More Downside for the Canadian Dollar
As a resource-based economy, Canada was devastated by last year’s commodity slump. The CAD to USD exchange rate plunged in tandem with the price of oil, but a housing bubble saved the currency from a full-blown crash.
Unfortunately, that housing bubble is about to burst.
Most Canadians are aware that Vancouver and Toronto have inflated real estate prices. After all, without those two hotspots, national home prices actually fell 0.3% in 2015.
That’s right, Canadian home prices would have dropped last year if it wasn’t for Toronto and Vancouver—two fragile threads holding together an entire economy. (Source: “Canadian home sales set record in April,” Canadian Real Estate Association, May 16, 2016.)
I have written time and again that it was a disaster in the making. Now there’s even more evidence that I was right.
When you look at the long-term numbers on real estate investment, there’s a clear warning sign before each housing crash. It’s this one number that should set off alarm bells.
It seems the magic number is seven percent—just look at the chart above. It clearly shows us that when real estate takes up more than seven percent of gross domestic product (GDP), a crash is soon to follow. That’s what history is telling us.
Look at the sharp drop in 2007. Obviously, that dip was related to the subprime mortgage crisis in the United States. The financial crisis that followed spread across the world like a cancer, leading to a minor setback in the Canadian economy.
But Toronto and Vancouver’s housing markets didn’t really collapse. In fact, they picked up steam very quickly and are now considered two of the most overpriced places to live in the world.
Don’t just take my word for it, either. The Organisation for Economic Co-operation and Development (OECD) has repeatedly urged Canada to slow down its housing sector before the bubble reaches critical levels. (Source: “OECD warns of ‘rapidly rising housing prices’ in Canada as Scotia takes ‘foot off the gas’ on mortgage growth in hottest markets,” Financial Post, June 1, 2016.)
As I see it, there are two main problems: 1) the big picture problem, and 2) the personal finance problem.
It’s very simple when you break it down.
The Big Picture Problem
Think of the Canadian economy as a rigid water balloon. I know it sounds absurd, but just humor me for a minute. Every year this water balloon is filled and emptied, filled and emptied, again and again.
But within one year, the water balloon is stretched to its breaking point. The rubber skin snaps, spilling water everywhere, but at least we learn something. We learn the limits of the water balloon.
The Canadian economy is no different. We’ve seen it break when real estate investment peaks above seven percent, yet we’re allowing the exact same thing to happen once more.
It’s pretty obvious that a housing bubble on that scale is bad news for the Canadian economy. And a crash in the Canadian economy would utterly destroy the Canadian dollar. The big picture is bad for the CAD to USD.
The Personal Finance Problem
If the macro-view of Canadian real estate didn’t convince you to run screaming from the Canadian dollar, I suggest you check out the micro-view. The median home price in Vancouver is now 11 times the average salary, meaning that it takes more than a decade to save for the down payment. That’s just asking for trouble.
How can condo demand stay high if the average Joe can’t afford to buy a home?
We saw this exact scenario play out in 2007 and 2008. The U.S. housing sector crumbled when it became too expensive for regular folks. As soon as defaults started to rise, the entire house of cards came tumbling down. Canada is headed down the same path. Foreign investors, not real demand, are propping up its housing market.
After being hit by a commodity slump, the Canadian economy hung on by a thread. Sadly that thread was the country’s overblown housing sector. It’s only a matter of time until that bubble comes crashing down, leading to a major crash in the CAD to USD.
So it doesn’t matter what angle you look at it from—the Canadian dollar looks like it’s doomed.