During the Dirty Thirties unemployment exceeded 20%.  Yet, interest rates were between two and three per cent.  Today, unemployment throughout North America is between five and six per cent but we have zero interest rates.  At least back then you would be rewarded on your savings.  Today, after-tax and inflation, one earns not a cent and in most cases lose money.   Without savers being rewarded there cannot be any sustained long term economic growth.  Those with savings tend to spend more freely when their money is generating a return.  Businesses understand this and are making smaller investments as a result.  Savers are also being squeezed by higher energy, housing and food costs.  People are being forced to borrow or cut spending just to survive.   This is not good for the world economy.

Too many Canadians are house rich and cash poor.  This is about to change because house prices are set to fall, if they are not already.  Mathematically, it is impossible for house prices to hold up.  Fewer people have the necessary savings for a proper down payment and the pool of buyers is drying up as ownership rates continue to break records.  Wage growth is almost non-existent.  The California Department of Finance states personal income in the state is the same as what it was in 1995.   Considering California is one of the most prosperous states, how are other states doing? 

A Vancouver real estate agent on the radio stated that prices in downtown were off 3% while prices in the suburbs when down 7% over the past couple of months.  Hong Kong and Singapore have in place a foreign buyer’s tax like Vancouver has implemented.  Prices in Hong Kong and Singapore have dropped 7% and 11% in the past year, respectively.

There are surpluses of foods, iron ore, copper, all types of energy, soya beans, and many more commodities yet prices are holding up. Three weeks ago every New York city gasoline storage tank was full.  Two tankers full of gasoline were sitting out in the ocean as they had no where to unload.  New Jersey was selling gas at the pump at the lowest in a couple of decades.

Here in Canada, Ottawa and Alberta are doing everything they can to close down the energy sector.  A recent paper by Ottawa stated that Canada does not need any more pipelines until after 2025.  This just provides proof that politicians are out to lunch because every oil executive in Alberta says we need pipelines built today.  All existing pipelines are running at above 95% capacity.  Guess who will win this battle?  Ottawa's answer is to add useless carbon taxes.  Australia provides ample evidence that it costs jobs and generates very little revenue for governments.  Not one of our trading partners is implementing carbon taxes.  As a result, Ottawa is making us uncompetitive. 

All this says deflation is coming.  The biggest threat is in housing.  Oil prices are heading back into the low thirties.  Unemployment will be going up this fall due to zero interest rates destroying savers and we are over producing most goods.  The stock markets are trading near record highs based on price-to-earnings. Enjoy the rest of the summer and continue to favour cash.   

Brexit

From the reaction of people over Brexit one would think that the world is coming to an end.  After a short period, maybe 2 to 5 years after the withdrawal, Britain will easily be outperforming most European countries.  The following is why we believe Brexit is nothing but a small bump in the road for Britain. 

• The British pound is the world’s oldest currencies and still one of the safest. In over 400 years the pound never was devalued.  It has always traded based on market forces.  Against popular opinion, we believe the pound is safer than the U.S. dollar.  The dollar will one day collapse due to the country’s out-of-control debt and its dysfunctional government.  In the past, not one currency has survived such politics and reckless spending.

• People from all over the world will continue to buy London real-estate and move some of their wealth to London.   It is one of the safest cities in the world.

• Some sort of agreement between Britain and the EU will be formed, something similar to what Norway and Switzerland have today.  Once Parliament presents the formal notice to withdraw, Britain has 2 years to fulfill its obligations.  Many agreements will be formed regarding trade, banking, immigration and travel. 

• You never avoid a rich country with over 80m people.  There could be a slow period until formal papers are signed, but Britain will remain a top trading partner.  Only morons would stop trading with Britain.   

• For Canada, Britain is a gift to sell our natural resources, especially natural gas.  Unfortunately, for the next four years, Ottawa and Alberta will do nothing to grab this market.  American will quickly grab it from us until PM Heart Throb is replaced.  

• Banks will not leave Britain.  The market is just too big, earns lots of money, English speaking, and foreigners prefer London to other European cities.  

• Business around the world will continue to slow as long as zero interest rates can dig the economy into a hole.  Much of this slow-down will be blamed on Brexit even though there will be no correlation. 

• London will remain one of the largest tourist destinations in the world and the birthplace of Rock.   

A few negatives might be: 

• Europeans will now make a mad dash into Britain before the 2 years are up.  This could create further political issues for both Britain and the EU.  The country has prospered because of immigrants from all corners of the globe.  Once these 2 years are over, Britain’s population growth may fall. 

• There will be so much time wasted on setting up new trade deals, international treaties, and most likely a new bureaucracy to arrange these deals.   

• Due to the vote, chances are there will be no interest rate increase until late 2017.  

• Bureaucracy in Brussels will not change - politicians are politicians.  The cost of the EU membership will increase to make up for the lost revenue from Britain departing.   

• Brexit might encourage other countries to leave.

Overall, Brexit is nothing to worry about.  It’s like an amicable break-up, even though one is sad to lose the other, the two will always be friends. 

A friend of mine sold his 1970’s, 3 bedroom North Vancouver teardown for $1.25m.  He bought it eight years ago for $650,000.  It is located on a busy street, but has a slight city view in the winter when there are no leaves on the trees.  Property taxes cost him $5,000 per year plus an additional $3,000 annually towards insurance and repairs.  The house was generating $35,000 annually in rental income.

After subtracting property taxes and repairs, his cash-flow generated $28,000 annually (I assumed he had no mortgage), or a yield of 1.8% - hardly something to brag about.

The house had also built up $75,000 per year in additional equity.  So upon selling he realized a capital gain of $600,000, or 92%.  This is an excellent capital gain no matter what the asset.  Combining income earned and capital gains he profited $824,000 (123%) in eight years, assuming there were no extra costs. 

Prior to selling he asked my opinion if he should sell and invest the money elsewhere, or keep it and continue to rake in the capital gains.  Obviously, I told him to sell.  Look at the graph above.  There is so much similarity to other bubbles in the past.  It is amusing that people think this can continue.  But, one cannot underestimate the effect that emotion has on commonsense.  

One rule of buying a home is to never take out a mortgage greater than three-times your household income.  The sole reason is to limit you from interest rate shock.  

Monthly Payments on a 25-year, $240,000 Mortgage
Interest Rate %	2.1	5	6	7
Payment $	1,028	1,396	1,536	1,681

As most surveys over the past few months have found, the majority of borrowers will be able to handle a normalization of interest rates.  However, it is the estimated 23% of Vancouverites who cannot afford an increase in interest rates, or any expense for that matter, that is the concern.  Where do the 23% expect to get the extra $4500 per year to cover higher interest rates (assuming a return to 5% mortgage rates)?  The answer is simple; they won’t be able to.  People will either be forced into foreclosure or it will come at the cost of other expenses such as vehicles, travel, and dining out.  Either scenario will have a large impact on the local economy.

Let’s put Vancouver house prices into to the context of the stock market.  Using my friend’s house as an example, the rent he was able to earn would give the house a price-to-earnings ratio of 35-times and a dividend yield of 1.8%.  The general rule of thumb in the stock market is to never pay more than 20-times earnings and invest for a yield of no less than 3%.  Anything outside of this, one is creating opportunity costs.

Don’t get me wrong, Vancouver is a beautiful city and its real-estate demands a premium, just not the one people are currently paying.  This summer will prove to be the peak in Vancouver’s real-estate market.  There is not one city in the world that has been correction free after a run-up in prices like Vancouver experienced.  If you or someone you know wants to enter the market, it is prudent to wait on the sidelines.  If you are one of the many Vancouverites who are nearing retirement and banking on your home to fund your golden days, the next few months will be the last time to take advantage of today’s prices.  This is the time to reap your profits rather than speculate.

Other than herd mentality, there is not one reason to justify today’s prices.  All lower mainland real-estate is going to correct.  It will then recover to levels that the average income can justify under normal frenzy-free conditions.  There is no doubt in my mind Vancouver will see today’s prices again, but not for a generation.

For the past few years we have warned about the growing surpluses of just about every thing we produce, farm, mine and harvest.  A few years ago these surpluses were not a big problem because China was buying it all, mostly to stockpile.  They stored iron ore, wool, cotton, oil and rare earth metals even though they have the world’s biggest reserves.  They also invested heavily in Botswana to add to their source of food.  Today, China has stockpiled so much they have no need for most goods.  The end result is that the world economy is stuck in neutral and will be for months, and maybe for years, to come.  

China has 400 years worth of natural gas but they prefer to use up everyone else’s first and keep theirs for as long as possible.  This is known as long term thinking and planning, something that is unheard of in the West.  This will one day make China self-sufficient and the economic powerhouse of the world.  

Another surplus which gets no discussion is cash.  Governments and central banks everywhere are printing money like it is going out of style.  Printing of cash by the central banks to create zero interest rates was supposed to be a quick way to create inflation and raise rates shortly thereafter.  All that has occurred are asset bubbles, such as the commodities bubble three years ago and today’s real-estate market.  

Low rates reward the borrower because it allows them to finance more debt.  This is at the expense of the saver.  The saver is the foundation of our economy since it is their cash that is needed to create the mortgage and the line-of-credits many of today’s consumers survive on in the first place.  People with cash instantly cut their spending and investing as soon as they see their returns start to shrink.  This is a slow and painful trip to the poor house.  

Japan has had zero interest rates for over 20 years.  The Japanese stock market is trading at the same level as 2006.  House prices on the landlocked nation still remain below their 1989 highs.  Now I know it this is hard for most Westerners to believe, but real estate can been a money losing venture like it has been in Japan nearing thirty years now.  Clearly, this policy has proven to be a failure.  Sadly, not one expert can see how bad this policy has been for Japan, nor conclude this is the direction we are headed. 

Until we get a complete change of economic thinking, the world is set to become poorer.  All those surpluses, including cash, will be losing value.  Soon it will be the housing market.  There is a surplus of homes around the world. Forget downtown London, Vancouver, Hong Kong, and so on, the further you get away from downtown the greater the number of homes that are available.  In many centres, like Vancouver, too many people are buying 2^nd and 3^rd homes as protection for their savings.  These people have already forgotten 2007-2009 when there was that same train of thought in the U.S. 

There is an old investment saying when everyone is jumping on the same train, get off as fast as possible.  The world economy is changing.  Sadly, most people will not realize this until it is too late.  Today, the advice is to get off the train now.

Quantitative Easing (QE) put the world into unchartered territory.  It is like being in the open seas alone to learn that your boat has sprung a leak and all you have is your finger to plug the hole leaving your boat to float freely - you just don’t know how it will end. 

The easy part of QE was forcing money into the system by printing money out of thin air to purchase bonds from the banks.  This was supposed to be a temporary measure used to free up cash to lend by pushing down interest rates, boosting the economy in the process. We admit that it worked, but only for a short period by pushing interest rates to historical lows.  This allowed people to rush out to buy stuff they didn’t need like larger homes, Alberta sized trucks, first class trips and other stuff they cannot afford under normal monetary conditions.  The end result has been debt at historical highs.  

Monetary theorists believed QE would make all corporations rush out to borrow and invest in new assets. Unfortunately, this plan has backfired because management understands their targeted customers have little money left over after they pay their monthly bills.  Instead, corporations are taking advantage of today's  interest rates by parking the borrowed funds in the bank for future needs.  In most cases, the end result has been an improved corporate balance sheet. The Central Banks are against this because they want all that borrowed money spent.

Governments, on the other hand, have been listening to these so called experts and are rushing to max their line of credits.  In Canada, our debt by decades end will soar by over $150b, which Ottawa will end up wasting most of.  Sadly, this nonsense is going on around the world.  Only one country is cutting spending, paying down debt, and building up a huge currency and precious metals reserves;  this is Russia.

Zero interest rates are destroying savings for the Boomers, which represent 30% of our population and claim nearly 85% of the wealth.  Today, a savings of $100,000 results in an after-tax income of around $500, or enough to feed a family for 1.5 months if their diet consists of cat food.  As a result of this failed policy, the saver is being forced into spending the capital or cut back on ones spending, both of which shrink the economy.  Spending by those who have savings will not increase until rates return to 4% or higher. 

After 6 years, Quantitative Easing has been a complete failure, something the central bankers, economists and politicians will never admit to.  The end result has been interest rates are slowing the world economy.  The longer we are stuck with zero interest rates the weaker the world economy will become.

Pumping money into the economy was easy. The painful part is going to be pulling that money out of the system, because the Central Bank must sell these bonds back into the market which will push down the value and increase interest rates in the process. Whenever the Central Bankers and economists suggest new economic policies, grab hold of your wallet because it is going to cost you huge.  Stock markets will not return to bullish mode until corporations start investing their war chest of cash.  This will not occur until the consumer has the disposable income to buy their products.

Ben Bernanke joked that "the problem with QE is it works in practice but it doesn't work in theory."  Once we try to unwind QE Central Banks will learn that it worked in theory but not in practice.