Over the next 2 weeks there will be plenty of speculation the Federal Reserve will be raising interest rates.  The truth is anything under a 2 percentage point increase is irrelevant.  It will do nothing but add to their debt burden by making it a little more expensive to carry debt.  Interest earned on deposits will only make a tiny improvement because financial institutions have a nasty habit of slowly moving up the rates, and usually at half the speed of debt charges rises.

There is no set rule what a fair interest rate is, however we believe 4% is a fair yield.  This would still make loans affordable at around 6% and allows risk-free investors are properly rewarded.  The truth is that if a person cannot afford to borrow at 6% then one should not borrow.  This is just basic finance.

The Bank of Canada cut interest another 0.25% on July 15th.  While the cut will help those with an oversized mortgage on an undersized condo, it is another slap in the face for those relying on their savings for income. Falling rates have created a flood of equity in the real-estate market that has made homeowners feel wealthy.  “The wealth can be tapped by taking a loan against the equity”, so the story goes amongst the housing bulls. Taking the equity out of the house via a loan eliminates the equity on the spot because the cash is as good as spent since it is matched with a liability. Therefore, in order for the equity to create the true benefits of wealth in the economy, the asset must be sold or the borrowed funds must generate a return greater than the rate of interest being charged.  I can guarantee that very few people do this.  Today’s real-estate market has become nothing but a Ponzi scheme which, to quote Warren Buffett, “only when the tide goes out do you discover who is swimming naked.”

Toronto has a reported condo rental vacancy rate of 1.2%.  This number does not include any vacant unit owned by investors which there is plenty of because investors are finding they cannot rent their unit to cover the mortgage payments, let alone the ever growing strata fees.  A new condo tower in Yorkville (Toronto) is supposedly sold out to investors but most of them sit empty today because people cannot afford what the investors are asking.

A third of Canada’s population will be retired within the next 20 years.  This is the demographic that has all the wealth.  However, todays’ retirees are being forced to dip into their savings at a faster clip due to falling interest rates.  Many are retiring with mortgage and credit card debt, and taking out those terrible Reverse Home Mortgages.  They are also the biggest users of Pay-Day loans.  Not surprising, seniors are the biggest sector declaring bankruptcy.  Assuming savings amongst this demographic average $100,000, the current risk-free rate will earn them roughly $70 per month instead of the historical norm of $400.  Multiply this sum by 10m Canadians and the benefits of higher interest rates will be exponential.  Or, we can continue to hold the hands of those who were romanced into the largest mortgages in history and push forward an inevitable housing correction.

People like to point out that the cost of a mortgage has declined allowing for the homeowner to pay the principal faster.  This would be correct in a fairy-tale economy but the average size of the mortgage has grown with house prices leaving the average mortgage term of 25 years unchanged.  At the end of the day, the average price of a house is based on the amount of principal and interest combined a borrower can finance.  When interest rates decline the consumer borrows more principal pushing up home prices in the process.

Both home ownership rates and consumer debt are at an all-time high.  Eventually, demand will deteriorate and force prices down with it.  Of course when the economy improves and rates start to move up many homeowners will find they cannot afford the higher interest charges.  The higher the interest rates go, the greater the collapse in house prices that will occur.  Either way, house prices are going to take a beating.  Our leaders can accept the fact and begin to reward the saver and cause short-term pain in the housing market, or continue on today’s path and strangle those with the savings that are needed for a healthy economy.

Given we are now into election time and not one politician has the guts to be a proponent of higher interest rates, Canada is at least 2 years away before the economy can begin a sustained recovery.  However, we can see the actual recovery being delayed until 2020 due to the huge outstanding debt.  Returning interest rates to historical norms would force a much needed housing correction but generate a flood of cash into the economy at the same time.  Would a risk-free rate of 4% which will generate higher passive income not benefit the economy more than accommodating a $500,000 mortgage on an overvalued home?  Time will provide ample evidence that it would.

Houses price today bare little relationship to family income.  The rule of thumb is to never pay more than 3 times family income.  Today, due to zero interest rates, 4 times might be acceptable if the buyer has no other debt and some assets.  In places like Toronto and Vancouver it is normal for people to pay a minimum 6 times income.  This means once interest rates move higher many will lose their homes as they will not be able to afford the increase debt charges.  Canadians are already stretched financially with $1.65 in debt for each dollar of income.  This means no extra funds to spend, as any interest rate increase will consume additional disposable income.

One cost of owning a house is going to increase substantially in the years ahead will be electricity.  Both Alberta and Ontario will be raising power rates for years to come. With rising energy prices the trend will be for smaller homes, meaning there is a potential for today’s large homes will become hard to unload in the years ahead.  Unless the government allows a large number of immigrants into Canada there will be surpluses of homes for decades to come.

Similar to the U.S., Europe and all other Catholic countries, Canada has a birth rate under 2.1 per woman which creates a shrinking population without immigration.   Canada’s fertility rate is 1.7.  Even India, with improved education, has seen their fertility rate fall from 5 thirty years ago down to 2.4 today.  The trend throughout most of Africa is also down due to better education.  Only in the Middle East countries, parts of Africa and Bangladesh have high rates. 

Today, zero interest rates are a boom for purchasers of homes.  However, if the rates stay low much longer it will become a negative for housing.  Specifically, it will cause the number of eligible buyers to dry up.  How can anyone save enough money to put a down payment on a house when interest earned is less than 1%?  If a family is lucky enough to have high paying jobs that allow for savings of $1,000 a month, which very few do, it will take roughly 8 years to save for a down payment of $100,000.  In other words, house price must fall to meet the savings of tomorrow’s buyers.

If you are one of the many Boomers who are relying on the equity in their home for retirement, now is the time that you should consider selling.  All indicators point to this summer being the peak of our housing bubble.  For investors, if we are correct about the future, real estate will be a terrible investment.  Real-estate investing today is an extremely high risk venture.

If one wants to buy a fixed income investment, then make sure to stick to a term of one year. If one wishes to purchase longer, do not exceed a term more than two years.  Most bond yields currently result in losses after taxes and inflation.  This loss will be exacerbated once the price of fixed income assets decline in value with a rise in interest rates. 

Let us explain.  Assume, back in the good old days you purchased the average 5-year bond trading at par ($1000) that paid you 7%.  That’s a decent return so you go and brag to your annoying neighbor Joe.  Filled with envy, he too decides he wants to invest in some.  The next day you wake up and there is a little bit of turmoil in the Middle East and the bond market reacted by pushing up interest rates premarket.  Joe can still get your bond, but cheaper and it now pays 8% (see chart).  He happily buys some. 

You hear his gate slam and you know he is on his way over to rub it in your face that he received a 15% higher rate of interest than you.  Just when you were wishing he would keep his mouth shut, he is quick to add that he was able to buy it at $875 which means he will receive an additional 15% on his dollar when the bond matures.  He raises his hand for a high-five and you bitterly participate.

As he turns away to walk home, you’re not only kicking yourself for bragging to  Joe the day before, but you’re hoping that you do not need a few quick bucks soon because if you do you will be forced to sell your bond at a 12.5% capital loss.  Even if you’re not forced to sell, you will still be slapped with opportunity cost and the fact that Joe has smug rights on you. 

As Joe found out, there is too much risk in buying longer-term fixed income securities when interest rates have bottomed.  In ordinary times it is difficult to accurately predict when interest rates are in a trough, but today it is a no brainer because they are at historical lows and cannot fall much further.  Furthermore, it is hard enough to guess what is going to happen next year, let alone 10 years from now.  

The Bank of Canada has made it clear it wants a lower dollar.  They continue to voice concerns about “the damage a strong dollar will do to the Canadian economy”, and believe Canada needs a weak currency to promote growth. Yet, a falling currency is the worst thing that can happen for the simple reason that it lowers ones purchasing power by pushing up the cost of imports. This makes its citizens poorer on the global stage.  A rising currency allows us to purchase more.    

The Bank of Canada’s interest rate policy is encouraging rising unemployment and a weakening economy. Interest rates have allowed for the average Canadian household to acquire debt to the tune of 165% of their income.  The Bank is determined to make every saver poorer in order to keep the borrower afloat.  Our interest rates are still sliding with no bottom insight.  Nobody in government or in the Bank of Canada understands that if consumers have little money they will not spend, let alone save.  Without savings, there is no investment and a weak economy.  Keeping borrowers happy with low interest rates solves absolutely nothing.

Canada’s strongest economy occurred between 2002 and 2007.  During this period we had near zero unemployment, low inflation, and the saver was rewarded with interest rates bouncing around 5%.  The Canadian dollar was the hottest currency in the world at the time.  On March 13, 2002 the Canadian dollar was worth $0.626US and then climbed by 75%, to an all-time high of $1.10US.  The Toronto stock exchange over the same period rose 34.4%.  Clearly, a strong Loonie had a positive effect on the economy.

There are plenty of examples throughout history that a currency can attract investment and contributes to prosperity.  Between 1970 and 1990 the Swiss Franc, the Dutch Guilder, the German Mark and the Japanese Yen all increased in value by over 300% against the U.S. and Canadian dollars.  During this period, all four experienced booming economies.  During the nineties the most successful economies were the U.S. and Australia.  Guess what?  Their currencies soared.

Today, the strongest economies are the U.S., New Zealand, and Switzerland.  All three have strengthening currencies.  Why can the Bank of Canada not see what has taken place and understand that a rising currency results in prosperity.

In the summer of 2007, Canada’s GDP was growing 2% annually and interest rates were 4.5%.  Today, Canada’s GDP is growing at 2.6%, yet 10 year T-bills are 2.04%.  The situation is the same in the US where in 2007 the 10 year T-bill yields 4.22% and GDP was 2.4%.  Today, that yield is 2.4%, GDP is 3% and savings accounts earn 0.09%.  North America is going backwards.

Today’s policies are punishing savers and probably forcing many people to work beyond retirement age.  The majority of savings are in bank accounts earning anywhere from .1 to 1.2%, before taxes. Doubling interest rates would increase passive income, attract investment throughout the economy and create a much needed higher currency.  The end result will be a wealthier Canadian.

Another month of savers being punished by zero interest rates has passed.  For every $100,000 a person has in a risk free asset they will make between $85 and $250 per year, depending on how long one wishes to lock-in for. With a return this small there is no wonder more retirees are accumulating excessive debt and taking undue risks with their savings.

The Boomers have started to kick off the largest demographic shift in western civilization. Just how exactly are they expected not to spend their nest egg quickly when it makes next to nothing? It appears as if politicians and central bankers cannot understand that the recipe for a healthy economy is an interest rate that rewards the saver and deters excessive debt at the same time.

The Boomer demographic holds the majority of wealth in our economy.  Can you imagine what effect higher interest rates would have if ones passive income jumped a few hundred percent?  Sure it would also cause pain but it would teach responsibility as well.  It would also encourage saving and reward it more at the same time. As long as interest rates remain where they are the economy will continue to do nothing but move closer to contraction.

A recent report showed that seniors in Ontario accounted for 10 per cent of all insolvencies in the province.  It also found that they had the highest level of unsecured debt at the time of their insolvency, averaging $69,031 each.  This works out to an average monthly interest charge of $400, with no change in the principal.

Many seniors have taken out reverse mortgages where the house is used as collateral but no monthly payment is made.   Instead, the interest is accumulated until the term ends at which point the house must be sold or the principal and interest is returned.  People hope the value of the house will increase greater than the outstanding debt by the end of the term.  Given today's interest rates can only increase, the chances of this occurring are zilch. We recommend people sell their homes rather than use a CHIP.

Unless you have been lucky enough to save a small fortune your retirement plans are in jeopardy.  Interest rates are going to ensure you will not have enough savings to retire at age 65 and have the life you wish.  Many will be forced to work longer than planned or cut their spending substantially.

It is becoming apparent that the world economy is going to be flat for the rest of this decade.   Capital gains will be hard to achieve so any the bulk of returns will come from rising dividends.  A one year GIC needs to pay 4% or higher before the economy returns to normal.  Unless the market forces them higher, this will not occur this decade   As a result, an economic recovery is many years away.

Based on this investors should be rethinking their retirement plans because the money probably will not be there unless one starts to save more today.

A major change is taking place and little is being reported about it.  While today the deviation is minor, if it continues to develop, which appears likely, we will begin to see a different world in a decade’s time that will change the economic landscape.  This change is a declining fertility rate.  Led by Japan, the industrialized world faces a shrinking population along with all its consequences.  Only the Middle East, India and most of Africa will continue to have a growing population.  Yet, even most of these countries rates are sliding. 

For the second year in a row, Japans population will shrink and continue to do so for the foreseeable future.  At 1.4, the fertility rate is one of the lowest in the world (2.1 is required for growth). To exacerbate the situation, their population is aging and the country allows little immigration.  This means market demand for all goods and services will weaken naturally over time.  What is to become of excess homes, stores, and local manufacturing?

Last year was the first time in years that America’s birth rate slipped under 2.1.  The U.S. is the only industrialized country that had a fertility rate above 2.1.  If this trend continues their population will also begin to shrink without immigration.  As the map above illustrates, a negative birth rate is common all over the world. The trend appears to be that the more democratic and well educated the society becomes, the lower the birth rate is.

Adding to the potential for a shrinking population, 2015 is the second year in a row that more Mexicans are leaving the U.S. than are entering.  Today, Mexico offers the local’s better jobs than they can get in America.  Their car industry is growing and taking jobs away from Canada and America.   It is believed that Mexico will soon be the world’s biggest auto manufacturer.  If Mexicans returning home is a new trend it will hurt America even more. 

In order for North America and Europe to maintain today’s standard of living they will have to increase immigration.  Unfortunately, as the map above illustrates, we will be competing with many other regions of the world.  Even when immigration does increase, it will not lead to a growing fertility rate overnight because it is the immigrants’ offspring that tends to have the larger family.  Therefore, a climbing fertility rate is at least 2 decades away.

With zero interest rates destroying personal savings throughout the world, historic levels of debt and population changes in force today, the global economy is setting itself up for slow economic growth (0 to2% annually) for the next few decades.  The outcome will be a transfer of wealth from the West to Africa, Asia and the Middle East.  This is already evident with GDP growth in these three regions surpassing most of the Western nations.