Two decades later, inflation looms again as an economic threat
By Ray Turchansky, For Postmedia NewsJanuary 16, 2012
You have to go back to the post-recession period of 1991 to find inflation above five per cent in Canada, but there are warnings we'll be returning to those lofty rates.
At investment seminars in Edmonton, organized by financial adviser Trevor Hamon for Dundee Wealth Management, presenters offered the recurring message that government debt in North America will spur them to flood markets with money, causing inflation to reach five to seven per cent by 2016.
That would profoundly affect things ranging from mortgage rates to employment to the way we invest.
Statistics Canada reports that the popular measure of inflation, the Consumer Price Index that shows increases during the previous 12 months, went from 1.0 per cent in July 2010, to 3.7 per cent in April 2011, and was at 2.9 per cent near the end of last year.
But at the Dundee seminars, it was suggested that governments will soon be struggling to pay the cost of servicing their debt, let alone the debt itself, and by trying to inflate their way out of the problem will be "playing with fire." If the public loses faith in a currency, there is a rush to convert it into something physical.
By way of background, in terms of purchasing power, people in 1973 were actually paid more than they are today. From 1973 until 1999, living standards were maintained by having two-income families. Then since 1999, standards were kept up by going deeper in debt.
Inflation was 2.0 per cent in 1971. It stayed above five per cent from 1971 through 1983 - hitting highs of 13 per cent in 1974 and 1981 - before being wrestled below five per cent by a 21-month recession.
However, the public measurement of inflation has been clouded over the years. The CPI, which was once an indication of what a family of four spent on their purchasing needs, has become more of an indication of what that family now needs for survival. CPI is now "seasonally adjusted," items that spike in value are removed from the basket of goods as anomalies, and inflation has been divided into "core" and "headline" measures.
And as people's annual cost-of-living salary increases often haven't covered real inflation, their purchasing power has diminished.
But the situation has gotten worse than that, due to the crumbling American housing market.
"When you have property values drop by a third, that is a deflationary part of the cycle," Hamon said. "The banks are terribly afraid of deflation. If they lend you 95 per cent of value of your home and the property drops by 10 per cent, you owe them more than what they could sell it for, and it strikes fear in the hearts of bankers. The Federal Reserve has stated: 'We will not let deflation happen in the U.S.' It happened in Japan with devastating results."
Deflation severely reduces employment and productivity, and there's little that central banks can do about it. Conversely, a little bit of inflation is deemed healthy - central banks often target one to three per cent - and they have some control over it, usually by raising interest rates. The problem occurs when inflation runs amok, hammering consumers who then consume less.
Hamon and others fear that two American attempts at quantitative easing - pumping a bunch of money into the hands of people to spend - hasn't stimulated the economy, and unhealthy inflation lies ahead.
The first sector to be hit will be the housing market. If banks raise interest rates to control inflation, mort-gage rates will rise, causing first-time homebuyers and financially-strapped people renewing mortgages to back off. Again, in recent days major Canadian banks have warned that most of the country's housing prices are headed for a pullback.
As for investors facing inflation, they are being advised to forget growing their portfolios and retirement plans, and to concentrate on preserving capital.
A common move is a flight to physical things in the ground - basically commodities such as gold and silver whose value isn't controlled by governments. Gold tends to do well during inflation and even better during deflation. Conversely, silver does better than gold during inflation, but does terribly during deflation.
Anticipating an upcoming love affair with gold, the Royal Canadian Mint held an initial public offering of Canadian Gold Reserves' Exchange Traded Receipts in November, traded on the Toronto Stock Exchange.
The ETRs are a certificate for 0.0109 ounces of gold, initially offered for $20, with the gold to be bought by the Mint with the money raised from the offering. In the wake of gold hitting $1,923.70 an ounce in early September, $600 million was raised in the IPO by the Mint, which was more than twice what had been expected. While there are some drawbacks -such as fees to have the Mint store the gold, plus redemption fees - they could be quite profitable if held in significant amounts.
Hamon noted the benefits of holding physical gold or gold certificates, as opposed to shares in gold mining companies, which often don't track the price value of the commodity itself.
Another way to insure yourself against the risk of soaring inflation is to invest in real-return bonds, which guarantee a return greater than inflation. For example, TD Bank has a real-return bond fund (which, by way of disclosure, I own), that has returned 15.31 per cent during the past year, which wasn't a period of particularly high inflation.
If inflation does rear its ugly head, some pre-planning will pay off nicely.
Edmonton Journal
turchan@telusplanet.net |
