The Canadian Economy and Household Debt: Awkward Dance Partners

Posted in Debt Free In 30
Posted by J. Douglas Hoyes, CA, CPA, LIT, CIRP, CBV

Canadian economy, household debt

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We're living in very different times in terms of our economy. To help us explore this topic further I talked with economist David Bond about how the Canadian economy as a whole is impacted by household debt and the root causes of debt, including income inequality and our tax system.

David is a PHD in economics from Yale University, but more than that he brings a broad perspective of someone who has worked as an academic, civil servant and in industry.

Economic ups and downs a fact of life

David points out that we must face the fact that we live in an economy that has cycles. A high household debt to income ratio (167.8% at the time of our podcast) puts both the individual, and our economy as a whole, at risk. If you lose your job, you may not be able to pay your debts. If too many people default on their debts, our financial institutions might go bankrupt. David's advice if you have debt and risk a job loss or income reduction:

first thing you should learn is when you're in a hole, stop digging

David also talks about how Canada is a small economy in the word picture, and that as a result, events outside of Canada have a significant impact on our own economic cycles.

Housing market changes

One of the biggest points David makes with which I fully agree, is that your home is not an investment. Yes, housing prices go up, but they don't always do so.

David believes much of the rise in housing prices was due to population growth. As baby boomers raised families, they wanted a home just like their parents. That caused a building boom which lowered prices. Today, housing stock isn't increasing at much which is putting pressure on millennials. This calls for a change in how we think about housing in our communities, particularly density. David also suggests millenials:

Think very carefully about that and think about what you would get if you rented instead of buying can take the difference and invest it in a mutual fund. And do just as well if not better.

Income inequality and taxation

Income inequality is a major concern because it creates an entire segment of society that is detached from the welfare of the community as a whole. And this is costly to everyone.

David believes one of the biggest causes of income inequality is our taxation system including the fact that capital gains are taxed at a favourable rate.

As far back as the 1960's the Carter Commissions recommended:

that a buck is a buck is a buck. How I get a dollar in my hand, whether it's through capital gains or whether it's through working, is immaterial because the impact of the dollar is the same. So, why do we offer special gain, special taxation, for capital gain?

Thoughts on basic income

David believes that poverty costs us more money as a society than the expense of a solution like basic income. Poverty affects children more than any other group, they can't study well to gain better skills. Poverty perpetuates a cycle of low income earners. This same group uses the health system more, the justice system more.

If we got rid of the flow into that class by eliminating poverty, the net savings to the country as a whole would be substantial.

Interestingly David does not support an increase in the minimum wage. He believes having a guaranteed income is a better solution. If we have a basic income guarantee, and wages are too low, the market will fix itself because businesses will have a problem finding employees.

Get ready for retirement - now

Canadians are carrying more debt into retirement than ever before.

David's last piece of advice on debt is to ask yourself how are you going to survive after retirement, particularly since your retirement, given your life expectancy, might last 18 or 25 years. His suggestion? Start saving for retirement now:

don’t sacrifice tomorrow for the passions of today.

For more of my discussion with David Bond about consumer debt and the Canadian economy, listen to the podcast or read the transcript below.

FULL TRANSCRIPT Show 112 with David Bond

canadian economy, debt, David Bond economist

Doug Hoyes: Today on Debt Free on 30 we're going to talk about the big picture when it comes to debt. My guest today has lots of practical advice on how we as individuals can deal with debt but he also has some great insights into how the economy as a whole is impacted by debt. In the second half of the interview we explore the root causes of debt and discuss income inequality and how the tax system helps the rich get richer. So, we cover a lot of ground on today's show. My guest is David Bond and I asked him to start us off by giving me a brief introduction to his career.

David Bond: I got a PHD in economics from Yale University and taught at various Canadian universities. I then was a senior civil servant, running at first the census and then the Department of Intellectual property in the old Ministry of Consumer of Corporate Affairs. That was the patent, the trademark, the industrial design office and eventually it took over both the corporate side including bankruptcy. And then I left that and became the chief economist for HSBC Bank in Canada and retired back in 1988 and have been living here in Kelowna for the last 13, 14 years.

Doug Hoyes: I believe Mr. Bond is only the second PHD I've had as a guest on the show and I wanted to have him on because he has insights as an academic, a civil servant and from working in industry, which is a very broad range of expertise. Statistics Canada recently reported that the ratio of household debt to disposable income is 167.8%, that's almost 170%. So, my first question to Mr. Bond was what exactly does that mean?

David Bond: That means that we have debt per household that is more than almost, well 170% of the income you have after you'd paid your taxes. That's mainly income tax and property tax in a particular city.

Doug Hoyes: And this is pretty much the highest level we've ever had.

David Bond: It is the highest level that we've ever had.

Doug Hoyes: Which, when you look at it historically. So, I'm looking at it and going that's a really big number but when you look at the economy everything seems to be good. Unemployment is low, interest rates are low, the real estate market in most parts of the country is fairly strong, I guess we could argue about Vancouver perhaps. Is it really a problem that debt levels are that high?

David Bond: Well, I mean you can assume that the current situation is going to continue forever. But if you assume that then you also assume that, I don’t know, you live to be 255 or something. The basic point is that we live in an economy that has cycles. And the concern with debt of 170% of your disposable income is if the economy goes into the tank you may lose your job and then how are you going to pay your debts? And if you can't pay your debts, what happens to the stability of the people who lent you the money? They themselves suffer a loss. And if their losses are too great they may go bankrupt. So, the concern is let's make sure that you have enough capacity that in a relatively modest downturn, you'll still be able to service your debt.

Doug Hoyes: So you raise a couple of points there, let's talk about the equation first, household debt to household income. We talked about the debt side of it, what's happening on the income side of it? I would assume if my debt is going up, my income's going up faster, I really don’t have to worry. Is that what's happening?

David Bond: No. Your debts growing faster than your income and that's the real concern.

Doug Hoyes: And that's what then could start the whole chain reaction that you just described, consumers get into trouble and then banks get into trouble.

David Bond: Yeah that's partly it. But the other side of course is that if your income stops growing period and your debt continues to grow you're in a hole and you're digging more. The first thing you should learn is when you're in a hole, stop digging.

Doug Hoyes: So it looks like the economy's in good shape now. You can tell me whether that's actually true or not but what could happen to get us into trouble? What are some of the shocks that you can see happening?

David Bond: Well, I think the economy's got some soft spots, certainly the energy sector is soft right now. Even though the price of oil has bounced back up to 50, I think it's going to stay below 50 for most of this year and next year and that means a substantial reduction in our earnings. But let's suppose the United States goes into a recession, that's our biggest export market. And that will have an adverse impact upon the economy of Canada.

The second thing is the soft wood lumber dispute is about to start up again. And that can have a significant impact particularly in both east, the Maritimes and Quebec and here in B.C. What else could happen? You could have a major meltdown in Europe, which could set off a global recession in one way or another. Or China could really have a major fall and that could have another impact that is adverse to Canada. We're an open economy, we're a small economy in the world and as a consequence events outside of Canada can have a significant impact on Canada.

Doug Hoyes: So, do you worry about interest rates going up?

David Bond: Well, I don’t lose sleep about it at night right now. But the point is that I don’t think the rate of interest that we're paying right now, which is, you know, the bank rate which is half of 1% is going to last forever. I can remember interest rates back in 1981 when my mortgage went to 21%. That was a shock I can tell you.

Doug Hoyes: Well, yeah and even around 1989 I can remember paying 13 and a quarter percent, which is unfathomably large numbers compared to today.

David Bond: You got it. And when I got my, you know, my mortgage came due to renew, I mean it was a shock to the Bond family accounts and we had to make significant adjustments in our expenditure patterns to service the mortgage because I didn’t want to lose my home.

Doug Hoyes: And that's the risk to people who today either have a variable rate mortgage or who have a mortgage that will come due at some point in the future, which is everybody I guess. If the rates are higher, and people don’t really grasp that I guess, they figure well, I got my variable rate mortgage, I'm paying 2 and a half percent, well I guess if mortgage rates went up to 5%, that's no big deal, that's only another 2 and a half percent. But that's really a doubling of what you're paying, that would be a massive increase.

David Bond: You got it. That's doubling, it's 100% increase.

Doug Hoyes: Which is 100% more that you're paying each month, so that could be a significant issue, so, how do you view the real estate market now? And I realize there are many different markets, but in general what do you see?

David Bond: Well, I see people have tended to regard buying a house as a major investment that would provide them with significant gains because housing prices always go up. Well, they don’t always go up. And I think that's something that has to be explained to people.

The second thing is that I think the market is a function of the growth of the population. And we had a tremendous demand for housing when the baby boomers, who are now approaching retirement, went into the market and they all wanted houses just like their mom and dad had. And now the millennials are finding that if they want to have houses just like mom and dad had, the housing stock hasn’t increased that much and so as a consequence the prices are going up. And I think you're going to see a change in the structure of the housing stock in many centres.

Let me give you an example, in 1895, the city of New York, the borough of Manhattan, the island, was primarily classified or zoned for residential housing. Well, the number of residents of individual residents in the island of Manhattan you could count maybe on both hands and both feet. I mean it's been, it's changed drastically. Most of the housing is in apartments or in condominiums and there are very few independent houses. I mean the former mayor of New York, Mr. Bloomberg, had an independent townhouse worth 28 million dollars and most people can't afford that with a salary of say $60,000.

Doug Hoyes: That's true, that's true.

David Bond: So the housing stock changed and that's what's going to happen in Canada. That means you've got to change the zoning and there is a large growing evidence in Canada that many people feel that their community should never change the structure. Well, that's just not going to happen, it's going to change.

Doug Hoyes: So the change that's required is moving to more dense housing for example. You can't have typical residential housing in the centre of the city, you need apartments, condos, that sort of thing?

David Bond: Yeah, density is going to increase. It might start with housing along the laneways and it also will result in apartment buildings and condos etc. Not all 95 stories but denser than they are now. I mean the best example would be around the major stops on the Canada line, that's the line that goes from Richmond or the airport into the centre of the city. And where the major stations are, the nature of the housing stock is starting to change pretty rapidly because people want to be able to walk to the subway and get on and then bang they go downtown.

Doug Hoyes: As opposed to the old days where we got in our car and drove into the city centre.

David Bond: Yes and the number of cars coming into the city centre is just astronomic and it's parking spaces, I mean god, you know, you own parking a space downtown, you're rich.

Doug Hoyes: Yeah, it's more valuable than anything. So, if you are giving advice to let's say a millennial or, you know, even someone older than a millennial who at some point in the future wants to own a house, what is the advice you're giving to them today?

David Bond: Think very carefully about that and think about what you would get if you rented instead of buying because in many cases you'll get a superior accommodation for the amount of money you have to spend for accommodation. And you can take the difference and invest it in a mutual fund. And do just as well if not better.

Doug Hoyes: The counter argument to that would be though house prices always go up, and you and I realize that's not true, but house prices always go up, I want to own something, I don’t want to be making the landlord rich, I don’t want to be paying off someone else's mortgage. How do you get over that psychological barrier that you can actually become more wealthy not owning a home?

David Bond: Well, I mean, you know, I can do the numbers for them. But they may believe it doesn’t matter. It's sort of like a Trump supporter, no matter what he does I still believe in him. Well, there are a lot of people no matter what I show them, they still believe that a house is the best investment they can make. I think they're dumb, but you know, come on.

Doug Hoyes: So, the obvious answer is crunch the numbers, don’t let your emotions be guiding you.

David Bond: That's what I would do.

Doug Hoyes: Yeah, crunch the numbers.

David Bond: Exactly. And the question you have to ask yourself, let's take a typical house in an urban centre, well we'll take a Hamilton where I grew up. How often do you spend time on the side lawn of your house or sitting on the front lawn of your house?

Doug Hoyes: In the winter not very much in Canada.

David Bond: Even in the summer not very much. I mean, you know, maybe you use the backyard but not the front and side yards. Well, that's, you know, come on, that's not an efficient use of space. And the message I got as an undergraduate in Geography, not economics, is that there isn’t any more land being created. I mean there's a small amount in volcanic places but I don’t think you want to live there.

Doug Hoyes: Iceland's very beautiful actually but you're right, that's not my first choice probably. So, we also have to rethink the way we actually live then is what you're saying. This vision of - like the picket fence and the yard and stuff, you've got to ask yourself am I actually going to use it or would I better investing my resources elsewhere?

David Bond: Yeah. And I mean, you know, there are a lot of people who live in apartments who don’t seem to have suffered greatly. I mean think of Paris, think of London, think of New York City, think of Chicago. I mean come on. Major urban centres you don’t have a front lawn, a back lawn and side lawns, you live in an apartment and your kids don’t grow up with two heads or something, you're just living a different lifestyle, that's all.

Doug Hoyes: Well, I guess New York City would be a classic example because you're only a 20 minute subway ride away from Central Park no matter where you live. So, if you really want to get outside and walk then it's certainly easy to do that. And of course in a place like New York City, you're walking everywhere anyways. You're not driving, you're taking the subway or a Taxi or something perhaps. So, the yard with the garage and everything is much less important. So, we really do have to rethink it.

David Bond: Anybody who owns a car in Manhattan is either filthy rich, I mean really filthy rich, or crazy. I mean Mr. Bloomberg has a car and I have a couple of friends in New York City, but they're filthy rich and they spend $40,000 a year for parking. I mean come on.

Doug Hoyes: Yeah, wow. You raise another interesting issue and that is about the filthy rich, so let's talk about them for a minute here. So, what are your thoughts on income inequality, do you worry that it seems like the rich keep getting richer? We've got this bigger and bigger divide, is that a concern going forward?

David Bond: It's a significant concern. It means that there's a section of the population which really is detached from the welfare of the community as a whole. They are able to float above it as it were. And I think that we've got to look at what's causing this inequality and then say maybe we can lessen it. We can slow it down from growing. And I think it would be a good thing because I think the more commonality that exists amongst the population, they greater is the concept of the community and what the community needs for its own welfare, their own wellbeing.

Doug Hoyes: So what do you think is causing it?

David Bond: Well, I think in many ways the tax system is one of the things. I mean the fact is that capital gains are treated at a favourable rate. And I believe in what the Carter Commission, which was the royal commission that looked at the taxes back in the 60s said that a buck is a buck is a buck. How I get a dollar in my hand, whether it's through capital gains or whether it's through working, is immaterial because the impact of the dollar is the same. So, why do we offer special gain, special taxation, for capital gain?

Doug Hoyes: So, let's just take a step back and explain, I mean I'm a chartered accountant so I understand what you're talking about, but for people who are listening tell me the difference, like what is a capital gain?

David Bond: Let's suppose I buy something for $100 and I sell it 10 years later for $1,000. The difference in the price between $100 and the $1,000 is capital gain. Nothing was done expect the passage of time. And the capital gain would be the $900. Or if I bought a house, say the house I bought in Vancouver when I first went out there to teach for $40,000 last year sold for 1.9 million dollars. It wasn’t my house anymore, I sold it many, many, many years ago. But the difference between the $40,000 that I paid for the house and the 1.9 million, which would have been $1,860,000, was a capital gain and they only have to pay tax on 50% of it.

Doug Hoyes: Because in Canada you only pay tax on half the capital gain so in effect the tax rate is half of normal tax.

David Bond: But the point is with housing, unlike other capital gain, that's tax free. So, that means I would have had 1.86 million tax free.

Doug Hoyes: So, your principal residence you don’t pay tax on no matter what the gain is.

David Bond: Right.

Doug Hoyes: A capital gain you pay tax at half the rate.

David Bond: You get taxed on half of the capital gains. And you pay it at your marginal tax rate.

Doug Hoyes: Got you. And a classic example of that would be I buy a stock and it goes up.

David Bond: Yeah.

Doug Hoyes: That would be a capital gain.

David Bond: That's usually the one. I know some friends who bought for example when they were in college bought a MGBT and kept the damn thing in a garage for 30 years and they can sell it for five times what they paid for it. But the number of people that keep their MGBTs in the garage are, you know, you can count them on one hand.

Doug Hoyes: Yeah, presumably there's some cost related to that, insurance and so on. Regular income then is taxed at full rates. So, the income I get from my job. And so your point is why should I pay more tax when I go out and work than what I would pay if I didn’t work, which is what a capital gain is?

David Bond: Yeah. And now the argument by start ups is, well, we can't pay good salaries so we give people stock options. And the best example of that is a guy named by Gates who lives down in Seattle. He got a lot of options in a company called Microsoft.

Doug Hoyes: I think I've heard of him. Yeah, Bill, I've heard of him.

David Bond: Yeah he made 70 billion. Well, it was all capital gain. Now the basic point is if you give in a start up people stock options because you don’t pay them money, I think that when they cash them in, they should pay that it's income. It's just deferred income.

Doug Hoyes: I mean everything you're saying makes sense but let's explore this. I'll be the devil's advocate here. So, I'm going to be starting a company and I'm going to pay my employees full rate, so I won't give them any special treatment let's say but let's say I've got to, you know, attract investors and investors have many different places to put their capital, they can put it in the bank and they can earn one or two percent or they can invest it in my new company, which they may make a lot of money on or they may go bust. I mean most new companies don’t exist five years later. So, is there not some rationale when it comes to creating jobs to be giving favourable tax treatment to the people that are actually taking risks to start businesses?

David Bond: Well, I think there's lots of different ways you can do that other than the tax system. And I think that this favourable treatment of capital gains is one of the major causes of income inequality. And I think that income inequality has gone to an extreme lately. I mean the 100 richest people in the United States have more wealth combined than all of the African American population in all of the United States. And they're one quarter of the population in the United States.

Doug Hoyes: So it's an insane disparity then between the top and everybody else. So, you talk about the tax system then, so capital gains would be one modification you could make, just eliminate the concept of capital gains, a buck is a buck as you say. Are there other changes in the tax system that you would contemplate?

David Bond: Well, I have to tell you that I don’t read the tax code for recreational purposes. And so there are a raft of what are called tax expenditures. Special exemptions granted to people over the course of time. And I would look at each and every one of those tax expenditures and say which ones are actually working?

For example, the Harper government put in a favourable tax deduction for buying public transit. And you could deduct the cost of it. And the point is that it appeared to have zero impact on public transit. Well, I would say let's take a look at all these little exemptions you get when you fill out your income tax and say are they really doing what they are there for? And if not, stop it.

Doug Hoyes: Make the system much simpler. So, what about let me throw two other concepts at you then. Basic income, where every Canadian got a set amount either through a negative income tax or through a cheque every month, would that help remove some of this income inequality?

David Bond: Well, I think it would to some degree. Now there's something that I think that people aren’t aware of. If you have a large degree of poverty or near poverty in the population, that impacts the children in that group worse than anybody else. They wind up with - you don’t study very well when you're hungry. You don’t study very well when you don’t have enough clothes to keep you warm in the winter time. And all of those things lead to the creation of an underclass. Now the underclass really are the ones that do the dishwashing in restaurants and other menial tasks.

But the point is it's an expensive luxury because they use the health system more intensively, they use the justice system more intensively, they're just a burden to society. If we got rid of the flow into that class by eliminating poverty, the net savings to the country as a whole would be substantial.

But to explain that to people they're like oh they're not doing a damn thing and getting my money, what goes? The point is if you don’t pay them now and stop them from going into that group, in other words give them some skills and provide them with food then the point is over time you're going to pay even more forever.

And so, I think it's a question of saying what is it we really want in society? Do we want to have a continual sector of society which is unskilled, poor health, given to crime etc? Or do we want to get a society where the welfare, the wellbeing of society is the number one concern of government. It's a simple thing as far as I'm concerned.

Doug Hoyes: And how would you then feel about an increased minimum wage, the same sort of thought process?

David Bond: No, I agree with Milton Friedman who was a far right economist as you may know, and Milton said let's have a guaranteed income, but let's get rid of minimum wage. And I think that makes sense. Because I think that the market will work in this case and if the wage is too low people won't go into it, they'll have a problem finding people.

Same thing has been happening here in the Okanogan, the Okanogan traditionally paid lower wages than say other parts of British Columbia. It was sort of a sunshine benefit apparently. Well, they're finding they can't find people to man all of these jobs because the wages are just not sufficient for anybody to survive. So, wages are going up in the Okanogan and there's great consternation amongst some business people. But hey, it's reality, the market works.

Doug Hoyes: So basic income would be a basic support that you don’t think would muck with the market too much, whereas minimum wage would have potentially negative impacts.

David Bond: Yeah now look, you'll always have people gaming the system and you've got to accept that. There's no perfect way to deal with this, so, where there is no quote cheating, unquote. There will be some. But the point is the cost of that cheating is a hell of a lot less than the cost of maintaining a portion of the population which is under skilled, poor health and given to significant social problems.

Doug Hoyes: Got you. So, you're looking at society as a whole.

David Bond: You've got it.

Doug Hoyes: Which kind of makes sense I guess. So, final question for you then, looking at this from the point of view of a consumer, everything we've talked about, debt and so on, what is your overall advice to the individual person? What should they be thinking about, what should they be looking towards over the next year or two? What could they do to keep themselves out of trouble?

David Bond: Okay well the first thing to realize is that your life expectancy if you're a male will be about 85 and if you're a female about 88. So, what are you going to do after your career? In other words, how are you going to survive from age 65 or maybe 70 by the time they get to be that age? Your retirement would last for another 18 or maybe 25 years. How are you going to support yourself? In other words, start thinking about stopping your consumption now and putting something away for your old age, most people don’t do that. And the baby boomers are a case extraordinaire that many of them are going to face very significant reductions in their standard of living because they failed to save for their old age. So, you can't start doing that too soon. If you start putting money away at the age of 25 and it's compounded even at 2%, it will double before you retire and so you should think of that.

Doug Hoyes: And I guess part of the problem with that is that a lot of those baby boomers have a lot of debt right now, they're not even thinking about saving. They've got to work on getting rid of the debt first.

David Bond: Yeah. Well, I mean they absolutely needed a boat and they needed a skidoo and they needed an all terrain vehicle and they wanted to go on vacations to Mexico or Hawaii. So, they did it all and they never thought about the future. And I'm saying don’t sacrifice tomorrow for the passions of today.

Doug Hoyes: That was my interview with David Bond who has a PHD from Yale and has taught at universities, worked for the government and worked as an economist for a big bank. Obviously he has strong opinions on the risks for consumers in today's economy. And while I don’t necessarily agree with everything he said, I think his practical advice bears repeating.

Perhaps the most controversial statement he made was that, and I quote, “a lot of people think that a house is the best investment they can make, I think they're dumb”, end quote. Well, my opinion is that you should never view a house as an investment. So, I guess I agree with him there because houses go up and down in value. If you think a house is a guaranteed money maker, you're more likely to buy a house that's bigger than you can afford and take on too big of a mortgage and that can lead to financial disaster, particularly if house prices go down. I agree with Mr. Bond's advice, crunch the numbers, figure out exactly what it would cost to rent and to own and seriously consider whether or not you really need a front porch that you'll never sit on and then make an informed decision.

I also agree with his point on our life expectancy. If you're alive today, it's likely that you live to be 85 years old or perhaps much older. Mr. Bond's advice is to live more frugally today so that you have more resources for the future. Mr. Bond made the comment that some people bought cars and boats and other luxury goods that they couldn’t afford and that has lead to their debt problems. Well, for some people that's true, for others their problems were caused by circumstances outside of their control like medical issues or job loss. So it's important not to paint everyone with the same brush.

Regardless, Mr. Bond's final piece of advice is correct. And again I quote, “don’t sacrifice for tomorrow for the passions of today”, end quote. I agree that we must consider both today and tomorrow. If we focus on eliminating debt today, we can save for the future and have a secure retirement.


About J. Douglas Hoyes

Doug is our co-founder and is a Licensed Insolvency Trustee, Consumer Proposal Administrator, certified Insolvency Counsellor and Chartered Professional Accountant.

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