David Stobbe/Reuters
Investors, both domestic and foreign, simply can’t get enough of Canada. In 2010, non-residents poured $116 billion into Canadian investments, the highest level ever. In January, they continued to add to their haul, snapping up $11.8 billion in Canadian securities. That month Peter Schiff, the CEO of Euro Pacific Capital and someone well known for his dismal view of the American economy, set up operations in Toronto and has been promoting the country as an ideal place to invest. “I think the Chinese appetite for resources is going to be particularly voracious,” he said in a speech from the floor of the old Toronto Stock Exchange. “Canada has a lot of what China needs.” Then, last month, HSBC, the U.K.-based banking giant, launched an exchange-traded fund devoted to Canadian stocks that will trade on the London Stock Exchange. “We think that Canada, with the relatively uncommon combination of being rich in natural resources coupled with having a stable political system, has attractive features for growth investors,” Mark Rodino, HSBC head of ETF sales in Europe, told the U.K.’s Money Observer magazine.
Eleven years into the bull market in commodities, it’s easy to forget just how much Canada has riding on strong resource prices. For one thing, the boom has boosted our paycheques. The rise in commodity prices was responsible for two-thirds of the 15 per cent gain in disposable income experienced in the last decade, Bank of Canada governor Mark Carney said in a 2008 speech. While Canada’s soaring loonie has hurt manufacturers, it’s also improved living standards by keeping inflation low. And rising commodity prices have also helped keep unemployment muted. As bad as Canadians think the recent recession was, in terms of the job market it was the mildest downturn of the last 30 years. In January, the Canadian economy added nearly double the number of jobs created in the entire U.S. economy, which is 10 times larger.
Investors have arguably been the biggest winners. The resource-heavy S&P/TSX total return index, which factors in dividends paid out to investors, has risen 120 per cent from a decade ago. That translates into a healthy annual return of 8.2 per cent, even after accounting for the roller-coaster plunge we went through in 2008. On the other hand, a Canadian investor who sunk his money into America’s S&P 500 total return index a decade ago has seen the index rise just 29.5 per cent since then. Worse still, once you take into account the soaring loonie, that S&P 500 investment is actually down 17.8 per cent, or an annual return of -1.94 per cent (after the U.S. dollar investment is converted back to Canadian currency). No wonder Americans are flocking north.
All of those benefits have fed directly into Canada’s apparently Teflon housing market. When the Great Recession hit, prices dipped briefly, but quickly rebounded as homebuyers borrowed heavily to get into the market. In fact, relative to incomes, house prices in Canada are now nearly as overvalued as they were in the U.S. at the peak of that country’s housing bubble, notes Madani.
As with soaring commodity prices, the strong housing sector has contributed in a big way to the country’s boom-time mentality and sense of invincibility. It’s been a crucial driver for labour markets. According to Madani, construction jobs account for close to 7.5 per cent of total employment, far higher than at any point since the 1970s. Meanwhile, as house prices climbed, households have been more inclined to go shopping.
But the housing boom has also gone hand in hand with Canada’s household debt boom. Over the last decade, Canadians have doubled their consumer and mortgage debt loads, to more than $1.5 trillion. For every dollar of disposable income households earn, they now carry $1.50 of debt, a level higher than in the U.S. That’s a worrying stress point that could undo the high-flying Canadian economy if it hits turbulence—in exactly the same way heavy debt loads left American households exposed. “Canada’s success story is uncomfortably similar to the U.S. success story,” says Robert Shiller, a professor at Yale University who accurately predicted the real estate crash in the U.S. “It might be offensive to Canadians, but we’re like two peas in a pod.”
What’s different is that the U.S. didn’t have the resource sector to fall back on. But how secure should we be in assuming the commodity boom won’t turn into a bust? Not very, says Shawn Hackett, a commodity analyst in Florida who has dug into the sector’s long history of booms and busts. He analyzed the 10-year average annual rates of return for commodity prices dating back to the early 1800s. At no time have prices risen as fast and as high as they have over the last decade without being followed by a sharp decline. “If history is any guide, we’re higher than the 1980 top and much higher than the 1950 top,” he says. “Unless we are going to do something right now that defies 200 years of the way the rules of engagement have been in commodities, we’re due for a nasty spill.”
What has always happened in the past, and what Hackett expects to see again, is that as prices rise, consumers cut back while producers ramp up supply. The end result is a supply glut that drives prices back down.
Just as we’ve come to rely on rising commodity prices for our prosperity, a resource sector bear market would hit Canada particularly hard. For one thing, it could strip Canada of the cherished view we’re more prudent than other countries. After all, Ottawa and the provinces vigorously drove up spending even before the stimulus measures of 2009 were announced. It’s just that revenues, from royalty payments and corporate and income taxes, rose faster. Today, Canada’s gross national debt stands at 82 per cent of GDP, up sharply from 65 per cent in 2007 and higher than at any time since the early 1980s, according to the International Monetary Fund. (America’s rate, at 92.7 per cent, is higher, but the gap isn’t as wide as Canadians like to believe.) Canada’s debt picture is forecast to improve over the next few years, but for that to happen, the commodity and housing markets must stay strong. If resource prices plunge, Canada could be left yet again with structural deficits similar to the 1990s.
