The chicken, the egg, or a bit of both?

Hello all

Hopefully we all understand that our consumer spending-driven pseudo economy has experienced ‘growth’ largely because people have been able and willing to take on more debt to buy crap they don’t really need.  We just examined the feedback mechanism that connects rising house prices with consumer confidence and consumer spending, employment, and the broader economy.  This mechanism in reverse is exactly why I feel confident that Canada will be back in recession by Q3 2011 and will see stubbornly high unemployment and sluggish growth for several years.

Now the question can be asked, “which comes first, the slowing consumer confidence or the falling home prices?”  Is it the chicken or the egg?  I think it’s a fair question.  Our economic growth over the past few years in particular has based largely on consumer spending, and that spending has based largely on the wealth effect created by rising real estate prices.  Because of this, a hit to home prices and/or a decline in consumer sentiment will be all it takes to start the mechanism working in reverse.  Let me suggest that with house prices near all-time highs and consumer debt at historic highs, there is an inherrent instability in the system.  There will be a correction.  The question is what will trigger it.

You’ll also recall that one of the big predictions of this blog is that we are nearing a time of debt deleveraging which will exert significant deflationary forces on the broader economy and real estate in particular.  Mass psychology being what it is, it’s impossible to know exactly when people will embrace this new frugality, but the timing is really only an academic issue.  When you consider that debt is at record high levels in Canada, savings are running at multi-generational lows, and interest rates can only rise in the long term, it’s not hard to see that a normalization of these three factors spells big trouble for real estate in Canada, and the broader Canadian economy by extension.

Even though the exact timing of the tipping point is impossible to guess, articles like this one seem to suggest that it may be nearing:

Canadian consumer confidence drops significantly

“Consumer confidence in Canada had remained about the same as December 2009, but then fell 14 points from 108 to 94 in the three areas that make up the index: current conditions, expectations and personal investments”

“Looking ahead to next year, fewer Canadians, 46%, feel the national economy will improve and that’s down nine points from three months ago.”

What a change from just a few months ago when all the talk was of a ‘V-shaped’ recovery and the return of party times.

“Half of Canadians say they are focusing efforts on reducing their debt over the next year and 39% plan on spending less”

Hey what do you know…there’s that debt-deleveraging and frugality theme right there.

Not to be outdone, the Sun ran this story based on the same data release:

Consumer confidence in reverse mode

“Future-oriented concerns about the economy seem to be plaguing Canadian consumer confidence most.  “Now, it even appears that Canadians might have the gear shift in ‘R’ for reverse,” the report said.”

Despite the best efforts of the media and politicians, the general public is seeing things as they really are.  The stimulus-induced recovery is fading.  Consumers are maxed out.  Real estate and the economy have only one place to go:  Down.

Keep an eye on consumer confidence readings out of Canada.  When our economy is so heavily dependent on consumer spending to generate growth, these reports warrant your attention.

In the U.S., the Consumer Metrics Institute Leading Indicators keeps track of consumer spending intentions.  From their own website:  

“The Consumer Leading Indicators on our web site track consumer interest in major discretionary purchases. These typically include such items as automobiles, housing, vacations, durable household goods and investments. Not included would be expenditures that are more or less automatic, relatively minor and/or nondiscretionary, such as groceries, fuel or utilities.

It’s unfortunate that such a measure does not exists on such a constantly updated basis here in Canada.  I’ve highlighted this graph before, but it bears reposting as it highlights the importance of consumer confidence and consumer spending on economic activity.  The graph shows the CMI Growth Index in red, GDP growth out of the US in green bars, and the S&P 500 (a broad stock index) in blue.  Thanks to Ilargi over at The Automatic Earth for creating it.  I should note that the GDP readings and CMI data have been overlayed, where typically there is a two quarter lag between them.


So it could well be that the camel’s back may well be broken by nothing more than consumer psychology.  All it takes if for the perception of bleak times for consumers to make those times a reality.  The consequence of this consumer retrenchment would be rising unemployment and a falling house prices.

Interestingly, Stats Canada reported today that building permits had plunged by 9.2% in August.  Hmmmm…..a sign of a retrenching consumer?  Let’s recall what effect falling housing starts had on unemployment in the US:

People without jobs don’t buy homes.  So will this be the catalyst to great unwinding to come?  Or will it be falling home prices back in line with fundamentals?  Either way, the picture for house prices, economic growth, and employment look pretty bleak.


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2 Responses to The chicken, the egg, or a bit of both?

  1. Pingback: Roundup: Turkey and Sweet Potato Edition | Financial Insights

  2. Pingback: Watching for signs of a deflating Canadian debt/real estate bubble | Financial Insights

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