Behold the harbingers…the pale horsemen of the coming deflation!

In the absolute must-read news of the day, CIBC came out with a great report detailing the significant headwinds facing the Canadian economy in 2011.  Now granted the report is much more in-depth and backed by some cute, colourful charts, but it basically makes the case for the same headwinds I’ve been warning people about since 2008.  The link is to an entry I wrote for my brother’s blog back in July, but you can look back through the archives to see for yourself that none of this is news to me or anyone following this blog or my brother’s blog.

So let’s discuss a few golden nuggets from this fantastic report:

1)  Consumers in the US remain in deleveraging mode.  You have to understand money creation and destruction and inflation/deflation to get the significance here.  Go back and read the deflation primer if you are new to this blog.  Basically, if credit is expanding at a rate greater than the expansion in the availability of goods and services, it’s like having more money in the system chasing these goods and services.  Thus the price of these goods and services rise, buoyed by the rising tide of money.  As people deleverage, a fancy way for saying that they pay off their debt, this tide starts to fall, and prices with it, particularly for leveraged assets such as real estate.  It’s more complex than that.  Just read the friggin primer!

This deleveraging is the result of an over-indebted society coming to its senses in the aftermath of a burst credit bubble.  Lest you have drunk the media cool-aid and believe that somehow we here in Canada are more ‘conservative’ than our lowly neighbours to the south, chew on this and this for a while.  So let’s understand that this is our future.  We are reaching the end of our ability to take on more credit.  There aren’t enough new debtors in the pipeline to keep the Ponzi scheme going.

So here’s what that is looking like in the US.  If you have been following this blog, you will understand that this is just the start of a major secular shift of which the United States is several years into and, as you will see in a moment, we here in Canada are just beginning.  We’ll have a nice fancy chart just like this by about 2012.  If you’ve read the deflation primer, you’ll know what the dual punches of increased savings and debt deleveraging do to our consumer-driven economy.

2)  The second major factor discussed in this report is the slowing of the wealth effect, which is already being felt here Great White North.  We’ve discussed this effect many times.  The main idea is that people are willing to go into more debt and spend money on crap they don’t really need when their assets are rising and they feel wealthier.  Since their personal residence is the largest asset most people ‘own’, when it rises, they are willing to borrow against it.  It’s a well-studied phenomenon.  It perfectly explains this obscene graph showing line of credit growth in Canada since 1999.

Now all this wealth-effect spending has the effect of buoying segments of the economy that would not otherwise flourish were people not willing to be so frivolous.  It also partly explains why employment, real estate prices, and home sales are so closely related.

This has been the miracle of the Canadian economic ‘recovery’:  we were able to stimulate demand by crashing interest rates, thus inducing a bounce in real estate values.  The reality is that the return of jobs to the Canadian economy, and the economic growth generated by our economy over the past 18 months has been largely attributable to one factor-  Real estate.  As the real estate correction in Canada intensifies, we will see just how ‘resilient’ our economy really is.

Back to the report:

“It’s no secret that house prices have been falling recently, but less noted is that the  performance of the housing market is already approaching levels seen during the recession. Even a modest 5% additional drop in average price in 2011, on top of the 6% it already shed from its peak, will lead to a negative wealth effect of $10 bn, stripping growth in consumer spending by more than a full percentage point.
The same goes for consumer credit, which has been a very important source of consumer spending.”

Look at these graphs! Stare at them until they are burned into your retinas!  I could leave you with these two simple graphs and wrap up this whole wretched blog.  It’s all summed up right here.  THIS IS OUR FUTURE!  This is the cause of the tumultuous times I keep warning about. It is the beginning of a secular shift away from the excesses of the past decade and the dual pale horsemen of debt deleveraging and slowing velocity of money via increased savings are the harbingers of the deflationary times to come.  Understand this!


Do you get it?  House price declines start a self-feeding cycle of reduced consumer spending, higher unemployment, and more house price declines.  The authors of the report don’t yet get the half of it….yet.  All of this is framed by the macro factors discussed in the primers.  If you haven’t read them yet, get on it.

And if you haven’t started saving and are still living off debt, correct that now!  Right now!  Hear those thundering hoof beats in the distance?  They’re coming!

-Ben

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One Response to Behold the harbingers…the pale horsemen of the coming deflation!

  1. Pingback: New home prices; Tough budget coming; Canada’s trade deficit widens | Financial Insights

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