The Decibel - What history can tell us about this economic moment

Episode Date: January 17, 2023

The economic forecast for 2023 is … less than rosy. Inflation is still running high. Central banks may continue to raise interest rates. And what everyone wants to know is: How long will this last before rates are lowered again?Globe and Mail columnist Tim Kiladze says you can look back in history to get some clues. And they suggest that an investor’s best asset for the next while might be patiences.Questions? Comments? Ideas? E-mail us at [e-mail]

You know, history doesn't always repeat exactly, but the saying in markets is that it rhymes. Today, we're going to go back in time with Globe business columnist Tim Collatz to find out how long is this gloomy economic moment that we're stuck in going to last? And to answer that, Tim says we need to look backwards to look forward. I'm Anika Raman-Welms, and this is The Decibel from The Globe and Mail. Tim, it's great to have you here. Thank you so much for joining me. Always happy to be here. Lots going on in markets. Yes, for sure. It's a good time to talk about all this. And I know you've come today with a bit of

a history lesson for us. You pulled out three examples from the past that help us understand today's strange economic climate. But before we get into those, let's just start by establishing what's going on in our current economic moment. How would you describe it? It's messy. It's chaotic. And even the experts aren't quite sure what to think. And that's why I thought it was so important to look back at some kind of seminal events that are relatable or related

to what we're going through today. And there are some pretty shocking parallels. What has led us to this current gloomy forecast here? To me, in my mind, the way I make sense of it is you need to take a step back and realize that what we did to save the economy, and it was necessary at the height of the pandemic or in the very beginning, was this like major injection to keep the economy humming in a way. We've flooded the system with money and then the money kind of like spread everywhere. And now that money has to kind of come out of the system as we normalize.

And it's a bit of a painful process, especially because we had a decade or longer of ultra low interest rates. And we've had a whole generation, maybe even multiple generations, like millennials and now Gen Z, that's all that they know. So the system that we think of as normal is actually, that is not a status quo standard there. Yeah. And people are hoping and praying that this is just some short-term thing, you know, like give it six months and we'll be back to good. And I don't think that's the case. Okay. Okay. There's a lot to unpack here and we will get to it. We've talked about this kind of at a high level here. I guess,

what have you seen though, on a personal level, like as people live through this time, how are they thinking about things? To be honest, there was one anecdote that kind of really fueled why I wrote this piece. And I was at lunch. This was, would have been right before Christmas. I think it was, it was at a restaurant in my neighborhood and the server and the table, there was two people at the table. They were regulars. They knew each other and they're talking and they all had bought houses or condos or something last year. And they were all like on variable rate mortgages. And they're like, I can't do this anymore. It's killing me. And one of them said, oh, as soon as rates fall to like 3% next year, I'm going to lock in on a

fixed rate and then the pain will be over, or at least I can manage it. And it took everything in me to not like lunge across the table and say like, that's not going to happen. You don't think you understand. And there's a huge disconnect right now. And there's a lot of hope that things will revert back in six months. And it's not likely going to be the case. Okay. So let's dip back into history here and actually see how these things have played out before. Can you give me your list of the three historical moments here, Tim? So there was three that really stood out in my mind. There's a dot-com bubble, dot-com crash, however you want to call it. There was the 2008 global financial crisis

that lasted for a number of years. And then there was the cannabis boom and crash here in Canada. So let's start with the dot-com crash that took place in the early 2000s. Tech companies are currently feeling a lot of pain. So I guess that's one parallel. But why else is that a moment to take note of now? For a lot of people who are younger, you know, like they probably don't even remember it. Or for them, maybe they were young and they like remember it happening and their parents talked about it. And that was at the height of what we call internet 1.0. That's when Amazon kind of first started to develop. And the idea was the internet was going to kind of radically change the way we do everything. And in many ways it has, that's how we communicate, how we text,

all that kind of stuff. But it was kind of this belief took hold that any physical shopping will be done online, you know? And it got so insane that I think the exact stat was like the value of the NASDAQ, which is the tech index in the US, quadrupled in three years. And it was, if you look at a stock chart of it,

it's literally looks like a knife's edge or something like it's like a mountain peak. It was like, yeah, it was that feverish going up and then it just crashed so quickly. But what people forget is that it took two and a half years for the NASDAQ to finally bottom. In that two and a half year period, there were eight bounces of the market rising, and people getting some of that false hope. And two of those bounces were 40% or more bounces. But I would say another major parallel to today is this idea of a revolution, like a revolution, the way that we do things. So then it was like, you know, you're going to be shopping online. Here, it was like, you're going to be working from home on zoom all day um you're going to be everyone's going to be working out at home on peloton all that kind of stuff and there

really was rapid growth or adoption of these things because of the pandemic and so no one knew what normal was anymore and as soon as you don't know what normal is, you kind of can latch on and just dream rather than be grounded in reality. And you mentioned too, that there were these over time, there were these like rallies and crashes kind of over and over again. Is that, is that something that we can kind of draw connections to now too? There's already been one. I'd say it's a little bit too soon to, know. I also think too that people need to be aware, particularly for the housing market, that even if things go sideways

or they kind of just like plateau for a few months, that doesn't mean it's over. You don't have to necessarily have a bounce, right? It could just plateau and then it could drop even further because some new economic pain hits or whatever. So the message is that there's lots of head fakes in there and don't fall for the first one that comes your way. Okay. Let's move on to the 2008 recession. I think a lot of our

listeners will probably remember how devastating that was for a lot of people, right? Like the jobless rate got as high as 8.7% in 2009. That's according to Stats Canada. And that's compared to the 5% we're at now. So unemployment is lower, and we are not officially in a recession yet. So why is this example relevant? I mean, I pray that we don't have anything close to that in terms of kind of economic pain. And I personally don't think we will. Like the problem in that one was that the financial system was badly beaten up, and there's lots of holes in it. And we've plugged those holes with safeguards and regulations and such. The connection now though,

is that there were warning signs leading up to like the real free fall in markets in September, 2008. There was a, people won't even know about it, but there was this fund that froze and prevented people from kind of cashing out of the fund. And it was tied to US mortgages, basically. And I remember distinctly, it was like August, 2007.

And it was the first uh-oh moment, but it kind of like stabilized. And then six or seven months later, Bear Stearns, which was one of the big US firms, literally went under. It had to be saved at the last minute. And this was like a major moment. And again, after a few months or weeks, people kind of just brushed it off. And then the

real pain hit. And what we're seeing now is there are some examples of kind of funds preventing investors from cashing out because those things are kind of rocky right now. And maybe it doesn't get severe, but I'm just saying you can't ignore what's going on. Don't focus on the positive or solely on the positive. Okay, okay. So this is a little bit different. But you're saying we shouldn't ignore this. And that recession in 2008, that led to a real collapse in the housing market.

Is there any reason to believe that it could get that bad today? There are some similarities, to be honest, particularly in Canada, because we really let ourselves turn housing into a financial asset. And you need investors in some extent, but they became the dominant buyer. When that happens,

people start to kind of become motivated by animal spirits, which is a market term. So can you explain animal spirits? What is that? You run around just pounding your chest, you know, oh, I made money. But, you know, you give into your instincts. It's like you go for the easiest answer or you, you know, there's a lot of human conditions built around, you know, what some people today would call FOMO, which is the fear of missing out. And so what had happened to be able to afford a home, people were taking variable rate mortgages, which were quite low.

And they were low because variable rates move in line with where the central bank benchmark rate is, is what it's called. And so in the last year, they've jumped by, you know, 4%, which is a huge shock to the system. Whereas a fixed rate mortgage, you're locked in for five years at a certain rate and you have some certainty around it. What people I think don't realize about housing right now is that there's a mindset shift.

You might start selling because you're like, oh, this is not actually a good investment for me anymore. The difference is that the vast majority of people are in good ground. Whereas in the U.S., which is what caused the financial crisis, that there were lots of people who were buying homes, particularly older people, who should never have been lent money in the first place. Okay. Okay. So there's a few similarities there. And I guess the other thing I'm just thinking as you're talking,

like you were saying how the 2008 crash, like there was almost a few false starts, right? You're saying there's warning signs at the start and then it took a while to really see what the big picture was. So that gets back to, I guess, your idea that this takes time to play out. Yeah. And no one can predict right now what's going to happen. We'll be back in a minute. Let's go to the next example on your list. I was actually surprised to see cannabis on it because, I mean, I know the market isn't doing well these days. And in fact, one index that tracks publicly traded cannabis companies, it's down 88% since September 2018. So significant.

But I guess I don't really think of it on the same scale as like, you know, the dot-com bubble bursting. So why did you include cannabis in your list? Because it was truly a classic bubble. When cannabis was being legalized here in Canada, I used to say you could scream bubble till you were blue in the face and people would not listen. And it was honestly a lot of retail investors who, I mean, sadly, a lot of them lost money. But it wasn't like you had some huge money manager, like Canada Pension Plan, that made this huge bet on cannabis and then it lost 88%. Okay. Okay. Okay. And so it sounds like the cannabis market is kind

of fueled by that, like speculation, the, the, the hope in a way, the hype that happens, uh, is, is that also where you see parallels to the current situation? Does that connect? Yeah. One of the big connections was that, um, with cannabis, if you just ran the numbers and you looked at, um, you know, this number of people in Canada will smoke, actually will even attempt to try cannabis. And we have so many producers in this amount, that's going to be produced within a year. You can see that there was this massive mismatch. And as soon as you have too much supply of anything, prices fall. It's that simple because you're trying to just sell your inventory basically. But there was always this story

about like, what's going to lead to more. And that's what's happened a lot in the pandemic. But like, we just made ourselves believe that we're going to radically change human norms. And everyone's just going to work from home for forever. Meanwhile, we ignore like, just as one example, that a good chunk of the population can't work from home, you know, so they actually shouldn't be included in those calculations of the what what's called the total adjustable market because they're nurses or bank tellers or something that requires in-person work. And how long did the cannabis industry kind of take to drop in that way? It depends on where you start and finish, of course, but I would say it was about two years.

Okay. So we've gone through those three historical examples you brought to us here, Tim. I think when we're talking and you hear people talk about our current economic situation, the period of high inflation right now, another period of high inflation gets brought up and that's in the 1970s and the 1980 taught central banks, which is the key thing. And the major lesson is inflation over everything. If I had to summarize it, what that means is inflation is the number one thing you have to focus on. Because once inflation becomes what they call entrenched, it just kind of starts to exist in the system. In our minds, everyone just assumes that things will keep going up and it just causes so much chaos. So one of the big problems from the 70s and 80s is that they were too slow to raise rates. And they didn't do it forcefully enough. So they kind of tried it a bit and what they ultimately decided and learned,

they had to like jack them up really quickly. Well, we've done that. And the current interest rate, we should say, is 4.25%. And there's a chance it goes up a little bit at the next meeting in the US. They're already saying that it's going to keep going up. The data is showing that it needs to go higher. Because there's been so much pain in the economy, some prominent economists in the US recently looked back at sustained periods of high inflation going back as far as 1950

and found that in that period, there was a number that resembled what we have today in that inflation was so far above the targeted rate of what is now 2%. What was interesting is that across these periods of high inflation, the median time it took to get down back to where you should be was basically five years. So yeah, five years. So think about even if rates don't go higher, imagine if rates just stayed where they are now for five years. Just consider that. Yeah. Wow. So I mean, it sounds like the takeaway here is that these moments of economic pain, they take longer than we'd like to resolve essentially. And we should brace ourselves

for the same this current time. I just want to push back a little bit, though, Tim, because we keep hearing over and over again that this time around, it's unpredictable, because we're in such a unique situation, right? Like, this current economic situation is so strange, because we've had a pandemic, the governments have handled that in different ways, they've put money into the system, that there was ensuing supply chain drama, a lot of things that came as a result of that. So isn't there reason to believe that this moment in time might not fit with the historical examples? Absolutely. But we're in this weird situation that I don't think it's talked about enough, which is that people, you know, on variable rate mortgages, for instance, want rates

to fall. But if things do resolve themselves relatively quickly, it just means the economy is going to keep humming because it's like a strong economy, things are okay. Well, if the economy keeps humming, interest rates aren't going to fall. They're actually going to stay where they are or go higher. Because in a good economy, you have higher rates and in a bad economy, you lower rates to try to stimulate the economy and get people boring and stuff again. So I don't think that that mental connection has like really worked out just yet. And so what's actually kind of nice about what's going on now is there's a bit of normalization happening and that's what we've needed for a long time. Okay. So it sounds

like in some ways, I mean, it's not a positive story, but you're saying normalization might in some way be a good thing? Yeah, it's a very good thing because we were living in a bit of a fantasy land of low rates for so long. If you look at a chart going back 50 years or so, you know, my folks always talk about,

you know, in the 1980s, GICs were 18%. You know, my mortgage rate was like 20%. And it's all true. I mean, that in itself was its own deviation from norms. But people didn't realize that what we had for the last decade was its own deviation, its own absurdity in a way. And what I think people forget quite often is where we are with rates

right now, you know, around 4% or so, it's actually not even that high, you know, like this, this is normal. And so if we have a lot of pain at 4% rates, it means that we were really like overextended in many ways, you know, like we were doing some stuff that was just, it was just silly. This was fascinating, Tim. Thank you so much for taking the time to talk to me today. Appreciate it. That's it for today. I'm Mainika Raman-Wilms. Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin.

David Crosby edits the show. Kasia Mihailovic is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.