Canada's "Other" Problem: Record High Household Debt

Earlier today, the Bank of Canada surprised some market participants by failing to cut rates.

True, the loonie was plunging and another rate cut might very well have accelerated the decline, further eroding the purchasing power of Canadians who are already struggling to keep up with the inexorable rise in food prices, but there are other, more pressing concerns.

Like the fact that some analysts say the CAD should shoulder even more of the burden as Canada struggles to adjust to a world of sub-$30 crude. In short, if Stephen Poloz could manage to drive the loonie lower, the CAD-denominated price of WCS might stand a chance of remaining above the marginal cost of production. Barring that, the shut-ins will start and that means even more job losses in Canada’s oil patch, which shed some 100,000 total positions in 2015.

Alas, Poloz elected to stay put, characterizing the current state of monetary policy as “appropriate.”

We’re reasonably sure that assessment won’t hold once the layoffs pick up and as we noted earlier, the longer Poloz waits, the larger the next cut will ultimately have to be, which means that if the BOC waits too long, Poloz may have to rethink his contention that the effective lower bound is -0.50%.

While there are a laundry list of concerns when it comes to assessing the state of the Canadian economy and the impact of either higher rates (the loonie is supported but growth is further choked off) or lower rates (the economy gets a boost but consumer spending is stifled as Canadians watch their purchasing power evaporate), perhaps the most important thing to remember is that Canada is now the most leveraged country in the G7.

According to a new report from the Parliamentary Budget Officer (PBO) the household debt-to-income ratio is now a whopping 171% which means, for anyone who is confused, “that for every $100 in disposable income, households had debt obligations of $171.”

That’s the highest level in a quarter century and it means that when it comes to household leverage, no other advanced economy does it like Canada:

That would be bad enough in a favorable economic environment with a benign outlook for rates, but it's a veritable nightmare when the economy is sliding headlong into recession and central planners are hell bent on trying to normalize policy some time in the next five or so years.

Put simply, the more debt you have, the higher the cost of servicing your obligations and just about the last thing a grossly overleveraged economy needs is a wave of job losses and a severe economic downturn. Brazil is facing a similar dynamic. 

"Since 1991, household debt has increased each quarter, on average, by almost 7 per cent on a year-over-year basis, with the sharpest acceleration occurring over 2002 to 2008," the PBO says in the report. "In the third quarter of 2015, household debt amounted to $1.9 trillion."

"On its own, however, the debt-to-income ratio provides a limited measure of the financial vulnerability of households," the report continues, adding that "what matters more for financial vulnerability is not so much the level of the debt relative to income, but rather the capacity of households to meet their debt service obligations."

Correct, and on that measure, things have only been worse on one other occasion: during the crisis.


As Canada's depression worsens, expect overburdened households to simply fold up under the pressure. That's when the dominos start to fall in earnest as a cascade of foreclosures bursts the nation's housing bubble once and for all and as the world discovers how exposed Canada's banks are to the country's levered up families. "Concerns about financial vulnerability are particularly prominent in the current context given the recent economic weakness and the expectation that interest rates will rise in the coming years from their historically-low levels," the report concludes.

Of course if rates don't rise, that's probably even worse news for Canadian households because it will mean that the country is still mired in recession. 

We close with two passages, the first from Finance Canada's Update of Economic and Fiscal Projections and the second from the Bank of Canada's Financial System Review.

Canadian household debt levels also remain elevated relative to historical norms. While this is not a risk in and of itself, it does limit the contribution that consumption and residential investment can make to growth. Moreover, if there were a negative external shock to the economy, this could trigger deleveraging among those households holding higher levels of debt, leading to a commensurate impact on consumption and residential investment.


Household vulnerabilities could be exacerbated by a severe recession that is accompanied by a widespread and prolonged rise in unemployment. This could reduce the ability of households to service their debt and cause serious and broad-based declines in house prices.