January 2009

Canada Finds Itself In A “Credit Deadlock”

This just in from:Jacqueline Thorpe, Financial Post Published: Tuesday, January 20, 2009

What if the Bank of Canada cut interest rates and nobody borrowed? As the Bank of Canada joins other central banks around the world in slashing interest rates to historic lows, this is the essential conundrum they face.

They may have brought some semblance of normality to credit markets, and harangued banks back into lending, but now borrowers are on strike.

Call it a “credit deadlock,” as David Laidler, fellow-in-residence at the C.D. Howe Institute, does, or a shift from “aspirational to desperational” spending, as Goldman Sachs quipped Tuesday, but the fact is people are becoming less willing to borrow and spend, even if the Bank of Canada’s benchmark interest rate is now a tantalizing 1%, the lowest policy rate since the Bank of Canada was founded in 1934.

If consumers were getting antsy about spending as house prices and stock prices tanked, they are hardly going to start borrowing and spending if they are now also losing their jobs.

The United States is now well into this consumer deleveraging process as the unemployment rate has risen from a trough of 4.4% to 7.2% in the space of little over a year.

In Canada, the process has only just begun. For a while, it looked like we might be able to skate through the slowdown with just a flesh wound or two but the complete and total collapse in commodity prices has put paid to that notion, as news Tuesday showed.

Manufacturing shipments for November fell 6.4% to $48.4-billion in November as commodity prices plunged. Strip out the price declines and volumes were still down 3% and new orders plummeted 12.9% as U.S. demand froze.

Meanwhile, Suncor Energy Inc. reported its first quarterly loss in 15 years, chopped spending plans for the second time in less than three months, and indefinitely postponed its oil sands expansion plans as oil has cratered to US$39 per barrel from its peak of US$147 in the summer.

We may have a healthier financial system than our G7 colleagues but our G7 colleagues haven’t seen their golden goose vaporized in the space of six months.

That goose — all natural resources combined — accounted for all the growth in Canada’s export earnings from 2004 to 2008 (non-resource exports slumped 17% on the back of a strong dollar and a drop in auto sales) half the value of the S&P/TSX until the third quarter of 2008 (up from 20% in 2003); and half the growth in business investment from 2003 to 2006.

The goose has not been a big jobs or GDP generator on its own since it is so capital intensive, but the boost to national income from the longest and steepest commodity boom in the post-war period has been phenomenal, stoking profits and the Canadian dollar which have been recycled back to consumers in the form of tax cuts, lower import prices and higher disposal income. That in turn has boosted jobs and income growth all down the pipeline.

Canadians were not afraid to take on ever-increasing debt under this rosy scenario.

But it has all vanished now. A report from BMO Capital markets Tuesday said many commodities such as copper and zinc are now trading below their average operating costs, let alone their all-in costs.

As we wait for other sectors to pick up the slack, the job losses will mount and the opposite, negative dynamic will take hold.

That is not to say the rate cuts will have no impact at all. They will help the banks, which dutifully passed on the cuts through a drop in prime lending rates to 3% from 3.5%. Those with variable rate mortgages and lines of credit will benefit.

An FP colleague who renegotiated her mortgage in September says her mortgage rate — prime, minus 75 basis points — will fall to an astonishingly low 2.25%. But she is not about to go out and run up her line of credit. People in general will try to cut back their debt and shy from fresh borrowing.

And while the Bank of Canada forecasts growth will rebound to 3.8% in 2010 from a contraction of 1.2% this year, debt workouts are usually long and painful as anyone who has watched them in the corporate sector knows.

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