Bank of Canada: the risks are still the risks

The Bank of Canada released its semi-annual Financial System Review this morning.  Introducing the Report to the media, Governor Stephen Poloz noted that the key risks identified by the Bank are the same as they were six months ago, and indeed the same as they have been for several years now: high and rising household indebtedness, and imbalances (read: overvaluation) in the housing market.

Gov. Poloz pointed out that household indebtedness continues to rise faster than household incomes. As the OECD noted earlier this month, Canada's households are now the most indebted in the developed world.  The increase in debt has seemingly not yet been affected by the Bank's increasingly urgent warnings, or its steps toward tighter policy.

Poloz noted that steps by the Government to regulate high-ratio mortgages (less than 20 percent down-payment) more tightly have reduced the issuance of such mortgages.  However, the Bank is concerned over a possible deterioration in the quality of non-high ratio mortgages, with amortizations stretching beyond 25 years and more such loans being taken out by highly-indebted households. New regulations will be forthcoming in the new year to regulate these mortgages more closely and ensure that the borrowers can withstand a rise in interest rates.  The Bank welcomes this prospect, though one wonders whether Poloz ever asks himself why the lenders need the Government to impose such prudence on them, rather than adopting it themselves.

As regards the housing market, Poloz notes that the froth seems to have come off the Toronto area market in response to steps announced by the Ontario Provincial Government back in April.  However, the Bank is waiting to see whether Toronto house prices follow the pattern set in Vancouver, where the effect of earlier government measures seems to have faded, with prices starting to rise again.  Poloz also notes that the fundamentals of the market are strong, with demand driven by rising population and employment.

The Bank's conclusion is that Canada's financial system remains "resilient".  That message is likely to be reinforced over the course of this week by the release of  financial results for the major banks.  The first of these, Scotiabank, today announced an 11 percent year-on-year rise in profits, a remarkable result considering nominal GDP is rising at less than a 6 percent pace.  So far there has been little evidence of any impairment in the banks' credit quality, despite the surge in household debt. Some commentators are suggesting that Gov. Poloz sounded a little complacent today, but for now, he seems to be on solid ground.   

Good news is no news

Canada's fiscal deficit for the first half of the current fiscal year (April-September) came in at C$ 5.9 billion.  That marks a sharp reduction from the $ 7.8 billion deficit posted in the same period last year, and suggests that the deficit for the full year could fall well short of the budget projection of just under $20 billion.

Remarkably, among the major news outlets only the Toronto Globe and Mail considers these strong numbers worth reporting online.  It will be interesting to see if space for the story can be found in the weekend print editions.  Doubtful, I'd say: advertisements for Black Friday and Cyber Monday sales have made it all but impossible to find any editorial content in the papers over the past week or so.

That's a pity, because there seems to be a lesson in these numbers that's worth hearing, and not only here in Canada.  When the Trudeau government announced its first budget a couple of years ago, featuring a return to stimulative deficit financing, it was roundly castigated in the media for wild irresponsibility.  Today's data seem to suggest, not for the first time, that stimulating economic growth is a sure-fire way to keep fiscal pressures under control.  And as George Osborne and now Philip Hammond over in the UK could tell you, austerity for austerity's sake produces neither a stronger economy nor a balanced budget.

This is not to give Trudeau and his Finance Minister Bill Morneau a free pass.  If the economy slows in the second half of the fiscal year, as most forecasters expect, the deficit for the full year may well end up much closer to the budgeted figure than today's partial data seem to suggest. Longer term, it is regrettable that the Government has no real plan for bringing the budget closer to balance.  Still, good news is good news -- except, apparently, when it gets in the way of the advertising copy.       

UK economy: officially a disaster

Chancellor of the Exchequer Philip Hammond is generally seen as the only functioning adult in Theresa May's Cabinet, so needless to say he is widely reviled by the hardline Brexit fanatics.  Today he tabled a budget that underscores just how badly the Brexit fiasco is already hurting the UK economy, with no improvement in sight for at least the next several years.

This summary from The Guardian captures all the main points and includes some useful glosses from the paper's political editor. (Kudos to her, by the way, for using the obscure legal term "resile"!)  A couple of things particularly stand out:

• UK GDP growth is already the lowest among developed countries, and, painfully for Brexit supporters, below the rate being achieved by the EU.  Hammond has now had to lower the official forecast not just for this year (to 1.5 percent from 2.0 percent), but for each of the next five years -- that is, well beyond the date of Brexit itself. The budget offers no specific explanation for the lower projections, but maybe one isn't really needed.

• Government borrowing for the current year will be lower than originally forecast.  It is projected to continue to fall gradually over the five-year forecast horizon, though not as rapidly as Hammond forecast last year.  Remember when George Osborne embarked on the austerity trail back in 2011?  The deficit was supposed to be gone by now.  Instead, half a decade of supposed fiscal responsibility has exerted a serious drag on the economy, with no end in sight. 

It's a depressing picture. Let's give the last word to the satirical website, The Daily Mash:  "Economic growth is bollocks and we don't need it, say Brexiteers". Or was that from The Daily Telegraph?

He's finally gone!

Unpredictable to the last, Zimbabwe President Robert Mugabe abruptly resigned this morning, just as impeachment proceedings against him were getting under way.

I never met the old rogue, but I feel like I have been following his career for half a century.  When I went for my day of interviews at Cambridge in the winter of 1966-67, one of the hot topics in international affairs was the future of what was then Southern Rhodesia.  The white minority government led by Ian Smith was resisting the efforts of the UK Colonial Office to move toward independence with black majority rule, as had happened all across Africa in the preceding decade.  Instead, Smith and his cohorts were threatening a unilateral declaration of independence, or UDI.

So I found myself getting into a lively discussion of Rhodesia and UDI with one of my interviewers that cold winter's day.  The interviewer was none other than Simon Schama, just a few years older than me but already taking on a teaching role in the university.  I can't have said anything too stupid or outrageous to Schama or the other interviewers, because I wound up getting accepted into the college.

While I was studying, UDI indeed happened, prompting the UK to impose sanctions on Rhodesia.  When I graduated, my first job was with the UK's Foreign and Commonwealth Office in London, where the Rhodesia situation was front-and-centre on a daily basis. Mugabe was already a major player in the resistance to Smith by then, having founded ZANU, the Zimbabwe African National Union, back in 1963. 

A combination of sanctions and Mugabe-led guerrilla activities through the 1970s finally made Smith's position untenable in 1980, and Mugabe became the first Prime Minister of the renamed Zimbabwe in that year.  It's remarkable to look back and see how he was regarded at that time: as a heroic resistance leader and all-round exemplar of liberation and enlightenment.  However, it did not take long for tribal rivalries to resurface, with a low-key civil war breaking out in 1981 between Mugabe's ZANU and the rival ZAPU, led by Joshua Nkomo.

Late in the 1980s the ZANU/ZAPU conflict ended, with Mugabe now assuming the Presidency and Nkomo taking a senior position in the government. For a number of years the economy seemed to recover well, but Mugabe's dictatorial ways soon put an end to the progress.  A combination of expropriations, venality and outright incompetence turned Zimbabwe from "Africa's breadbasket" into a basket case.  With inflation reaching Weimar Republic levels and living standards collapsing, millions of Zimbaweans fled the country, with most heading to South Africa. 

Mugabe contrived to stay in office despite losing the 2008 election to Morgan Tsvangirai, but it appears that his determination to see his second wife Grace succeed him finally led the army and the long-suffering populace to oust him.  The key question now is, how can Zimbabwe rebuild after the decades lost under Mugabe's misrule? 

Can the agricultural sector be reformed so as to restore some of the country's former export capabilities?  The farmlands taken from the white planter class were distributed to new owners, who may not wish to give them up.  Will South Africa look to return its 2-3 million Zimbabwean immigrants quickly to their homeland?  The migrants are a major burden on the South African economy (and a convenient scapegoat for its high crime rate), but it would be almost impossible for Zimbabwe to reabsorb them quickly, given the very high unemployment rate that already exists. 

Perhaps most important, will Zimbabwe's foreign friends come to its aid with more than just kind words?  The UK, as Zim's former colonial master, would be a logical place to turn for help, but the government in London is bogged down in the Brexit morass, and the anti-foreigner mood among UK voters might make it difficult to offer much material support.  A more likely source of help is China, which has been investing massively in east Africa for a number of years.  The opportunity to add another state to its growing roster of friends in the region will surely prove irresistible to Beijing, and whoever takes over from Mugabe will not be in any position to drive a hard bargain.

Roll out the pork barrel

The next Provincial election here in Ontario is set for June 7, 2018.  A few months ago, Premier Kathleen Wynne and her unlovely crew were insanely unpopular with the electorate: at one point the Premier's personal approval rating dipped as low as 14 per cent, a depth to which even Donald Trump has not yet sunk.  With nothing much to lose, and a strong local economy providing a healthy revenue boost, the Liberals have embarked on a truly astounding series of targeted giveaways aimed at buying back the lost voters.  There was yet more largesse in yesterday's Fall Economic Statement from Finance Minister Charles Sousa.

My aging memory isn't good enough to recall all the money that's been thrown around, but this list should be representative enough:

• The minimum wage, currently C$ 11.60/hour, will jump to $14 at the start of 2018 and will hit $15 at the start of 2019 -- the latter increase being, of course, contingent on the Liberals being re-elected in June.

• The small business sector has been warning loudly that the higher minimum wage will be a job killer, so Sousa's statement yesterday included a cut in the corporate tax rate to offset some of the impact.

• Prescription drugs will be provided free of charge to everyone under the age of 25, starting in January. At the moment only seniors get their drugs paid for. 

• Tuition fees for college have largely been eliminated for lower-income students.

• Homeowners can get a smart home thermostat for nothing.

• The Provincial portion of sales tax on electricity bills has been waived, as part of a series of measures to stem the dizzying rise in energy costs resulting from the Government's "green" initiatives.

And so on.  According to Sousa, the Government will run a balanced budget in each of the next three years despite all of this new spending. We will have to wait and see what the Provincial Auditor, who has been loudly and repeatedly critical of the government's accounting standards, has to say about that.

These are not all bad initiatives, by any means, although the long-term costs for the short-term energy price relief will be enormous.  What grates is the sheer gall of the Government in assuming that a raft of giveaways just ahead of the election will suffice to make the voters forget the incompetence and scandals that have been a feature of the administrations run by Wynne and her predecessor Dalton McGuinty.

The Liberals are leaving nothing to chance.  Canadian governments are always big buyers of media advertising, but the scale of the marketing effort being put behind these measures is startling.  There's scarcely a prime-time ad break that doesn't trumpet one or other of these initiatives.  The ads are blatantly partisan, but a recent rewrite of the rules by Wynne's government leaves plenty of wiggle room, and they're using all of it.

I'm immune to being bought with my own money, but I'm not sure about my fellow citizens. Will people re-elect a government with a leader they heartily dislike just to get their hands on a free thermostat?  We shall see. 

Some things never change -- Tories, for example

It's now more than five years since we came back to Canada from our fourteen-year sojourn in the UK.  Looking back across the Atlantic has been a mostly depressing experience. First there was the Cameron/Osborne austerity policy, entirely ineffective and hugely damaging; then the whole Brexit referendum fiasco, created by Cameron entirely for the purpose of seeing off the rebellious right wing of his own party, with disastrous results; and now the Brexit "negotiations" themselves, with a clearly overwhelmed Theresa May presiding over a Cabinet of schemers and buffoons, with a sex scandal or two thrown in for good measure.

My wife commented a while back that it's a good thing we don't live there any more: we'd be angry all the time, and we're too old to live like that. She's right. I think what would make me angry -- and still does, even at a safe distance -- is that the Tories are only ever motivated by what's good for their party, not what's good for the country.  Did Boris Johnson ever really believe the lies he told on the campaign trail back in 2015?  Surely not, but he saw them as a way to power, and that was enough.

A friend recently gave me a quirky book called "The strange death of Liberal England" by George Dangerfield.  It was published in 1935 (though its style seems older than that) and it deals with the years leading up to the Great War.  The names of some of the players are familiar -- Balfour, Asquith, Lloyd George -- but the detailed history of the period is less well known, and offers some interesting foreshadowing of more recent events.

From 1906 to 1910 the Liberals had a majority in the House of Commons, but their ability to pass legislation was repeatedly thwarted by the Tories, who used their huge majority in the unelected House of Lords to turn everything back.  A fresh election left the two parties almost tied, with the Liberals agreeing to support limited Home Rule for Ireland in return for the Parliamentary support of Irish MPs.  The death of King Edward VII and the accession of George V presented the Liberals with an opportunity to bring in legislation eliminate the Lords' effective veto, backed by a threat to create as many as 500 new peers (all Liberals) if the Lords attempted to veto the move. After a closely-fought and rancorous debate, the legislation passed, and the Lords have never since that time been able to overturn legislation passed in the "lower house".

Deprived of the Lords as a weapon, how did the Tories respond?  Determined to oppose the Liberals at every turn, they chose to make nice with the Ulster Unionists, Protestants intransigently opposed to Home Rule -- "Home Rule is Rome rule".  One of the delights of Dangerfield's book is his startling frankness: he doesn't like Tories very much, and he views the Unionists with nothing short of contempt: "they cared for no-one but themselves".

The Tories didn't much like the Unionists or what they stood for, but needs must, and so an unholy alliance was formed.  It's that alliance that prepared the ground for all the troubles that followed -- the rising in 1916, the post-Great War conflict that ultimately led to the creation of the Irish Free State, with the six most Protestant counties of Ulster gerrymandered off to create Northern Ireland, and the decades-long "Troubles" that flared up in 1969 and were only ended by, of all people, Tony Blair, with the Good Friday Agreement.

That Agreement allowed something resembling real peace to reign over all Ireland for the first time in almost a century, with the border between the Republic and the North fading into insignificance. Sadly ironic, then, that one of the many potentially baleful consequences of Brexit could be the return of a "hard" border between the two jurisdictions, with unpredictable consequences.  And tragically, the hapless May is only able to govern at all through a devil's bargain with -- who else? -- the Unionists.

Having conspired in the division of the island for partisan political reasons a year ago, and having never looked past military force to keep it in place ever since, the Tories may be about to leave their mark on Ireland all over again.  And all because of a partisan decision by David Cameron that went wildly wrong. Truly, some things never change.

Canadian job market still very strong

Labour market data for October, released by Statistics Canada this morning, surely put to rest any suggestions that the economy is facing a prolonged slowdown.  The marginal decline in GDP for August reported by StatsCan earlier this week, coming in the wake of a flat reading in July, had led some analysts to proclaim that the run of strong data seen through the first half of the year was definitively at an end.  It seems nobody told the labour market.

The headline number -- an employment increase of more than 35,000 -- was well above the analysts consensus, which had called for a rise of just 15,000.  The details of the report were even stronger than the headline.  Full time employment rose 88,000 in the month bringing the increase over the past two months to a remarkable 200,000*.  Part-time employment fell by more than 50,000 in October.  On a year-over-year basis, full time employment has risen by 397,000, partially offset by a decline of 88,000 in the number of part time jobs.  Although the unemployment rate ticked up to 6.3 percent in October, it stands 0.7 percentage points lower than a year ago.

There are signs that the tightness in the labour market is having an effect on earnings.  The year-on-year rise in average hourly earnings in October was 2.4 percent, the fastest gain since April 2016.   As recently as April of this year, this increase had been as low as 0.7 percent. Although the Bank of Canada has signalled its intention to be cautious in making any further tightening moves, this is a trend it will be following closely in the months ahead.

The one caveat that needs to be kept in mind in assessing this very strong employment report is that employment is usually a lagging indicator of economic activity.  This may mean that the strength in employment as the economy enters the final quarter of the year simply reflects the strong growth seen in the first half.  If this is the case, the deceleration in GDP growth seen in Q3 may translate into slower employment gains in the month ahead. That caveat aside, there is little to dislike in today's report.

*  Remarkably, it looks as though the strike at a GM plant in Ingersoll, Ontario from mid-September to mid-October, which led to widely-publicized layoffs across the Province,  had no discernible impact on the national employment numbers.

Friendly fire

It's not common for retired central bankers to criticize the current incumbent, so this intervention by former Bank of Canada Governor David Dodge is noteworthy.  Dodge thinks that the high level of household debt should induce the Bank to tighten more rapidly, so as to discourage further debt accumulation.  As Dodge notes, the Bank seems to be pausing its tightening cycle, possibly for many months,  with its benchmark rate at just 1 percent, far below the 3 percent that the Bank itself regards as a neutral level. 

Based on his comments to the House of Commons Finance Committee in his semi-annual testimony this week, it seems that Gov. Stephen Poloz may think the exact opposite -- that the high level of debt may mean that excessively rapid tightening could sink the economy. Poloz told the parliamentarians that the Bank had "recalibrated" its economic model in regard to household income and debt, and went on to say that "the economy is likely to respond to higher interest rates more than it did in the past". 

This seems intuitively obvious, but also ominous.  Despite some slowing in the most recently reported months, the economy is operating very close to full capacity.  Even though inflation is tame, conventional wisdom would suggest that this should entail setting interest rates at least at a neutral level, or even slightly higher.  If fears over household debt mean that even in current circumstances, the Bank feels powerless to tighten its policy stance, it's hard to imagine a set of economic conditions in which it will ever be able to move rates back to more "normal" levels.