Rate Cut, Dollar Drops…

Canada dollar, interest ratesBank of Canada dropped the bank rate a quarter point today. The dollar dropped about a penny against the USD.

The Bank cited a mild recession in the first half of the year for the cut.

The immediate effect of the cut has been to have the banks trim their mortgage rates slightly. Which will have a small effect on housing prices taking the price of a crack shack in Vancouver from 1.1million to 1.2 million. Now some people might think the crack shack at 1.1 million was fairly priced (others of us will tend to say things like…Are you insane?). But in the grand scheme of things putting a tiny bit more air in a bubble simply postpones the day when the bubble pops.

Out in the real economy it is very unlikely that a company thinking about a multi-billion dollar investment in an Oil Sands play will change its mind because money is a little cheaper. The price of oil is just a wee bit more significant. Nor will a 1/4-point cut change many investment or employment decisions in smaller scale businesses. And the corresponding drop in the value of the dollar, while it may make some Canadian manufactured goods more attractive to our American friends, will be offset the next time you go to buy lettuce.

So what is really going on?

At a guess, the BOC realized it was going to have to cut and decided to cut well outside the election period coming up. The next rate-setting window is in September and that is very close to the October election. But there is another issue at work as well: for a variety of reasons – mainly outside the control of the BOC – the Canadian economy is looking a bit flaccid. Obviously oil prices have hurt. But so has the massive overinvestment in houses and the building market. The crack shacks are one side of that, the towers full of 500 square foot condos are another. Keeping the housing bubble inflated may not make much economic sense but it is critical politically. When the bubble bursts, and it will, a vast number of Canadians will be deeply worse off on paper. They’ll still have their houses but those houses and condos will drop significantly in value. think 30%.

People living in a $600,000 house with a $550,000 mortgage will be deeply underwater. They will feel poorer. In fact, when they come to pay the monthly they will feel broke as Hell and, in a market where the supply of houses will vastly outstrip the demand, they will be profoundly illiquid. They will be stuck and they will be angry and they will be frightened.

For the last decade the Conservative government has followed a policy of deficit containment rather than elimination. Provincial governments have ignored containment and have sped ahead to staggering deficits. All of which means that the room for fiscal manoeuvre in the face of a housing sell off with its resulting loss of confidence is minimal. The Conservatives strategy was ill considered, many of the provinces – looking at you Ontario – were simply reckless.

Poloz, as Governor of the BOC, is rightly considered non-political. However, the politics of the coming debt crunch in Canada are non-partisan. They will favour no party because all of the parties will be stuck with the same mess. Worse, none of the parties, governments or the BOC will have many tools to fight the fire.

Today’s cut kicked the can a few months down the road. The federal election can take place without any of the participants having to face the looming crash. So they won’t and we’ll have an election which studiously ignores the fiscal and monetary catastrophe waiting in the wings.

I can hardly wait.

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