Deflation 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 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.
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