There is a specific sequence of events where high levels of Canadian household debt can lead to a deflationary, recession-ridden period for the economy that resembles Japan after 1990. The Bank of Canada, having learned the lessons of Japan’s experience, will use everything in its arsenal to prevent it. In all probability, it will be successful.
“The global economy has never been more leveraged,” wrote Morgan Stanley strategist Hans Redeker in a July 18 research report. Mr. Redeker noted that debt levels reduce future economic growth rates unless productivity or the size of the working age population climbs significantly.The strategist believes that the extent of global debt exceeds the ability of productivity, or labour force growth, to compensate.
“The BoJ failed to boost Japan’s inflation rates above the rates of its trading partners. Consequently, Japanese real yields were too high for its leveraged economy. As a result, Japan’s private sector went through a painful balance sheet consolidation process," said Mr. Redeker. I believe the Bank of Canada will be able to prevent a decades-long, Japan-like scenario with appropriately low rates. Otherwise, the risk is that high inflation-adjusted borrowing costs cause bankruptcies and declining consumer spending, which in turn causes unemployment and yet slower growth.