Canadian Real Estate Faces A New Problem: Deflation

Canadian households are facing a problem they didn’t think was possible a few weeks ago – falling consumer prices. Statistics Canada (Stat Can) data shows the consumer price index (CPI) fell in April. The deflationary move is the first seen in Canada, in over a decade. A month isn’t a trend, but if it continues, the impact on heavily indebted households could be huge – and not in a good way.

Deflation and The Real Value of Debt

Deflation is when consumer prices fall. Sounds great, right? Who doesn’t want to pay less for things? Declines at certain times, especially if due to decreasing manufacturing costs, can be great. Consumers have more money they can spend or invest. However, it becomes a problem if it spreads across more segments, and the general economy. It becomes a huge tailwind during an economic slowdown.

Widespread economic deflation can lead to something called a “deflationary spiral.” Since prices are dropping, consumers wait to see if they can get a better deal. If businesses can’t sell inventory, they slow orders for new inventory and investment. This leads to lower employment… which leads to less demand… leading to further price drops… which leads to… you get the point. It becomes even more of an issue if interest rates are kept low for a long period before. Keynes himself once warned that lowering rates after a period of extended low rates, will fail to stimulate demand.

Not sounding so great now, right? There’s an even bigger problem for Canada’s heavily indebted households – an increase in the real value of debt. It’s common knowledge the value of debt can be inflated away, but it’s less common that people realize the opposite can happen. The value of debt can increase in real terms in a deflationary environment. This makes existing debts harder to pay, since debt loads and payments are the same, but they exist in the same universe as higher unemployment and lower wages. It also generally means lenders need to raise interest payments, because the value of debt decreases.

Canadian Inflation Falls For The First Time Since 2009

Canada experienced its first taste of deflation last month. CPI fell 0.2% unadjusted in April, down from a 0.9% gain the month before. On a seasonally adjusted basis, this works out to a drop of 0.7% in April, compared to the month before. This is the first decline for CPI since September 2009.

Canadian Consumer Price Index

The unadjusted year-over-year percent change for Canadian consumer prices.

Source: Stat Can, Better Dwelling.

Over A Third of Major CPI Components Are Deflating

The slowdown earlier this year was mostly due to commodities, but it’s other segments are now seeing it as well. Transportation, clothing and footwear, and recreation and education are all major segments to see declines. For gasoline and clothing, both suffered the largest decline in the history for those components on record. A little more than a third of major components made declines last month.

Canadian Consumer Price Index By Component

The unadjusted year-over-year percent change for Canadian consumer prices.

Source: Stat Can, Better Dwelling.

One month of deflation isn’t a reason to panic, but it should pique the interest of most investors. It’s not a deflationary spiral at this point, but deflation is worse than too much inflation. You can provide cheap money, but you’re depending on a change in consumer sentiment to spin things up again. As the fallout continues, and the economy begins reopening, we’ll start to see how drastically consumer behavior has changed.

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  • Mortgage Guy 4 years ago

    Even at zero bound, debt levels are high enough lenders need a high enough return for the risk to make sense. Private lending virtually dried up overnight, and that was responsible for a substantial number of purchases in Greater Toronto, especially in the new construction segment.

  • TL 4 years ago

    Shopify is one of the biggest lease holders in downtown Toronto, and we were just notified we can work from home forever. Since hearing this, where I’ve been looking for a home completely changed.

    No point in paying a premium to walk to work, when now I would rather have an extra room.

  • Owe Canada 4 years ago

    (the current crisis) “tells you the importance of getting your fiscal house in order . . . ideally, you would go into an unexpected shock like this with a much stronger fiscal posture.”

    Jerome Powell, Chair U.S. Federal Reserve (April 29, 2020)

  • Investor 4 years ago

    Just simply explain that it puts a downward pressure on Core Inflation and makes the economy go ballistic. The impact then turns into a chain reaction. All the dominoes (which are interconnected) crumble like a house of cards.

  • SH 4 years ago

    “Deflation is when consumer prices fall.”

    This poor English makes me cringe.

    What you mean is “Deflation OCCURS when consumer prices fall.”

    I learned to avoid “is when” in grade 8 or 9.

    • Stephen Lawson 4 years ago

      I have been ruminating about the spectre of deflation. It seems impossible that the consumerism economy will not shift in some meaningful way from ‘wants’ to ‘needs’. To food and shelter away from 80 inch screens and a second car. This will be reflected in the shrinking of the world GDP in some dramatic and sustained fashion. I wonder what gold does in this deflationary paradigm?

    • Toque-nicallySpeaking 4 years ago

      This is what you chose to comment on? Actually, it is a toque-nically correct statement. The author has defined the state when “consumer prices fall” by the term “Deflation.” What you are describing is two dependent events, not a definition. You may be confusing English class with Statistics class.

    • Luigi Vampa 4 years ago

      You sound like a lot of fun.

    • Jason Chau 4 years ago

      I love Canada. People with last names that indicate they’re of color, receive critiques about their ability to speak language.

      I don’t recall anyone questioning Bloomberg’s very white author using the description, “… deflation, when overall prices drop…”

      • Micheal P 4 years ago

        SH is sadly unaware that deflation is a noun, and not a verb. It’s the situation, not the actual act.

        The fact the author’s first language is French likely makes him hyperaware of grammar, since native speakers infer usage, whereas non-native speakers have to learn usage. This is painfully obvious to anyone no raised with english as their primary language.

      • Mike 4 years ago

        I’m very English, which means I speak a language of half rules, everywhere!

        Who cares!

    • Jupiter 4 years ago

      Oh you angry little thing, I assume grade 8 is the highest level of education you got. I think the author is good, the article is well written.

    • carlton 4 years ago

      What ! How dare him!

      Get his English teacher on the phone this instant.

    • Marie ML 4 years ago

      This correction is pedantic and fails to appreciate that “is when” can be construed as “exists when”. There’s not anything inherently “wrong” with “is when”; it’s just more colloquial, but crucially its meaning is safely preserved.
      I too was an English teacher.

  • Juane 4 years ago

    SH ,

    I assume is the abbreviation for sh*t head?

  • Rahul 4 years ago

    A lot of that decline is driven by oil price, which is recovering now. So stop blowing things out of proportion.

  • Justin tobby 4 years ago

    All I’ve seen are higher prices and that’s why I’m not ready to shop. Where are the deals?

  • Manoj 4 years ago

    All governments operate out of their self-interest. They falsify the statistics, revising them routinely, especially CPI after learning that everything is indexed to CPI. So if you reduce the CPI, you cut benefits without having to confront the people. They removed real estate, which they considered an investment as opposed to an associated cost of living, and replaced it with rent.

    House prices have gone up by more than 10% annually since 2009 crash. In 2016, house price assessments went up by 40% in Vancouver. We all know why, foreigner’s got into the act of flipping houses to each other and inflating the prices by $100,s thousands each time the houses changed hands. In some cases it was 3-4 times in a space of one year. Local banks were also lending to these foreign buyers and securitizing the mortgages with CMHC. And the organized real estate machinery cheered on and the locals got into the act and now they are begging for taxpayers to bail them out.

    Do not even look at these fake CPI and the stats. They are always lagging by months and are manipulated to conform to the narratives of the self interest parties of the asset group.

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