Thursday, May 31, 2012

How United Is Europe?

The Pew Research Centre recently released a report entitled "European Unity on the Rocks: Greeks and Germans at Polar Opposites".  In this report, Pew looks at the divided nature of Europe, how European member nations regard the Union, whether the euro is a good thing and how each nation regards the European Central Bank (ECB).  Here is a summary of their findings from Pew's survey of 8 Member States including Britain, the Czech Republic, France, Germany, Greece, Italy, Poland and Spain.

As one would expect, Europe's debt crisis has uncovered a nest of festering resentments across Europe.  Nations differ greatly on their opinions about bailing out their poorer "cousins" and are discontented with Brussels' ability to oversee their spending and budgeting processes.  The EU, an experiment in unifying sovereign states under the umbrella of a megastate "overlord", looked to be successful at first.  After its adoption of the euro as its signature currency in 2002, it appeared that the Union could well supplant the United States as the world's economic engine and many so-called experts suggested that the euro could replace the United States dollar as the world's reserve currency.  Unfortunately, at this point in time, the European debt crisis appears to have put a sudden halt to those dreams of grandeur.

How do Europeans feel about the state of their State?  Here is a graph that shows what percentage of respondents in each state feel that economic integration under the EU has NOT strengthened their economy:  

For your information, a median of 66 percent of respondents from all countries surveyed feel that their economies have not been strengthened by the integration of Europe.  Even Germans, who have done quite well economically since the union, are less than resounding in their support for the economic benefits of the EU with 41 percent suggesting that the union has done little to benefit their economy.  Not surprisingly, the two worst debtor nations in the EU, Greece and Italy, overwhelmingly feel that their economies have basically not benefitted at all from the union. 

How do Europeans feel about the euro as their currency?  Here is a graph showing just that, noting that only the countries that have the euro as their currency have been surveyed:

That's hardly what one would call a ringing endorsement of a currency, is it?  So much for the euro being the world's reserve currency.  Again, even Germany which has benefitted under the new economic reality can only muster 44 percent support for its currency.  Talk about not cheering for the "home team"!  Most of the respondents from Britain seemed quite complacent in their pride for sterling with 73 percent stating that they are quite happy that they didn't adopt the euro as a replacement for currency with the Queen's visage.

Lastly, let's take a look at each nation's support for the European Central Bank, the organization that has backstopped much of the debt crisis as it has unwound:

Across the nations sampled, a median of only 39 percent of respondents gave the ECB a passing grade with only one nation, Poland, finding more ECB supporters than detractors.  Not surprisingly, only 15 percent of Greeks found anything to like about the ECB.  Just over one-third of Italians supported the ECB; my suspicion is that this could change very quickly if Italy is forced to its knees by its nearly €2 trillion debt load.  

In another posting, I'll dig a little deeper into this interesting report but in closing, I'll leave you with this screen capture from the report showing exactly why it's pretty hard to get enthusiastic about either Europe or the euro as an investment:

Greece certainly comes off poorly all around, doesn't it?  Unfortunately for the holder of the world's third largest nominal debt, they aren't regarded all that well by their neighbours either!  Europe - the world's largest Peyton Place.

Wednesday, May 30, 2012

America's Workforce Non-participation

A recent article on the Federal Reserve Bank of Atlanta's website by Dave Altig, the Atlanta Fed's Executive Vice President and Research Director, discusses the issue of the declining labor force participation rate and provides us with an explanation for the decline as I will outline in this posting.

This graph from FRED quite clearly shows the decline:

The labor force participation rate peaked at 67.1 percent between the years of 1997 and 2000 and has fallen rather steadily since then to a 17 year low of 64.7 percent.  The fall has been most dramatic since the Great Recession; the rate has dropped from 66 percent in 2008 to 63.6 percent in April 2012 as shown on this chart:

Here is a less looked at labor force participation graph showing the participation rate for men:

Male labor force participation peaked at 87.4 percent in October 1949 and has fallen steadily to 70 percent in April 2012, a drop of 19.9 percent.

Here is the labor force participation graph showing the participation rate for women which looks completely different:

Back in the late 1940s when men's participation rate was peaking, only 33 percent of women were in the workforce.  Women's participation rate peaked at 60.3 percent in April 2000 and has slowly fallen to 57.6 percent in April 2012, a drop of only 4.5 percent.

Here are two more graphs.  The first graph shows the labor force participation rate for those 25 years and older with less than a high school diploma:

This data in this graph shows that the labor force participation rate for these Americans is currently 45.2 percent, down only 6.2 percent from its 20 year peak in October 2008.  I found that rather surprising considering that Americans without a high school diploma have generally been considered among the least likely to have regained employment since the end of the Great Recession.  That said, it is interesting to see that their participation rate is 18.4 percentage points (or 28.9 percent) below that of the general population.

This final graph shows the labor force participation rate for those 25 years and older with a Bachelor's degree or higher:

The participation rate for these Americans peaked at 81.9 percent in July 1992 and June 1993 and has fallen rather steadily to its April 2012 level of 76.2 percent, just off its 20 year low of 75.6 percent achieved in January 2012.  Surprisingly, since the end of the Great Recession in June 2009, the participation rate for more educated Americans has dropped by 1.8 percentage points.  While this looks rather unsettling, recall that the labor force participation rate for those Americans without a high school diploma in April 2012 was 31 percentage points lower. 

Back to the Federal Reserve's analysis.  Many mainstream and non-mainstream journalists have attempted to resolve the issues behind the drop in the labor force participation rate.  The author notes that the decline in the headline unemployment rate from March (8.2 percent) to April (8.1 percent) was driven by yet another decline in the labor force participation rate.  Why is the participation rate falling and how much impact is this having on the unemployment rate? 

Staff at the Federal Reserve have calculated that if the labor force participation rate had remained constant from March to April of 2012 instead of falling, that the unemployment rate would actually have risen to 8.4 percent rather than falling to 8.1 percent.

Why is the labor force participation rate falling?  Many people feel that the current job market is so poor that unemployed Americans are simply giving up and falling off the Bureau of Labor Statistics' radar.   Mr. Altig notes that at least some of the decline in the participation rate is due to population aging as older workers retire and remove themselves from the workforce.  Here is a chart from the article showing the impact of demographic changes on the labor force participation rate:

Since the beginning of the Great Recession, the labor force participation rate has dropped by 2.4 percentage points.  The Atlanta Fed estimates that 40 percent of the changes in the participation rate can be accounted for by changes in the age and composition of the population.  Since the beginning of the Great Recession, 0.9 percentage points of the decline in the participation rate can be explained away by the aging of baby boomers since the labor force will grow more slowly than the total population aged 16 and older.  If we look back at the FRED graph showing the participation rates by educational levels and gender, it becomes apparent that, if indeed Mr. Altig is correct, it is American males with a college degree that are responsible for the lion's share of retirements.  As well, since the participation rate fell by 2.4 percentage points, this leaves 1.5 percentage points unaccounted for.  It is this 1.5 percentage point drop that may well be due to cyclic unemployment (i.e. higher levels of unemployment during a recession) that is becoming permanent structural unemployment (i.e. jobs that are never regained even during an economic boom). 

The Federal Open Market Committee has projected that the unemployment rate would be 7.5 percent at the end of 2013.  Mr. Altig proposes the following:

1.) If the participation rate stays at 63.6 percent, the economy needs to create 144,036 jobs per month to reach an unemployment rate of 7.5 percent by the end of 2013.

2.) If the participation rate rises by the 1.5 percent that is unaccounted for by demographic changes, the economy needs to create a whopping 304,260 jobs per month to reach an unemployment rate of 7.5 percent by the end of 2013.

While it certainly would be wonderful if the unemployment rate really did drop to 7.5 percent, a level that is still high by most historical post-recessional standards, I suspect that the FOMC is dreaming in technicolor.  By the end of 2013, the world could well be in the grips of another recession; at the very least, it is quite possible that within 18 months, the European debt influenza will find itself well established in the world's economy, negatively impacting employment levels around the world. 

Monday, May 28, 2012

The Unmitigated Failure of European "Austerity"

Michael D. Tanner of the CATO Institute recently published an article entitled "Europe's Failed Austerity" discussing the recent election results in Europe as they relate to the public's backlash against austerity programs.  He notes that many American advocates of "bigger is better government" use the apparent failure of European austerity measures as an example of why Washington must make a sharp U-turn, reversing its very modest attempts at fiscal balance.  This seems to be of particular importance to these advocates because they draw the conclusion that Europe's very modest recent economic growth is directly related to cuts in government spending.  This recent GDP data release from Eurostat would appear to bear up that argument:

Outside of the former Iron Curtain countries of Slovakia, Estonia, Latvia and Lithuania plus Finland, the United States' Q1 2012 GDP modest growth rate of 2.1 percent looks stellar when compared to most of the rest of Europe where the average economic growth rate is a barely perceptible (and easily correctable in a downward direction) 0.1 percent for all 27 nations.  Apparently, these big government advocates would suggest that it is Europe's cut and slash ways that have triggered a near-continentwide recession; this logic would suggest that America should continue along its "stimulate by spending more than it brings in" philosophy to keep the Union out of recession.

On average, Europe's government spending contributes more than half of GDP.  Government spending appears to still be at roughly the same level despite so-called austerity.  Rather than cutting spending, nations have elected to raise taxes, a measure that according to some economists is likely to have the exact opposite impact on debt than anticipated.  Here is a breakdown of the austerity measures for both France and the United Kingdom:

1.) France has raised taxes by imposing a 3 percent surtax on incomes above €500,000 accompanied by a one perentage point increase in the top marginal tax rate, raising it from 40 to 41 percent.  France also increased corporate taxes by 5 percent on businesses with more than €250 million in revenue and closed some corporate tax loopholes.  This was topped off with an increase in VAT from 19.6 percent to 21.2 percent.   All of this was implemented to keep the budget deficit for 2012 to 4.5 percent of GDP which is still above the 3 percent European Union target.  By the end of February 2012, the budget deficit had narrowed by 13.5 percent on a year-over-year basis, however, year-over-year spending was up from €57 billion to €63.56 billion.  Fortunately, revenues were up 13.5 percent to €43.2 billion.  Despite France's best-laid plans, the budget deficit hit 5.2 percent of GDP.

2.) The coalition government in the United Kingdom has hiked personal income taxes for those earning more than £150,000 to 50 percent.  According to Mr. Tanner, that move actually managed to decrease income tax revenues by £509 million.  Oops!  While the U.K. government did trim payrolls and programs, British government spending consumes more than 49 percent of GDP and has risen by £59.2 billion from 2009 to 2011.  Again, oops!

This seems to be the pattern throughout the Eurozone.  Raise taxes on the wealthy and promise that you'll cut spending at some distant and poorly defined point in the future.  In addition, governments in the Eurozone have decided that raising the level of the Value Added Tax "licence to print money" is the best option to achieve a semblance of fiscal responsibility.  As shown on this chart, here's how many Member States and other jurisdictions are adopting this practice:

Never let it be said that there's an original thinker among our leadership.

How lucrative is the VAT machine?  Looking at the case of Germany, government's receipts from VAT totalled 36.6 percent of all revenue compared to only 21.4 percent from income taxes on wages.  To simplify things, the more Germans spend, the more the government makes.  In my opinion, this certainly is not a sustainable situation particularly if a continent-wide or global recession takes hold.

While the topic of a Value Added Tax (VAT) has been on the back burner since it reappeared in early April 2010 after a comment by Paul Volcker, the imposition of a consumption tax is not likely off the table over the long-term, particularly since the U.S. is the only OECD nation without a national sales tax.  With four deficits in a row in excess of $1 trillion, Washington desperately needs a "money machine" since apparently, it has not seriously crossed the minds of those in Congress to cut spending.  With a debt of $15.7 trillion, Washington will be looking for any source of revenue that it can get its hands on.  It's going to be a case of "monkey see, monkey do" for cash-starved Washington.

To put this tax into perspective, here is a chart showing current VAT rates across Europe:

Washington will be hard-pressed not to engage the services of this particular cash cow and what better time to do it than when a President is in his second term with no need to try for re-election.  From personal experience, living in a jurisdiction that is about to implement a similar tax, governments will do whatever they can to assure voters that these regressive forms of tax are anything but regressive and that you will actually be financially better off under the new regime.

I summary, looking back at Europe, we see governments grabbing for cash using creative tax measures at the same time as they are making very modest attempts at spending restraint.  Could these very unpopular moves be why voters in France and Greece couldn't wait to turf their governments in recent elections?  Perhaps the electorate in other European nations will follow suit as they tire of watching their governments grossly mismanage their fiscal responsibilities.

Moving to the western shores of the Atlantic Ocean, perhaps Americans will adopt the same modus operandi in November 2012.  Maybe we're all just a wee bit tired of the same old nonsense from those that we elect to "lead" us.

Wednesday, May 23, 2012

The Global Derivatives Market - The Next Implosion?

I recently took a wander through the website for the Bank for International Settlements or BIS and found one very interesting chart that I'd like to share.

First, I'd like to give you a bit of background information on BIS and then I'd like to give you a quick explanation about derivatives so that we can put the data that you will see in the chart into perspective.

In its own words, here's what BIS is and what it does:

"The mission of the Bank for International Settlements (BIS) is to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.
The BIS pursues its mission by promoting discussion and facilitating collaboration among central banks, supporting dialogue with other authorities that are responsible for promoting financial stability, acting as a prime counter-party for central banks in their financial transactions and serving as an agent or trustee in connection with international financial operations

As its customers are central banks and international organisations, the BIS does not accept deposits from, or provide financial services to, private individuals or corporate entities. The BIS strongly advises caution against fraudulent schemes.

Basically, BIS is the banker of all bankers.  It is the penultimate central bank, coordinating the efforts of its 58 member banks.  BIS has two goals: first, to regulate capital adequacy for banks and second, to make bank's reserve requirements transparent to ensure that the risk of bank runs is minimized.  Editorially speaking, I'd say that BIS must have been sitting on its hands during the Great Recession and during the recent implosion of many of the banks in the Eurozone.

On to part two.  What is a derivative?  Here is the definition from Investopedia:

"A derivative is a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage." 

For those of you that have some knowledge of how stock exchanges work, you are aware that you do not physically have to hold a company share in your account to "own" that share, bond or commodity.  You can "own" it by holding a futures contract, an option to buy or sell, a swap or a forward contract.  As such, these instruments can be used to deflect risk on such things as future declines in price, future changes in exchange rate or even future changes in weather that could impact the price of a commodity.  Basically, you name it, and the minds controlling Wall Street have found a way to monetize it through the creation of a derivative.  

Basically, derivatives are just "something that is based on another source", that is, it is something created from something else.  In our increasingly "paper economy", it is creating something made of "paper" from something that originally had value.  If you want to know just how dangerous these paper fabrications are to the economy, you need to think back only 4 short years ago when the global financial crisis began.  In large part, the near implosion of the world's economy was caused, in part, by the creative proliferation of derivative products that were tied to United States residential mortgages.

Back to BIS.  Here is the chart from their latest Semiannual OTC Derivatives Statistics to the end of December 2011 in billions of dollars, remembering that only 13 of the 58 member countries are reporting their statistics:

All tallied, BIS reports that there were $647.762 trillion worth of derivative contracts globally at the end of December 2011.  Of all of the over-the-counter derivatives, interest rate contracts are by far the largest when measured in terms of dollar value.  In interest rate swaps, two parties agree to exchange (or swap) interest rate cash flows with the ultimate goal of preventing exposure to fluctuating interest rates or to allow the parties to gain access to a lower interest rate.  Clear as mud, right?  At the end of 2011, there were $504.098 trillion worth of interest rate contracts and, of these, $402.611 trillion were interest rate swaps.

Let's quickly put these numbers into perspective with this graph from the World Bank:

That's right.  The GDP for the entire world was $63.257 trillion in 2010.  That means that, according to BIS statistics, the world's entire stock of derivatives was 10 times the size of the world's GDP.  What is even worse is that some experts, including Paul Wilmott, estimate that the notional value of the world's derivatives markets is closer to $1.2 quadrillion or nearly twice what BIS statistics tell us.

As I noted above, interest rate swaps are the largest component of the world's derivative market.  When interest rates rise, one of the parties will be on the right side of the trade and the other will find themselves on the losing side as is the case with all derivatives.  With the size of the interest rate swap market exceeding the size of the world's GDP by many times, the fallout could be very, very ugly particularly when one considers how ugly it got when the much smaller credit default swap market collapsed in 2008 - 2009.  There are always winners and there are always losers on any trade; unfortunately, this time, we could all find ourselves on the losing side.  

Sunday, May 20, 2012

Quebec's Fiscal Situation - The Necessity of Austerity

Quebec's austerity measures which include the raising of tuition fees for its post-secondary students have been headline news in Canada recently and now Quebec's September election is front page news.  In light of that, I thought that it was time to do a brief posting on Quebec's financial situation.

Let’s start by looking at Quebec’s debt.  Quebec is Canada's second-most indebted province after Ontario and has the misfortune of having a bond credit rating that is in the lower middle of the pack, well below Alberta, Saskatchewan and British Columbia, Manitoba and below New Brunswick and Ontario at A+ (Standard and Poor's), the same rating as Nova Scotia.  This poor rating makes it more expensive for Quebec to service its debt.  Quebec's total debt in fiscal 2011 - 2012 is estimated to be $170.9 billion; this compares to Ontario's estimated debt of $237.6 billion.  Quebec's debt nearly twice the size of all other provinces combined (excluding Ontario).  Here is a graph showing how Quebec's net debt has risen since 1986 - 1987:

Quebec's debt-to-GDP is estimated to be 51.2 percent in 2011 - 2012, the highest in Canada by a very wide margin with Ontario coming in second place at 37.2 percent and Nova Scotia coming in third place at 35.2 percent. 

Here's a graph showing how Quebec's debt-to-GDP ratio has grown since 1986 - 1987:

In the March 2012 budget, the Charest government noted that the deficit for fiscal 2011 - 2012 was lower than predicted in the fall, coming in at $3.3 billion or 1.0 percent of GDP compared to the estimated deficit of $3.8 billion.  A large part of this improvement is due to a decrease in spending on interest owing on the debt of nearly $300 million, mainly on the back of lower interest rates.  That said, in fiscal 2011 - 2012, Quebec spent $7.452 billion on debt interest charges which works out to 11. 4 percent of revenues and 12.1 percent of program spending.  Projecting forward, even as the debt hits $183.4 billion in fiscal 2013 -2014, Quebec does not anticipate debt interest charges in excess of 12.2 percent of revenue.  Best of luck!

As an aside, Quebec's headline austerity measure, the increase in the Quebec Sales Tax from 8.5 percent to 9.5 percent on January 1st, 2012 had an impact on consumer spending in the province as consumers hastened to make purchases before the tax increase.  I can only imagine how many provincial treasurers are watching this move with great interest.

Here is a graph showing how and when Quebec plans to return to budgetary surplus:

Here is a graph showing how Quebec plans to cut the annual growth rate of spending increases from an average of 5.7 percent annually from 2006 to 2010 to an average of only 2.8 percent from 2010 to 2014:

I find this interesting, particularly since Quebec's population, like that of the rest of Canada, will be aging and availing themselves of more and more of the province's health care over the coming years yet, Quebec plans to spend less.

Quebec's objective is to reduce its very high debt-to-GDP ratio from a peak of 55.3 percent to 45 percent by 2026 as shown here:

My suspicion is that this too will be a difficult target to meet, particularly if interest rates on its existing debt rise to historical norms.  As well, should another deep recession become entrenched in the global economy, it will be very difficult for a future Quebec government to avoid spending additional funds to stimulate the economy just as they did during the Great Recession.  As well, Quebec has booked $825 million in "new measures" which will consist of either revenue raising or expenditure restraint that will take place from 2014 - 2015 onwards.  Since these "measures" have not been identified, they provide a downside risk that the plan to cut debt and deficit will not be met.

Quebec's economic growth is projected to be rather modest, particularly when compared to the rest of Canada as shown here:

This sub-par growth forecast is due in large part to softness in job creation and an expected slowdown in the province's housing market.  Sales of existing homes and new home construction levels are both declining and this decline is expected to continue through 2013.  Interestingly enough, TD Economics projects that Quebec's housing prices will correct in the range of 10 to 15 percent by the end of 2013.  When all economic data is tallied, the government assumes that GDP will grow by 1.5 percent in 2012 and 1.9 percent in 2013, slightly less optimistic than TD's forecast.

While Quebec's move toward fiscal balance are admirable, there are many unknowns in the equation that may prevent fantasy from becoming reality.  Quebec has traditionally relied rather heavily on transfers from the federal government as shown here:

If the Harper government follows through with its plans to wean Canada's have-not provinces from the federal teat, Quebec may find it impossible to meet its fiscal goals.  As well, when interest rates return to normal levels, Quebec's expenditures on debt interest payments will become an ever-increasing portion of its overall spending.  Since Quebec is already Canada's most highly taxed regime, if the province hopes to meet its targets, it has only one choice - cut spending now.

Friday, May 18, 2012

Facebook Mania - Twenty-First Century Tulipomania?

The recent mainstream media coverage of the "Facebook Event of the Century" has me thinking that one of two things has happened.  First, either it is a very, very slow news cycle or, second, we have entered yet another stock mania.  My suspicion is that this is yet another mania, created by the "pump and dump" set and very heavy coverage by the media.

By way of comparison, let's take a look back at one of the original manias, Holland's tulip mania of the 1630s, also known as "tulipomania".  Tulips were highly sought after by the wealthy in parts of Europe.  By the 1630s, even the middle classes strove to own tulips since they were seen to be an important part of maintaining one's social status.  In Holland, since tulips bloom in mid- to late spring, the buying and selling of tulip bulbs generally occurred during the summer months so that prospective buyers would have a chance to view the flower and have an idea of what they were buying since the value of the bulb varied with the appearance of the flower.  Once the bloom had died, the bulb was removed from the soil.  The problem with this system was that the flower varied from one season to the next.

In 1635, prices for tulip bulbs began to rise and bulbs, rather than being sold individually, were sold by weight while they were still in the ground.  The weight was measured in aasen, a unit of measurement that is less than 0.0017 ounces.  This meant that larger bulbs cost purchasers more than smaller bulbs and since tulip bulbs become heavier after they are in the ground for a period of time, the price of a heavier bulb could increase by 300 to 500 percent even if the price by weight remained the same.  One advantage to the larger bulbs was their increased ability to produce smaller offset, the small bulbs that are attached to the mother bulb.  This also made larger bulbs more valuable.

The most valuable tulips were those with contrasting, variegated markings.  Most desirable were those that had flames of red or purple against a white or yellow background.  This variegation is created by a mosaic virus that is carried by aphids.  Unfortunately, growers had no idea which bulbs would result in these markings and, on top of that, infected bulbs were less likely to produce the smaller offset bulbs since they had been weakened.

In 1635, the price of tulips began to rise.  Purchasers bought their bulbs in the winter, were handed a promissory note and took delivery in the summer, one of the first futures markets.  Buyers promised to pay a specific price for bulbs in the ground at a specific date in the future, speculating that the bulbs would be more valuable in the future at which time the promissory note could be sold to the new buyer in the hope of realizing a quick and risk-free profit.  By the last two months of 1636, speculation was rampant with the price of the most desirable tulips doubling or tripling.  Many speculators suddenly became rich which enticed other speculators who wanted to get in on the party.  Speculators paid for bulbs using cows, land, shops and houses; in one town, a farmhouse was exchanged for three tulip bulbs.  Buyers and sellers automatically assumed that the bulbs could be sold at ever-higher prices.  The trade in tulip bulbs was so lucrative that they were even traded on the Amsterdam Stock Exchange according to some sources while others state that tulip trading was always on the margins of Dutch society.

At its peak, a single tulip bulb weighing 410 aasen (0.7 ounces) sold for 3000 guilders.  This was approximately 20 times the annual salary of a skilled craftsman and, at the time, would have bought eight pigs, four oxen, twelve sheep, twenty-four tons of wheat, two tons of butter, a thousand pounds of cheese and a ship.  The record price for a bulb that was to be split into two was 5200 guilders or 35 times the annual salary of an average Dutch citizen.

The tulip market crashed (as do all manias) in rather spectacular fashion.  At one auction, the "greater fool" did not show up and, bulbs that had been priced at 5000 guilders a few weeks earlier, fell to one hundredth of that amount.  In the end, the promissory notes were deemed valueless and only contracts made after November 1636 were valid; buyers in these contracts would be freed from the contract upon the payment of 10 percent of the contract's value.  The few who had enriched themselves by selling their bulbs at the height of the market stood in sharp contrast to many families who were ruined by their  "investment" in tulipomania, many merchants and noblemen ended up living on the streets as a result of their foolishness.

While I realize that the Facebook initial public offering is somewhat different that tulipomania, there are some parallels.  People are making the assumption that Facebook will be the next Microsoft or Google and want to get in on a “good thing” before it is too late. While that may be the case, Facebook's valuation is purely speculative at this point and, most importantly, unlike Google and Microsoft, for now, they are pretty much offering a single product.  As we all know, consumers are a particularly finicky lot with extremely short attention spans; what is "cool" today, may be "crap" tomorrow a lesson that does seem very hard for humanity to learn.

On the upside, a few Facebook insiders just became multi-millionaires.  Apparently, history really does repeat itself.


Canada's Perfect Retirement Storm

Canada's Bank of Montreal recently released the results of another one of their fascinating surveys; this time, they asked Canadians whether or not they expected to be carrying a mortgage as they "rode west" into their sunset retirement years.  Here are the results.

Across Canada, an average of 51 percent of Canadians expect to be carrying a mortgage into their retirement years.  Regionally, these numbers vary greatly as shown here:

Canada Average: 51%
British Columbia: 59%
Alberta: 46%
Manitoba/Saskatchewan: 48%
Ontario: 47%
Quebec: 58%
Atlantic Canada: 43%

I am not overly surprised by these numbers, particularly for British Columbia where housing prices on the Lower Mainland are stratospheric and mortgages are practically lifelong indentured servitude.  Ontario's results are a bit off if one were to consider only the 416 area code, however, many parts of Ontario outside of the GTA remain relatively affordable.  While Atlantic Canadians have the lowest overall household incomes in Canada, they also benefit from some of the lowest-priced real estate in Canada, leaving them the least worried about carrying mortgage debt into retirement.

On top of the issue of too much mortgage for too long, 52 percent of Canadian homeowners feel that their debt load or mortgage is hindering their ability to save for retirement.  

Let's look at some reasons why Canadians are concerned about having debt in their sunset years.  As shown on this graph, Canada's household debt levels (in red) are higher than the Eurozone, the United States and the United Kingdom:

Here is a graph showing what has happened to the ratio of debt to personal disposable income in Canada since 1980:

Notice that mortgage debt alone is approaching 100 percent of personal disposable income up from a low of just above 40 percent less than 20 years ago.

Here is another interesting graph showing the mean debt of Canadians in 2010 by age group in thousands of dollars and by type of debt:

Canadians between the ages of 56 and 65, prime retirement years, still have a substantial debt load consisting of mortgage debt, secured lines of credit and other consumer credit. 

This graph shows the distribution of household debt by age group as a share of the total household sector debt:

Note how the blue line lies above the red line?  As a consequence of the aging population, the proportion of total household debt held by older households has risen over the decade from 1999 (in red) when compared to 2010 (in blue).

In this graph, we see how overall household indebtedness has increased for the same age group (31 to 35 years of age) between 1999 and 2010:

In 1999, a typical household aged 31 to 35 years of age had total mean debt of $75,000; by 2010, a typical household aged 31 to 35 years of age had a total mean debt of $120,000, an increase of 37.5 percent.

This final graph shows the mean mortgage debt held by Canadians based on income and age group for 2010:

Mortgage debt rises for households with increased levels of household income as would be expected, however, I was rather surprised to see that the 50 to 64 and 65 plus age groups (green and yellow lines) still had mortgage debt even when their household income was in excess of $125,000 annually, twice the average Canadian household income.

Canadians concern about their personal debt levels during the last decades of their lives is, well, concerning.  If, as many analysts predict, housing prices drop or interest rates rise, older Canadian households will find it even more difficult to retire on a fixed income if, in fact, they have a pension at all.  The baby boomer generation may be facing the perfect personal financial storm for the following reasons:

1.) Higher than historically normal household debt levels.
2.) A rising interest rate environment.
3.) A housing market that is declining as more of their peers sell into a saturated market to capitalize on their built-up home equity to fund their sunset years.
4.) A lack of pension income outside of OAS and CPP, underfunded pensions or defined contribution pensions that have lost value.

Yes, things really are different this time, particularly if you compare the retirement prospects of baby boomers to the generation that preceded it.  The 51 percent of Canadians that will still be heavily indebted in their retirement years will find their new reality far different retirement reality from that of their parents.