While many Western Standard readers will recall the damaging period of inflation and high interest rates of the early 1980s, the roughly 40% of Canada’s population born after 1988 is familiar only with the recent and long period of low inflation and interest rates. For them, the last year has been a nasty shock as inflation stripped out 8% to 10% of the value of their purchasing power — more in grocery stores — and the cost of loans soared..Here's the good news: both the Bank of Canada and the US Federal Reserve Bank predict while more rate increases are likely in the near- or medium-term future, they will likely be smaller..Further down the road — and among all the other uncertainties — it's also clear central banks will eventually lower interest rates. Even better, there's early evidence inflation has begun to moderate, supporting less aggressive future monetary actions..Unfortunately however, that’s about as good as the news gets. Our economic world is experiencing unique times as we respond to the economic and social damage of the pandemic and, after decades of low interest rates, the burst of inflation mentioned above. In the weeks to come, I will be publishing a short series of articles written as investor advice with particular reference to the prospects for the western energy industry..First though, for the benefit of that 40% still struggling with the idea of rapidly rising prices, a word about what inflation is and how you can anticipate it from government actions..“Inflation refers to a general increase in the prices of goods and services in an economy.” In Canada “it averaged 8.1% per year from 1971 to 1980 and 6% from 1981 to 1990, and from 1991 to 2020, 1.88% per annum,” increasing to 3.4% in 2021 and this year in Canada approached 8% in November. This was likely the peak for 2022..As economist Steven Globerman, writing for the Fraser Institute, further explains,“Inflation occurs when the aggregate demand for goods and services in the economy exceeds the capacity of the economy to meet that demand at the current price level.” Aggregate demand is usually a function of the money supply but complicating the calculation, the velocity of money also an important variable..Conventional wisdom among economists and advanced world central banks is that moderate inflation, targeting 2% (a band of 1%-3% in Canada for example,) is an appropriate level for long term growth and stability. Such levels also “minimize the redistribution of income and wealth that often result from high inflation.”.That’s the theory, and one might suppose governments are sincere in their efforts to combat inflation. And sometimes perhaps, they are. However, it is important to understand governments “are typically major financial beneficiaries of inflation given that a significant portion of the tax base is not indexed to the rate of inflation.” It’s known as bracket creep: As the taxpayer’s income increases, he moves into a higher tax bracket..So, what just happened here? In a word, COVID..As the economy collapsed in the spring of 2020, businesses closed and social interactions diminished. With so many people struggling financially, virtually everyone agreed government support — albeit clumsy and wasteful — was critical and appropriate. Central banks accommodated this unprecedented spending by way of “new policy instruments including quantitative easing and forward guidance.”.Quantitative easing involves the central bank buying large quantities of government bonds and mortgages to hold on its balance sheet. Effectively printing money that previously didn't exist; this injects liquidity into the economy..Yes, it increases federal government debt. Most considered it a necessity anyway..With respect to forward guidance, the Bank of Canada and others underestimated the consequences of quantitative easing, describing the inflation it caused as “transitory.”.It has however, been anything but. The resulting criticism of central bankers as late to respond as the cost of money and almost everything else increased quickly, is in my view entirely legitimate. To be charitable, there was an unusually high level of uncertainty and anxiety at the time and it is not easy to pick the exact moment to pivot from so-called easy money to a mandate of fighting inflation..In that regard one can better understand the dramatic increases of bank rates in North America. Certainly, the higher interest rates — an unprecedented four successive increases of 75 basis points that moved the Bank of Canada rate from .25% to 4.25% — reduced the demand for money and by thus reducing purchasing power, brought down prices. Did the bankers wait too long?.Some will say so. But the other risk was going too far, too fast and increasing the risk of recession (meaning two consecutive quarters of negative growth) and further criticism..Here they may catch a break as employment numbers in North America remain strong and unemployment relatively low at this point in the cycle, partly as a result of the post-pandemic bounce-back..The debate continues as to the likelihood, but no one doubts lower economic growth by the design and actions of central banks..Some market indicators suggest there will be no recession and, to the extent that a sharp decline in stock markets portends a recession, the market is more characterized as volatile in both directions and is supported by a strong energy sector which has outperformed in the last year or two..On the other hand, there is an inverted yield curve (the deepest since 1982 according to a November 30 article in the Wall Street Journal,) which simply means future interest rates are lower than short term rates. Economic concern leads to more buying of low-risk, short-term bonds pushing up prices. Six of the last seven recessions were preceded by an inverted yield curve..How to bet, then?.The mid-December 50 basis points increase in the US puts rates slightly higher than in Canada pressuring the already weak Canadian currency, versus the US dollar. Higher interest rates are in Canada have helped to attract capital and support the Canadian dollar..The biggest risk of continued inflation however, one that creates and maintains upward pressure on interest rates, is the ongoing spending of national governments injecting liquidity into the economy..Keep that in mind next week, as we do a country-by-country investor review, and the week after as we look at Canada particularly.
While many Western Standard readers will recall the damaging period of inflation and high interest rates of the early 1980s, the roughly 40% of Canada’s population born after 1988 is familiar only with the recent and long period of low inflation and interest rates. For them, the last year has been a nasty shock as inflation stripped out 8% to 10% of the value of their purchasing power — more in grocery stores — and the cost of loans soared..Here's the good news: both the Bank of Canada and the US Federal Reserve Bank predict while more rate increases are likely in the near- or medium-term future, they will likely be smaller..Further down the road — and among all the other uncertainties — it's also clear central banks will eventually lower interest rates. Even better, there's early evidence inflation has begun to moderate, supporting less aggressive future monetary actions..Unfortunately however, that’s about as good as the news gets. Our economic world is experiencing unique times as we respond to the economic and social damage of the pandemic and, after decades of low interest rates, the burst of inflation mentioned above. In the weeks to come, I will be publishing a short series of articles written as investor advice with particular reference to the prospects for the western energy industry..First though, for the benefit of that 40% still struggling with the idea of rapidly rising prices, a word about what inflation is and how you can anticipate it from government actions..“Inflation refers to a general increase in the prices of goods and services in an economy.” In Canada “it averaged 8.1% per year from 1971 to 1980 and 6% from 1981 to 1990, and from 1991 to 2020, 1.88% per annum,” increasing to 3.4% in 2021 and this year in Canada approached 8% in November. This was likely the peak for 2022..As economist Steven Globerman, writing for the Fraser Institute, further explains,“Inflation occurs when the aggregate demand for goods and services in the economy exceeds the capacity of the economy to meet that demand at the current price level.” Aggregate demand is usually a function of the money supply but complicating the calculation, the velocity of money also an important variable..Conventional wisdom among economists and advanced world central banks is that moderate inflation, targeting 2% (a band of 1%-3% in Canada for example,) is an appropriate level for long term growth and stability. Such levels also “minimize the redistribution of income and wealth that often result from high inflation.”.That’s the theory, and one might suppose governments are sincere in their efforts to combat inflation. And sometimes perhaps, they are. However, it is important to understand governments “are typically major financial beneficiaries of inflation given that a significant portion of the tax base is not indexed to the rate of inflation.” It’s known as bracket creep: As the taxpayer’s income increases, he moves into a higher tax bracket..So, what just happened here? In a word, COVID..As the economy collapsed in the spring of 2020, businesses closed and social interactions diminished. With so many people struggling financially, virtually everyone agreed government support — albeit clumsy and wasteful — was critical and appropriate. Central banks accommodated this unprecedented spending by way of “new policy instruments including quantitative easing and forward guidance.”.Quantitative easing involves the central bank buying large quantities of government bonds and mortgages to hold on its balance sheet. Effectively printing money that previously didn't exist; this injects liquidity into the economy..Yes, it increases federal government debt. Most considered it a necessity anyway..With respect to forward guidance, the Bank of Canada and others underestimated the consequences of quantitative easing, describing the inflation it caused as “transitory.”.It has however, been anything but. The resulting criticism of central bankers as late to respond as the cost of money and almost everything else increased quickly, is in my view entirely legitimate. To be charitable, there was an unusually high level of uncertainty and anxiety at the time and it is not easy to pick the exact moment to pivot from so-called easy money to a mandate of fighting inflation..In that regard one can better understand the dramatic increases of bank rates in North America. Certainly, the higher interest rates — an unprecedented four successive increases of 75 basis points that moved the Bank of Canada rate from .25% to 4.25% — reduced the demand for money and by thus reducing purchasing power, brought down prices. Did the bankers wait too long?.Some will say so. But the other risk was going too far, too fast and increasing the risk of recession (meaning two consecutive quarters of negative growth) and further criticism..Here they may catch a break as employment numbers in North America remain strong and unemployment relatively low at this point in the cycle, partly as a result of the post-pandemic bounce-back..The debate continues as to the likelihood, but no one doubts lower economic growth by the design and actions of central banks..Some market indicators suggest there will be no recession and, to the extent that a sharp decline in stock markets portends a recession, the market is more characterized as volatile in both directions and is supported by a strong energy sector which has outperformed in the last year or two..On the other hand, there is an inverted yield curve (the deepest since 1982 according to a November 30 article in the Wall Street Journal,) which simply means future interest rates are lower than short term rates. Economic concern leads to more buying of low-risk, short-term bonds pushing up prices. Six of the last seven recessions were preceded by an inverted yield curve..How to bet, then?.The mid-December 50 basis points increase in the US puts rates slightly higher than in Canada pressuring the already weak Canadian currency, versus the US dollar. Higher interest rates are in Canada have helped to attract capital and support the Canadian dollar..The biggest risk of continued inflation however, one that creates and maintains upward pressure on interest rates, is the ongoing spending of national governments injecting liquidity into the economy..Keep that in mind next week, as we do a country-by-country investor review, and the week after as we look at Canada particularly.
