Making Economics Meaningful – How Official Inflation Figures Obscure Reality

Since 2008 (that evergreen financial milestone) central banks have tried to stimulate economies by keeping borrowing rates extremely low. The idea was that people and corporations would be encouraged to borrow and spend money since the cost of that borrowing would be so cheap. This would eventually stimulate the economy through growth, help people get back to work and ultimately lead to inflation as shortages of workers began to demand more salary and there was less “slack” in the economy.

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Following the financial crisis lending rates dropped from historic norms of around 5% to historic lows and remained there for most of the next decade.

Such a policy only makes sense so long as you know when to turn it off, the sign of which has been an elusive 2% inflation target. Despite historically low borrowing rates inflation has remained subdued. Even with falling unemployment numbers and solid economic growth inflation has remained finicky. The reasons for this vary. In some instances statistics like low unemployment don’t capture people who have dropped out of the employment market, but decide to return after a prolonged absence. In other instances wage inflation has stayed low, with well-paying manufacturing jobs being replaced by full-time retail jobs. The economy grows, and people are employed, but earnings remain below their previous highs.

Recently this seems to have started to change. In 2017 the Federal Reserve in the United States (the Fed) and the Bank of Canada (BoC) both raised rates. And while at the beginning of this year the Fed didn’t raise rates, expectations are that a rate hike is still in the works. In fact the recent (and historic) market drops were prompted by fears that inflation numbers were rising faster than anticipated and that interest rates might have to rise much more quickly than previously thought. Raising rates is thought to slow the amount of money coursing through the economy and thus slow economic growth and subsequently inflation. But what is inflation? How is it measured?

One key metric for inflation is the CPI, or Consumer Price Index. That index tracks changes in the price or around 80,000 goods in a “basket”. The goods represent 180 categories and fall into 8 major groupings. CPI is complicated by Core CPI, which is like the CPI but excludes things like mortgage rates, food and gas prices. This is because those categories are subject to more short-term price fluctuation and can make the entire statistic seem more volatile than it really is.

CollegeInflationArmed with that info you might feel like the whole project makes sense. In reality, there are lots of questions about inflation that should concern every Canadian. Consider the associated chart from the American Enterprise Institute. Between 1996 – 2016 prices on things like TVs, Cellphones and household furniture all dropped in price. By comparison education, childcare, food, and housing all rose in price. In the case of education, the price was dramatic.

Canada’s much discussed but seemingly impervious housing bubble shows a similar story. The price of housing vs income and compared to rent has ballooned in Canada dramatically between 1990 to 2015, while the 2008 crash radically readjusted the US market in that space.

The chart below, from Scotiabank Economics, shows the rising cost of childcare and housekeeping services in just the past few years, with Ontario outpacing the rest of the country in terms of year over year change when it comes to such costs.

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My desktop is littered with charts such as these, charts that tell more precise stories about the nature of the broader statistics that we hear about. Overall one story repeatedly stands out, and that is that inflation rate may be low, but in all the ways you would count it, it continues to rise.

DIe6Fh2UMAEDmaIIn Ontario the price of food is more expensive, gas is more expensive and houses (and now rents) are also fantastically more expensive. To say that inflation has been low is to miss a larger point about the direction of prices that matter in our daily lives. The essentials have gotten a lot more expensive. TVs, refrigerators and vacuum cleaners are all cheaper. This represents a misalignment between how the economy functions and how we live. 

DJs5AdwXoAANcDTEconomic data should be meaningful if it is to be counted as useful. A survey done by BMO Global Asset Management found that more and more Canadians were dipping into their RRSPs. The number one reason was for home buying at 27%, but 64% of respondents had used their RRSPs to pay for emergencies, for living expenses or to pay off debt. These numbers dovetail nicely with the growth in household debt, primarily revolving around mortgages and HELOCs, that make Canadians some of the most indebted people on the planet.

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In the past few years, we have repeatedly looked at several stories whose glacial pace can sometimes obscure the reality of the situation. But people seem to know that costs are rising precisely in ways that make life harder in ways that we define as meaningful. When we look at healthcare, education, retirement, and housing it’s perhaps time that central banks and governments adopt a different lens when it comes understanding the economy.

It Doesn’t Matter if There Isn’t A Real Estate Bubble

Last week I published a piece on the dangers of the housing bubble in Canada. It caused a stir with a number of clients and followed many articles over the past two years about our concerns with the Canadian economy.

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But on Wednesday I was at an industry lunch with another group of advisors talking about the Canadian housing market and was met with a curious objection over whether there was any real danger at all. Another advisor happily pointed out to me that while the indebtedness of Canadians may be high, it is still affordable, and we should be mindful of the famous investors you have been hoisted by their own doom saying petards.

While it’s true that many doom saying predictions don’t come to pass and we should be careful before signing on to one particular points of view, arguing that lots of debt is affordable and therefore no threat is similar to a drug addict arguing everything is under control because they still hold down a job. The job is irrelevant to the problem, although it’s absence is likely to make matters worse.

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This is why it is somewhat irrelevant to worry about the Canadian housing market. Whether you believe there will be a soft landing, a hard landing or no landing at all, what Canadians have is a debt problem. Only it’s not a problem because it’s affordable. Also it’s a problem.

If that last sentence is confusing, don’t worry. It sounds worse coming from the Bank of Canada, who in their December Financial Systems Review pointed out that debt levels continue to climb but the relative affordability of the debt remains consistent. And while an economic shock to the system could make much of that debt unserviceable, for now that seems unlikely. They concluded this section of the report identifying the risk to Canadians as “elevated”.

This is non-committal nonsense. In economic terms there is a bomb in the room that needs to be diffused, has no timer but will go off at some indeterminate future point. The problem is that Canadians can’t seem to help by adding more debt to the pile. In January Canadians added another $80 billion of debt through mortgages, lines of credit and credit cards, a jump of 4.6%. Our private debt is now over $1.8 Trillion, larger than our GDP. Household saving’s rates are at a five year low, 3.6%. But in 1982 the savings rate was 19.9%. In other words we’ve had a dramatic shift away from savings and towards debt.

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While 30% of Canadian households have no debt, almost every demographic is susceptible to the growing debt burden. Even seniors have a growing debt issue. Canada is now unique in the world for having debt levels in excess of the peak of the American debt bubble in 2008, and is currently only surpassed by Greece. Traditionally I am highly cautious about grand pronouncements about market doom and gloom, but in this instance I am of the opinion that ignoring Canada’s debt problem is willful blindness.

How to best handle this problem will have to be left to others. There is no simple solution that will not trigger the bomb, and the goal of any government is to slowly reduce the average debt burden without hurting the economy or deflating the bubble. For my part I tend to advise people to pay their debts down, shy away from things they cannot afford and encourage saving rather than debt spending to limit risk. When it comes to saving for the future there is no reason to make many people’s problems your problems.