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Econowatch

What we’re seeing now is not really deflation . . . at least, not yet.


 

EconowatchDeflation is the word that strikes fear into the hearts of economists more than any other, and this week it was the one on everybody’s lips. Both Canada and the United States reported that consumer prices slipped into reverse in June. The 0.3 per cent decline in Canada’s consumer prices was the biggest since the 1950s, and the first time the cost of living has dropped from a year earlier since 1994.

The news sent many observers into an anxiety attack. But there are two critically important things you need to know about this.

First: deflation is indeed a nasty, frightening business. Second: what we’re seeing now is not really deflation . . . at least, not yet.

Now all this fear of falling prices may seem counterintuitive. After all, why wouldn’t consumers want to pay less for stuff? A drop in the cost of living should be cause for celebration, right? If only.

Deflation is the granddaddy of all vicious cycles, and once it gets loose, it’s extremely difficult to control. It always starts with a slowing economy and mounting job losses. People drastically reduce their spending, and companies are forced to cut prices in order to move inventories. This happens on such a massive scale that, throughout the economy, businesses see their pricing power disappear. Consumers see prices dropping and rather than stoking demand, it snuffs it. Even people with steady jobs and disposable income avoid buying because, in a deflationary environment, they know that they can buy that TV even cheaper if they just wait a few months. Companies are forced to scale back production, putting more people out of work and cutting wages, which only adds more fuel to the deflationary fire. Japan suffered under this scenario for much of the 1990s—a self-perpetuating downward spiral of falling prices, falling profits and rampant fear. Scary stuff.

But what we saw this week was different. The decline in prices on both sides of the border was driven overwhelmingly by the price of gasoline. A year ago, we were in the midst of a sharp spike in energy prices, which drove the cost of gasoline over $1.30 per litre across the country. This year, it costs just over $1 on average. There were also modest drops in the cost of clothing and shelter, but, by and large, consumer prices are rising at a rate of just under two per cent a year, just like they should.

Deflation remains the nightmare scenario of this economic crisis. But for now, it’s still the stuff of bad dreams—not reality.

GRAPH OF THE WEEK: The low, low price of food

Yes, inflation in food prices is a serious problem in the developing world—and we’ve seen a bit of a hike here—but when you look at the long term, it turns out food has never been so affordable. It’s another reason why comparisons between today’s hard times and the Great Depression tend to ring false.

The low, low price of food

THE GOOD NEWS

Under construction
U.S. builders picked up the pace of new home construction in June, offering yet another sign that the collapse of America’s housing market may have hit bottom. New home starts in June jumped 3.6 per cent from the prior month, according to the Commerce Department. Meanwhile, the number of single family starts jumped 14.4 per cent, the biggest monthly increase since 1991.

TSX on the rise
After a bit of a nasty tumble in late June, the S&P/TSX composite index has seen a nice surge lately, putting it within spitting distance of hitting a new post-crash high. It hit 10,500 earlier this week, up a full 40 per cent from a low in early March. Economists say the rise is mainly due to rising commodity prices—copper, for instance, has just hit a nine-month high—and some early signs of new life in the U.S. economy.

Leading the way
The U.S. Conference Board’s leading index of indicators rose for the third month in a row in June, up 0.7 per cent. For the second quarter, that translates into an annualized increase of 7.4 per cent, a pace not seen since mid-2003. Economists say the index points to an end to the recession coming later this year.

THE BAD NEWS

Fear factory
Manufacturing took another hit in May. Canadian factory sales plunged six per cent to $38.4 billion, far worse than economists had expected. The sector was hit hard by automotive plant closures and trouble in the aerospace industry. Though companies are chipping away at their backlog of inventories, new orders aren’t coming fast enough to warrant more production.

Foreclosed
Even as some economists see signs of stability in U.S. real estate, the foreclosure rate continues to worsen. More than 1.5 million properties were in the foreclosure process during the first half of the year, according to RealtyTrac, up by 15 per cent from the same time last year.

Double-digit misery
Fifteen states, as well as the District of Columbia, now suffer from unemployment in the double-digits, according to a report from the U.S. Federal Reserve. Michigan is faring the worst with unemployment above 15 per cent, the first state to reach that level since 1984. The Fed expects the national unemployment rate, now at 9.5 per cent, will hit 10 per cent this year and stay there through 2010.

Whole lot of nuthin’
Canada’s wholesale trade fell to its lowest level since 2005. Sales in May slipped 0.3 per cent to $40.1 billion in May, the eighth-straight monthly decline. The drop was led by the equipment, food, and metal sectors.

SIGNS OF THE TIMES

SIGNS OF THE TIMES

  • Scores of modern-day hobos are overrunning trendy New York neighbourhoods, camping in half-built luxury condo projects that have been shuttered by the downturn. The squatters, who call themselves “gutter punks,” haven’t endeared themselves to the locals as they’ve transformed some areas into heroin hot spots.
  • The roar of a Harley-Davidson motorcycle doesn’t seem to have the appeal it used to. The Milwaukee-based company says it’s cutting 1,000 jobs, following a plunge in U.S. sales last quarter by 35 per cent. Even before the recession, Harley was struggling to expand its market beyond male baby boomers. But in this economic climate, even that demographic is putting off buying pricey new bikes.
  • High-end Las Vegas restaurants are struggling, and that’s meant uncertain times for celebrity chefs. In an already crowded market of five-star eateries, as many as 30 new restaurants—such as France’s Pierre Gagnaire and San Francisco’s Michael Mina—are set to open in December as part of the US$8.5-billion CityCenter project. Yet with the big spenders vanishing, wait staff who once took home $150,000 in tips have already seen their incomes cut in half.
  • Remember all that talk about how little kids who devoured Harry Potter books wouldn’t have time for the movies now that they’re teens? So much for that: the boy wizard recently conjured up US$159.7 million at North American box offices in just five days. Despite the recession (and flops like Brüno), Hollywood has managed to boost overall ticket sales by 12 per cent over last year.

LATEST INTELLIGENCE

For some, the astounding US$3.4-billion quarterly profit recently announced by Goldman Sachs is cause for hope. For others, it’s cause for unmitigated rage. Many are furious about the quick return to huge bonuses being paid out to bankers, especially since Goldman benefited from taxpayer dollars in big way. As Wall Street improves while Main Street continues to suffer, there’s a lot more anger to come.

Lawrence Summers,“There is no financial institution that would be reporting the kind of positive results we have seen in the last quarter, but for the extraordinary public support provided by the government.”—Lawrence Summers, director, White House National Economic Council

“My main concern is that it seems to be a return to some of the flawed short-term compensation structures that played an important role in the run-up to the financial crisis.” —Lucian Bebchuk, professor of law, Harvard University

Jon Stewart“It’s what’s known in business as the invisible government-funded scaffolding of the free market. And it worked, just enough for Goldman Sachs to pay its employees a total of $11.36 billion so far this year. So fret not America, your work has not gone in vain.”—Jon Stewart, host, The Daily Show

“There will be outrage.” —Senator Jon Tester, Montana

“[Goldman’s] results understandably generate claims of ‘unfair’ proprietary trading gains. The reality, however, is that capital markets are very profitable for those with means and desire.” —Roger Freeman, banking analyst, Barclays Capital

“I wouldn’t be surprised if there’s some sort of a backlash, but if you’re Goldman, you’re in good shape here. There’s not a whole lot they can do to enforce any sort of compensation restrictions.”—William Fitzpatrick, analyst, Optique Capital

THE WEEK AHEAD

Thursday, July 23: The Bank of Canada will issue its latest Monetary Policy Report. It’s expected that the second quarter output forecast will be up a bit, as the first quarter wasn’t as bad as expected.

Friday, July 24: The U.S. survey of consumer confidence results for July will be released. Preliminary figures show a big decline.

Tuesday, July 28: The S&P/Case-Shiller Home Price Index for May comes out. Recently prices have been declining, but at a slower rate.


 
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