The New Normal? Economic Prespective from one of Canada’s Top Economists

I was fortunate enough to catch Benjamin Tal’s presentation in Calgary recently, presented by our friends at FirstLine Mortgage, as he discussed what he calls ‘The New Normal’.  For those of you unfamiliar with Benjamin Tal, he is the Deputy Chief Economist for CIBC  World Markets.  As usual, Ben delivered an engaging and entertaining discussion about world events and their direct impact on the national and local economies. It really is quite remarkable how Ben can make economics seem like so much fun!

As a mortgage associate with Verico, I am particularly interested in Ben’s forecasts of upcoming bond markets and Bank of Canada decisions, as well as his prognosis of the real estate market. He always delivers a terrific amount of information and value every time he speaks.

Although he discussed several issues ranging from oil price shocks, the deleveraging US consumer, pending Fed and Bank of Canada decisions and the booming (?) US manufacturing sector, the most important message he left us with was the impact of a rogue fundamental economic indicator, the ‘Velocity of Money’.

Gross domestic product (GDP) is a function of not only the money supply, but how fast the money supply moves through the economy (i.e., nominal GDP = money supply x velocity).  The ‘Velocity of Money’ (M2), also called velocity of circulation, is simply the average frequency with which a unit of money is spent in a specific period of time, and has been considered a good indicator of economic vitality. M2 is frequently used by economists as a metric to quantify the amount of money in circulation and explain different economic monetary conditions.

During the last recession, M2 by the US consumer dropped nearly 13%, which was the largest decline on record. The good news is that M2 grew by 1.9% since the recession officially ended, showing that improved consumer confidence with households has begun to loosen their purse strings and start spending again. What’s important here is the level at which spending is occurring.


This plot shows the velocity of money since 1959. With one exception (mid-1970s), velocity drops during recession. This makes sense. The general consensus during a recession is to tighten your purse strings and hope you don’t lose your job.

This graphic is much more recent, and again shows the decreases in spending during a recession. What is noteworthy is how dramatically lower US consumer spending is now over all compared to 10 years ago.  This is partly what Benjamin Tal meant by ‘The New Normal’.

This variable (M2) is especially important to watch right now for several reasons. If M2 goes back to the pre-recessionary levels (~1.8), the 5-year fixed mortgage rates will dramatically increase.  Increased mortgage rates will crush the housing sector, as consumers pull back from planned purchases, refinances and move-ups. Inflation will justly increase, as both variables responsible for inflation, namely liquidity in the market and consumer spending, will be accounted for.

So should we be worried? Well, considering that Bernenke is planning to stop printing money on June 30, 2011, the actual effects of quantitative easing will be tested.  If, as many economists suggest, quantitative easing in the US was not solely responsible in helping to stabilize the economy (remember, we need money in the market + someone to spend it), then it truly will be the US consumer that will be held accountable for any future inflationary pressure.

But hold on, the US consumer is currently not only in a holding pattern, but is actually deleveraging the market at a significant rate!  For the first time ever, the debt to income ratio in the US is falling, and the savings rate has increased from 0% to 6%, a rate which has been, until now, practically unheard of.  The home equity ATM-style spending spree of the last boom is dead. In 2007 alone, the American homeowner borrowed over $700 billion in home equity, financing 50% of the increase in consumer spending. With US home values still exhibiting a down-trending pattern, the American consumer is not in any position to begin spending any time soon.

So who cares, you say, I’m Canadian! That’s their problem, they created their own mess, and were different over here in Canada.  Agreed, to a point. Canadian economic fundamentals are very different when compared to the US market. The quality of mortgages in Canada are significantly greater when compared to past US subprime products that dominated their market during the last boom. Canadian household income has increased compared to US households over the last decade, and we’ve had a much stronger and more robust credit card market than our US counterparts. Overall, the percentage of debt stressed Canadians (the percentage of households in Canada that have less than 20% equity and debt service ratio of greater than 40%) is only 4.1%, compared to over 22% in the US.  Considering how severely the US economy suffered, we should feel fortunate that there is a political border between us!

Well, not so fast.  Before you go off shooting your six gun and celebrating at the county fair, let’s take a look at what Ben sees ahead for the Canadian market.

Despite our differences as a nation to our neighbours to the south, and despite the fact that our recession was not nearly as severe as it could’ve been, we’re not in the clear yet. Inflation and rising interest rates are still a concerned. Recent increases in the price of oil due to political unrest abroad teach us that we are clearly engaged in a global economy.  The American consumer remains our largest trading partner, leaving us ‘in-waiting’ as they rebuild their fragile economy.   Our potential for a strong Canadian market is severely limited while the US economy remains struggling. There are still some hurdles ahead for sure.

In closing, Benjamin leaves us with a few thoughts on the Canadian housing market. The equity ride of the past remains but a memory, as our future housing market will not be that exciting.  Except for possible buoyancy during the spring 2011 housing market, he expects a “stagnant market for the next 2 to 3 years.”  In a quote that still baffles my mind, Ben makes the statement that “the best thing for us is a stagnating market for 24 years, which will allow fundamentals to catch up with prices”.  I think I’ll be in a nursing home by then, wake me up when it’s over.

This entry was posted in Uncategorized. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *