Canadian household debt is an important factor in shaping the business environment. And the current debt level is far from a good news story. Executives should be paying attention.
About 80 per cent of our household debt relates to housing, with mortgages claiming 65 per cent and home equity lines of credit claiming 15 per cent. The remainder is bank installment loans, credit cards, and auto finance. At about 100 per cent of GDP and about 168 per cent of disposable income, Canadian household debt is in unprecedented territory.
The international business community has taken serious note of our household debt situation, no small feat for a country with well under both one per cent of the world’s population and three per cent of the world’s GDP. The Bank for International Settlements has been particularly aggressive in warning us of the potential dangers of our profligacy, including financial instability and crisis, and putting us in the company of highly levered emerging locations like China and Hong Kong.
In a 2017 report called Household Indebtedness and Financial Vulnerability: Recent Developments and Outlook, the Office of the Parliamentary Budget Officer (PBO) nails our household debt future, albeit in bureaucratically understated fashion: “Household debt-servicing capacity will become stretched even further as interest rates rise to more ‘normal’ levels over the next five years.
Based on PBO’s projection, the financial vulnerability of the average Canadian household would rise to levels beyond historical experience.” And it should be noted that our historical experience covers two World Wars, the 1929 and 2008 stock market crashes, and the Great Depression, as well as multiple recessions, bear stock markets, and currency crises. Causation in debt binges is usually fraught with ambiguity and controversy—but not so with the Canadian household debt explosion. The primary cause is clear: the worldwide financial crisis in 2008 and the deep recession that followed ushered in a decade of very slow economic growth and central banks, including the Bank of Canada, responded by pushing interest rates to historic lows.
Debt was a bargain basement fire sale and Canadians could not resist loading up on cars, holidays, furniture, and especially housing in the process of pushing housing prices, particularly in Vancouver and Toronto, through the roof. Exploding housing prices in turn drove more household debt in a decidedly unvirtuous cycle. It didn’t help that financial regulators were slow and tentative in reining in the housing market drivers of debt growth or that financial institutions for their own bottom-line purposes were so aggressive in marketing household debt products.
In a speech late last year, Bank of Canada Governor Stephen Poloz noted Canadian household debt levels had risen to the point that they now are one of the things that kept him awake at night. He specifically referenced the growth in home equity lines of credit and the fact that they often require only interest payments. Another concern is that they can be used for imprudent speculation like owning multiple properties.
It is unnerving that household debt keeps Poloz awake at night when it competes for his worry time with global geopolitical issues like Russia and North Korea, brutal international competition and trade wars, cyber threats, slow economic growth, very weak business investment, poor performance on innovation, and the unpredictability and dysfunction of our major economic partner, the United States. And sleep difficulties at the Bank of Canada over household debt are not confined to the Governor. In March, the BoC’s Senior Deputy Governor Carolyn Wilkins noted household debt was her number-one keeper-upper too.
“Executives need to realize the fiscally conservative Canadian household of our folklore now has something in common with the dinosaur.”
The folks carrying all the debt probably aren’t sleeping well either. And it is time for the corporate world to wake up to the problem and manage the related risks. After all, numerous business environment variables that are crucial to sound executive planning and decision making are materially sensitive to our household debt situation.
First, having so many Canadians so deeply in debt serves as a huge impediment to economic growth. Consumer spending is 70 per cent of our gross domestic product; maxed out and tapped out consumers have no choice but to cut back on their spending and that comes right out of economic growth. Canada’s potential economic growth is now below two per cent a year and the contribution of household debt to that lamentable prospect should not be underestimated. Strong economic growth makes the executive’s job easier; executives are in for disappointment.
Second, interest rates are an important input into corporate investment, acquisition, and finance choices. Household debt should never be allowed to reach a point where an input into raising interest rates is the number of households that could fail. But Canadian household debt is now a material consideration in the willingness of our central bankers to raise rates, even if tightening monetary policy is solidly justified on business cycle grounds because higher interest rates could quite literally bankrupt a large number of Canada’s most indebted households, with wide-ranging negative consequences. As a result, if the course of interest rates matters to your corporate situation, then you should not be sleeping too easily these days.
Third, inflation affects corporations in several ways, including product pricing, labour negotiations, supplier contracts, and the management of working capital accounts like cash, money market investments, receivables, and payables. And when household debt stands in the way of raising interest rates when it is otherwise necessary, it is a short step to household debt being a factor in the inflation outlook—another reason for executives to monitor household debt.
Fourth, the value of the Canadian dollar against foreign currencies very much affects many corporations. This is especially the case with the U.S. dollar because of the massive two-way trade volumes between the United States and Canada. Our household debt rears its not-so-pretty head here, too. The higher our interest rates, all other things equal, the more foreign money flows into Canada to get the higher financial returns and, accordingly, the higher the exchange value of the Canadian dollar because you normally cannot invest in Canada without buying Canadian dollars. The more Canadian dollar buying, the higher the value of the Canadian dollar. In other words, our household debt cannot get in the way of raising interest rates without getting in the way of a stronger Canadian dollar. If your executive interests side with a low Canadian dollar, our household debt situation is your friend. But if your interests are a stronger Canadian dollar, look for other reasons for it to rise than interest rates.
Finally, in the process of selling their goods and services, many organizations become providers of credit to their customers. Accounts receivable are set up with the expectation of orderly repayment. If your customers are households, it is important to bear in mind that many households are not the credit risk they once were. It always pays to monitor accounts receivable aggressively but especially today. Written-off receivables come right out of the bottom line.
Executives need to realize the fiscally conservative Canadian household of our folklore now has something in common with the dinosaur. The days when household debt was a sleepy macroeconomic variable are over. If the people in our boardrooms and C-suites are sleeping better than our monetary policy makers, they are out of touch. It’s Ambien time all round!