Canadian real estate buying may be slowing down, but the long-term problems are just starting to brew. Numbers from the Bank of Canada (BoC) show that mortgage debt is ballooning as interest rates make minor upticks. Mortgage debt is now at the highest ratio compared to the economy it has ever been. Even though the debt service ratios are manageable, it’s created a complex problem that almost certainly won’t be a happy ending.

Gross Domestic Product Vs Mortgage Debt

There’s two things you’ll need to know today, Gross Domestic Product (GDP) and mortgage debt. GDP is the value of goods and services produced in a country, which more bluntly stated is, a broad measure of the economy. Increases don’t necessarily correlate with a wealthier country in my opinion, but it’s the best general measure we have. Mortgage debt is pretty self explanatory, it’s the amount of outstanding debt on residential real estate.

Mortgage Debt Is Now The Equivalent of 76% of Canada’s GDP

Mortgage debt is the largest it’s ever been, in contrast to our GDP. The end of Q3 2017, saw the value of outstanding mortgage debt reach 76.27% the value of our GDP. That’s up 47% since the Great Recession kicked off in 2007. I know. That means nothing to you if you’re just a homebuyer, or trying to understand the economy. Don’t worry, we’ll break it down.

Source: Statistics Canada, Bank of Canada, Better Dwelling.

Mortgage debt is accumulating faster than the broad measure of the economy. We need to go back 12 quarters to find one where GDP growth is higher than mortgage debt growth. Going back that far, we only find one quarter. We need to go all the way back to 2001, to find an actual period where GDP grows consistently higher than mortgage debt growth.

Source: Statistics Canada, Bank of Canada, Better Dwelling.

There’s a reason really smart, and wealthy people are hating on the Canadian housing economy. No, it’s not because they’re jealous of your wicked 400 square foot condo with a combination kitchen/bathroom/bedroom, that’s now worth almost a cool million. It’s created a problem that’s getting worse – what to do with interest rates.

The Complex Problem That’s Getting Worse

Monetary policy isn’t as complex as your high school Econ teacher made it. It’s just difficult to make the right decision, at the right time. Interest rates are lowered to stimulate the demand of “interest-sensitive expenditures.” That’s fancy pants for houses, cars, and other super expensive items that need long-term financing. This weakens the dollar. Interest rates are raised in order to attract capital inflows, in pursuit of higher yields. The increased capital inflow, leads to an appreciation of the Canadian dollar. Central banks are still pretending they don’t know that lowering interest rates leads to inflows that end up in places like urban land banking, but that’s a topic for another day.

Source: National Bank of Canada, Better Dwelling.

Mortgage debt levels are now so high, it’s hard to do anything without setting off a bad reaction. Raising interest rates would require households to spend even more money to service that pile of household debt. This in turn would reduce the free capital available to spend in the economy, likely compressing GDP growth. That’s bad, but we would get a stronger dollar, and that sweet foreign capital to bolster productive aspects of the economy.

Leaving rates lower will prevent the GDP compression, sending debt levels higher and sending the dollar to perma-weakness. Lower interest rate levels will further stimulate demand for those interest-sensitive expenditures you learned about (a.k.a. houses and cars). However, capital inflows won’t end up in the right parts of the economy, weakening the Canadian dollar even further.

Will Canada take higher home prices, and a weaker dollar to continue the growth of the housing economy? Or face the very real consequences of such a poorly structured economy, and face a half decade of suppressed economic growth?

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