Later this week the nation’s real estate cartel will unveil its latest stats. No mystery there. Sales flat and prices up. This is deflation at work.
Yesterday we parsed the latest data on jobs and wages. The labour participation rate is falling and so are income gains. Lots of layoffs and 1.3 million out of work. Expensive Boomers being punted for cheaper kids. More deflation.
If you have the bulk of your net worth in a house, if you lack cash reserves or have a honking big mortgage, pay attention. As I’ve been saying here for a long time, deflation is the bête noire you should lose sleep over, not the buy-now-or-buy-never trash talk of the housing industry.
It’s already happening in some places. The latest Bloomberg Markets Global Investors Poll found people are overwhelmingly worried about deflation ripping through the euro zone. Three-to-one, investors fret more about that than inflation. It’s already nailing Portugal, and in the entire 18-nation zone, inflation at just 0.7% is only a third of what the central bank is striving for.
As the Financial Times points out this week: “If low inflation were to turn into outright deflation, governments would find it much harder to manage their outstanding debts. Falling prices might also induce shoppers to delay purchases, weakening demand and threatening recession.” In response, the European central bank will probably cut interest rates to 0% and deposit rates to less than that. Money in the bank, in other words, would be penalized.
Deflation happens as demand falls or the supply of money or credit contracts. Ultimately it brings the price of goods and services lower, and wages along with them. Things cost less, but people have less money with which to acquire them. It’s the polar opposite of inflation, when incomes grow but because everything costs more, people are no better off.
In modern economic theory, inflation’s okay because it means demand is chasing supply and the economy’s growing. Deflation is bad because demand trails supply, making money more valuable but reflecting slack in the economy. So in Canada, for example, when you have 29,000 job losses in one month with reduced wage gains, despite historically low interest rates and after five years of government deficits, you have to wonder. Where’s this puppy headed?
Many will balk at my first sentences today. After all, when house prices go up, isn’t that inflationary? Sure it is, but a hallmark of deflation is that the cost of living doesn’t decrease for average people (as was pointed out in yesterday’s comment section). Houses cost more, but people are buying them with credit, not cash. That credit represents future earnings, not money generated at present. It doesn’t reflect the actual economy, but rather what people expect the future to bring (and if it doesn’t – if they lose a job – they’re screwed). Same principle for those insane 84- and 96-month car loans.
Governments are no better. Virtually every one of them in the country is currently in deficit, the political equivalent to household debt at 164% of income. Debt’s fine, if you can make the payments, and governments can always raise taxes to cover the shortfall (just look at the current Ontario Liberal election budget). But in the absence of continued economic growth (and inflation), more deficits, taxation and personal debt all spell trouble ahead. We’re pulling demand from the years to come for stuff we want to consume now, because we lack the ability to pay for it. This is why credit has exploded.
All of this debt comes with a cost. Current cash flows are consumed by monthly payments. Families owe more, make no more, and have less to spend. The local Staples down in the mall closes because of poor sales and 22 people lose their jobs. The economy dips a little, but nobody’s cost of living falls. This is how houses can cost more while the people buying them, and the community, are diminished.
Inflation and deflation are occurring at the same time. It’s a lousy combination. You pay more but earn the same, and worry about your job. On a societal level, risk is shooting higher. When most people own houses and shoulder substantial debt, while saving and investing precious little, they’re sitting ducks for trouble. Layoffs, restructurings, tax grabs, failed marriages, aging – take your pick.
Just imagine where our economy would be today without all those mortgages, car loans and government borrrowings. The bloating of credit – drawing wealth from days yet unlived – only works to bridge hard times when it’s followed by a surge of growth.
Six years after the crisis, house prices and debt have careened higher. And here we are, seriously jawing about deflation. I hope that worries you a little.