Are rising consumer debt loads the Achilles' heel of the Canadian economy?
Before we tackle that question, let's back up a few months and revisit the lecture Bank of Canada Governor Mark Carney gave the country on rising personal debt levels, and the fact that while money is cheap today, it could get expensive again — and quickly.
"Low interest rates today do not necessarily mean low rates tomorrow," warned Carney. "Risk reversals, when they happen, can be fierce; the greater the complacency, the more brutal the reckoning."
What's happened to consumer debt levels since he scolded Canada's profligate spenders? Well, apparently nobody was paying much attention, and over the first three months of this year a new study suggests consumer debt has continued to climb.
According to the credit rating agency, TransUnion, Canadians now owe an average of almost $26,000 on their credit cards, lines of credit and auto loans.
That's an increase of 4.5 per cent, or another $1,000, over the same period last year.
The picture becomes even bleaker when you factor mortgage debt into the TransUnion report. Currently, Canadians owe just over $1 trillion in mortgage debt, and that pushes the $26,000 figure to just over $100,000 per Canadian family.
Now let's bring that debt picture into line with earned income.
According to the Ottawa-based Vanier Institute, the average Canadian family is now carrying a household debt that amounts to 150 per cent of their personal disposable income. That's the highest level in history. And stated in a starker way, for every $1,000 a Canadian family earns, they have to make about $1,500 in debt payments.
Sadly, according to TransUnion, Canadians persist in carrying large credit card balances at onerous rates. And the amount being carried on plastic only fell $25 to an average of $3,539 over the last year.
At the same time, the national credit card delinquency rate rose 11 per cent.
And despite Carney's hectoring and the rule changes surrounding lines of credit, they are still the most popular lending vehicle. Excluding mortgages, they accounted for more than 41 per cent of outstanding debt at the end of the first quarter at $33,981, up 5.9 per cent from the first quarter of 2010.
It's interesting to note that Canadian indebtedness rose as interest rates came down steadily over the last ten years. And that begs the question: what will happen when interest rates start to rise again as many analysts believe they must?
In fact, speaking earlier in June, Carney warned that while he was holding the core bank rate at one per cent, it would rise from crisis lows at near zero to what many economists believe to be a more normal rate in the six-per-cent range.
That's where broader economic conditions come to bear on debt levels.
If interest rates jump, the impact will be immediate on floating-rate vehicles like lines of credit and variable-rate mortgages. For example, someone with a 3.5 per cent variable-rate mortgage can carry a $400,000 mortgage at around $2000 a month.
If interest rates climb, and the variable rate reaches six per cent, that same mortgage would jump to almost $2,600 a month.
The debt picture also gets complicated when you compare the growth in mortgages to annual wage gains. In its annual report, the Canadian Association of Accredited Mortgage Professionals said that over the last 15 years, the annual growth rate in mortgage debt has been around 7.5 per cent. And yet wages have been increasing at around 2.3 per cent a year.
Why is that important? Simply because if consumers are already stretched to keep up because of flat-lined wage increases that have barely matched the inflation rate, they have very little room in their budgets to accommodate rising costs triggered by a surge in interest rates.
Obviously loan delinquency and home foreclosures would increase. And if you add a job-killing recession to the mix, you have the onset of a perfect storm that could see an increasing number of Canadians fall into personal bankruptcy.
Perhaps that's why Finance Minister Jim Flaherty joined Carney in warning Canadians to cut back on debt. He certainly fears that the world could be faced with another recession, given the sluggishness of the global economy and the inability of the U.S. to get its fiscal house and economy in order. "I am quite worried," said Flaherty in an interview. "We have lived three-and-a-half years now since the credit crisis started in late August, 2007. We are seeing in Europe, in particular, some very difficult situations."
Fortunately, so far the Canadian economy shows little sign of weakness with the Bank of Canada predicting growth in the three-per-cent range for this year.
But with economic stimulus programs being withdrawn in the U.S. and Flaherty vowing to turn off the spending taps in Ottawa, growth could slow sharply as the country enters 2012. If it does, Canada's debt binge could make things even worse as consumers cut back on their spending to reduce their loan balances.
Only time will tell. But for now, Canadians seem determined to ignore the warnings and keep on borrowing.