There was a great debate the other week in the house of commons between Pierre Poilievre and Justin Trudeau, where Trudeau vehemently denied that he was responsible for the highest inflation since 2003. Mr. Poilievre accused the Trudeau government of causing “#Justinflation” with the Liberal government’s record deficit spending. Mr. Poilievre then went on to call Trudeau’s denial “simply #Justincredible!”
While the debate was humorous, and as much as I enjoy seeing Justin Trudeau take some heat, the reality is that inflation rates are soaring globally right now, not just in Canada. As central banks flood the economy with stimulus cash to counter supply chain disruptions and economic lockdowns due to the pandemic, a surge in demand for consumer goods caused prices for just about everything to rise rapidly.
Inflation And Interest Rates
Now, we will always have inflation, for the simple reason that the alternative – deflation – is terrible for an economy. Prices go down, but so do people’s homes, their investments, and their jobs. Deflation causes deep and painful recessions that can be difficult to recover from. For this reason, the Bank Of Canada tries to keep the inflation rate around a healthy 2% baseline. As of now, we stand at 4.7%, which is high. The US inflation rate has surged even higher, hitting an almost 40-year high of 6.8%. More concerning, some commodities have risen even higher. Gasoline prices rose by 43.6 percent in 2021 up to November. Incomes, in contrast, have only risen 2.8%.
The problem, in my opinion, is that the Bank Of Canada is caught between a rock and a hard place. Canadians want to see higher interest rates to cool off inflation, particularly in the white-hot housing market. However, if they raise rates too quickly, it could derail the post-pandemic economic recovery. With wave after wave of lockdowns, and the Omicron variant ripping through the globe, this is not an environment that is conducive to rapidly rising interest rates.
More likely, as we hopefully move past the pandemic, we will see a few gradual quarter-point interest rate hikes. However, we will still be in a historically low-interest-rate environment for some time.
There is some debate over if this bout of inflation is transitory or a sign of things to come. Regardless, I always advise clients to hedge against inflation. In my opinion, the best way to do this is simply to buy your principal residence.
The Ultimate Inflation Hedge
Think about it. Not only do you need a roof over your head, but essentially you’re making a leveraged bet that the price of everything will be higher in 30 years. To me, that’s a pretty good bet, because in my view higher prices are as sure as death and taxes. From coffee and groceries to lumber, concrete, gypsum, and of course land – all of these things will cost more in the future.
What makes this powerful is the leverage component – you’re putting down 15 – 20%, which allows you to buy a million-dollar asset in today’s dollars and hold it in tomorrow’s dollars. The principal residence exemption means that any capital gains on the sale of that property are completely tax-free. (I wouldn’t put it past Trudeau to steal that from us one day. However, it’s unlikely given that such a move would be political suicide.) While RRSP’s are great for tax shelter, you are capped at your annual contribution – the principal residence exemption is unlimited. This is why for most Canadians, their homes are their single best investment.
Trudeau or no Trudeau, that is unlikely to change any time soon.