Bank of Canada holds on interest rates. Here's 4 points you want to consider

The Bank of Canada MANTAINS interest rates today. The US Federal Reserve is making their announcement in the next hour or two. Here’s 4 points to consider with the actions of Tiff MacKlem, Bank of Canada Chair:

1.??????Savings is being punished. If consumer prices are rising by 5-6%, and savings rates are 1%, then the effective yield of your investment is -4% to -5%. When interest rates are not driven by the market, there is always an intended societal behaviour in order to centrally plan the economy. That behaviour is to get the Canadian household to continue to spend their money. Considering 58% of Canada’s GDP is from household spending, economy is unreasonably dependent on consumerism. It’s really a confidence shell game if you think about it. This is the basic premise of Keynesian economics - that spending (consumerism) is the motor of the economy and that governments should arrange their actions to promote more spending if the economy falters. Ludwig Von Mises more correctly wrote that savings is the motor of the economy, that people saving will have the opportunity to deploy that savings to make the right investment, and should be free do to so without the interference of market manipulation by the state.

Consider this: central banks were started in the early 1900’s with the expectation of avoiding bank collapses and building consumer confidence to stabilize prices. But prices aren’t stable – they are designed to increase by 2% per year, based on the mandate of the Bank of Canada. In essence, they are stealing 2% of your purchasing power every year whether you like it or not!

2.??????Low interest rates allow the government to get into more debt. We have seen a directed movement in the Ministry of Finance's Annual Reports away from talking about the amount of the debt and replacing that with the interest cost of the debt, and the debt relative to GDP. That sleight of hand only lasts for so long, until either the interest cost start eclipsing other spending, or until rates adjust significantly. Either way it’s a massive gamble with investor confidence in the government’s ability to pay its bills on the line.

Government bonds are offered to the public or directly to the Bank of Canada in a private auction, mostly because no one else wants to buy securities with such a low rate of return. The Bank of Canada also has committed to maintaining a functioning Government Bond portfolio by purchasing bonds from institutional investors in the secondary market. When the Bank of Canada purchases a bond, it either has to dump existing assets to create liquidity, or it creates new money through a computer entry, and inflates the supply of money, which allows banks to multiply their loans based on the reserves created by the assets purchased by the Bank of Canada. Government has the facility to spend the extra dollars as stimulus to people or corporate contracts for infrastructure etc. As of March 2020, the Bank of Canada owned $118 Billion of total assets, $76 Billion in Canadian government debt, and today that total is $499 Billion, $434 Billion in Canadian government debt. That extra $381 Billion of new money printed, and $351 Billion of that went to the Canadian government.

3.??????Higher rates will increase the interest cost of the existing government debt. Out of the total Federal debt, $508 Billion is confirmed maturing before the end of next year. If institutional investors hold these securities, they dispose of them at maturity and the government is forced to pay out the face value of the bonds. However, unless the Bank of Canada is aggressively raising rates by selling off assets, they tend to roll their government bond portfolio over instead of disposing them at maturity at the market interest rates especially as the Government of Canada is not paying off these debts any time soon. The Bank of Canada isn't as concerned about returns as an institutional manager would be. If the Bank of Canada raised interest rates by 1 or 2%, it’s possible that government bonds may get stuck at those higher rates when the bonds matured, which means the average interest costs to the government’s bottom line has the potential to double from $10 Billion to $20 Billion on that short-term maturing amount alone. Balancing out the needs of the economy has the potential of terrible repercussions on existing or new debt, as the interest costs borne by tax increases lowers the discretionary spending from point 1 above.

Interest rates are increased by the Bank of Canada disposing of its assets and decreased by buying more assets. Based on the needs of government spending, the Bank will be hard pressed to sell off assets on one hand and buy new government debt with the other hand, just in order to maintain equilibrium on their balance sheet to keep rates steady; and will be very hard pressed - in my opinion – to decrease their balance sheet and find an eager buyer on 0.25% 2 to 3 year bonds.

4.??????The effect of the US Federal Reserve announcement. It’s been said that when the US coughs, Canada gets a cold. There is an obvious strong trade and economic relationship between the two countries, and there will be a Canadian effect should US FED Chair Jerome Powell make a move to increase rates as the Bank of Canada maintained their rates. This is about the movement of capital in the global economy, and like water that follows the path of least resistance, money tends to flow where it generates a return. The overnight rate in Canada is ?% and the federal funds rate in the US is ?%, so an increase of 100 basis points or more could make a remarkable difference in this low rate environment as investors seek returns.

So what's the best course of action?        

The best solution to this attack on savings remains to reduce taxes on the amount that you earn. Certain asset classes in real property (such as real estate and precious metals) continue to be used by some as a hedge against inflation; creating, growing and stewarding capital in the tax-exempt environment of a properly designed life insurance company that can safely create a storage facility for your short and long term capital, and provide some reasonable arbitrage against inflation; and companies that have consistently produced an income through all stages of the market cycle seem to be preferred over growth companies in times where rates may be on the rise. You have to consider and weigh out the risks before making any decision, so make sure you’re speaking to qualified and certified professionals that can provide feedback and perspective so you can make an informed decision.

Data sources:

https://www.bankofcanada.ca/stats/goc/results/en-goc_tbill_bond_os_2021_12_31.html

https://www.bankofcanada.ca/rates/banking-and-financial-statistics/bank-of-canada-assets-and-liabilities-weekly-formerly-b2/

https://www.bankofcanada.ca/2021/10/staff-analytical-note-2021-23/