When an article was released by the Canadian Press last Wednesday advising us plebs what to do in the face of a meagre 0.25% rise in interest rates, one has to wonder how bad the economic situation really is in Canada under the debt-driven facade.
TORONTO — Many consumers will soon find their debt loads heavier now that Canada’s central bank and the country’s biggest commercial lenders have raised their benchmark rates by one-quarter percentage point.
The country’s biggest banks raised their prime rates after the Bank of Canada hiked its overnight lending rate Wednesday by a quarter of a percentage point to 1.25 per cent.
It’s a challenge for Canadians still struggling to cope with the record amounts of consumer debt they amassed after the 2008 financial crisis because lenders use their prime rate as a benchmark for setting some other short-term rates including variable-rate mortgages and lines of credit. A hike is good news for savers as the prime rate also affects interest rates for savings accounts.
Tracing back to first principles, the idea of taking a personal loan is to invest in oneself, to apply one’s own skills and labour and generate wealth through production, resources and efficient use of capital. If capital is missing from that equation, the loan temporarily provides that to get the engine rolling, and once it does the debt can be repaid in a timely manner.
Interest rates are set by the market based on the demand for capital and the potential for its growth from its borrowers. When there is doubt of growth, interest rates will rise. Lenders will be more hesitant to risk loaning their capital if the promise of getting repaid is bleak. In other words, to incentivize the issuance of debt, there will be a higher rate of return. Simultaneously, it disincentivizes those with no growth prospects from frivolously taking out loans.
If you think about how the housing market has been rising in Canada due to low interest rates, and then the Canadian Press article pops out indicating a rising rate while suggesting how much of a burden an added 0.25% is, we can extrapolate this to our first principles and deduce how bad the economic situation really is in Canada. The pop from this housing bubble will be deafening.
The rising interest rate suggests that money is too cheap. After years or perhaps decades of artificial suppression via the central banks buying up bonds through monetary expansion, it has finally reached the point where the interest rate is now catching up with the market, because the market deems the issuance of loans too risky with respect to the rates of return. In a normal, free market, this would simply indicate that the demand has been met and growth potential has been realized and interest rates would stabilize to reflect the harmony between growth prospects and risk.
In a Keynesian driven market, instead what has happened is wasteful spending of decades of future earnings right now, with no plan to figure out how to make all that money back to repay the loans. Theoretically we were supposed to spur current demand by moving the money of the future to today. In reality, we simply moved that future money around in zero-sum games (primarily housing in Canada), and the winners are taking all that future money and exiting the markets since there was and will be no incentive to produce. A lot of wealth is being accumulated at the expense of others in speculative bubbles. This deprives industries the future capital intended as stimulus, stunting growth of the economy for decades to come.
This is why the majority of Canadians are freaking out over a quarter-percent interest rate rise. They are the current and future losers of this zero-sum game, having spent decades of future earnings right now, not experiencing the necessary wage growth to repay their mortgages at 1.25%.
The majority of homeowners are depending on the value of their house rising forever, which was wholly caused by artificial stimulus. They were never banking on investing that money into themselves, as loans were principally designed to do, to improve on their skills or to acquire resources that aid in increasing their productive capacity.
This is also why the theoretical market-set interest rate is likely much higher than the actual rate. In reality, there is little faith in Canadians to make up the loaned money through traditional, productive means. This will feed into a nasty loop where faith dwindles more causing rates to rise, which adds debt pressure on Canadians, which further exposes how unlikely Canadians are capable of repayment, which increases lending risk causing rates to rise, which adds debt pressure, and so on.
What we see now is that cycle of debt at the personal level to keep homeowners afloat, much like how at the national and international level, new debt is being drawn to pay off old debt. Sitting on jumbo mortgages, Canadians are relying on HELOCs to pay off credit cards, and they are relying on credit cards to pay for necessities. When everyone is living their own personal Ponzi scheme, it will certainly not end well.
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