You might also want to adapt this mantra if you’re an investor since it’s equally applicable in terms of understanding business cycles. We investors have a tendency, when times are good, to think that they will always be good. When interest rates are low, we think interest rates will always be low. And when the economy sucks,  well… you get my drift.

The reality is very different. Free market economies regularly move through phases of expansion and contraction.

When a business cycle is in an expansion phase, jobs are created and incomes usually go up. The increased prosperity gives consumers loads of confidence so they go out and spend loads of money.  All that spending drives the production of more goods and services to keep up with the demand, further fueling the economic expansion. That over-demand and under-supply can fuel increase in prices. When those prices hit some magic number – a tipping point – consumers pull back. Now companies are left with an over supply of their products and services so they, in turn, pull back, cutting production to reduce inventory and laying off workers. This is where the expansion phase turns to the contraction phase.

When the business cycle is contracting it’s because sales and incomes are generally falling and unemployment is increasing.  Consumer confidence is nowhere to be seen so people start to squirrel away a little money because they now believe the worst can happen. Governments usually step in to stimulate spending or hiring and try and mitigate the impact of the contraction.

If the trough is deep enough, it’s call a recession. Typically, during a recession, production as measured by GDP falls. Business profits fall. So too does employment and, as a result, household incomes. All this results in lower inflation, higher levels of bankruptcy and increased unemployment.

What is GDP? Gross Domestic Product (GDP) is one of the primary indicators used to gauge the health of a country’s economy. It represents the total dollar value of all the goods and services produced during a particular period of time. At its most basic (because the calculation is actually quite complex) GDP is calculated by adding up what everyone earned in a year including total compensation to employees, companies’ gross profits, and taxes (less subsidies). Or, more commonly, it can be calculated by adding up what everyone spent in a year, including total consumption, investment, government spending and net exports. When you hear that GDP has risen by 2% over the past year, it means economy has grown by 2%.

If the trough is deeper still, it’s called a depression.  While there’s no universally agreed upon definition for a depression, one rule of thumb used is that a depression is a period during which GDP declines by more than 10%.

There’s an old joke amongst economists (who are, by nature, not particularly funny):

A recession is when your neighbour loses his job. A depression is when you lose your job.

Ultimately, like the sun rising or the seasons changing, the business cycle will shift, moving once again to expansion. Unlike the seasons changing however, there is no regularity to the business cycle, which is one reason why we poor fools keep getting sucked into believing that things will never change. Cycles vary in length. Cycles vary in intensity. But while we can never predict the longevity of a current cycle, it behooves us to keep in mind that what goes up must come down. And vice versa.

The financial news has been full of talk about deflation. Almost everyone knows that inflation means the price of stuff is gonna go up.  But the flipside of inflation – deflation – is something most people have far less experience with. Like it or not, you might just have an opportunity to share in this interesting reversal since economic indicators say we may be headed for a period of deflation.

So what is deflation, and how will it affect you?

When an economy experiences a reduction in prices for it’s goods and services, that’s called deflation. Don’t confuse “deflation” with “disinflation” which is simply a slowing of inflation. Deflation is a full on reversal. And for many economists, deflation is a way more serious problem, largely because it’s tougher to control.

People are always bitchin’ about how inflation makes things more expensive, so one would think that a period of reduced prices would a be welcome respite. After all, if stuff becomes cheaper to buy, money will go further, right?

Yes and no. Yes, things will get less expense, and that can be good in the short-run, particularly for people living on fixed incomes. The No comes in when deflation drags on. When prices are falling, consumers are willing to wait for even lower prices before putting down their hard-earned dough. Inventories pile up. Sellers are forced to cut prices further to increase demand. Companies’ profits fall. That leads to production cut-backs, reductions in wages, layoffs and even the closing of facilities. Unemployment increases and since fewer people are working and have less money to spend (and less taxes are being paid) the economy cannot expand. There is no growth. People get even more scared, spend less, and the whole thing just spirals down.

The U.S. fell into a deflationary period during the Great Depression in the ‘30s; deflation hit 10% and unemployment hit 25%.  Japan went into a deflationary period in the ‘90s and that economy still hasn’t really recovered.

The big benefit of deflation is, of course, the fact that stuff gets cheaper. Yes, it’ll cost less to live. But less is relative, since deflation also brings reductions in income.

So what can you do to protect yourself (kinda) if we do fall into a period of deflation.

Reduce your debt. (Gee, Gail, that’s your answer for everything.) As we’ve already seen happening, interest rates go up for riskier borrowers during a period of deflation. Since growth is at a standstill, lenders are less willing to let you spend money you’ve haven’t yet earned.

Get your fixed expenses under control. If you lose your job, you’re going to be working on a bare-bones budget. High fixed expenses are anathema to survival. So those mortgage payments. car payments, loan payments that are gobbling up your paycheque are going to get even harder to stomach.

Build up your emergency fund. Since deflation brings higher unemployment, if you’re one of the newly unemployed, you’ll need an emergency fund (cash not a line of credit!) to survive.

Focus on increasing your personal marketability. Get some new skills. Keep your resume up to date. Look for ways to shore-up your employment prospects.

During periods of deflation, cash is king. Do whatever you can to store up your money. If the deflation thing never comes to fruition, you won’t be any worse off having some extra cash available for investing. If it does, you’ll breath more easily knowing you have some resources to see you through.

Assuming you had $100,000 to put down and got the mortgage at 3.7% (the lowest available at a major bank at the time I wrote this) and amortized your mortgage for 35 years (the longest available), your mortgage payment would be $3,809.75.

If the mortgage payment alone was to hit the 35% suggested in the Life Pie for what housing should cost (assuming you had no taxes, utilities, insurance and maintenance costs), you’d have to NET almost $11,000 a month to pull it off.

Okay, so the real estate market is a little overheated. What’s a body to do? You have to live somewhere, right?

I just wonder how those folks are going to cope with the rising interest rates when it comes time to renew. So I went back to the same bank I used for the mortgage quote (I used the one-year closed rate) to see how the payment changes. Their five-year closed rate is at 5.79% and that takes the monthly payment up to $4,964.42. This takes the percentage of your net income used for housing up to 45%, without taxes, utilities, insurance and maintenance costs. Ouch! Betcha that home-buyer will be putting those fees on her line of credit and her groceries on her credit card.

One of the reasons I chose the five-year rate is that new rules came into effect earlier this year that are designed to stop people for over-extending themselves. Now borrowers must meet the standards for a five-year, fixed-rate mortgage, even if they choose another term with a lower rate. (Anyone want to take bets on how long it’ll take for lenders to offer “special five year rates” so they can help customers get around this little mole-hill?)

While nobody seems very flustered by the fact that the Bank of Canada raised it’s rate another ¼% — hey, let’s not scare off the borrowers – if you’re carrying debt or planning to renegotiate a mortgage at some point in the future, you should be paying close attention.

But that’s just Vancouver, right? Elsewhere things are saner. Well, maybe. Calgary watched it’s home prices slip 8% at the beginning of the summer. If that happened in Vancouver, $80K of that $100K downpayment would be wiped out. Some people are under the impression that the drop off is a result of rising bankruptcies in the hitherto spend-free city. But it was an over-supply in housing that was the real culprit.

Earlier this month, Stats Can reported a drop of 5.3% in Canadian residential construction permits. And this week a National Post article quoted home sales as down 20% in June compared to June last year. That’s a whisper in the wind that there may be an over-supply of housing in the future. That doesn’t bode well for people who find they can’t make their mortgage payments and decide to downsize to something they can actually afford to carry and have a life too.

So how do you know if you’re contemplating buying in a over-heated market? Check the “affordability index,” which measures home prices against gross household income for an area.  Some pundits say you shouldn’t buy an area where the index is over 4, meaning that house prices are 4 times gross earnings. (When I was still just a kitten, the rule of thumb was under 2.5 times gross earnings. See how things change?) Vancouver’s index is sitting at almost 9.5. Toronto is at 4.93. The national average is just over 5.

Where do you find the affordability index? You’ll have to search the internet for it. And you have to look at the numbers and not so much at the yackety-yak that goes with ‘em. Since the numbers are often produced by banks, and banks are in the business of lending money, the “spin” is often designed to encourage borrowing. If a bank goes so far as to tell you that a market is actually overheated, take heed.

Keep in mind that the affordability index reports for an entire area. There may be pockets of very reasonably priced real estate within those areas, so don’t go getting all despondent and think you’ll never be able to afford anything. It will mean you’ll have to shop hard. And you’ll have to be patient. Someone else may be just about to bail and you’ll get your house on a sell-off at a considerable discount from the current “market” rate.

What you should not be doing is taking on more home than you can reasonably afford. If you do, don’t be surprised when you become “just another statistic” in the housing drama.

CDIC – the Canada Deposit Insurance Corporation – is the government agency that guarantees your bank deposits for up to $100,000 just in case your bank goes bust.  ‘Course that guarantee comes with a price tag, which the banks pay in the form of premiums. Now CDIC is floating the idea that it will raise deposit insurance premiums – doubling them – to ensure it has the resources it would need if a major failure occurred.

Part of the problem comes from the fact that Canadians may be parking more at their local bank for a couple of reasons:

• They were scared out of the markets and sought what they thought of as higher ground… bank deposits of all types, and
• They may also be saving more as they finally wake up to the fact that you can’t spend every red cent you make.

Whatever the reason, the end result is that the amount CDIC has to cover has jumped. The Globe and Mail reported a CDIC spokesperson as saying that while deposits typically grow by about 6%, last year they jumped by 15%.

I wouldn’t be in the least bit surprised to see CMHC (Canada Mortgage & Housing Corporation), the organization that insures mortgages, follow suit.  With interest rates at record lows and lenders offering clients more than enough rope to hang themselves, when interest rates start to rise – and rise they will – it’ll be interesting to see how homeowners cope with higher mortgage payments. If they can’t, it’ll be CMHC that’s left holding the bag, covering mortgages that go under.

If you borrowed $350,000 at 2.75%, and interest rates increase by even 1%, you’ll see a jump in your mortgage payment, unless you extend the amortization when you renew. So your $1600 a month payment would jump to almost $1800.  And if you had to renew at 5.49%, which is today’s posted rate for a five-year term, you’d have to find just over $2,100 a month to keep your home. Would you be able to come up with $500 a month more?

Canadians haven’t come anywhere close to feeling the pain of our American cousins. The New York Times Magazine reported last weekend that millions of Americans have watched as their homes have gone under water financially. They call it having “an upside down mortgage”: one where you owe more than the house is actually worth. And even Americans who CAN afford their payments are choosing to stop making those payments rather than throwing good money after bad. So the crisis down south ain’t over yet.

Further north we have been insolated from the same kind of meltdown because of our national banking system that demands higher reserves, and because of a central bank policy determined to hold interest rates down. But for how long? And then what?

If our economy had rebalanced during the last recession – yes there would have been more pain, but at least it would be over – I might be a little more optimistic. But it didn’t.  And while you’ve heard me rant on and on about the fact that “the fundamentals” can’t change, we still have people saying that they have. And we have governments prepared to pour millions into a broken economy, rather than accept the fact that markets – all markets – have ups and downs, and you have to learn to take the bad with the good.

Like protective parents who can’t stand to see their children suffer in any way, these governments have put their own financial health at risk to try and keep us happy and spending so we can buoy up the economy. But it isn’t working.

The bail-out of domestic car companies have left them holding inventory nobody wants to buy, while foreign dealers continue to rake in the money from consumers who think things are all fine on the northern front. The suppression in the natural rise of interest rates – in the global economy inflation is ratcheting up with a vengeance — has kept real estate markets hot and given home-owners the false impression that real estate values can’t go down. “Hey, we came through a recession and our house is worth even more, aren’t we smart.” Hey you only have to look down south to see that real estate is just one more asset class susceptible to market cycles.

George Athanassakos who is a professor of finance at the Richard Ivey School of Business at the University of Western Ontario, says in his column that he can’t sleep. He says that when the recession hit, about 60% of Canadian households were in a net debt position. Since then the problem has actually gotten worse as we continue to take on mortgages we won’t be able to afford when interest rates start to rise. Apparently the recession did nothing to knock some common sense into our heads. Oy!

I’ve always believed you should plan like a pessimist so you can live like an optimist.  If you owe money, it’s time to stop spending on anything that isn’t an essential, pay down your debt, and build up your emergency fund. Since it’s impossible to predict what it will take to push Canada over the edge, you better be shoring up your financial defenses if you want to be able to ride out the storm that’s coming.

Here are three upcoming locations for book signings:

Saturday, Jan 23  @ 1 pm – Chapters, Oshawa Centre,  419 King Street West
Wednesday, Jan 27 @ 7 pm – Indigo, Manulife Centre,  55 Bloor Street West
Saturday, Feb 6 @ 1 pm – Chapters, Square One, 189 Rathburn Road West

This will likely be the final three, so come one, come all and let’s par-tay!

Alex has recently become employed in a grocery store. She knows she has to come up with her share of the money for university, and she’s balancing work, school and her extra-curricula to make as much as she can without blowing her marks. This was when I learned that a cashier over 18 makes more money than one under 18 who works 28 hours a week or less. Yup, by sheer dint of age, two people doing the same job at the same time in the same place can make different incomes. Hey, isn’t there some rule on the books about age discrimination? Guess not!

Alex was further appalled to find out that despite not even making minimum wage, she would lose almost 20% of every paycheque to union dues. “So, Mom,” she said, “if they can’t even get me minimum wage, what exactly am I paying the union to do?”

“Hey, “ I said. “This is the way of the world, and you can suck it up or you can get another job.”

Since it’s her first job, for the sake of a stable work history she’s decided to suck it up. But the question made me go and check who else is getting less than the minimum wage that the media and The Spurts like to quote when they’re bantering about incomes.

Between 1995 and 2005 minimum wage in Ontario rose from $6.85 an hour to $7.45. That’s right, in ten years the minimum wage went up a whopping 60¢. Wow! We’ve made some progress since then since the general minimum wage now sits at $9.50 (thanks Nicki) and is headed to $10.25 in March 2010.  Unless you’re under 18, in which case it’s $8.90. (Ontario has the distinction of being the only province that still allows young workers to be paid less than adults.) Or you serve liquor, in which case it’s only $8.25.  Home workers – people who do paid work in their own homes like sew clothes for a clothing manufacturer or answer telephone calls for a call centre – make $10.45 an hour as minimum wage. Hey, you mean if I don’t have to get dressed or pay for transportation I actually make more?

In Alberta, minimum wage is minimum wage and is only $8.40. But Albertans say that the average hourly wage Albertans make is $24.17 per hour. In B.C. the minimum wage for most workers is $8.00 per hour and that hasn’t moved since Nov. 1, 2001. In Saskatchewan it’s $9.25 but there’s also the provision that most employees are entitled to at least a minimum payment (“minimum call-out” pay) every time their employer requires them to report for work (other than for overtime), even if it turns out there is no work for them. The minimum wage in Manitoba is $8.50 per hour as of April 1, 2008 but the minimum wage provisions may not apply to agricultural workers, sitters, or part-time domestic workers. In Quebec the minimum wage rates since May 1, 2008, are $8.50 an hour unless you usually receive tips in which case it’s $7.75 an hour. Down east the rates are:

• New Brunswick: $7.75
• Newfoundland and Labrador: $8.50
• Nova Scotia:  $8.10 (unless you’re inexperienced: $7.60)
• PEI: $8.00

Up north the rates are:

• NWT: $8.25 (and it hasn’t moved in six years)
• Nunavut: $10 (the highest in the country)
• Yukon: $8.89 (really? They couldn’t spring for the extra penny?)

All this is to say that generalizations about income must be very frustrating for people who live in areas where they are paid less than the “stated” minimum wage. And there are a lot of people who are just barely getting by. Minimum wage is not a living wage. Almost everyone agrees that it’s just about impossible to live independently on $17,000 a year in any major Canadian city. And while the labour movement likes to point out that it’s no coincidence that the lowest paid jobs are typically non-union, Alex has her own take on that point.

According to The Stats Man average income after tax in 2007 were:

So how do you and your family compare? What are your frustrations about the current state of employment and pay in Canada? And if you could change one thing, what would it be?

The Money Supply refers to the amount of money in the economy, some or all of which can be used to buy stuff. In the U.S., the most common measures of money supply are termed:

• M0: The total of all currency plus accounts at the central bank, which can be exchanged for currency.
• M1: Measures M0 plus the amount in demand accounts, like your chequing account.
• M2: Measures M1 plus savings accounts, money market accounts, and certificates of deposit under $100,000.
• M3: Measures M2 plus all certificates of deposit over $100,000 along with deposits of Eurodollars and repurchase agreements.

In Canada, the terms are slightly different:

• M1: Measures currency in circulation plus the money in personal chequing accounts.
• M2: Adds in personal savings accounts and other chequing accounts, along with personal and non-personal deposits which require that notice be given before withdrawal.
• M2+ includes all deposits at non-bank deposit-taking institutions, money-market mutual funds, and individual annuities at life insurance companies.
• M2++, also includes all types of mutual funds and Canada Savings bonds.

In the U.K. there are just two official money supply measures:

• M0: Measures all cash outside the Bank of England plus private banks’ operational deposits with the Bank of England, and
• M4: Measures all cash outside banking institutes including money in circulation, deposits with private-sector retail and wholesale banks and building society deposits along with certificates of deposits.

Are your eyes glazing over? The point I’m trying to make is that different countries measure the money supply in different ways. But who can spot the one thing missing from it all?

The theory behind the importance of the money supply is that central banks monitor the rate of money growth and then exert their influence by changing short-term interest rates. When the central banks’ rates change, other rates like those paid by consumers for loans change along with them. In theory, when interest rates rise people are apt to borrow less and pay back existing loans, slowing in the growth of M1.

Okay, have you spotted the problem with the theory yet?

In economic theory, the availability of money and credit must expand over time, and central banks are responsible for ensuring that the rate at which more money is introduced into the economy is consistent with long-term stable growth. By influencing the rate at which the supply of money and credit is growing, total spending can be kept stable.

So what’s the bug in the ointment?

How about the fact that credit cards aren’t the traditional form of borrowing, that high interest rates in no way motivate borrowers to pay back their credit card debt, and that nothing the central bankers do ever has an impact on the interest rates that credit card companies charge? How about the fact that the credit available through credit cards is acting like money – it’s used to buy goods and services – but it is in no way reflected in the calculation of the money supply? And how about the fact that as a result of this oversight, we allow credit to be issued at a whim, to whomever credit card companies want to give it to, in whatever amount, without a whit of consideration to how that “extra spending power” is impacting on the economy as a whole? Sure we had unprecedented growth in spending over the past decade. But we didn’t use money to do it. We used credit.

What we’ve witnessed of late is the fallout of a rampant spending problem that comes from having an unlimited supply of money. Hey, that’s what credit has become in many people’s minds: disposable income. Never mind that it’s income that hasn’t yet been earned.

While there’s a lot of yackety-yak right now about a “cardholder’s bill of rights”, the one thing nobody wants to hear is that spending money on credit is an act of madness because you are spending money that has yet to be earned. And since you can’t predict what your earnings will be in the future, you’re spending money you may never have.

Once upon a time you had to have a good reason to borrow money. You wanted to build a business; you wanted to improve an asset; you wanted to invest in something that would generate a solid return. When borrowing became just another way to buy STUFF, credit moved from one part of the economic formula to another. If we don’t start taking “credit as money” into account in terms of it’s impact on our economy, we’ll just keep scratching our heads and wondering how things went so badly off the tracks.

And if we don’t stop spending money we haven’t yet earned on Stuff, we don’t have a hope in hell of ever fixing what’s broke!

Have you ever hear the term “seed money”? Know where it comes from? In the farming world, you always had to hold back a certain number of “seeds” to start your next-year’s crop.

Imagine that you’re a farmer and have decided to grow corn. At the end of the season, you grind and eat all the corn you’ve grown. How will you start your next year’s crop? So you set aside some of your corn to use as seed to get your crop started after the winter. And you set aside a little more of your corn to take care of whatever other crap hits the side of the barn.

If each year you found a way to plant enough corn to live comfortably and start your next year’s crop, you would have reached what economist call a “state of equilibrium.”

Suppose that in spring, after you had planted all your seed,  a hail storm hit just as your corn was coming up, ruining your crop. You could starve, or you could go and borrow seed from another farmer. Or you could have had some extra corn set aside just in case.

If you did have that extra seed at the ready, you would have been prepared for the emergency. And if you planted a little extra corn each year, saving a little more seed each harvest, and increasing your production over time, you’d be growing your assets.

Without an emergency seed supply, you would have to borrow seed or starve. The farmer down the road might be very willing to lend you 100 seeds with the agreement that when you harvested, you would return 130 seeds to him, since he couldn’t plant those seeds to increase his own crop.  See how interest works?

Now you’d have to pray that you could make do on the crop you bring in, less the 30% you have to give to the other farmer for lending you seed. Or you have to find a way to make your crop produce a higher yield so that you offset the cost of borrowing. Complicated, isn’t it?

Imagine that instead of saving some of the seeds from your next crop, you decided to sell the whole shebang because you wanted to buy a shiny new truck. Without seed money to start your next crop, you’d be back to borrowing and paying interest. Course the truck’s not quite so shiny, but you’re still out-of-pocket all the seed you spent. Hmmm.

Even with the vast improvements in fertilizer and pest control, you just can’t bring in enough crop to pay back the seed and live through until the next harvest. So instead of borrowing 100 seeds, you borrow 200. Now you must return 60 seeds to your friendly farmer, putting you even further behind the interest harvester. I guess borrowing to pay off debt just doesn’t work, huh?

Of course, you could just cut your current consumption so that you could not only have the seed you needed to repay the friendly farmer, but set aside your own seed for the next crop. So, out of what you harvested from the borrowed 100 seeds, you’d have to give your friendly farmer 30%, and set aside an additional 30% for your own future, leaving you with a measly 40% to live on for the year! Yes, that might mean going without a lot of things, even some basic things, but it would set you straight. That might be the smart thing to do.

Of course, if the townsfolk convinced you that there’s no way they’d ever let your farm fail because they needed your corn and would also keep you in business, you might be convinced to take their bailout plan and continue consuming the products and services they were offering to keep them in business. Sound familiar?

But when your next crop came in, as did all the crops from the surrounding farms, and there was way more corn than the town’s people could eat, you might find them unwilling to pay the amount for your corn that you’d been banking on. Ooops. So now you have a surplus of seed, but no money to buy the other things you need like meat and ale. Guess your back to cutting back.

The principals for money management are simple. If you have 100 seeds and you use up 100 seeds for whatever reason, you’ll have nothing. If you have nothing, then you’re going to have to borrow to move forward. If you borrow, you’re going to have to pay to use someone else’s seed. And that’ll cut into how much seed you can keep. Or you can go to work for another farmer, busting your butt 18 hours a day to do two jobs, and finally re-establish a state of equilibrium.

Of course, if you want to have some seed for when you don’t have the poop to work that hard anymore, equilibrium won’t be enough. You’ll need to set aside extra for those latter years, or plan to die in the field.

The term “seed money” has come to mean the money you saved and used to establish something new. Whether you want to restyle for retirement, stop working for The Man, or take time off to ruminate with the cows, if you don’t have some money, you probably can’t grow your dreams.

p.s. I’ll comment on the case study tomorrow. g

Imagine that you’re selling lemonade. It’s a hot day and there’s a big demand for a long, cold glass of you’ve got. You can probably charge two bucks a glass and get away with it. Yup, thirsty people won’t think twice about shelling out for a little lemony relief. And if you’re down to your last glass or two, someone may offer a premium, coughing up an extra fifty cents to grab a glass. So, when supply is low and demand is high, prices jump. Of course, if your next-door-neighbours all decide to set up their own lemonade stands, you’re going to have to practically give it away to get it off your hands. And if the weather suddenly changes, a cold wind blowing the leaves and your customers’ thirst away, nobody is going to pay a red cent for your lemonade.

What’s true for lemonade is also true for money. When there’s more money than stuff to buy, prices go up. When there’s more stuff than money, prices go down. Inflation is the measurement of the changes in prices of all that stuff.

Enter interest rates. The lower the interest rates, the less it costs to borrow so there’s money to buy stuff.

Think of interest rates as the price of money. The central bank is in charge of deciding the cost of money overall, so it is the central bankers who set the interest rate. When central bankers raise interest rates, they make money more expensive and so the demand for it goes down. The less money available to buy stuff, the more pressure there is on prices to come down. That’s why higher interest rates lead to lower inflation.

Of course, if the central banker decides to raise interest rates to fight inflation, that means that the economy is going to slow down. After all, if nobody has the money to buy TVs, then the company that makes TVs is going to make fewer, so they’re going to lay off some TV builders, who then won’t have the money to buy food, never mind TVs. And that’s why the interest rate/inflation dance is such a precarious one.

Whenever there is news about the changes in the central bank rate, most people’s eyes glaze over. We know if rates go up, that’s no good for borrowing. But that’s about all we know.

At the turn of the new century, our central bank, the Bank of Canada, introduced a new system of eight “fixed” or pre-specified dates each year for announcing changes to the official interest rate it uses to implement monetary policy. Since the rates could no longer be changed on any day in response to an economic ill wind, this was seen as a good way of stabilizing interest rates. Central banks in Europe and the U.S. Federal Reserve also use this system. Of course, the central bankers reserved the right to make a change off schedule under extreme circumstances.

The Bank of Canada sets interest rates with the objective of keeping inflation between 1- 3%, with an optimal target of 2%. So when the inflation rate hit 3.1% last July (over July 200&), it was the biggest jump we’d seen since September 2005. Then in August, inflation jumped again by 3.5%. Ooops.

Of course, the central bank’s decision has an impact on our ability to borrow money. And while many a lender has been holding the line – not raising rates – to keep customers coming through the doors, those days are drawing to a close. Expect to see higher interest rates as lenders themselves find money is tight and they must pay more.

When rates go up, it isn’t all bad news. Only the borrowers suffer. The savers jump up and down clapping their hands because their deposits are working that much harder. While, typically, periods of high interest rates are associated with periods of high inflation, as with everything else, things will change again. If interest rates jump way up, you should consider buying investments that will hold those higher rates for as long as possible.

Start your research on various interest-based investments now. Learn about options like mortgage-backed investments (don’t laugh), the various types of bonds, and mutual funds that are based on fixed-income investments. Figure out what TIGRs and STRIPS are. Learn the language of investing — including all the stupid acronyms — so you’re ready to take advantage of what comes next.

We are leaving the age of rampant borrowing. Who knows what age we’re entering next. As with everything else in life, the changes are painful. But the opportunities are great. Get focused. Know what you want. Get educated. Take advantage of what the future holds. Become an OWAP…. an Optimist With A Plan!

If you want to know how to make this decision for yourself, you’re going to have to wrap your head around an economic concept called the “yield curve.”

The yield curve is a graphic representation of the interest rates being paid on government bonds of differing maturities. If the one-year bond is at 5%, the two-year at 6%, the three-year at 7%, and so on, you can see that the longer the term, the higher the interest rate. The yield curve is curving upward from left to right. This is referred to as a Normal Yield Curve because this is the way the curve usually looks. A normal yield curve represents investors desire to charge more for the use of their money over the long term because longer term investments are inherently more risky. To encourage investors to plunk down their money for a longer period of time, a higher interest rate is offered as compensation for the extra risk being taken.

Sometimes yield curves are Inverted: the longer term carries a lower interest rate. And sometimes the curve isn’t a curve at all; it’s flat, but it’s still called a Flat Yield Curve. That’s when there is virtually no difference between the interest rates right now and those five years from now.

So what can the yield curve tell you about mortgages? Well, if the curve is normal, then the longer-term rates are predicted to be higher than the shorter-term rates. In other words, right now Them That Knows say that interest rates are going to go up. All you have to do is look at the difference between the one-year and five-year mortgage rates to see where interest rates seem to be going.

If they are, in fact, predicted to go up (I say “predicted” because anything can happen), then the question you have to ask yourself in making the decision of what term to choose is how much the increase in interest rates will affect your ability to make your mortgage payment.

Find a mortgage calculator on the net. Put in the mortgage amount and the new higher rate. If you have 10 years to go on your existing mortgage, put that 10 under the amortization period. (Do not used a longer amortization period because you want to see a lower payment. That’s delusional.) Look at what the monthly payment amount will be.

Let’s take the example of a $350,000 mortgage amortized over 12 years.
At your existing rate of 4%, your monthly mortgage payment would be $3,058. But if the one-year rate has jumped to 6% your monthly payment is $3402, biting another $344 a month from your cash flow. If the five-year rate is 7.5 %, your new monthly mortgage payment will be $3672, a jump of $622 a month.

While my numbers are examples taken from a net calculator and will differ from what you get from your lender, they are enough to paint the picture.

Here’s the tough part. Now you have to decide if you are going to take the “risk” of a one-year renewal where rates are less, but there is no security, so rates may go up even further, in order to keep your increase to only $344 OR are you going to bite the bullet and take the five-year term, coughing up another $622 a month so you know where you stand for the next five years.

I can’t make that decision. If you’re mature enough to have bought a house, you’re mature enough to decide your own term. I will say, however, that there are more than a few people who say if you consistently take a three-year term, you can iron out the bumps a little more easily. And while Adjustable Rate Mortgages (ARMs) have been the hot ticket to lower costs historically, lenders are eliminating the “premium” (the interest rate discount on ARMs) so that right now they are a lot less attractive.

Do the math, take your stress levels into account, and then decide what you’re going to do. Make sure you negotiate hard for the best rate going. Just because the mortgage rate is posted at 7.5% doesn’t mean that’s what YOU have to pay. Lenders routinely discount their posted rate for customers who have shown they are trust-worthy. If you’ve been a good borrower, now’s the time to use it to your advantage.

FYI: The Yield Curve is also said to be able to predict a recession since for the past 50-odd years an inversion in the yield curve has proceeded every recession on record. An inverted yield curve means that Them That Knows think that rates are going to come down from where they are today. Why does that smell like a recession? Usually it’s because Them That Knows believe the central bankers are trying to fight inflation, so they’re tightening up the money supply to discouraging people from borrowing. When the curve inverted in 2007, that might have been The Signal We Ignored that the economy was about to hiccup and then choke.

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People are always asking me about what they should be spending in various areas of their budget. I don’t like giving specific answers because there are so many variables: where you live, your priorities, your income.

Speaking of which, I know I’ve said this before but I’m going to shout it this time: YOUR GROSS INCOME IS NOT YOUR IINCOME. Your gross income is yours and the government’s income. If you want a budget that works, you have to work with your NET income.

If you gross $60,000 a year – the average Canadian FAMILY earned just over $66,000 in 2007 — you don’t have $5,000 a month to spend because:

• If you live in B.C. you have to give $12,455 to the government
• If you live in Alberta you have to give $13,491 to the government
• If you live in Saskatchewan you have to give $15,141 to the government
• If you live in Manitoba you have to give $15,317 to the government
• If you live in Ontario you have to give $12,957 to the government
• If you live in Quebec you have to give $16,518 to the government
• If you live in New Brunswick you have to give $15,679 to the government
• If you live in Nova Scotia you have to give $15,590 to the government
• If you live in P.E.I. you have to give $15,353 to the government
• If you live in Newfoundland you have to give $15,189 to the government
• If you live in N.W.T. you have to give $12,568 to the government
• If you live in the Yukon you have to give $13,240 to the government
• If you live in Nunavut you have to give $11,717 to the government.

(BTW: According to the book Tax Facts 15, income taxes account for only 34.7% of the taxes the average Canadian family paid in 2007. Ouch!

Okay, let’s take Manitoba as our example. Instead of $5,000 a month, AFTER TAXES your NET income – would be $3,723.58.  Hey, wait a minute. That’s not your TAKE HOME PAY. If you have deductions your TAKE HOME PAY WOULD BE LESS. You might have to pay employment insurance, CPP/QPP, or other deductions. And if you get company benefits – health benefits, for example – that are taxable, they’re going to take even more tax off your cheque.

Let’s face it, if you earn $60,000, you can’t just divide by 12 and think that’s your income. And if you’re basing your budget – and more importantly, your thinking – on your GROSS income, it’s no wonder you’re going deeper and deeper into debt each year.

So, if you make $60,000 a year and bring home $3,600 a month after deductions, how much should you spend on housing. According to the Gail Pie – and this is only a guide, people, it’s not written in stone – you should spend no more than 35% of your income on rent/mortgage payments, taxes/condo fees, heat, electricity and maintenance. That tops you out at about $1,260 a month.

Does $1,260 seem like a lot or a little to you? With rents and house prices eating a larger and larger portion of our income, we’re becoming numb to the impact on our ability to spend, which ultimately pushes us to use our credit.

According to the Canadian Real Estate Association, the average house price in June this year in Canada was $341,100.

Assuming you put down just 5% as a down payment and amortized for 25 years at 5.5% your monthly mortgage payment would be $1977.94. So you couldn’t afford the average house. Let’s say you got into the market a while ago, and had a $200,000 mortgage, your monthly payment would be $1220.78, which would leave a whopping $40 to cover your taxes, heat, electricity and maintenance. Hmmmm.

But wait, Gail, you said that the percentage wasn’t written in stone.

It’s not. If you can find a way to get to work without spending 15% of your budget on transportation – which would be $540 a month – you could lump the rest into your housing budget. Or if you had no debt, you could lump that 15% into your housing budget, or your transportation budget, or your LIFE budget.

Most of us aren’t don’t or can’t hoof it to work every day, so we have a car and with it a car payment, insurance, maintenance and fuel costs. According to the Stats Man, the average Canadian household spent $9240 a year – or $770 a month – on transportation. But this was back in 2006 (the last year for which he has numbers) before gas was over a buck a litre, so we’re spending a tad more now, me’thinks.

It’s getting harder and harder to make ends meet, while having at least some of the things we WANT.  There’s a better TV, a better cell phone, a better digital camera. How about a holiday down south, or a trip to Europe, or a boondoggle to Vegas? And since the styles of clothes, shoes, handbags keep changing, we have to buy at least a couple of new things each season just to stay current, especially if we have a visible job. And those darned kids just keep growing! Never mind what we have to put out for skating lessons, piano lessons, hockey equipment… the list is endless.

Retailers know how to help us part with our money. But they’re always looking for new ways. According to a Cornell University team, if restaurants use a numerical price format without the accompanying “$” symbol, diners spend more on a meal. I guess without the dollar sign there as a reminder that we’re spending MONEY, we forget. Really?

Okay, so you’re not as rich as you think. Your housing costs are eating a bigger part of your budget. Transportation costs are soaring. Demands on our pockets keep growing and retailers are coming up with new and improved ways of parting us from our hard earned moolah. What’s a person to do

Back to basics boys and girls:

Make a budget. You’ve got to WRITE IT DOWN. And I don’t mean in a notebook, or on a post-it note. I mean on a BUDGET WORKSHEET.  Start by looking at your June bank statement and using only the income you put in the bank. Never mind that some months you earn commission, or your partner does an extra job and brings home a little more, or your deductions fall because you’re close to the end of the year and you’re all paid up. If you have a fluctuating income, then you’ll have to build a two-tiered budget: one for the basics when the well is dry, and one for the extras when the money is flowing.

Get rid of your debt. If you have no debt, you have more money to do the things you want to with your family. If you have debt, get it paid off. It doesn’t matter what you have to give up or how much harder you have to work, GET OUT OF DEBT.  Once you’ve figured out your budget, if the amount allocated to debt repayment means it’ll take more than three years to be debt free, you MUST find a way to increase your debt repayment amounts.

Dump the expenses that you think you HAVE to have, but aren’t related to keeping body and soul together. Once upon a time there were no cell phones and we didn’t die. Once upon a time there was no cable and we didn’t die. Prepared meals didn’t exist.  Coffee was something we brewed at home. Eating out was for special occasions. Nails were something we grew and food never had the word “junk” in front of it.

Now we spend money on energy drinks, buy sixty-two versions of cleaning products (whatever happened to a mop and bucket?) and wouldn’t dream of NOT buying our lottery tickets because if our numbers came up we’d be mad as heck! We throw huge weddings, going thousands into debt for ONE NIGHT of fun and frolic. We throw ridiculous birthday parties for our kids, inviting whole classes so no one will be offended. We spend buckets of money to try and not look old, lose weight, be healthy. (It’s not fooling anyone but you. Sorry.) And we believe that if the deal is good enough, it justifies spending money we haven’t yet earned.

If you want a life that’s not riddled with stress, you’ve got to know where you’re going and how you’re going to get there. It doesn’t mean throwing wads at the wall and hoping something sticks. If you don’t have a written budget that you’re following like the gospel, then you’re a Wad Thrower and you’re doomed. ‘Course you won’t have to wait to die to go to hell; you’re there now!

I was browsing around the web the other day when I came upon an article that talked about an economic phenomenon called the “lipstick indicator.” I was intrigued.

According to Investopedia’s dictionary, it’s a term coined by Leonard Lauder, the chairman of Estee Lauder, the cosmetics company. Lauder noticed that when the economy got tough, lipstick sales would go up. Why? Well, it seems that we turn away from big spending to small indulgences; lipstick fit this bill. In fact, in the months following the September 11 terrorist attacks, lipstick sales doubled.

Three sorts of products sell well during tough times: there are your small indulgences, then there are your morale boosters – to make you forget that your investments are down 20% or that you can no longer afford that nifty $400 cell phone. And then there are your inferior goods – the crap people buy so they can keep shopping even though they can’t afford value anymore.

It seems that not shopping would be just too depressing.

Even the Richy Riches are beginning to feel the pinch, it seems. According to a poll by a U.S. marketing company whose clients include retailers in the luxury goods market, there’s been a 20% decline in spending on luxury goods in the second quarter of 2008, and the lowest luxury consumer confidence level in the about five years.

If you’re south of the border and received a piece of the $50 billion stimulus from Mr. Bush, no doubt you’re still spending. Scott Hoyt, senior director of consumer economics at Moody’s Economy.com says that those cheques could spur spending until September, falsely buoying the economy since consumer spending accounts for about 70% of the U.S. economy. In Canada, no one is throwing money at us in an attempt to keep us spending (though $50 BILLION would go a long way to paying down some debt, wouldn’t it?)

If you accept the idea that small indulgences are one way to offset the yuck of a nasty economy, then the next question is what are you going to indulge in, and how often? I’m not a lipstick girl. Couldn’t care less about make-up. Natasha, who does my makeup for the show, has to practically fight me to do my touch-ups. For me, it’s not coffee either, since I don’t drink the stuff. But lots of other people do. And while it may have been a small indulgence in the past, Richard Bach ruined it for a lot of people.

Ever since Bach equated lattes with waste, the idea of small indulgences has taken on a different meaning. A small latte at $3.74 a pop works out to about $1,000, which is not a SMALL anything. So there are lots of people who won’t do that anymore.

Of course, if coffee doesn’t work we can always turn to football and the Super Bowl effect. Basically, it goes like this: If a team from the AFC wins the Super Bowl, the national economy will do badly. If a team from the NFC wins the Super Bowl, the national economy will do well. There doesn’t seem to be much proof either way, but in many of the years of the Super Bowl being played, it was more or less true.

What are some of the other signals people use? Umemployment, certainly. Inflation? Yup. Gross domestic product as well. How about rubber bands?

What?

The Rubber Band Indicator is this: when the economy is bad, the rubber bands around broccoli bunches at the grocery store are thinner. Hmmm.

How about an increase in the number of laundry lines as people attempt to cut back on their power usage? Or the percentage of gardens given over to growing FOOD instead of flowers? Or the number of people who are cutting back on cable?

So what are your signals that the economy is in the toilet? What changes have you made to the way you’re managing your money? What are your small indulgences? And what will it take for you to believe that the economy has made the turn and is on the mend?

The unemployment rate in Canada hit 6.2% in July, despite record high employment rates in Alberta, Manitoba and Nova Scotia. With all the crap happening south of the border, unemployment is likely headed up in the short term as we deal with the credit crisis. Often, when we find ourselves out of work, we duck and hide, embarrassed at our change in circumstances. And we spend. Unwilling to admit that things have changed, and with time on our hands, we spend and spend and spend. Well, if you’ve seen my show, you know where that leads.

In my last blog, I talk about the unemployment rate in Canada and the potential downturn we may experience. I thought I should give you some world figures to put things in perspective.

The credit crisis is causing rising unemployment in the UK, with official unemployment figures for last month the worst since 1992.  The UK unemployment rate is 5.2%.

In the U.S. people are cheering because their unemployment figures seem great compared to elsewhere, but July’s rise in unemployment was the seventh straight; the current 5.7% is the highest rate since March 2004.

According to Eurostat, the Statistical Office of the European Union, unemployment sat at 7.3% in the euro area in June 2008.The lowest unemployment levels were recorded in Denmark (2.7%) and in the Netherlands (2.9%); the highest were in Slovakia (10.5%) and in Spain (10.7%). Poland sits at 7.3%, Bulgaria and Ireland are at 5.7%.

The Organization for Economic Cooperation and Development (OECD), which is made up of 23 European countries and Australia, Turkey, New Zealand, Canada, Mexico, the United States, Japan and South Korea, is predicting an average rise in unemployment in 2008 and 2009.

So what do you do if you find yourself out of work?  Here are 9 Things to Do if You Lose Your Job:

1. Tell your family not to panic. Yes, things are going to be different for the short- or medium-term, but you’ll weather this together. You need to have a clear sense of what your priorities are so that you can work together to get through this without fighting, bitching, snarking, crying, or being a’feard.

2. Tell everyone you know that you need a job. Many jobs never make it to the advertisement pages since people in a company will be asked if they want the job, or if they know of anyone they could recommend for the job. The more people you tell the better your chances are that someone will put forward your name. Be clear about what kind of job you are seeking and what your skills are, and someone may be able to help you get a new job. But also be open to experiencing something new, and using your skills in different ways. If you hated your last job, don’t get another one just like it.

3. Apply for employment insurance benefits. While this is usually barely enough to keep body and soul together, it’s still better than a kick in the teeth. If you find employment before your benefits begin you can always cancel the claim.

4. Start looking for a job. Dust off your resume. Hit the web. Some part-time work that supplements your income while you’re looking for a full-time job will help to keep you busy and focused on making things happen. One of the biggest problems with unemployment isn’t just the lack of money, it’s the abundance of time and the sense that this will never end. Get busy.

5.  Cut your expenses. First, you need to cut back to the bare minimum so that you can make your emergency fund (you have one of these, right?) last as long as possible. Ditto your employment insurance benefits, your severance, your partner’s income or whatever else you may have that you can use.  Cancel the cable, decide between the home telephone and the cell phone, don’t buy anything that isn’t food, and consider your quarters your entertainment budget. Second, since you may not find a job paying the same money, you need to decide what your Basic Costs of a Good Life are so you know how much salary you can live without.

6. Talk to your creditors. Don’t ignore your bills. Contact your creditors and explain your problem. Offer to make regular smaller payments that you can afford for a short period of time. Ask for an interest rate concession. Get those credit payments in line with your new income.

7. Embrace change.  In all likelihood if your industry is in retreat you’re not going to find a similar job for similar money easily.  Two part-time jobs may be as good as one full-time. Contract work may be a good option for rebalancing your life. Business opportunities may present themselves and you’ll have to have your eyes open to take advantage of them. Don’t be closed to a relocation if that’s what it takes to get you back on track.

8. Take care of yourself.  Don’t climb on the couch and hide. Don’t dig into a big tub of cookie-dough ice-cream. Don’t stop exercising, socializing, empathizing. If you find yourself becoming really sad about your situation, find someone to talk to about it. Don’t let yourself go into a nose-dive. Keep to a schedule and keep your focus. Volunteer so that you can keep meeting new people, widening your network, and putting more people into the job-hunt on your behalf. Take a course to update your skills or learn new ones.

9. Keep your sense of humour. When things get tough, our funny bone is the first to go. Don’t let it. You can do so much when you’re smiling. Your interviewers will see you differently. Your family will be reassured. Your friends won’t run and hide when you call. Hang on to that funny bone!

There’s no longer such a thing as a Job for Life. Gone are the days when you retired from the first company that hired you. The new reality is that you can expect to have up to eight – count ‘em EIGHT – careers over your working life.

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The big news of late is how much more expensive it is to a) eat, and b) get around.

These are pretty basic needs. Most of us can’t walk everywhere we need to go and even if we could, the cost of fuel is pushing up the goods and services that have to be transported to the stores where we buy them. Eating… well… that just goes without saying.

So why does the consumer price index make it look like we’re in such fine shape? Inflation, while pinching us at the gas pump and in the supermarket, doesn’t seem to be reflected in the numbers we hear on the news. That’s because there are a lot of things that make up the Consumer Price Index (CPI) basket including:

1. Food – 18%
2. Shelter – 27.9%
3. Household operations and furnishings – 10%
4. Clothing and footwear – 6.6%
5. Transportation – 18.3%
6. Health and personal care – 4.3%
7. Recreation, education and reading – 10.4%
8. Alcoholic beverages and tobacco products – 4.5%

The products in the basket are weighted based on their common usage – those are the percentages. The weights determine the impact that a particular price change will have on the overall consumer budget.  For example, a 5% rise in the price of milk would have a much greater impact on the average budget of consumers than a 5% increase in the price of tea, because people spend on average more money on milk than they do on tea.  The weight for Canada assigned to milk (0.69%) is greater than that of tea (0.06%).  Without weights, price changes for all commodities in the CPI basket would be given equal importance in the calculation of the All-items index. Here’s one of the problems: according to their own documentation the current set of weights refer to household expenditures for 1992. 

With housing prices having skyrocketed in the last decade, me’thinks the numbers could be a little off. Housing is eating way more than 28% of our budgets in many parts of the country. Ditto the fact that while some costs have risen dramatically affecting everyone’s budget, others have fallen, affecting only some people’s budgets.

The costs of computers, TVs, software, audio equipment, clothing, appliances and new cars have gone down, offsetting the increases in things like food and gas, to make inflation appear less dramatic than most of us are actually feeling in our wallets.

And while the price of a box of yogurt may appear to have remained stable, food manufacturers are dealing with the increases in costs not by raising their prices, but by reducing the amount they put in the box. So quantities are going down, while prices seem to remain stable. (Have you noticed that your food containers hold less food? Check it out.)

Ultimately, as the costs for covering our Essential Expenses rise, less and less will be available to spend on the bottom half of the CPI basket of goods. The problem with that is a vicious cycle: we don’t buy TVs or cars and the manufacturers have to lay off the workers who build them; then people laid off don’t have the money to keep body and soul together.

This would have started a long time ago had so many people not had credit available to buy the things they really couldn’t afford. We’ve been buoyed by a credit bubble that’s burst in the U.S., Australia, and elsewhere around the world. Don’t let the pundits fool you. We’re in deep doo doo and we’d better learn to live on what we make FAST.

There is no doubt in my mind that we will see increases in unemployment across the country as we come to terms with our new economic reality. The really sad part is that we might be able to hold on with one income in our family, if we didn’t owe money to every Tom, Dick & Harry. With our debt loads having reached record levels, we don’t stand a hope if we don’t get ourselves in the black. And SOON.

The economy, like the stock market and life itself, is a cyclical thing. Where we are today is not where we will be in six months, a year or a decade. But if we don’t have the tenacity (and the emergency fund) to hold us through the bottom of the cycle, the cost emotionally and to our families’ sense of well-being can be devastating.

So, what’s it going to be? A new TV? A better cell phone? Or the peace of mind that comes from knowing you can weather the economic storm that may or may not be just around the corner?