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David Rosenberg

What's behind Canada's economic miracle? Housing Add to ...

Looking back to last year, it would have been inconceivable to talk about a Canadian economic miracle; however, that is exactly what we have on our hands today.

Unlike the nascent U.S. rebound, the Canadian recovery has occurred with no arithmetic support from inventories, and with a lot less intervention in the form of fiscal stimulus. The National Bureau of Economic Research is still unsure of when (or whether) the recession ended south of the border, but Statistics Canada boldly told us a little more than a week ago that the domestic downturn was officially terminated back in the third quarter of last year.

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So, what was the principal factor underpinning this impressive Canadian economic revival, especially in relation to what is happening in the United States? We can answer the question in one word: housing.

The housing sector is the quintessential leading indicator of the economy, and, true to form, it caught fire in Canada before the overall economy did. The U.S. market has stabilized, at best, with the help of massive doses of government support, but in Canada, housing activity has absolutely been ripping: Housing starts in March were up 38 per cent on a year-over-year basis and up a resounding 75 per cent from the trough of February, 2009; existing home sales are up more than 60 per cent from the bottom in December, 2008.

Real estate-sensitive retail sales have risen nearly 15 per cent year over year as of February, the fastest pace in seven years.



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On an annualized basis, real residential construction is up about 20 per cent since the recession ended.

Construction employment has jumped 6 per cent (that's 66,000 jobs) from the low of July, 2009. This employment represents only a 7-per-cent share of the overall employment pie but has been responsible for nearly 40 per cent of the aggregate increase in employment since the recession bottom.

We did a bottom-up accounting from the gross domestic product data to see just how much of the post-recession recovery in Canada has been due to the direct and indirect effects of the housing boom. Part of that indirect impact comes via the "wealth effect" on consumer spending from the 20-per-cent year-over-year surge in home values, since housing comprises nearly one-quarter of the asset base in the household sector.

In Canada, this means that every dollar increase in housing wealth translates to 7 to 9 cents of incremental spending in the GDP accounts. Housing has tremendous spinoff effects outside of the wealth effect, and it's all locally driven.

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Now that we have ascertained the root cause of this economic revival, it pays to assess the driving factors behind the surge. No doubt the Bank of Canada's move exactly a year ago to cut the policy rate to a mere 25 basis points was a huge factor - not to mention the pledge to keep the rate low through mid-2010. But the aggressive move to ease Canada Mortgage and Housing Corp. guidelines was equally stimulative.

For a good while, Canadians could secure a microscopic interest rate with a 40-year amortization mortgage with practically no money down. What a great deal! However, the government announced tighter rules a few months ago, and, like the Bank of Canada's pledge to keep rates low, this is only serving to pull activity forward. This impact of "borrowing activity from the future" will likely be accentuated by Ontario and British Columbia's moves to harmonize their sales taxes with the federal government in July.

So the housing market in Canada, the goose that laid the golden egg for the broader economy, is now going to be operating without the crutch of massive government support. After all, federal fiscal policy promises to be a drag next year - the restraint in Finance Minister Jim Flaherty's recent budget will squeeze real GDP growth by 125 basis points next year, just as the lagged impact from the coming Bank of Canada rate hikes will be having its greatest effect. It will be fascinating to see how this all plays out, especially since so much housing demand has already been filled by the frenetic activity of the past year.

With all the real growth in the economy since last summer being derived from the residential real estate market, it's legitimate to ask: who exactly will be picking up the baton?

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