Canadian real estate prices are rising at rates even the banks are warning about. There’s a lot of reasons this is happening, but one rarely discussed is the supersized borrowing from the Government of Canada (GoC). A lot of cash was needed during the pandemic, but Canada’s discretionary spending topped the G20. To help facilitate this spending, the Bank of Canada (BoC) made use of quantitative ease (QE). The unconventional policy tool’s use is debated, but its impact is well established.
Keeping rates artificially low causes distortions in other areas of the economy. The longer and large the use of the program, the more distorted markets become. In an economy twice as dependent on real estate as the US during its housing bubble, you can guess where it landed. Let’s talk about government spending, QE, and how it made buying a home even more difficult.
Government Debt and Quantitative Ease (QE)
Quantitative ease (QE) is a policy tool where central banks buy government bonds. The goal is to increase demand enough to raise government bond prices. By increasing bond prices, the rate paid to new bondholders (yield) falls. Since credit markets compete for similar capital, borrowing costs drop across the market.
Credit markets are subject to the laws of supply and demand, like most markets. If the GoC needs more credit than borrowers will readily lend, yields need to rise. In a QE environment, the BoC aggressively buys bonds to lower borrowing costs. The more a government needs, or the longer it does, the more QE usually needs to be used. The longer QE is used to create artificially low rates, the longer they distort markets.
To the average person, the government borrowing at low rates seems like a great thing. Taxpayers pay less in interest, right? The problem is there’s more to life than what the government pays for. By distorting borrowing rates, everything from pensions to home prices becomes distorted. One fund manager that deals with pensions called it “financial vandalism.” Trading in a pension, or paying 50% more for a home, may not be such a great deal for those corporate handouts… to some, anyway.
Quantitative Ease and Mortgage Rates
I can go on forever about market distortions from QE, but one of the biggest ones is mortgage credit. The GoC 5-year bonds directly influence the cost of 5-year fixed mortgages. Since lenders try to fund for as low as possible to make up on volume, they drop to compete with the GoC. Mortgage lenders typically pay a small premium on the GoC bond rate, as a slight “risk” premium.
If GoC rates fall, fixed mortgage rates for comparable time periods fall. Lower mortgage rates increase the amount of debt a borrower can take on. Increased budgets allow a borrower to more easily absorb higher home prices in a hot market. After all, if you don’t have the money — you don’t have the money. Prices can only rise as much as budgets will allow. If everyone has more money, well — buyers can compete to see who gives it to the seller.
It’s key to understand this isn’t just a low interest rate problem either. It’s beyond that. Low interest rates increase budgets. QE makes interest rates artificially lower than the market would naturally support. This makes budgets larger than the market can naturally support, causing huge distortions. Large and persistent QE can make home prices rise faster than possible in any normal market.
The other day on Twitter, a politician and investment banker both said I was wrong about QE and mortgages. Rather than debating the issue with them, like it’s a big mystery, let’s check in with the Bank of Canada. Here’s what they say:
Government bond yields have a big influence on other borrowing rates. Lower yields make it cheaper to borrow money. So, QE encourages households and businesses to borrow, spend and invest. For example:
1. We can buy five-year government bonds, which will lower their yield. This would be reflected in lower interest rates on five-year fixed-rate mortgages, making it cheaper to borrow to buy a house.
Glad we cleared that up.
The Bank of Canada Bought 95% of Canada’s New Government Debt Issuance
Just how big was this QE program, anyway? The BoC now holds $360.8 billion in GoC bonds as of April 14, 2021. National Bank of Canada (NBC) determined, as of April 9th, the BoC held about 40% of the GoC total outstanding bonds. The bank said, “it’s taken just one year to radically transform GoC bond ownership.”
Bank of Canada Ownership of Government Bonds
The dollar value of Government of Canada bonds the Bank of Canada has on its balance sheet. Source: BoC; Better Dwelling.Prior to the pandemic, NBC says the BoC held much less. Their analysis found the BoC held a relatively stable 13% of bonds issued in the past. They also found the BoC bought the equivalent of 95% of new issuance between March 2020 and March 2021. The bank said this is, “an absorption rate that’s really hard to overemphasize.” It’s also hard not to distort the market when you need to make a supersized budget affordable.
Bank of Canada Expected To Taper QE Buying
The BoC is expected to announce a tapering of QE this week, but that depends on how much debt is needed. Currently, the BoC is buying $4 billion of GoC bonds per week to help keep rates affordable. It’s expected they’ll drop it to $3 billion per week soon, with the economy doing better than they had forecast. Even with the taper, NBC is forecasting the BoC will own 45% of GoC bonds by year-end. That’s a lot of rate suppression and artificially low rates to still come.
BoC deputy governor Beaudry argues, “we are not providing a free lunch for the government through QE. The government will have to repay the bonds that we purchase.” However, he recklessly fails to acknowledge artificially low rates are a free lunch. By supporting lower than market rates, the government can borrow much more than usual. Ditto with homebuyers. While that’s a discount for the government, it comes at a cost of distortion to everyone else.
Is the government financing debt for corporate handouts worth paying much for a home? How about retiring with less cash in your pension? I have no idea what that means to you, but I know how I feel. I’m okay with QE being used for necessary spending gaps. However, I do think a low amount of scrutiny leads to its toxic overuse. The issue goes far beyond whether tax revenues can support the payments.
Regardless of whether the spending is justified, or some of it frivolous waste, the point is QE exists. A lot of it. The artificially low rates spill beyond government spending, into other areas like housing. That’s great for the government and people refinancing, but not so much for buyers in a hot market. QE pulls forward demand and allows prices to grow faster than they naturally could.
Artificially low interest rates are great for the government but lead to market distortions. The larger and longer the use of QE, the worse the resulting inefficiencies. Especially if most of the credit growth is in a single area like residential mortgages. As QE tapers, the segments that saw distortion also tend to correct to bring them back to natural levels. However, sometimes markets are pushed to such inefficiency it will take decades to fix.
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Central banks and households are on two totally different pages.
> “making it cheaper to borrow to buy a house.”
It makes the debt cheaper. If you lower my costs by 5% for 5 years, but raise the cost of buying a house by hundreds of thousands of dollars, I’m not really saving money. The bank just makes it up on volume, so that’s not really an issue.
There’s very little analysis on the net cost of issues from governments. They live 4 years at a time, and mostly only focus on looking good that year.
“If you lower my costs by 5% for 5 years, but raise the cost of buying a house by hundreds of thousands of dollars, I’m not really saving money.”
LOANS CREATE DEPOSITS
The money for ‘mortgages’ is created out of thin air by the banks themselves–see Money Creation in the Modern Economy (Bank of England, 2014)–which creates asset inflation.
Economists such as Richard Werner and Steve Keen have recommended restricting the use of bank credit for asset purchases.
The government issues bonds so they can spend money they don’t have.
Government guarantees they can pay.
The central bank buys 95% of the bonds.
The central bank pays for the bonds by expanding the money supply, devaluing the currency.
The borrower secures the borrower’s loan to the lender, which are the same people.
LOL! Sounds like a legit economy. If Canada defaults on the loan, it can just take out another loan to pay the central bank.
One other question I have is that if credit is subject to the laws of supply of demand, why is the price of GoC debt so high? Given that there’s so much of it available shouldn’t the price go down and no one want to buy it?
Every time the BOC needs to expand the money supply to buy bonds, it needs to dilute the money supply. You lose a little purchasing power.
Systems like MMT only work if a country doesn’t have to conduct trade, or it’s the Global Reserve currency like the USD. Even the USD dabbling in this kind of management has billionaires preparing for a de-dollarization even.
https://www.kitco.com/news/2021-04-16/Diversification-is-key-as-world-faces-currency-debasement-threat-Ray-Dalio.html
This seems empirically false. Japan has being doing “MMT” for decades and hasn’t had any depreciation of currency and has mostly struggled with keeping deflation under control. Why would a government voluntarily “debase” their currency? And what would that mean if you have a floating exchange rate currency? What would Canada debase its currency against?
Prices seem to be more affected by whether there are enough microchips available or if there’s a ship stuck in a canal somewhere or if crops got hit by a drought, not how much money is in the economy. There are people saying there’s a risk of all this saved money to start heating up the economy, but that’s different than saying it’s because there’s too much money in the economy.
He’s right. In Japan’s case, deflation is occurring because Japanese corporates are paying down debt and therefore reducing the money supply. Most money supply is created by commercial banks in the form of loans.
Please look up what MMT is. That’s absolutely not what Japan has been doing.
Kitco news is for gold-bugs preparing for doomsday
A government reflects its people. Not a huge surprise they can’t live within their means.
Why would the Bank of Canada (a crown corp owned by the Government of Canada) need to be “paid back” for bonds it purchased from the GoC? And given that the GoC is “paying” interest its own crown crop, what difference does it make what the interest rates are?
It doesn’t matter who buys the bonds. The Government needs to make the payments, or it becomes a country that doesn’t pay its debts. If it doesn’t pay its debts, it becomes Venezuela or Zimbabwe, trying to print its own cash flow, which makes it useless for trade.
If a country has cash that’s useless for trade, it exists the international market system and is basically a Soviet state running its own closed system.
If the purchaser of the bonds is an entity owned by the issuer of the bonds, it makes no difference whether the issuer of the bonds pays itself back. It the source of the payments and the endpoint. This is the case for all sovereign currency issuers.
Venezuela and Zimbabwe are not comparable to Canada for obvious reasons.
What obvious reasons are those? Just curious not hostile
I believe Zimbabwe’s debt was mostly denominated in foreign currency. In order to pay those debts back, Zimbabwe has to obtain foreign currency by selling off its goods or taking on more debt.
Venezuela, which has had moderate to severe bouts of inflation at times, pegs its currency. It’s not floating rate, so they choose to attach their money issuing to some external factor, similar to how the gold standard used to function. So they’ve chosen a system where they cannot issue currency at will.
Canada’s debt is denominated in Canadian dollars, which the GoC is the monopoly producer of. (Imagine in Canadian Tire said, we have to tax back some CT money before we can give more out.) The GoC cannot run out of the legal ability to put more money into accounts, and it’s also a floating currency, so it’s not pegged to any external condition. That’s not to say there aren’t consequences for more and more stimulus, but interest payments and the threat of ruining Canada’s credit are a bogeymen in this situation.
Because Canada’s debt is viewed in totality. Some debt is owed to BoC. Some is owed to private bond holders. And Canada’s debt is traded on international markets. The only thing that makes GoC bonds worth anything is the government’s ability to raise taxes to make good on its debt. There is simply no separating the debt held by BoC and the debt held by anyone else. Were the government to come out and state that “we never have to pay this debt back because it’s held by the BoC”, the crisis in confidence in our currency would be immediate and devastating. Such an intent would indicate that the government believes there is no limit on money printing, which itself would lead to a devastating debasement of the currency. That’s why the BoC has been so clear that “we are not giving the government a blank cheque; they will pay interest on this debt and make good on repayment when it matures.” To do otherwise would be an admission that the CAD is now useless monopoly money.
The GoC owns the BoC, and together the are the monopoly producer of debt and currency denominated in Canadian dollars. If you’re a monopoly producer, that means you set the price of what you produce. This is the case with every sovereign floating exchange rate currency issuer. And you can see that in motion when the BoC does buys debt at *non-competitive* bids from the GoC. Look up the article ‘The “Bank” at the Bank of Canada’ by a BoC analyst. It says explicitly that the BoC can provide CAD on demand and without limit. That’s just how the system works.
Canada has no need for private bond holders. Private bond holders actually need the Canadian government, because it is absolutely risk free money (all GoC debts are private assets by definition), because Canada will always be able to make payments, as the BoC analyst notes.
The end game is around the corner. Canada will hit 50 million people by 2030 and jobs will be more and more scarce while housing will be at all time highs then. Hopefully the crash happens before that and what a crash it will be. Better prepare now before the carnage happens. It will be legendary.
Crash? Maybe you’re misreading but the government and BoC literally put in a floor at current valuations.
I don’t see where the author said crash, but people said the US put in a floor in 2006, and would prop up values going forward. The government can’t control an inefficient market.
They either produce inefficient wages, making it globally not competitive or run people out of the region. There’s no such thing as a high tax version of Monaco.
Apparently the government has created negative cash flow condo investors and sustained housing gains of 15-30%. Lmfao. All this with the income stats of a city equivalent to St Louis missouri or another tier-2-3 American city. Yet it commands NY-esque prices. OK then. It’s totally sustainable that credit growth is powering the economy.
Keep your money in American markets or gamble in the maple-syrup colored canadian ponzi scheme.
My comment was meant to be a reply to “D” talking about a crash, not the article, my bad 🙂
Also the US was an absolutely different situation in 2006-2008 and nowhere near similar. What we’re seeing is extreme intervention alongside currency devaluation, which has put in a floor and things should likely slow down near the end of the year and stabilize.
Every metric used to measure housing (price/income, price/rent) is far worse in Canada today than it was in the US in 2006. Also, interest rates are much lower today than they were in 2006 America, meaning the BoC has considerably less cushion room available than did the Federal Reserve in 2006. And as history shows us, even the Fed didn’t have enough firepower to stop the carnage.
I’m not making a prediction for an imminent crash. This bubble has been growing for 20 years. It may grow for another 20. The longer something lasts, the longer something is likely to last (Google “Lindy effect”). But that doesn’t mean its sustainable.
Really Smaug
Are you bringing laser eyes over to Better Dwelling. Lindy effect back over to Twitter 😂
If you look back, the Fed did have enough firepower in 2008/2009. They could have printed much more to allow the govt to issue a much larger stimulus. Obama chose not to go there, and instead allow a crash.
” However, sometimes markets are pushed to such inefficiency it will take decades to fix.”
This is the problem. I’ve been waiting years for some sort of correction or return to some semblance of regular market principles in Canadian Housing. Low rates for too long have distorted the market for too long. I can’t help but think that the Pandemic was the perfect screen for a wise government to allow the correction to take place while softening it with Pandemic-related initiatives. Lots of options to do this.
Instead, GoC and BoC engaged in massive QE. Some may have been needed to inject a boost during a time of need….but the level to which it occurred is unconscionable. It’s to the point where I wonder if our leaders have been secretly launching Canada toward a brave new world of MMT….
Either way, housing unaffordability will exist for millenials and Gen-Zers for awhile to come.
I’ve voted Conservative, Liberal, Green and NDP in the past. I’m not tied to a party but always try to be practical and objective. So please take this to be without bias. Justin Trudeau is the poster-boy for all of the fall-out of the market distortion we are experiencing. Every time you drive by a “SOLD $$$ Over Asking” sign and curse in bitterness at the ridiculous state of Canadian Real Estate, and wonder who is stupid enough to screw regular Canadians worse than any leader in the past, remember the guy with the nice hair.
There is no difference between any of the parties on this issue. No party would have put forward an austerity budget right now.
We are seeing the same thing across the Western world.
Anybody who was surprised by this budget hasn’t been paying attention.
You’ve completely voiced out what I have on mind. Big thumbs up!
Look, it’s standard old-school, trite stuff to say that our economy is based on a fractional-reserve banking system, where money is created by banks when they lend. It’s also trite to say that lack of spending and too much saving results in recessions. Countries with capitalist economies like ours need people to borrow and spend.
Monetary policy is a blunt tool. Though low rates over the past 20 years have created asset price inflation, especially in real estate; otherwise, we’ve been fighting deflation and lack of growth. Governments are seeing us save too much. When we borrow, we sink that money into real estate – we’re not spending in a way that yields enough velocity. That’s why rates are low, and of course they’ll stay low, especially while unemployment is still so high. Again – that’s trite, old-school stuff. Central banks care about inflation (CPI) and unemployment. Real estate prices are not in their mandate.
Right now, governments across the western world are trying to spend their way to growth in a pandemic environment where allowing further deflation would be catastrophic. Governments are spending to push us to spend.
Yes, I agree that house prices are too high. But government decisions – at federal, provincial and municipal levels – on various issues, including taxation, immigration, and zoning – have resulted in this. If governments have an appetite to change this, they can. Central banks don’t need to get involved. But governments don’t have that appetite right now. As they’ve shown with the federal budget – real estate is the last thing on their minds. They are fighting deflation otherwise and will not risk anything right now that could open the door to another crash, and more unemplyment. This is not just a Canadian thing.
Of course some say that we won’t see growth in the Western world until we get some deflation to clear debts. But honestly – that’s a really Austrian way of looking at things…… We’re in Keynes land now, for better or for worse.