Sunday, February 1, 2009

Economy Hanging by a Low Interest Rate Thread

Concern over the economy is likely to dominate the thoughts of Canadians for at least the next year. And well it should considering the average Canadian is carrying about $30,000 in personal debt according to Statistics Canada, and that includes children. Put another way that equates to household debt of about $150,000 for a family of 5. And with that being an average it means many people are carrying substantially more.

Money fortunately is cheap right now, as it has been for the better part of the past 2 decades. In fact a large part of the reason Paul Martin and the Liberals were able to eliminate the annual federal deficit is due to this on-going climate of low interest rates. But how long can rates remain low?

A scary indication in available HERE. CIBC rates for their Tax Free Savings Accounts go from 2% in year one to 8% in year five. If the banks are committing to paying 8% interest in the 5th year of a TFSA GIC, well you can expect that the interest they'll be charging to borrowers will be at least a couple of points higher. Imagine what will happen to many Canadians who see their mortgage payments double and triple over the next 5 years.

Canadians used to be savers, but no longer. In fact the average saving rate for Canadians was somewhere around just 1% in 2007 according to StasCan. There are many Canadians who now actually spend more than they earn, that is to say that for every $100 earned some are spending $101 or more.
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What effect will this have on our economy?

We've already seen the fallout in the US sub-prime mortgage market. Consumers were able to take out mortgages at incredibly low interest rates, including people whose credit histories would have normally seen them declined for even a credit card. When the introductory low interest rate period expired, and rates were jacked up...people began to walk away from their homes. This kicked the tar out of real estate values in the US, which were already incredibly inflated by all the buying going on due to these shady lending practices. Now as the economy worsens everyone is feeling the pinch as housing values plummet amid fears of job loss.

We're hearing from almost every level of government that Canadians need to get out and spend money. At the same time our Federal Government is doing all it can to ensure that we have access to cheap credit. But is this a good idea? Should Canadians be heading into debt to help keep the economy afloat with the spectre of double digit borrowing costs heading our way in the not too distant future?

The Conservatives are plunging this nation into massive debt, projected at over $100 billion over the next five years...and more if the economy doesn't perform up to expectations. They're cutting taxes, hoping that those lucky enough to avoid unemployment will keep the economy rolling.

If things look bleak now, they'll be far worse if interest rates start climbing substantially...and given the direction the banks are moving its hard to avoid that conclusion. Rather than spending Canadians in my opinion need to start saving, and big. Those that do will be far better equipped to handle an environment of high interest rates than those that kept bellying up to the cheap credit bar. There's a hangover coming that no aspirin will ever cure for those that over indulge.

If you're looking for some ideas on ways to economize I posted some strategies back on December 8th, 2008: Surviving The Coming Financial Storm.....

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