This is part of a Globe series that explores our growing dependence on credit – from the average household to massive institutions – and the looming risks for a nation addicted to cheap money. Join the conversation on Twitter with the hashtag #DebtBinge
Everyone knows that Canadians are sinking deeper into debt. What no one knows is exactly why.
The remarkable run-up in household borrowing over the past 25 years can be explained in one of two contrasting ways: Either people are extremely smart or they are rather dim.
Economists and bankers tend to line up behind the first theory. They see consumers as rational decision makers who make intelligent choices in an attempt to even out their standard of living over their lifetimes. Borrowing provides savvy young households with a way to transfer money from the future – when presumably they will be much more affluent – and spend it in the cash-strapped present.
There's definitely something to this theory. Without access to loans, many of us would not be able to attend university, buy a house or purchase a car – or at least, we wouldn't be able to until we were over 40 and had accumulated a hefty bankroll.
Perhaps families are now more aware of how they can employ debt to smooth their lifetime consumption. Perhaps, too, banks and other lenders have become more flexible in catering to younger consumers. If so, there's no need to fret about all the borrowing.
Or so the theory goes. The problem with this perspective is that older people have also joined in the debt frenzy. This is not what you would expect to see if today's high debt levels simply reflected greater borrowing by young families who want to dip into their future earnings.
The average debt of a Canadian household, in inflation-adjusted terms, more than doubled from $46,000 in 1984 to $110,000 in 2009, according to Statistics Canada's most recent Financial Capability Survey. People of all ages participated in the borrowing boom. Allan Crawford and Umar Faruqui of the Bank of Canada, who analyzed the increases between 1999 and 2010, found that people in their 20s borrowed more; so did those in their 30s, 40s, 50s and early 60s; and so did those over 65.
The broad surge in household debt suggests that something fundamental has changed – but while the researchers point to several possibilities, they stop short of naming a prime suspect.
"The widespread nature of the increases – across all age groups and in both mortgage and consumer credit – suggests that a variety of factors … have contributed to the growth in household debt," they concluded.
The mystery around why household debt is soaring deepens even further if you look beyond Canada. For all the gnashing of teeth about rising debt levels in this country, our outburst of borrowing looks positively tame compared to many other nations.
A survey last year by the Reserve Bank of New Zealand found that private sector debt has soared since the turn of the century in 28 advanced economies. Its figures indicate that the ratio of household debt to disposable income in 2014 was lower in Canada than in many other nations, including Denmark, the Netherlands, Switzerland, Australia and New Zealand.
What could have ignited a simultaneous boom in borrowing across countries with such different demographics and varying economies? One theory holds that it's all about increasing inequality.
Aldo Barba of the University of Naples and Massimo Pivetti of the University of Rome argued in a 2008 paper that the U.S. economy welcomed higher and higher levels of household debt because it needed that borrowing to maintain high levels of consumption as wages stagnated for many blue-collar workers.
According to this view, flattening or shrinking incomes prodded many people to go into debt to bridge the gap between their paycheques and their spending. The upswing in borrowing can be seen "principally as a response to stagnant real wages and retrenchment in the welfare state," according to Profs. Barba and Pivetti.
But while this income inequality theory may fit much of the U.S. data, it's less persuasive for other countries, according to Chris Hunt, an adviser to the Reserve Bank of New Zealand. In particular, the theory flops as an explanation for the surging household debt levels in countries such as Denmark, Norway and Sweden, which have generous welfare systems that tend to offset any trend to income inequality.
Mr. Hunt, like the Bank of Canada researchers, believes a cluster of factors are behind the global rise in household debt. Financial innovation and falling credit standards have undoubtedly played a role. But in recent research papers, Mr. Hunt places the greatest emphasis on two other factors – high home prices and low interest rates.
As interest rates have fallen around the world, families have been able to carry more debt for the same amount of cash flow. They've used that debt to bid up the price of homes, which means other families need to pay even more to get into the market, which means they too have to take on more debt.
But how smart is this in the final analysis? As Mr. Hunt points out, many younger households are comfortable pouring a big chunk of their incomes into mortgage payments because they are operating under the belief that house prices reliably rise, based on their parents' experience as homeowners.
"However, for that [earlier] generation, high inflation during the 1980s meant that mortgage payments quickly diminished relative to nominal income," Mr. Hunt writes. He cautions that today's much lower inflation may make the real burden of a mortgage much heavier and longer lasting.
If he's right, the soaring levels of household debt around the world are based on a fundamental misunderstanding.
Rather than being rational consumers who are doing a fine job of optimizing their consumption over the the course of a lifetime, households are badly underestimating the true sting of the debt burdens they are shouldering.
If so, the next stage in the great Canadian borrowing binge is not likely to be a pleasant one.
Ian McGugan