Canada avoided much of the impact of the global financial crisis, especially with regards to its financial system. Canadian banks and regulators alike won praise from investors worldwide for following prudent, conservative policies with respect to risk management. While for many quarters the big five Canadian banks met or exceeded expectations, recently however Bank of Montreal (BMO) and Royal Bank (RY) reported disappointing earnings for the second quarter.
In the past, Americans used to save less than Canadians. But the phenomenon is changing. Nowadays due to de-leveraging the personal savings rate in the U.S. is higher than Canada as shown in the chart below:
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Source: The Boeckh Investment
From the latest edition of The Boeckh Investment report:
“While Canada has deservedly had a good ride in recent years particularly through the global recession, due to strong Federal Government finances and a strong balance sheet, all is not quite as rosy as meets the eye. Chart 16 shows that, while the U.S. savings rate has gone from 2% to 6.5% since 2007, the Canadian savings rate, after a brief rally, has collapsed to about 2 1/2%. Canadian households have continued to add to their debt, oblivious to the changed world environment. House prices rose to new highs during the recovery, while U.S. house prices are down over 30% from their peak. Moreover, while federal debt levels and trends are good by world standards, provincial debts are disastrous. There is even some talk of Ontario going the way of California. Its per capita public debt is ten times that of California whose bonds are rated slightly less risky than Croatia’s.”
Canadian household debt continued to increase in 2008 and 2009 while in the U.S. it decreased as shown in the table below:
Source: Where is the Money Now: The State of Canadian Household Debt as Conditions for Economic Recovery Emerge, The Certified General Accountants Association (CGA) of Canada
From the CGA study:
“A cross-country comparison of household debt in Canada and in the US may be a useful exercise for a number of reasons. Both countries have relatively high levels of per capita income and living standards, are located in geographical proximity to one another, and share close historical and commercial ties. Both countries have experienced similar rates of inflation in the past decade and exhibit great resemblance in demographic characteristics when it comes to aging population, levels of labour force participation, and high reliance on immigration.
Similar to the situation in Canada, US households have been rapidly increasing their indebtedness in the past two decades with total household debt outgrowing consumer spending and disposable income. However, during the most recent recessionary period, some noticeable differences emerged in the debt dynamic of Canada and the US. Specifically, in Canada, mortgages and particularly consumer credit continued to expand in 2008 and 2009 at annual rates very similar to those seen prior to the economic downturn. In contrast, the US saw brisk contraction in both components of household debt (Table 2). In turn, a dramatic drop in interest rates that occurred in both Canada and the US at the end of 2008 did not much alter the household debt-service burden in either country, leaving it at approximately the same level in 2009 as it stood in 2006.”
It must be noted however that difference in the debt-service ratios between U.S. and Canada is large because of the methodology used to calculate the figures. In the U.S. mortgage interest paid is tax deductible but that is not allowed in Canada. This creates an incentive for borrowing in the U.S.
Overall, while on the surface Canada appears to be much stronger than the U.S., in reality it is not. Unlike the U.S., Canada is still a commodity-based economy and it is heavily dependent on trade with the U.S. Should the housing market in Canada collapse and the U.S. economy enter another recession, Canadian economic strength will be tested significantly.