Capital, with a Capital C

Way back when we were in grade school the word capital came up a lot. In English class we were taught to make the first letter of a sentence a capital. In Geography we were taught the capital cities of Provinces and States. However, school certainly fell down in teaching all of us about just plain old capital. You know, capital – the thing that makes the world go ’round.

Capital is required for almost every single transaction on the planet. Businesses require capital to go into business. Homeowners require a downpayment – a form of capital to buy a house. Capital is everywhere, but it seems the people that should know the most about capital – disregard it. Here is why the word capital is going to matter a whole hell of a lot to your mortgage business in the next 12 to 18 months.

In case you went into a coma on Monday – Tuesday had the release of Budget 2024. Nothing much in the way of goodies for real estate – unless you consider empty words and promises from politicians to mean something. However, there was a re jig of capital gains as we are all aware. What we aren’t all that aware of is how this is going to hurt your mortgage business.

I have long had a philosophy in life that by the time the government gets around to regulating a problem – the problem has already solved itself. That philosophy has never let me down. On Tuesday we witnessed the feds raise capital gains taxes for, well, almost everyone. Of course it was billed as a ” tax the rich ” policy, but we will all pay the price. I am not going to debate semantics of whether it is fair, or right, just what it could mean for the economy – and your mortgage business.

Canada has had a bit of a problem of late. No, I don’t mean housing, I don’t mean homelessness, I don’t mean out of control grocery prices, and I don’t mean $1.80 a litre gasoline. Canada is suffering with a capital problem. Not the capital that goes at the beginning of a sentence, and not the capital city type of problem – a money capital type of problem. As anyone who knows me will testify, I LOVE money. Now please don’t take that to mean I would do anything for money – because I won’t, but I love money. The reason I love money is that in money you find things that do not exist anywhere else. Money, unlike humans has no feelings, no emotions, no pronouns and no good vs. evil. Money is just money. People, as a group, can make some pretty dumb decisions when they allow emotion, feelings, power, etc. get involved. I would point to the Capital City of Canada to prove my point. However, money does not take any of these things into account – it simply flows where it can be best utilized. Money has no emotional attachment, no power, no feeling – it just flows.

Like water will always try to find its level, money will always try to flow to the place where it can be best utilized for its owner. In Canada for the last 15 or so years, that place was real estate. Since 2008, when the Fed, and by default all other world Central banks dropped interest rates quicker than a senior at a frat party dropping his pants, they created a problem known as TINA ( there is no alternative ). Since interest rates were so low, it meant bond yields were also low. This was done on purpose to stimulate the economy. Money could not grow very well at low interest rats, so it forced people into other assets that they may not normally go into. For the last 15 years it was tech stocks and Canadian real estate. However, every trade gets crowded, and in the early parts of 2022, as interest rates crept up, we started to see money realize it had better alternatives than real estate. This brings us to today, and real estate is somewhat stuck in the mud, and everytime you get ahead a little bit, it seems to slip back down into the muddy pot hole.

Money, or better yet – the owners of money collectively decided to take their money from real estate and invest it where they thought it could perform better for them. All of a sudden GIC’s were paying 5%+ with no risk. Gold has shot up, crypto currency is on fire, and commodities as a whole are making commodity brokers party like it’s the 1980’s. This is not news – you see it all around. So why am I rambling on?

Capital flows around the globe at the speed of light. The flow of capital is like the flow of anything else – it needs to be steady. Think of it like your kitchen tap. The flow can be low pressure, or high pressure, and you can adjust. However if the water pressure at your kitchen tap is very low, and then very high, and then in the middle, and then spraying everywhere, it is hard to do dishes. Likewise, if there is no flow, you can’t do dishes at all. But when the kitchen sinks flows the wrong way cause the drain is plugged – you have a real problem on your hands.

Canada today is like a broken sink. Capital is flowing alright, but it is all flowing the wrong way, and it is going in a hurry. In the last 3 months, Canada has witnessed over 31 billion dollars of net outflow of funds ( All funds brought in to Canada minus all funds taken out ) . On Top of the 31 Billion net outflow, money that remained saw a net redemption of government securities of an additional 15.1 billion. Basically, international investors are fleeing the country with the capital. Now ask yourself, why would international investors all of a sudden feel Canada is not the best place for their money? I think you already know the answer. And keep in mind, this number is before the budget when taxes were increased on capital gains.

Events like Tuesday’s budget ensured that the trend won’t likely be reversed. When you tax the supreme shit out of people – they take their ball and go home. Canada used to be viewed as a relatively safe place to invest your foreign capital. Not so much now. In fact, there has been such a drop in demand from international investors that the Canadian government had to issue government bonds so they could turn around and purchase mortgage bonds with the proceeds. Of course it was wrapped up as an affordable housing policy, but no government has issued debt to buy other debt outside of a crisis ( US in 2008, European Union in 2011 when Greece basically failed etc. ).

If international investors keep dumping Canadian stocks, bonds, government debt, mortgage debt and currency, it is going to make a problematic economy even worse. Since the current administration can’t seem to NOT spend money, they need to issue bonds in order to pay for the shortfall. If international investors are not only not buying, but also selling Canadian paper, it means there isn’t a buyer for the 40 + Billion dollars of government debt that will be needed just to cover this years deficit. Never mind the investment needed to roll over maturing government debt. Now we know the Canadian banks, CPPIB and the like will be natural buyers of some of that paper, but if international investors are not coming to the table, who will buy the rest?

Money is like an old man – it likes consistency, it likes routine, and it like predictability. Unfortunately for Canada, the climate is not any of those things. The government keeps changing the rules, prices are out of control on a lot of things, taxes can be changed on a whim, and undo 40 + years of saving and planning in one day, the housing market is changing hour by hour it seems, and organizations like the OECD have said:

The OECD previously forecast Canada’s addiction to debt, both public and private, will make it the slowest economic growth of any advanced economy for decades. 

All of this could quite easily mean that in order for the Canadian government to attract capital to it’s bond market – it will have to offer higher interest rates to compensate. Higher interest rates on government bonds mean – you guessed it – higher mortgage rates for fixed terms. As I have stated before, and I will say again, we could very well see a scenario whereby Tiff and Co drop overnight rates ,and the fixed market continues to climb. International investors don’t give a damn about Canadians paying their mortgage. They only care about the return on their capital. If Canadian bonds rise enough to justify an investment – the money will flow back into Canada.

Capital matters in every business in the world. Capital is the ‘thing’ that makes a business work. Capital is what finances every single thing. It appears that the overlords of government finance have not figured this out. Capital, while important, is also shifty. Capital decides where, when and how it will be best utilized. Unfortunately for a lot of people, we didn’t treat capital correctly, we didn’t nurture the capital, allow it to grow, and prosper, and now, we could be looking at being screwed – with a capital S.