Bank of Canada governor Mark Carney is issuing a broad warning to Canadians, firms and governments that the financial and economic crisis is far from over and they need to rein in their appetite for cheap money.
Returning to a theme he began speaking about last week, Carney told the Economic Club in Toronto that the global recovery is so weak that advanced nations may need to keep interest rates super-low for a long period, and the U.S. may have to resort to yet another round of printing money.
"(But) cheap money is not a long-term growth strategy," he warned.
"Experience suggests that prolonged periods of unusually low rates can cloud assessments of financial risks, induce a search for yield and delay balance sheet adjustments."
For Canadians, he noted with alarm that household credit has grown by seven per cent since the recession's trough, compared to a 3.5 per cent decline in the U.S., perhaps an indication that
Canadians believe the easy ride on debt payments will be permanent.
When the reckoning comes, he warned, it could be swift and brutal. The Bank of Canada will set interest rates based on inflation, not on whether a large swath of Canadians have taken on too much debt, he added. In fact, he suggested the bank may tighten even in a low-inflation environment to discourage risky behaviour.
"While the bar for further changes remains high," he said, "the bank has the responsibility to draw the appropriate lessons from the experience of others who, in an environment of price stability, reaped financial disaster."
The speech gave no new forecast for the Canadian and global economies — Carney is saving his ammunition for the next interest rate announcement on Jan. 18 — but it is clear the central bank governor has become alarmed by what he sees happening in Europe and the U.S.
Twice in the speech he raised the spectre of Japan 's lost decade and even the Great Depression, suggesting some of the problems faced today are as formidable.
"The crisis is not over, but has merely entered a new phase," he said. "In a world awash with debt, repairing the balance sheets of banks, households and countries will take years. As a consequence, the pace, pattern and viability of global economic growth is changing, and Canada must adapt."
He said history suggests that recessions involving financial crises tend to be deeper and take twice as long to recover from, with reduced growth rates and higher unemployment lasting a decade. This recovery is following that trend, he said.
U.S. unemployment is in peril of becoming structural, meaning it will remain high even after the economy recovers.
The solutions are difficult, but as he did last week alongside the release of the bank's financial systems review, Carney singled out China and other Asian countries with artificially depressed currencies as particularly intransigent.
He said with currency tensions rising, there is a concern about protectionist measures as occurred during the Great Depression because of the "death grip" of the U.S. dollar.
"Over a dozen countries are now accumulating reserves at double-digit annual rates," he pointed out, "and countries representing over 40 per cent of the U.S.-dollar trade weight are now managing their currencies," or subtly manipulating them.
The global adjustment means Canadian exports will remain weak, he said, urging firms to improve their competitiveness to meet the challenge.
But the bigger warning is for borrowers, who are being lulled into a false sense of security because of low interest rates.
"Low rates today do not necessarily mean low rates tomorrow. Risk reversals when they happen can be fierce; the greater the complacency, the more brutal the reckoning," he said.