Expect anger as Poloz pulls the punch bowl: Don Pittis
Raising rates and ending the party is essential, but many Canadians feeling the sting will complain
Stephen Poloz has swiped the punch bowl and, just like at a real party, some Canadians deprived of their means of staying happy are going to switch from flying high to furious.
If that sounds dated, I should make it clear it is by no means a fresh analogy.
The reference comes from 1955, when the U.S. Federal Reserve's sternest and arguably most competent, boss, William McChesney Martin, described the Fed chair's hardest job, raising interest rates after a period of stimulative cutting.
A chaperone's duty
At such a moment the central banker "is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up," Martin famously said in a speech to investment bankers.
In the summer of 2013, when Stephen Poloz took over for the departing Mark Carney, the new Bank of Canada governor was destined for the role of "party pooper."
There are profound differences between the effects of cutting interest rates and the effects of raising them.
Cutting rates makes money cheaper. It makes stock markets go up as investors borrow to speculate. Falling rates make bonds rise in value.
Falling rates make it easier to get a mortgage and make that mortgage easier to pay off. Low rates make the price of your house rise as everyone piles into the market, stimulating the construction and real estate industries.
Low rates stimulate exports by keeping the loonie lower than it would otherwise be.
Partying up a storm
And in economic terms, Canadians have been partying up a storm. The economy has been growing at an annual rate of 4.5 per cent, a point and a half faster than in the U.S.
The unemployment rate hovers at the lowest levels in nine years.
As the Fed's Martin predicted more than 60 years ago, once low rates had done their job, it was the painful and essential duty of central bankers to prevent inflation by increasing those rates again. And he didn't expect people to like it.
"In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects — if it did not, it would be ineffective and futile," said Martin.
Those "onerous effects" are exactly the opposite of the pleasurable ones listed above.
Higher rates make money more expensive. They drive down the price of existing bonds. They can pull down stock prices.
Feeling poorer
As we've already seen, higher rates make mortgages dearer and harder to obtain, especially for young people just putting their foot on the real estate ladder. Falling real estate prices can make you feel poorer still, even if your house is paid off.
Higher rates push up the value of the Canadian dollar, making exports more expensive in foreign markets.
"Those who have the task of making such policy don't expect you to applaud," Martin told his audience of bankers.
Among the angriest will be the one-third of Canadians who, as we heard this week, already feel overwhelmed by their debts.
For people with home equity loans, a half-point increase in interest rates in only two months can raise each monthly loan payment by more than 10 per cent. Variable-rate mortgage payments will rise by a similar amount.
For those living paycheque to paycheque, where will that money come from?
There will be winners. But the over-borrowed are not the only ones who will feel squeezed, especially if, as markets are now predicting, there are more rate hikes to come.
Expect anger from investors, the real estate industry, construction and exporters. Expect business concerns about the rising cost of capital. Expect protests that the increase was not needed and statements about how central banks cause recessions. Expect complaints that the bank has interfered in markets, even though few complained when they interfered to push rates down.
Steering through the rearview mirror
And Poloz cannot be sure he has done the right thing. The future remains unknowable, and there are many potential external crises from NAFTA failure to a new Korean war that could bring the Canadian economy crashing down again. Poloz must steer by looking in the rearview mirror.
Taking the punch bowl away does not make you a lot of friends. But for a responsible central bank, it is an essential part of keeping an economy sound.
And as William McChesney Martin said so long ago, the complaining would be worse if the central bankers waited too long.
"If we fail to apply the brakes sufficiently and in time, of course, we shall go over the cliff."
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