Something really interesting is happening in the economy. Canadians are paying down debt and starting to save money even though interest rates at almost zero. This usually happens when there's a financial asset price bubble; in case of , it's the housing bubble.

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Japan went through this from 1995-2005 and the US in 2008; also known as "Balance sheet recession".

As @AtifRMian says, historically, severe economic downturns are almost always preceded by a sharp increase in household debt. We are seeing that in .

With COVID, people have more or less suddenly realized that these high debt levels are risky and now believe it's in their best interest to pay them down. When many people slash spending at the same time, the result will be a depressed economy. We saw this in 2008 in the US.

When consumers start saving money and start paying down debt, the money being saved goes into the financial system to be borrowed against. However, if no one is borrowing right now, corporations included, with interest rates at zero, what happens?

The corporate debt in outside the financial sector reached a record of 118.7% of gross domestic product at the end of the second quarter in 2020. With COVID, corporate indebtedness is resulting in widening corporate bond spreads and increased delinquency rates.

This means that corporations are underwater, just like consumers. They have more debt than assets on their balance sheet... so they are using their cash flow to pay down debt and stop borrowing ; turning from a profit maximization objective to debt minimization.

It is the right thing to do at the micro level but when everybody does it all at the same time what happens to the macroeconomy?

In an economy, if someone is saving money, you better have someone on the other side borrowing it through the financial system and spending it to keep the economy going. When borrowing increases, we increase interest rates, and vice versa.

What happens with interest rates go down to zero and nobody is borrowing money? If you are underwater, logically no borrowing or lending will happen. The money is stuck in the financial system doing nothing so the economy starts to shrink for every dollar essentially being saved.

This happened during the Great Depression in the US. People and corporations were underwater hence they started to pay down debt and were saving and not borrowing. US lost half of its GDP in just four years from 1929 to 1933 as a result.

Monetary policy is largely useless. Central bank brings rates down to zero but no one is borrowing. So if the government wants to keep the economy from falling into this deflationary spiral, it must be the one to borrow the money that is not being used to keep the economy moving.

They provide a fiscal stimulus, the economy improves, and the budget deficit gets too large so they cut it, however, the corporations + people haven't finished deleveraging from being underwater.

If the government doesn't keep the fiscal stimulus up until they've deleveraged, you end up in a zigzag of an economy, as it happened with Japan from 1990 until 2005, when they finally climbed out of it.

So what does this mean for ?

We have to wait until people + corporations are not underwater with their assets and have finished deleveraging.

For Canadians, that is paying off most of the high-interest debts (avg $72,950 for non-mortgage debt). Second, pay off HELOC's that they have taken out. If they can, try to remortgage their property. Another tweetstorm on this in the future.

The government essentially has two options: fiscal stimulus and debt relief to help with deleveraging. They want to either put a stop to asset prices declining and reversed OR get the debt levels reduced (hence lending tightening by CMHC).

The government can step in to spend because the private sector can’t, and it can also reduce private debts to allow the debtors to spend again; we are seeing this happen in the US with Feds buying company bonds.

CERB is the fiscal stimulus that is in action right now. We have seen rent relief. I won't be surprised if we also see debt relief coming soon, especially if too many houses go underwater.

Jobs. People need their cashflows otherwise, the government will need to keep supporting those without cashflow with CERB... This won't last since we rely on immigration.

Immigration is a key lever in the Canadian economy. Student immigrants + skilled families; it is our strength. We need to open that up as fast as we can to keep up our growth + have people start new companies, helping create more jobs.

For corporations, maintaining the cash flow, stopping anything that isn't making money, paying down the debt, and hopefully not getting out-innovated by a younger company.

I like learning from past history. We shouldn't be repeating these mistakes. The Canadian government is doing a phenomenal job in my opinion.

Lastly, If you've read this far, thank you. I love learning about economics so send any great reads on it. :)

One more thing, if you want to join a small group of people who love discussing economics and learning about it, like this tweet :)