I promised at the end of yesterday's blog to talk about why I think it somewhat economically foolish for the cities of Toronto and Vancouver to, independently of all other parts of our great country, push away foreign capital. Here's why and this is not just economic theory - it is a reality.
In an open/flexible/floating currency system (like almost all of the developed world), there is a system to track how money flows in and out of a country. This Balance of Payments is comprised of two types of "accounts" on the federal government's books: the Current Account and the Capital Account. The Current Account tracks goods and services that are bought and sold with other nations (commonly referred to as "trade surpluses and deficits" but they do include services too, not just hard goods). The Capital Account on the other hand tracks capital flows between residents and non-residents (things like investments, loans and yes, real estate).
The economic theory/reality is that there must be Current Account/Capital Account Parity. That is to say, if a country runs a Current Account Deficit, it must run an equal Capital Account Surplus to offset that Current Account Deficit. The two must "balance" out at the end the day.
And according to studies like that of the CIA World Factbook 2017, here are the top countries running Current Account Surpluses (those exporting more goods/services than they import):
Interesting. So for countries like the USA and Canada, which run high Current Account deficits, there is an equal and offsetting requirement for them to run Capital Account Surpluses. That is to say that they need to attract foreign capital each and every day to fund that Current Account Deficit.
And how do you attract capital to fund your Current Account Deficit? You keep interest rates high (Note German 10yr bonds yield .64% while US 10yr bonds yield 2.89%), you create incentives for foreign investors to invest in your country and yes, you allow those foreigners to buy real estate. Any readers own a place in FLA?
So what is so bad about running Current Account deficits? Well, for starters, you need to keep interest rates high to attract capital and high interest rates put a bit of a stranglehold on economic growth. It also means you are beholden to foreign capital flows (Saudi Arabia, China and Japan are all massive holders of US Treasury bonds which helps fund the US's Current Account deficit).
In the USA, we are seeing the Trump Administration follow through on their campaign promise to "bring back manufacturing jobs to the USA". It is highly unlikely that Trump is going to go out and say he wants to shrink the Current Account Deficit but, in fact, that is exactly what he is trying to accomplish. Last week, we had a well-read client ask about the US$ going into free-fall. If Trump has success over the next 3 years in shrinking the Current Account deficit in the USA, there is the potential that the Capital Account surplus will shrink as well which may mean the need to attract foreign capital will lessen. Not sure it will lead to a free-fall of the US$ but it could maintain its recent weakness.
In Canada, we are in much the same boat as the USA. We run a very stout Current Account deficit so we need to equalize that every day with a Capital Account surplus. Again, this balance of payments situation means we need to attract in foreign capital every day. So I find it rather stunning that the mayors of the two largest cities in our country, unilaterally, decide to push that much-needed foreign capital away (or at least attempt to). Any idea how that affects our country's balance of payments on the whole? We need that foreign capital. And I do realize there is a question that some foreign money (the press talks a lot about Chinese investors) may be buying houses with ill-gotten gains but it is the responsibility of the Canadian Real Estate Board to vet all foreign buyers and report to FINTRAC (watchdog for anti-money laundering). Wouldn't it be better to properly vet the money rather than refuse it? Can you imagine if you simply were not allowed to buy a house in the State of Florida? (I could go on about relative value in the global residential real estate market, the principles of property ownership in a democratic society etc, but this is about the economic reality of Current Account/Capital Account parity).
Anyway, this is the reality of the state of our natural and constant demand for foreign capital in Canada.