Hurricane – a powerful storm system characterized by thunderstorms, strong winds and heavy rain. The “Eye of the Hurricane” is an area in the middle of the hurricane that is abnormally calm and free of clouds that is surrounded by an “eye wall” of thunderstorms producing the strongest winds and heaviest precipitation.

     We are in the calm of the eye of the largest economic hurricane the world has ever seen. As the storm moves on we will run into the strong wind and rain of the eye wall when the back of the hurricane hits us. Typically, the back does more damage because the front of the storm will have weakened structures allowing the back of the storm to complete its destruction.

     In an economic hurricane, the front of the storm weakens confidence, increases fear, drains treasuries, decreases tax revenues, destroys jobs and leaves us vulnerable to the destruction that will be caused by the rest of the storm. There is no recovery. Brace yourself; the damage that will be caused by the back half of this economic hurricane will be far worse than the front. 

More Canadian Commentary

     Some people have asked for more commentary on the Canadian situation so, thanks to Garth Turner’s articles and his latest book “The Money Road” as well as Macleans magazine, The Globe and Mail and several other sources, I will add more information on the Canadian economic situation. However, I will still update the American story because what happens down there does NOT stay there and inevitably affects (infects?) us also. I’ll also update the global situation such as the European sovereign debt crisis and the Chinese bubble. Canada does not exist in a vacuum. It is greatly affected by the entire global economy. 

The American Economy

     First, let’s update the U.S. situation. The spin and propaganda has reached epic proportions. America’s leaders are proclaiming that the recovery is underway. 

     Let’s look at the numbers. The headlines reported that U.S. GDP grew 5.7% on an annualized basis in the 4^th quarter. If true, this is very healthy growth although typically growth coming out of a recession is usually much higher at 7 to 8%. The key phrase is “on an annualized basis.” This means a low quarterly growth of 1.4% is multiplied by 4 to extrapolate a full year. There’s considerable wishful thinking going on here ( I did mention spin and propaganda, didn’t I?) 

    Let’s dig a little deeper beneath the spin with my thanks to David Rosenberg, Chief Economist & Strategist of Gluskin Sheff for graciously including me on the daily newsletter of Canada’s pre-eminent wealth management firm that focuses on high net worth individuals (for which I would qualify as a fly-on-the-wall.) They ran simulations that showed that without the U.S. government’s massive fiscal and monetary stimulus, the 5.7% 4^th quarter growth would instead have been – 1.5% (yes, negative growth) and the full year instead of a – 2.4% would have been – 4% (yes, both negative.)    – David A Rosenberg, Economic Commentary, Feb. 4, 2010

     Now consider that the U.S. Fed has almost tripled the money supply, almost doubled the annual deficit with spending programs, bought more than a trillion dollars of questionable mortgage backed securities and increased national debt to 84% of GDP (and climbing fast.)  Even with all this money thrown at the problem, GDP growth is still negative. No recovery there, sorry folks, move along, there’s nothing to see.

American Unemployment

     Is the U.S. employment situation improving? The lame stream media says it is. However, this does not bear up under closer scrutiny (I know you’re surprised at this.) 

      Below is Chart of the Day and commentary for January  U.S. unemployment 

“Today, the [U.S.] Labor Department reported that nonfarm payrolls (jobs) decreased by 20,000 in January. Today’s chart puts that decline into perspective by comparing job losses following the beginning of the current economic recession (solid red line) to that of the last recession (dashed gold line) and the average recession from 1950-1999 (dashed blue line). As today’s chart illustrates, the current job market has suffered losses that are more than triple as much as what occurs at the lows of the average recession/job loss cycle. It is also worth noting that 25 months after an average recession/job loss cycle began during the second half of the 20th century, the job market recouped all losses and was already in process of adding new jobs. At the same 25 month mark during the 21st century, the job market was still suffering losses.”

     However, as I’ve said in previous commentaries, this is not a normal recession; this is the beginning of a depression. Notice in the above chart, that each downturn gets progressively worse. The blue line is the average of recessions from 1950 to 1999. The gold line is 2001 to 2006 and the red line is where we are today. 

     Furthermore, buried in the fine print is this startling statistic. These January numbers include 427,000 fictitious jobs “created” by the birth/death model. You may remember from previous commentary that the Bureau of Labor Statistics (BLS) cannot poll every new business so they estimate jobs created by the birth of new businesses minus the estimated jobs lost by businesses going out of business. Given the present economic climate, how the BLS can justify the creation of so many jobs (in one month) is beyond comprehension. Their justification is that the numbers are revised on subsequent reports. In the fine print of course, where the main scream press doesn’t pick it up. For instance, March, 2009 were revised downwards by 930,000 and the total for 2009 by 1.3 million. Some recovery!  – John Mauldin’s “Thoughts from the Frontline” A Bubble in Search of a Pin, Feb. 5, 2009 

      Keep in mind when looking at U.S. unemployment numbers that the U.S. needs about 100,000 NEW JOBS A MONTH just to keep pace with immigration, graduations and population growth. So even if they produced 99,000 new jobs a month, U.S. employment would still be shrinking.

     Here’s another perspective from David Rosenberg. The current U.S. level of employment of 129.5 million is the same as it was in 1999 but the U.S. working-age population has risen by 29 million. In other words there are 29 million more Americans competing for the same number of jobs there were more than a decade ago. Some recovery!

A Chinese Bubble?

     There seems to be a lot of hope pinned on China somehow rescuing the world economy. Yes, China is on track to overtake Japan as the world’s second largest economy (second to the U.S.) However, China represents only about 8% of the global economy (GDP – Gross Domestic Product.) Here’s Equedia’s concerns about the results of China’s recent massive stimulus.

 “China’s impact has already begun to affect their neighbours. The pace of Real Estate prices are now rising the fastest in 18 months. In Shenzhen, southern China’s manufacturing hub, property prices have surged 19 per cent from last year.

The price of water, food, and tea are all soaring with their main stock market leading the way, surging 80 per cent last year.

Home prices both in Hong Kong and Singapore are flying. Revived demand and rising house prices in Australia are sending interest rates higher. Meanwhile, ballooning prices for items such as rice and potatoes in India nudged its inflation rate to a one-year high of 7.3 per cent last month.”  – Equedia Weekly, Jan. 24, 2009

 PIIGS Collapsing

     Several countries on the periphery of Europe – Portugal. Italy, Ireland Greece and Spain (known as PIIGS) are in danger of collapsing from too much debt. Iceland is the most recent example of a failed economic system but Iceland is tiny compared to any of the PIIGS all of whom are in the EMU the European Monetary Union. Major European countries such as Germany and France are reluctant to bail out any one because the rest would then be lined up with their begging bowls. The nature of the European Union makes it difficult for the IMF to bail them out. What to do? 

     China has distanced itself from this mess knowing it’s a no-win situation. America is actually in worse shape. 36 out of U.S. 50 states are financially insolvent but the U.S. because of its size and reserve currency has a “get-out-of-jail-free” card for the moment, at least until the contagion starts in Europe. Don’t forget, the last Great Depression started in the U.S., spread to Europe and then a failed European bank drove the contagion back to the U.S. 

     The next few weeks will be critical. Major players like Germany or France may step up to the plate at the last minute but all that will do is start a chain reaction with no end in sight. It’s notable that all the PIIGS are socialist states. This proves once again the validity of the Austrian School of Economics’ principle that every action has consequences (“There ain’t no free lunch.”) Or, as Margaret Thatcher once quipped, “Socialism works until you run out of other people’s money.”

Canada “Awash in a Sea of Debt”

    That’s the title to Macleans magazine (Feb. 8, 2010) recent article by-lined “Rebuilding the Middle Class.” That’s an interesting byline as the Canadian middle class hasn’t crashed yet. The obvious implication is “it will.” 

     In Canada, over the last two years, residential mortgage debt load has increased 18%.Over the last 10 years, mortgage and consumer debt has more than doubled and in the last 20 years, mortgage debt alone has quadrupled. Shucks, if the Americans can implode their real estate market, so can we.

     Canadians are not immune to self-deception. Granted, our banks are healthier, our mortgage rules tighter and our regulators more adept then the clowns running the U.S. Treasury and Fed. “But most of all we’ve convinced ourselves we’re a nation of prudent savers and responsible borrowers.” Unfortunately, this is ancient history. In terms of household debt to GDP we are neck-in-neck with Americans except Americans are paying down their debt while we’re still piling it on. “Canada is virtually the only country where households have taken on more debt during this recession.” Since the early 1990s, Canadian lines of credit have exploded by 4,800% – yes, that’s 48 times as much. How prudent is that? 

     Scotiabank says Canadian house prices need to come down at least 10%. David Rosenberg of Gluskin Sheff says it’s more like 15% to 35% depending on location.

     Low mortgage rates are another ticking time bomb. Rates are at a once-in-a-lifetime low point with nowhere to go but up. 40% of first time home buyers have variable rate mortgages while another 10% chose one year mortgages. In other words, half of all new mortgages are exposed to rate changes which are expected to start increasing within a year. Increases of 2% to 4% will be enough to put these homeowners under water. Central banks no longer have the rate-setting clout they once had. Rates are now driven by the markets and the markets are very skittish which is why they’re running away from the European PIIGS unless they get higher rates.

     Yes, our banks are better capitalized than the American’s so our banks probably won’t blow up like those south of our border. That’s good news for the banks but bad news for households because Canadian bankruptcy laws make it far harder for Canadians to walk away from their obligations. And therein lies the danger for the rest of us. When our housing market collapses, and Canadians start dragging themselves out of debt, they won’t be spending, buying cars, renovating the kitchen and driving the recovery anymore. So, our economy will go for a shit. 

“NO BUBBLE, EH?”

“Toronto, the largest housing market in Canada, started the year off with a bang, with existing home sales jumping 87% year-over-year from last January (albeit from a very depressed level). Median home prices climbed 15% YoY and average prices saw an even bigger 20% jump to nearly $410,000. Inventories of active listing declined 41% YoY and homes sold more quickly (average of 28 days versus 49 days last January).”

“The national housing market has also seen a rebound in recent months and has gotten the attention of government officials (although most say we are not in a bubble — shades of the U.S. denial circa 2005-06).”  – David Rosenberg – Gluskin Sheff, Feb. 4, 2010

“Inquiring minds are reviewing the results of the 6th Annual Demographia International Housing Affordability Survey. Countries in the survey include Australia, Canada, Ireland, New Zealand, the United Kingdom, and the United States.

The article shows the top 58, I captured the top 20 above.

Congratulations To Canada And Australia

Congratulations go to Vancouver, Canada for being the least affordable city in the survey. Vancouver thus wins the gold medal in the individual competition.

Sydney Australia proudly wins the Silver medal and the Sunshine Coast Australia wins the bronze. It was close but no cigar for Australia’s Gold Coast. Honolulu Hawaii came in a respectable fifth place.

[Gerold note: tied at 20^th for cheapest is Windsor and Thunder Bay.]

– Mish Shedlock Least and Most Affordable Housing in the World…  Feb. 1, 2010 

     Saturday’s Globe and Mail’s headline “Big Six banks urge Ottawa to tighten mortgage rules.” Shades of American history! It’s too late boys! The horse is out of the barn, ran away, starved, died, eaten by the dogs, shat out, dried up and blown away with the wind. If they had sounded the warning before 50% of new mortgagees put their heads in the guillotine it might have made a difference.

    But don’t take my word for it. Read Garth Turner below.

Garth Turner’s Canadian Perspective

     I won’t paraphrse Garth Turner’s commentary as he does an excellent job of getting his message across. I highly recommend http://www.greaterfool.ca/  and http://shop.xurbia.ca/

     Below are direct quotes from several of his recent articles. After that, I’ve re-printed several of his recent articles. You’ll notice he is very concerned with Canadian’s lack of financial diversification. Canadians have a disproportionately large amount of assets tied up in real estate. He says, and I agree, that this is a recipe for disaster. In previous commentary I warned that the Canadian real estate market will collapse as millions of Boomers retire, downsize their homes by putting their McMansions up for sale to buy smaller homes or condos or rent or move into nursing homes. Who is going to buy all these homes? They haven’t repealed the law of supply and demand. When a lot of homes are put on the market, prices plummet. Just look at the U.S.

He says “seven in ten [Canadian] Boomers have no pension while six in ten have no retirement savings. But they do have real estate – sometimes way too much of it, and often including the family cottage. As this nine-million-strong cohort starts turning 65 next year, the waves crashing through cottage country will not just be on the lake.”  – Garth Turner “Go Fish” 1-18-10

“But how so many people can believe the price of an asset will rise endlessly is hard to understand. How Canadians, by the millions, can be so sure they’re immune from what happened to the south, for the same reasons, in the country which most mirrors ours, mystifies.

The reason, I guess, is they want to believe it. Just like Bre-X stock would go to $10,000 or dot-coms would make every dad with a E-Trade account a millionaire…

… All booms end badly. All bubbles deflate. All pendulums overshoot. And everyone thinks it’s different this time – especially when the whole damn establishment is telling you so.” – Garth Turner “Trust” 1-21-10

“My advice is what you’d imagine: Sell [real estate] now and reap, or wait a couple of years and weep…

… Ahead of us lies a sea of uncertainty as governments ramp back spending, interest rates and taxes rise and the house-hugging Boomers realize they’re financially skewered. This is a drum I’ll keep beating as long as people are listening, because the Numero Uno money mistake being made by most Canadians now is a serious lack of diversification.

Here’s the rule: Strive to have no more than 40% of your total net worth in your house. Especially if you’re over 50. If you don’t make that cut-off, then you damn well better sit down and understand why.

… If the value of your houses rises and constitutes the bulk of your net worth, then it’s time to rebalance the portfolio. Remove some equity to reduce the real estate exposure and diversify into other assets – bonds, stocks, commodities, [segregated] funds, whatever. That way you’re reducing risk which, given current events, is a genius move.

How to remove equity? (I was asked that question last night.)

There are a few ways: Sell and downsize. Sell and rent. Sell and lease back. Use a home equity loan and get a tax-deductible borrowing. Move to Windsor. Just don’t get a reverse mortgage (unless you hate your children).”  – Garth Turner “The Rule” 1-22-10

“In Vancouver and the Lower Mainland right now, not being a real estate crackhead is weird. Thinking people who pay $900,000 for an unrenovated schleppy Fifties bung in a dodgy area are delusional is weird. Not succumbing to the pressure of helicopter parents and nesting spouses to throw yourself into a pit of mortgage debt for your entire adult life is weird.

As I told folks, the world is now a volatile and unpredictable place. Just as the Vandroids will discover when the Olympic idiocy ends, so Canadians in total will soon see what the legacy is of the past 10 months. The March 4th federal budget will mark the beginning of a new austerity program. Interest rates start heading north four months later. The HST nails 16 million people on Canada Day. Every single provincial government is mired in deficit with only two ways to get out – spend less and tax more.

The BC real estate orgy is the greatest example of a denial which stalks the land and makes people do things that are, well, weird. In a time of recession and falling incomes, they borrow and buy. While the memory of a near-meltdown of the financial system is still fresh, they jump into bidding wars and fist fights over condos. After a crisis caused by too much debt, they plunge into record amounts of it.

And, above all, when assets like houses hit their highest value point ever, they line up to buy – just months after dumping other assets, like stocks, when they hit low tide. Apparently normal in this country is doing what your friends are doing. It’s wanting what others want, when they want it, because they want it, and paying too much because of it. Normal is selling stuff when it gets cheap, and buying stuff when it’s dear. It’s believing that what’s happening today will happen each day forever. Normal is fearing risk, yet walking into its embrace.”  – Garth Turner “Weird” 1-23-10

      Here’s his suggestion to put your own mortgage inside your own RRSP. I’ve never heard of this but if you’re a homeowner (I rent) you might want to investigate this further.

“Jacquie and Len live in BC and read here a few weeks ago about how it’s possible to put your own mortgage inside your own RRSP, thereby making payments into your retirement plan instead of a bank’s coffers. I laid out the process for making this happen, and the reasons it’s worth exploring.

Jacquie contacted her financial advisor, the guy who sold them the mutual funds their RRSP now holds. He works for a national firm you’ve all heard of. Bad idea, he said. Besides, we don’t do it so you’re out of luck.

To ‘prove’ his argument he attached an article written for BC Business before his recent death by a guy billed as a ‘vice president and investment advisor with CIBC Wood Gundy, a division of CIBC World Markets Inc.’ Impressive.  But misleading.

The banker disses an RRSP mortgage because it takes some effort to set up (legals and appraisal). Fair enough, just like a regular mortgage. But then he claims if you were ever to stop making mortgage payments to your savings plan, “your RRSP must ultimately foreclose and sell the property to get its money back.”

Actually an RRSP mortgage requires CHMC insurance, which protects your RRSP if you don’t pay. Then the taxpayers pony up. But nice try.

The article also says an RRSP makes no sense because you have to charge yourself a rate no lower than the banks charge (so what’s the point?), and this…

“…moves us to the heart of why it doesn’t make sense to have your mortgage in your RRSP. The problem is that you and your RRSP have completely different goals. Your goal as a borrower is to pay the lowest possible interest rate. Your RRSP’s goal is to get the highest return possible. Those two goal sets simply cannot be reconciled if you are on both sides of the transaction as the payer of the mortgage and the owner of the RRSP.

“So what do you end up with if you hold your own mortgage in your RRSP? No flexibility, no rate breaks, no payment concessions. Just a mortgage that costs somewhat more to setup and maintain than a regular mortgage, and an RRSP investment that pays a very small return.”

If bankers understood an RRSP mortgage as I explain it in the book, they’d know it’s in your favour to have as high a mortgage rate as possible, so you shovel big payments into your RRSP – enough to exceed the annual contribution limits (the only way of doing so legally). They’d also understand (and likely do) if you gave yourself a 6% mortgage, you’d be earning 300% more than banks currently pay on the GICs they recommend for RRSPs.

They’d know holding a mortgage on your own home is a stable, secure, no-surprises way for your retirement plan to realize a pile of money, and also that you’re able to give yourself a fixed or variable rate, prepayment options, monthly or weekly payments and any other features currently available from the banks. But most important, they would know (and do) this is all about achieving financial security and independence, without incurring debt or lining someone’s pocket.

Now, this move ain’t for everybody. Far from it.

It costs money to set up. It’s unconventional and takes courage. And it requires the help of an advisor who cares more about his clients than his next Mercedes.

If yours is incapable or unwilling, it’s time to roll.” 

– Garth Turner “On Advice” Jan. 31, 2010

Garth Turner  – February 4th, 2010

Is there a nasty surprise waiting for real estate investors? You bet.

Eight years ago Toronto was short $72 million. Last year the gap was $447 million. Thus year it will be $700 million. In nine years it will be at least $1.2 billion. To balance the books then would take a property tax hike of 37%.

Welcome to the next decade, kids.

Ontario is short $24 billion this year. BC about $3 billion. Alberta over $4 billion. In fact every province in Canada’s in the red.

The feds, of course, are short $56 billion. When you add up the money all governments are spending this year that they don’t have – which I figure is just a little under $100 billion – you get an idea of what’s coming. And it’s inevitable: (a) honking big tax increases, and (b) huge spending cuts.

The tax increases will be in the form of the HST (provincial), a higher GST (federal) and property taxes (local). That’s for starters – over the next three years. After that, you should expect the age at which CPP is paid to increase to match that in the States (67), the RRSP tax deduction to become a credit (cutting the benefit by up to half), health care premiums to creep across Canada and a surtax on ‘high income’ Canadians (over $100,000).

The spending cuts will be insidious. Already BC is closing schools and shutting down emergency response units. Toronto charges people to own cars and put out their garbage while it’s also phasing out schools and pools.

And how long before we get to this state?

COLORADO SPRINGS — This tax-averse city is about to learn what it looks and feels like when budget cuts slash services most Americans consider part of the urban fabric. More than a third of the streetlights in Colorado Springs will go dark Monday. The police helicopters are for sale on the Internet. The city is dumping firefighting jobs, a vice team, burglary investigators, beat cops — dozens of police and fire positions will go unfilled. 

The parks department removed trash cans last week, replacing them with signs urging users to pack out their own litter. Neighbors are encouraged to bring their own lawn mowers to local green spaces, because parks workers will mow them only once every two weeks. If that. Water cutbacks mean most parks will be dead, brown turf by July; the flower and fertilizer budget is zero. 

City recreation centers, indoor and outdoor pools, and a handful of museums will close for good March 31 unless they find private funding to stay open. Buses no longer run on evenings and weekends. 

Could this be the scene in Canada in five years? Ten? After all, it may come down to a choice between endlessly increasing taxes, or governments simply living within their means.

Personally, I see no alternative. Governments country saved nothing, let infrastructure crumble and were totally unprepared for an economic meltdown we were talking about on this blog a year before it happened. In merely 10 months, Ottawa has driven taxpayers into debt faster than during the Great Depression or either of the World Wars. The consequences will be with us for a long time.

So, what to do?

First, avoid taxes. Stuff money into RRSPs and collect the massive deduction that does along with that. Slide all your investment assets inside the shelter of a TFSA so you avoid paying any more. Make your mortgage tax-deductible by selling assets, paying off the home loan, then reborrowing to buy the portfolio back. Stop collecting interest and start paying 80% less tax with the same amount of dividend income. Create a tax-free pension using universal life. Use the homebuyer’s plan to leverage up a downpayment with tax money. Income split with your kids and recycle capital gains to them with a tax-free savings account. Use leverage to get money out of a RRIF free of tax.

All of those strategies are in my latest book, and if you don’t know how they work, find out.

Second, prepare for a property tax storm and a service drought. The worst may be a few years away, but that makes it no less inevitable. Pay close attention to the taxes on any real estate you consider buying, then ask yourself if you could afford to pay 50% more. Also realize what that might do to property values, especially in cities where homeowners are already nailed.

Finally, in keeping with the squirrel-loving, contrarian, coonhound -‘n-ammo nature of this blog, imagine living in a place with a third fewer cops and first responders, restricted public transit, dead parks and rarely-spotted snowplows or police cruisers. In that kind of world, where would you want to be?

Yeah, I know. The bunker.

Good luck with the razor wire.

Garth Turner     February 5th, 2010

Real estate’s a fundamental part of net worth. You should have some.

I have not been propertyless since I was twenty. Probably never will. But I made the decision long ago, having been through real estate booms and busts, the bulk of my net worth would always be elsewhere.

It’s this one tenet of personal finance which has saved me. Instead of buying high, I bought modest. Rather than pile on debt, I scrambled out of it. I sold routinely to take profits and never put them back into real estate. And I don’t have granite countertops in the bunker (pictured above).

But that’s me. I’m unconventional. Liquidity turns me on.

I mention this because most people are so screwed. And real estate has done it. Ever-higher prices have been trumped only by ever-higher expectations. Cheap money for some time has made modest people feel wealthy. Children buy first homes nicer than their parents’ final ones. Consumption replaces wisdom, and HGTV becomes the news.

Debt seems immaterial since so young buyers know they’ll never actually pay it back. All that matters is the carrying cost. The mortgage that was there upon purchase will still be there when it’s sold. You just pray the market keeps rising, and rates behave. But those times are ending.

I thought of this in light of a new survey – one of the many done this time of year by banks. On one hand they pimp us with bushels of near-free money, on the other they guilt us for owning much and possessing little.

This report is clear and stark. Twenty per cent of people are counting on an inheritance or a lottery win to retire. Over 90% are afraid of retirement. Over 50% of those working fear they have e saved too little. And 60% of those under 35 basically have nothing.

I could go on. Seventy per cent of us have no pension. Six in ten have enough in an RRSP to last two years. Millions will be spending a decade or two living on CPP. Max $17,000 a year.

At the same time, close to 70% of Canadian families own real estate, making us one of the most house-hugging nations on earth. We’ve made the collective decision to plow most of our net worth into bricks and dirt, having swallowed the Kool-Aid that values will always rise.

But nothing rises endlessly. All booms end badly, and every bubble bursts. Given the historic debt now gripping each nation, all levels of government and virtually every household, such a path is a dangerous one. Like I said, real estate’s an important asset and most of us should have some. But it is not a substitute for real wealth – the kind you can use for gas, food and your ISP bill.

What’s my point?

Simple. It’s time to take profits. Put them elsewhere.

Live beneath your means. And above fear.

Disclaimer: I’m not an investment advisor and these articles are for commentary only. For specific advice you should consult your own investment professional.

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