Finance Minister Flaherty: Slow Down Spending Borrowed Money

Handswallet400I think this is a very challenging time to be in government.  In 2011 many of us are looking for better economic times ahead.  We had gone through the terrible time of economic meltdown of 2008 and since then have been treading water in our collective attempt to get our economic mojo back.  Earlier today federal finance Minister Jim Flaherty took steps to limit the amount of debt Canadians could carry.  He’s worried that higher interest rates will catch many Canadians short.  It seems in our attempt to live better, many of us have an insatiable appetite to borrow more money.

What Mr. Flaherty did was unveil new rules to cut the maximum amortization period to 30 years for government backed insured mortgages with loan to value ratios of more than 80%.  He also cut the amount Canadians could borrow in refinancing mortgages to 85% from 90% of the value of their homes.  He also withdrew the Canada mortgage and housing Corporation insurance on home equity lines of credit.  The debt to disposable income now stands at a huge 148% for Canadians; so many could be caught in an interest rate environment that goes higher.

Of course I am not privy to any Cabinet conversations between ministers or with the Bank of Canada.  However, I could just imagine the conversations about the federal government securing home lines of credit, which would be used for buying all kinds of luxury items.  There is a generation of Canadians who don’t know what it’s like to pay high interest rates.  Mr. Flaherty’s rule changes today are at least one attempt to give them a wake-up call.

Being in government now means having those conversations.  If we’d lived in the never never land of thinking that interest rates would never rise again we could just borrow incessantly as long as we could service the debt.  Finance Minister Jim Flaherty knows that there is an ebb and flow to economic cycles and eventually we would be caught.  What may make news in the next economic cycle is inflationary pressure on some of the very core basic items that families use.

Is no secret to me as an agricultural economist that the world is sitting on the precipice of what may be a food disaster?  At the present time we are using far more grain than we are producing.  Ending stocks for corn and wheat and soybeans are decreasing substantially and if the trend is not reversed there will be widespread food riots throughout the Third World.  Yes, it is true that we have been here before and always pulled back from the abyss.  What is different this time around is that consumption at least up to this point has seen no signs of decreasing.  So in 2011, there is a real chance we will see some major food inflation.

For many Canadians this will be like a fly on a windshield.  For instance Canadians spend about 16% of their disposable income on food and this has not changed in quite some time. However, in parts of the Third World food costs take up a large part of disposable income.  It just so happens that this year there’s a huge possibility of that and if it gets bad enough it will affect Canadians propensity to spend on food. Somewhere in the back of the cabinet room I’m sure there are some briefing notes about that.

There is also a double-edged sword to the run-up in commodity prices for Canada.  You can make an argument that this run up in commodity prices is good for us almost on every level.  There are lots of us who are employed in the commodity business here in Canada.  So as commodities go, so goes our income, which is a net positive for Canada.  It would be the same thing for food commodities except for the fact that everybody needs to eat and not everybody necessarily needs copper and iron ore.   Governments get a bit nervous when food staples have some price pressure.

At the same time that this is happening, our urban media is starting to fill their pages with rumours of a pending election. Democracy always gets messy when we mix tough economic decisions like this with the optics of being reelected. You can bet that the Prime Minister is walking the tight rope of making the right decision versus orchestrating the defeat of his own minority government.

So I will be watching the Bank of Canada closely to see if they raise interest rates in the short-term.  It would not surprise me.  It’s pretty clear our leaders want us to spend less borrowed money.  They are giving us a wake-up call.  We need to listen.