How Does the European Bailout Affect the Canadian Real Estate?

Canadian Flag by Kevin Timothy
Canadian Flag by Kevin Timothy

Europe seems to be sinking deeper and deeper into crisis and those who were pretty optimistic at the beginning have already started to lose hope. The old continent used to have it all. What exactly happened, and more importantly, why? Does the euro crisis pose any threat for the Canadian economy? Can the contagion spread worldwide and smash down our markers as well?

Why is there a Euro Crisis?

It was back in December 2009 that Greece first admitted that they had a problem: 300 billion euros of debt was the highest in modern history. Greece is burdened with debt amounting to 113 per cent of its GDP — nearly double the Eurozone limit of 60 per cent. Several rating agencies including Standard and Poor’s and Fitch’s have downgraded the Greek bank and government debt.

The level of Greek debt was shocking new information for EU governments and residents, but the country has been battling for much longer. Goldman Sachs has been helping Greece to fix its debt problems for almost two years before anyone else knew something terrible was about to happen. They have been advising the government about how to tackle its debt and helped to cover the debt as well. Greece had a chance and high possibility to improve its financial situation and take care of its debt problem. But they didn’t.

In January 2010, an EU report criticized severe irregularities in Greek accounting methods. The Greek budget deficit was re-evaluated upwards to 12.7 per cent from 3.7 per cent, which is four times the maximum allowed by EU rules. Soon after, Greece, Portugal, and Ireland revealed that they had economic problems as well.

In 1997, EU countries that wanted to join a single currency signed the Stability and Growth pact. The pact implemented a rule to limit their total borrowing to 3 per cent. Let’s have a look at how the biggest players in Europe, Spain, Germany, Italy and France, dealt with the limit.

Italy by Davide Oliva
Italy by Davide Oliva
Italy was first to break the rule and it has kept breaking it ever since with Germany and France following closely behind them. None of these countries was able to keep its deficit below 3 per cent. What might come as a shock is that it was actually Spain keeping its borrowing within the limit until the financial crisis in 2008. Considering how EU countries obeyed the rule, there wasn’t much they could do about Greece and its skyrocketing debt.

Looking at the debt levels of the above mentioned countries might leave us wondering why it was Greece and Spain and Italy asking for help. What makes Germany stand so confidently even though its debt isn’t really appealing either? There was a huge build-up of debts in Greece, Spain, and Italy before 2008. However, those debts had nothing to do with their governments. It was purely private sector debt compiled of mortgages and loans of different companies and investors. The big problem started to appear as interest rates fell to unprecedented lows in southern Europe. In Germany, however, government debt make up 77 per cent and private debt 164 per cent. They add together to 241 per cent of the total debt. Spain is now adding to its 72 per cent government debt, which would be a tolerable figure, and to its striking 283 per cent private sector debt. At this point, austerity measures are becoming inefficient, as Europeans doesn’t really have any funds to pay their mortgages back, nor have they any funds to save for harder times. The hard time is now.

Powerful European leaders all know what mistake was made when the Eurozone pact was signed. It was a mistake to look at all countries equally. Yes, in theory, all the countries are equal; however, different laws and customs apply in each. We can’t expect Italians to work like Germans and it would be unthinkable for a German businessperson to take a siesta and relax for a couple of hours after lunch. It was a mistake to even think that all the countries would produce and spend more or less equally. Before the crisis hit, governments in Spain, Portugal, and Ireland were in surplus and had comparatively low debt.

The crisis isn’t a result of unbalanced fiscal policies. If it were so, a loan from the bailout fund would be sufficient. It would provide temporary financing while the countries in need of extra money would restructure their revenues and expenditures. The budget problem in Europe lies elsewhere. The euro crisis is a symptom of flaws in the structure of the Eurozone itself. Our Canadian economy is matched by fiscal unions that systematically transfer large amounts of income from one region to another. Ottawa and other provinces redistributed approximately 6 per cent of Alberta’s GDP. Such transfers are unthinkable in Europe. Fiscal austerity will only deepen the recession in Europe as long as the European Central Bank (ECB) resists calls for more monetary stimulus.

Would Canada join the IMF program?

This question was hanging over all of us during the recent G20 summit in Los Cabos, Mexico. Canada and the United Stated were appointed by the International Monetary Fund (IMF) to join the program. The Conservative government’s reasons to stay out of the IMF loan program are not deeply convincing. However, the reasons it should support the fund are even less so.

The fund doesn’t bring a solution that needs financing. If there is a stone on the road, they are just kicking it further. Maybe they can kick it really well — far beyond what we are able to see now, but we will come to it eventually. In our case, the stone is getting bigger with every kick, so it’s possible we won’t be even able to kick it next time. The Eurozone budget problem has been happening for four years now and all the reforms have just made it worse.

We are in the process of ongoing Canada/EU trade agreement talks. Not participating in the program can hurt our position. There is only one way for Europe to translate its prospective need for a loan into increased leverage: if Canada decides to let them. Would-be debtors are in a position from which they can dictate the terms only when their creditors are unable to write off their debts. Countries like Greece, Spain, and Italy might have that power over their European partners, but we all know Europe doesn’t have such power over Canada.

The last reason mentioned at the summit was a little bit flimsy. If we ignore the call for help from Europe, it might diminish our standing in the international community. Ignoring the economic forecasts and advise and joining the IMF because that is what every country should do is exactly the reason why the crisis is spreading so quickly. The countries that are going along with the European loan program are not doing any good for themselves or for the EU. Both sides are indulging in a fantasy that European leaders have an ace in their pocket and know how to tackle the problem. They don’t. The only realistic solution to the euro crisis would require a fundamental change in its structure — a system of fiscal transfers between countries of the Eurozone.

The Conservatives have made the right decision. If we agreed and assisted IMF with a $430 billion bailout package, it would pull our country deep inside the crisis and even though matters would improve momentarily, it would be a wrong move in the long run. European leaders are on the wrong track and it is a time for everyone to stop pretending otherwise.

How independent is Canada really?

Canada  view from above by Moon Angel
Canada - view from above by Moon
Angel
Looking at the economic forecasts and various analyses, we can see a tendency for two possible scenarios. As always, one is optimistic and the second one — well, not so much. I choose to start with worse so that we have little hope towards the end.

One possible way is that Europe’s debt problem would explode in a way we can’t imagine. It would spread the contagion across the global financial landscape. Global credit would freeze up, world economies would slow down, commodity prices would plunge, and the world would take trade-invested Canada into a deeper recession than the one three years ago. However, it is also possible that European leaders would finally adapt the solution presented at many summits as the only one: fiscal union. That would revitalize the markets and restore confidence in the world economy, and commodity prices would be stronger while Canadian exports would rebound.

So far no one has known which forecast to believe. It is not only our reputation at stake. Important investment strategies and profits need to follow one of those tracks. Markets are extremely volatile now and all of us are walking on very thin ice, suffering from everyone else coming towards us as the ice might crack. It has been four years since Greece admitted it has financial problems. Many summits were held to resolve the euro question, and billions and billions of dollars were pumped into the Eurozone, each time with hopes that it would be the last.

“If you look at the volatility index, which is referred to as the ‘fear gauge,’ what we saw in the Lehman Brothers crisis (in 2008) is a huge spike up, and now fear is again elevated,” Wright points out. “You see that in weakness in investment and weakness in hiring.”

After the last summit held over the past few days, Europe is beginning to get a clearer picture of what needs to be done to save the Eurozone. The negotiations towards fiscal union are about to start later this month in Brussels. Canadian economists, including Bank of Canada governor Mark Carney, believe Europe is finally on the second, more optimistic track. That is the main reason why the Consensus of Major Forecasting Houses expects a growing Canadian economy. They are predicting 2 per cent growth next year, meaning 1.5 per cent is on the low side and 2.5 per cent on the high. The Bank of Canada was almost in the middle, with 1.9 per cent in the first quarter.

Following this prediction, we can expect more jobs being created — 10,000 to 15,000 a month. It is still less than needed; however, in times like these, even slight improvements against the previous quarter are an extremely good sign. Salaries will remain the same; they will keep up with inflation but probably won’t rise much.

Real estate markets are stable, and even though they have fallen slightly in the first quarter, they are making their way up in the second quarter and the forecasts are optimistic. "We don’t have big trade ties, we have minimal banking exposure, and we’ve benefited from Canadian dollar depreciation and lower interest rates,” says Derek Holt, vice-president of economics with Scotiabank.

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