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Recent GDP and jobs data don’t paint a picture of a resurgence, yet they tell the whole story of excessive fiscal policy.Ronnie Chua/iStockPhoto / Getty Images

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The global economy is on the brink of a perilous financial collapse, and the lack of curiosity about the true risks has allowed a dangerous situation to fester. The facade of stability is deceptive as strong headline gross domestic product (GDP) numbers, job growth data and declining inflation figures mask an imminent financial crisis fuelled by excessive government spending and restrictive credit conditions.

Debt-to-GDP ratios have reached levels not seen since the Second World War. Retail sales are weak, full-time employment is on the decline, and economic indicators such as recent regional U.S. Federal Reserve Board surveys and purchasing managers’ index data are unsettling. Case in point: The four-month average of U.S. retail sales, ex-autos, is at negative 1.20 per cent, well below the long-term average of 4.62 per cent. Clearly, interest rate hikes are starting to bite.

The U.S. regional banks and commercial real estate sector are teetering on the edge of a credit crisis with global implications, further strained by China’s deflating real estate bubble. As Japan and the U.K. grapple with recession and Canada’s growth approaches contraction, we’re reminded of the dark prelude to the 2008 global financial crisis.

Economic mirage brewing

The exuberance on Wall Street reflects an economic mirage. The financial community has ceased to question the underlying weaknesses in the private sector and inconsistencies in the labour market. A closer examination of GDP and jobs figures doesn’t paint a picture of resurgence, yet it does tell the whole story as excessive fiscal policy, retail sales below long-term averages, and the construction and housing sectors buckling under the weight of soaring interest rates. For example, in Canada, all the jobs added in January were part-time jobs while full-time jobs declined by about 11,600. Substituting full-time jobs with part-time jobs is a troubling sign.

These warning signs demand a reinvigoration of curiosity and a rigorous examination of the full implications of our economic actions to avert a pending economic disaster.

In 2022, the Fed and other central banks ignored financial stability concerns as it continued to raise interest rates to fight inflation caused by exogenous supply shocks. Then, in March 2023, the Fed introduced the Bank Term Funding Program as the U.S. regional banking crisis roiled markets. The end of this program in March adds to financial stability risk, exacerbating the challenges faced by U.S. regional banks, which are the predominant holders of commercial real estate loans in that country.

Raising interest rates at a historical pace while ignoring financial stability concerns, all in the quest for the 2 per cent inflation target, has set the stage for the possibility of another global financial crisis. The Fed can’t continue to ignore financial stability concerns even if Wall Street lacks the fortitude to call them on it. The consequences of inaction in the face of these mounting risks could be dire, leading to a massive deflationary shock.

The situation is even more acute in Canada. A nation that was a beacon of resilience through previous financial crises now is on the brink of historical amnesia, having forsaken the ability to glean wisdom from past tribulations. An economy reliant on debt and real estate for growth stands on precarious ground, its sustainability in question.

Despite the metastasizing financial crisis, Canadians seem to be dismissive, perhaps even evocatively so, buoyed by the belief their financial system towers above others in security and regulation. This sense of invulnerability harks back to the nation’s experience during the 2008 global financial crisis when Canada’s banking system stood firm amid the tempest.

The Canadian government’s proactive measures and stringent regulations deserve credit for shielding the financial system from the same turmoil that engulfed other nations. However, this sense of security may be fostering a dangerous complacency, blinding the nation to the perils lurking within its own economic edifice. The urgency to reduce interest rates cannot be overstated. The financial sector’s indifference to glaring warning signs is alarming.

Today’s dilemma lies in the fact that, while former Fed chairman Paul Volcker is revered, his focus on finding the right answer to the day’s economic problem has been replaced by a policy-driven research agenda, particularly the 2 per cent inflation target. A closer examination of economic indicators reveals that the aggressive tightening of rates has been too severe and not based on comprehensive data analysis. The Bank of Canada’s (BoC) policy mimicry of the Fed fails to acknowledge the specific vulnerabilities facing Canada’s economy.

Bold action is needed

The burgeoning household debt and overheated property market are indicators of potential trouble. Weak economic indicators, the erosion of quality jobs, and sluggish retail sales highlight the disconnect between the optimistic narrative and the harsh reality.

For example, the unintended consequences of the BoC’s interest rate hikes have led to a slowdown in construction, with building permits declining by 14 per cent month over month in December 2023 and 3.75 per cent during the second half of the year – levels not seen since the onset of COVID-19 or during the global financial crisis.

Warren Buffett once said, “It’s only when the tide goes out that you learn who has been swimming naked.” A credit event could lead to a deflationary shock that the global economy is not prepared to handle. Ignoring signals from the financial system could result in severe consequences. In focusing on the wrong risks, such as adhering to inflation targets without considering broader financial instability, we may be sacrificing the health of the entire economy.

The Fed, BoC, and all central banks must prioritize the maintenance of economic stability over the narrow pursuit of inflation metrics. Bold action is needed. The BoC can, and should, lead the way by recalibrating its monetary policy to address the unique challenges facing the Canadian economy. By doing so, Canada can not only prevent a financial downturn but also pave the way for future economic success and stability.

James Thorne is chief market strategist at Wellington-Altus Private Wealth Inc. in Toronto.

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