Canada is in one of its greatest ever economic crises - and doesn't seem to realize it.
The Bank of Canada is strangulating the economy and tomorrow Canadians will reaffirm the federal government that has sleepwalked the country into this mess.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
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TLDR Summary
Canada is currently experiencing its longest and one of its deepest recessions in decades. Real GDP/capita has been declining for almost three years and is now 3% below its peak. Unemployment has risen along the way and is now the highest in 8 years (ignoring the pandemic outlier). Americans are now 60% (!) more productive than Canadians. 10 years ago both countries were equal on a GDP/capita basis.
Fundamentally, this divergence is hard to justify. Both countries offer political stability and prosperity for motivated immigrants and both countries have access to cheap natural resources that should boost the competitiveness of their industries.
Therefore, this misery is primarily the product of disastrous policymaking, most importantly by the Bank of Canada. They have copied the Fed for the most part of the last three years, not understanding that a) Canadian households are much more vulnerable to rate hikes than Americans and b) the Canadian federal government is running much lower deficits than the US government.
Excess inflation in Canada is not driven by an overheating economy (which could be addressed by rate hikes), but by mortgage interest payments (that are oddly a component of CPI calculation) and by the weak CAD/USD FX rate. Canada’s imports from the US are 15% of its GDP. That includes a lot of necessities for Canadians and that have become very expensive.
The Bank of Canada is strangulating the Canadian economy which is now escalating because hundreds of billions of Dollars of pandemic mortgage debt will be refinanced this year at much higher rates. Discretionary spending will collapse under that burden. And those in charge are completely unaware of this as evidenced by the latest rate cut pause.
Meanwhile, tomorrow’s federal election promises little change. Canadians will happily reelect the current administration and reaffirm the people in power that have sleepwalked the country into this mess. And even if they don’t, the challenger seems to have little understanding for the country’s issues as well. Poilievre is making a big deal of cutting deficit spending, presumably inspired by the movement beyond the southern border. Deficit cuts would send the economy even deeper.
Aggregate GDP…
Canada’s GDP is rising both in nominal (4.6% YoY) and in real (2.2% YoY) terms. However, the true meaning of those numbers is clouded by population dynamics. Canada’s population has been growing consistently at more than 2% annually for three years. Its population now stands at 41.5 million.
That’s 3 million people more in just three years. Almost the equivalent of an entire Montreal, the second largest city in the country.
To put this further into perspective, this puts Canada into a league with the fastest growing populations in the world:
I hope you agree with me that it makes little sense to look at aggregate GDP when measuring a country with so much population growth. We obviously need to adjust for that by looking at GDP per capita.
… vs. GDP per capita
Using this metric, Canada has been in a recession for almost three years.
Canada’s real GDP/capita is now $55,100, 2.8% lower than its peak in May 2022. It has been declining in a straight line for almost three years which it did not even do after the Great Financial Crisis.
Unsurprisingly, the labor market is under pressure. The unemployment rate has been rising for two years. Ignoring the pandemic for a moment, this is the highest level in 8 years.
And all of this is not happening in the middle of a global financial crisis or recession. The US economy has been on steroids for years. Its GDP per capita is almost 60% higher than Canada’s. 10 years ago, they were identical!
Fundamentally, this divergence makes little sense. The economies of both countries are very much integrated (at least they have been until now) and they have similar economic strengths, i.e. their attractiveness for motivated immigrants, their political stability and their access to natural resources. So, where does this disconnect come from?
The Bank of Canada’s strangulation of Canadian consumers
A very important issue is the utterly deluded monetary policy. The Bank of Canada has by and large followed the Fed’s leadership, not understanding that the Canadian economy is subject to very different debt dynamics right now. Firstly, Canadian households have much more debt than their US counterparts and the duration of that debt is much shorter, making them more vulnerable to rate hikes.
And secondly, the Fed’s rate hikes have to be understood as a response to excessive fiscal deficit spending. The US Treasury still spends 7-8% of US GDP every year. Unprecedented outside of recession times. At the same time, Canada has not seen a renewed fiscal impulse. The federal deficit has stabilized at about 2% of GDP, which I consider completely unproblematic from an inflation perspective.
If Canada has had an inflation problem during the last few years, it’s certainly not due to an overheating economy from out of control deficit spending. There are two other reasons. Firstly, the Bank of Canada itself is driving the CPI because their rate hikes have increased mortgage interest costs (yes, they are a component to CPI, I know it’s absurd).
And secondly, the Canadian economy is highly dependent on the US economy. In 2024, Canada imported goods worth almost C$500bn from the US. Excluding energy trade, Canada has a trade deficit with the US. The weak Canadian Dollar is making imports more expensive which is raising living costs for Canadians. And why is the Canadian Dollar so weak? Because the Bank of Canada is strangulating Canadian consumers.
As I have argued before, Canada has a huge mortgage refinancing wave coming up this year because it has been five years since the pandemic borrowing binge and five years is the typically mortgage term in Canada. In fact, this wave has recently started as illustrated below.
On an LTM basis, mortgage originations have increased 20% in a relative short period. This will continue for a while until a full echo of the bump in the chart above has been formed. Every new refinancing depletes the pockets of Canadians further which will devastate industries depending on discretionary spending even more.
I usually abstain from making political recommendations. I want to focus on what will happen, not what should happen. It’s usually easier to figure out (political leadership is harder than most people think) and even if I could figure it out, nobody would listen to me anyway. But I will make an exception today: It’s blatantly obvious in my opinion that the Canadian economy needs more rate cuts.
However, the Bank of Canada thinks otherwise. It seems the situation is not dire enough for their taste. On April 16, 2025, they held their policy rate steady at 2.75%. They highlighted economic uncertainty from the trade war and acknowledged a weakening of the economy due to a drop in business confidence and consumer confidence. They also pointed to inflation volatility from tariffs and the removal of the consumer carbon tax, but recognized that long term inflation expectations are little changed.
What role will and can the federal government play?
Tomorrow, Canada will elect a new federal government. You would think that Canadians would use this opportunity to oust those who have been in charge during this misery. However, it seems that they won’t. Betting markets heavily favor Carney.
To be frank, I am not sure how much a new government could actually change. There are forces at play that are beyond Ottawa’s control. I am a bit surprised though that Canadians are so willing to keep the same people in power. It should be an easy bid for Poilievre in this environment.
Perhaps he is not running the right campaign. Perhaps Trump has been a disservice to the conservative movement globally (making people suspicious they are all ideological nutheads). Perhaps the trade war is a welcome opportunity for those in power to present a unifying external enemy.
But even if all those factors matter, it still seems that Canada’s abysmal performance against the US and against its own potential is not fully appreciated.
Sincerely,
Rene
What do we know about the immigrants? If they are mostly low socioeconomic status, young students etc, wouldn’t that alone be an explanation for the GDP per capita problem?
Canada has silly premiums on a number of things. Insurance (I.e. if in BC only ICBC) and phone plans tend to be a bit ridiculous. Grocery prices have been impacting households significantly over the last couple years. I've enjoyed living in Canada but not sure how majority of households afford it in the expensive major cities (I.e. Toronto, Vancouver, etc.), especially with lower salaries vs their American counterparts.