Get Ready For The Next Recession

August 1st, 2017 | J. Hodgson

Poloz said the bank would cut interest rates if President-elect Donald Trump’s policies put the bank’s inflation target at risk. “Should any of those downside risks materialize and put our inflation target at risk then we would have the room to manoeuvre,” Poloz said. “Yes, a rate cut remains on the table and it would remain on the table as long as those downside risks were still present.” ~ The Financial Post, Jan 18th, 2017

What a difference six months makes.

Now Stephen Poloz is raising interest rates and talking about raising them even more! This despite the fact that our inflation rate is only 1% and our economy can hardly be described as “hot” and despite encouraging first quarter growth (due mostly to the housing bubble).

So why the massive about face? Did the data really show that things have turned around in Canada so quickly? Or is something else going on?

As with most things in life, the likely explanation is that something else is indeed going on. A possible clue can be found over at The Greater Fool blog with a post from June 29. The theory is that Trump administration folks aren’t happy with Canada’s trade advantage due to our 75 cent dollar. This gives Canadian business a 25% cost advantage when doing business across the border. The rumour is that some back channel pressure was applied on Canadian officials. If we didn’t strengthen our dollar then NAFTA would be even more of a political hot potato than it already is. In other words, strengthen your currency or we come at you on trade like you won’t believe. The Liberals then extended this message to the Bank of Canada and suddenly the data started showing that, yes, perhaps the time is right to finally raise interest rates after all! Funny that!

Many people now might be saying, “Hey wait a minute! The Bank of Canada can’t be influenced by partisan acts independently of the government!”

Yeah. Sure it does.

I correctly wrote this article in 2014, published here at Poletical called, "Master Economist and Strategist", predicting that Stephen Harper would not raise interest rates before the next federal election. He went one better and lowered them...twice. It wasn’t enough to give Harper a 4th win unfortunately. There are always more elements at play during election campaigns than people realize and for Harper it was likely that voter’s desire for change for the sake of change was too much to overcome.

Which brings us to today.

The Liberal Party is in trouble. There are two years left until the next election and most of the time, elections are based on the economy. John Ibbitson wrote a good piece about this topic in the Globe and Mail and I spelled things out a little more dramatically with this article from November. The fact is Canada is due for a national recession. Alberta, Saskatchewan and Newfoundland have already been through the ringer over the past two years, but for the rest of the country the economy has been kind of okay. A full-blown recession isn’t unnatural and we usually don’t escape from having one for more than 10 years at a time. The last big one was 2008/09 and since then Canada has had a fairly tepid average GDP growth. (The “technical recession” of 2015 was simply a product of oil price decline and with later data collected, it’s unclear if that downturn can be considered a true recession at all) Any positive economic signs lately seem to be indications of bubbles or debt rather than real innovations in productivity or exports. Thus, the Liberal Party is in trouble, because the more time that passes before we experience a true recession, the closer we get to October 21, 2019...election day. No political party wants to campaign during a recession.

It’s very likely that the Liberals are comfortable strengthening the dollar even at the risk of pushing the economy into an orchestrated recession. The thinking is that short-term pain brings about long-term gain and you can get a recession over with before people are able to vote-punish you out of office. This decision will also buy credit with Trump and his administration, thus deleveraging the currency issue as a weapon during trade talks. By the time October 21, 2019 rolls around, most voters won’t remember much about what the economy was like two years ago and will vote based on what the economy is like in the moment.

For this reason, I think we are heading towards a made-in-Canada recession within the next 10 months.

Making future predictions is a fool’s errand of course, and obviously many things could change or occur over the next 10 months which nobody can predict, but current indications are pointing to a downturn on some level and it wouldn’t be reckless to take fiscally conservative steps to prepare yourself for what’s coming. Pay down debt, save some cash, keep on the look-out for side-gig opportunities...these sorts of endeavours should be a way of life anyway, but it wouldn’t hurt to double-down before the next downturn. Should I be wrong, then’ve saved some extra cash. Congratulations. If I’m right and there’s a storm on the horizon, then you’ll be glad to have taken a few extra precautions.