Monday, December 12, 2011

Y U No Spend?

Bank of Canada governor Mark Carney is speaking again -- again -- this time to businesses, on how to pull Canada through what looks to be a period of uphill growth (emphasis mine):

Canadian households increased their borrowing significantly. Canadians have now collectively run a net financial deficit for more than a decade, in effect, demanding funds from the rest of the economy, rather than providing them, as had been the case since the Leafs last won the Cup. 
Developments since 2008 have reduced our margin of manoeuvre. In an environment of low interest rates and a well functioning financial system, household debt has risen by another 13 percentage points, relative to income. Canadians are now more indebted than the Americans or the British. Our current account has also returned to deficit, meaning that foreign debt has begun to creep back up...
In other words, households are chasing diminishing returns and the point at which this debt will be impossible to properly service is a looming risk.
Our strong position gives us a window of opportunity to make the adjustments needed to continue to prosper in a deleveraging world. But opportunities are only valuable if seized.
First and foremost, that means reducing our economy’s reliance on debt-fuelled household expenditures. To this end, since 2008, the federal government has taken a series of prudent and timely measures to tighten mortgage insurance requirements in order to support the long-term stability of the Canadian housing market. Banks are also raising capital to comply with new regulations. Canadian authorities are co-operating closely and will continue to monitor the financial situation of the household sector. 
To eliminate the household sector’s net financial deficit would leave a noticeable gap in the economy. Canadian households would need to reduce their net financing needs by about $37 billion per year, in aggregate. To compensate for such a reduction over two years could require an additional 3 percentage points of export growth, 4 percentage points of government spending growth or 7 percentage points of business investment growth. 
Any of these, in isolation, would be a tall order. Export markets will remain challenging. Government cannot be expected to fill the gap on a sustained basis. 
But Canadian companies, with their balance sheets in historically rude health, have the means to act—and the incentives. Canadian firms should recognize four realities: they are not as productive as they could be; they are under-exposed to fast-growing emerging markets; those in the commodity sector can expect relatively elevated prices for some time; and they can all benefit from one of the most resilient financial systems in the world. In a world where deleveraging holds back demand in our traditional foreign markets, the imperative is for Canadian companies to invest in improving their productivity and to access fast-growing emerging markets.
This would be good for Canadian companies and good for Canada. Indeed, it is the only sustainable option available. A virtuous circle of increased investment and increased productivity would increase the debt-carrying capacity of all, through higher wages, greater profits and higher government revenues. This should be our common focus.

Carney is pleading with businesses to invest to make up for what household spending has done in the past 3 years (and longer), in part by expanding enterprises away from Europe and the United States where growth prospects look anaemic. It appears that increases in -- or even the maintenance of -- the average household debt-to-income ratio will be a trigger for further tightening of credit availability.

Carney has also provided confirmation that banks are increasing their capital reserves for household loans, which means less credit will be available going forward and banks will need to be more selective in the loans they make. It is unclear what criteria banks will use to ration their loans but may involve regional considerations, as was done by HCG earlier this year.

The Bank of Canada is trying, with the limited tools it has available, everything it can to get businesses to spend. If businesses do not spend the burden will be borne by households and governments and this, in Carney's view, is the outcome most likely to lead to subpar (or negative) economic growth. The federal government has been attempting to facilitate private investment through tax breaks and other investment programs, but now Carney, at least, is appealing to patriotism. That is a wonderful stance in principle.


大傻 said...

good post! It looks like Carney's on a speech-frenzy on the topic of household debt levels, even mentioning the housing market. I wonder him being the new Chairman of the Financial Stability Board have anything to do with his ramped-up attention to household debt. After all, he needs to take care of his own backyard to be more credible on world stage ; ) I agree that a further round of mortgage/credit tightening in spring 2012 is more and more likely now.

VMD said...

(oops, that was me, VMD's alternate name on Chinese forums)

jesse said...

As I stated back in June, "It would certainly be embarrassing if the Bank of Canada's governor would preside during a situation of high private debt ratios, experience a subsequent house price crash and concomitant fallout, all without said beneficial countercyclical reserves in place."

mohican said...

Carney does seem to have solid handle on what is required to happen. Business investment is critical and has been lagging for many years in most sectors.

Canadian businesses need to take some risks, invest aggressively in infrastructure, technology, people, training, etc to improve productivity and expand to capitalize on new opportunities.

jesse said...

Stephen Gordon has some words on productivity.

"Business sector MFP [Multifactor productivity] has been declining over the past ten years, driven by a sharp fall in productivity in the goods sector. If we dig a little deeper, the obvious culprit is the mining, oil and gas sector, where MFP has been falling since Statistics Canada started collecting the data in 1961. (The reason for this is that the low-hanging fruit has been picked; resource firms are increasingly obliged to work harder to extract less.)

The resource boom has shifted labour and especially capital to the resource sector, and this greater weight is dragging down MFP estimates for the goods sector and for the economy as a whole.

If you were concerned with productivity alone, you would view this shift as an unwelcome development and recommend measures to divert investment away from the resource sector. This sort of analysis fails to consider why productive capacity is being shifted to the resource sector in the first place. Higher commodity prices have more than offset sluggish productivity growth, and have provided Canadians with increased incomes."

jesse said...

As for increased productivity in the oil and gas sector, one thing that I found from my (limited) involvement is that many investments that can improve productivity aren't undertaken because the returns are less than increasing capacity. For example there are two options, to increase capacity of an existing install or look at improving efficiency of the transmission system. Both have paybacks but the capacity increase is measured in months, the transmission efficiency increase has longer payback.

If I were a CEO looking to allocate my shareholders' capital, only but the best returning transmission upgrades are going to make it. If I were a CEO of some manufacturing entity OTOH, the margins might be thin enough that lower payback capex might be considered.

One hopes Carney is talking to a few executives from the resource industry listening to how they decide to invest.

Anonymous said...

I wonder if Carney understands that the coming consumer deleveraging along with the burst of the BRIC bubble economies will probably result in a decrease in business spending.

I also take great issue with the statement:

...the federal government has taken a series of prudent and timely measures to tighten mortgage insurance requirements in order to support the long-term stability of the Canadian housing market.

Is closing the barn door after the most of the animals have left "prudent and timely"?