt will cross $19t.  But, since they like to apply accounting practices that put Enron to shame, if one includes “off-balance sheet” items their outstanding debt is actually $64.8t.  This works out to $200,496 per citizen or $792,943 per family.  Family savings is a meagre $9,052, or 11.4% of that debt.  There is no way they can ever pay this back so the demand to borrow will continue to grow.

The collapse in the price of oil has made many governments poorer. This is true for any oil producing nation, including Canada, but holds especially true throughout OPEC nations.  Thankfully, Canada has other industries we can rely on to soften the blow to our energy industry.  OPEC nations, on the other hand, rely on the one industry, and instead of working together to tighten their belts and lower the amount of production to push up prices, their solution has been to lower the price of oil and borrow more money.

When demand for loans exceeds available cash this pushes up interest rates because money flows to the highest bidder.  In a slowing economy the pool of bidders grow while the amount of cash available dries up meaning interest rates must go higher.  After all, the majority of governments, Canada included, are all chasing the same savings.

We are amongst the few who believe that interest rates in the U.S. can be above 4% by year end.  For one, the States are bankrupt and one day soon the world will wake up to the fact.  And secondly, the rest of the world is not far behind.  At the end of the day, all nations are fighting for the same savings the U.S. are, and considering the amount of leverage out there is breaking records,  interest rates can do nothing but be forced up.  Central Banks will never let interest rates climb, so the belief goes.  Unfortunately, most are naïve to believe that monetary policy cannot be overtaken by market forces.  If that was the case, Greece would be paying 1.5% on its national debt, not the 11% they currently do.