The Bank of Canada just announced another rate hike on June 1.
As expected, the overnight rate increased by another 50 basis points, from 1% to 1.5%.
Is that going to drag us into a stagflation?
What is a stagflation?
How is that related to our GDP and unemployment?
It’s essential economic knowledge you must know.
And I’m going to simplify it for you.
The main focus of the rate hike is of course inflation.
Canada’s inflation rate hit 6.8% in April, a new 31-year high.
And if you haven’t heard, there’s a new term called “lunchflation”.
As people are returning to the offices, they realize the cost of lunch has gone up significantly.
A report from Square shows that hamburger prices are up 26% over the past 2 years.
Salads are up 25%.
Sandwiches are up 20%.
That’s lunchflation.
The cost of commuting is increasing as well.
Gas prices are now hovering around that $2 mark, around a 20% increase from April.
You see, it costs that much more to just go to work.
That’s why workers are demanding wage increases.
On the employers’ end, they are fighting wage inflation.
That means the business owners will see an increase in their costs.
And what are they going to do next?
Increase the prices of their products and services.
So consumers will end up paying more for products and services.
You see how inflation ripples through and affects pretty much everyone.
The Bank of Canada is trying to fix that by raising the interest rate to curb demand.
A higher interest rate would discourage people and businesses from borrowing money.
Businesses would be less likely to expand and they hire fewer people.
Individuals would tend to cut their spendings because it is now more expensive to borrow money.
The problem is, if people and businesses all stop spending money, then we go into a recession.
You see, the Bank of Canada has a really tough job to do.
If they raise the interest rate to a certain point where it’s just enough to bring inflation down to the normal 2 to 3% level and yet it doesn’t kill our economy, then that’s perfect and we have a soft landing.
But if they don’t do it right, the scariest thing is we go into a stagflation.
We all know what inflation is, but what the heck is a stagflation?
Stagflation is used to describe an economy where inflation is very high, but unemployment is also high and GDP is declining.
That’s the worst situation, right?
Things are very expensive, but people have no jobs and the economic growth is very slow.
A stagflation occurred in the 1970s when unemployment and inflation were both high at the same time.
Everything got so expensive because the global price of oil went up dramatically all of a sudden due to political issues.
But the economy was actually very slow and unemployment was high.
So are we in a similar situation now?
A combination of money printing and global supply chain issues creates a high demand and low supply situation.
As a result, we all know, very high inflation.
What about unemployment then?
Canada’s unemployment rate actually fell to an all-time low of 5.2% in April.
So our labour market is actually extremely strong.
What about our economic growth?
Canada’s projected real GDP growth in 2022 is 4.2% and that’s too high.
The Bank of Canada wants to bring it down to 3.2% in 2023 and eventually to 2.2% in 2024.
Yes, you heard it right.
It’s in the Bank of Canada’s April Monetary Report, our GDP is too high right now.
What does that mean?
GDP is the total market value of all the finished goods and services produced within our country.
And studies have shown that a high GDP correlates to low unemployment, which is exactly what we are seeing in Canada right now.
So isn’t that great? You would think the higher the GDP, the better, right?
When things are too good to be true, they break.
When unemployment is so low, 2 things are going to happen.
#1, most people are employed, they have money to spend and the demand for goods and services is going to increase. If supply is unable to catch up with demand, what are we going to see?
Inflation.
#2, when the labour market is so tight, companies have to fight for workers and we’re going to see what?
Wage inflation.
And then companies have to raise prices for their goods and services to cover the extra cost.
In the end, consumers will be paying more for the end products.
You see, too much GDP growth will also cause inflation.
Going back to our discussion about stagflation, it’s essentially very high inflation in a recessionary environment.
It is true that all these interest rate hikes are going to slow down our economy.
But with our all time low unemployment rate and high GDP growth, it seems unlikely that we would be going into a recession.
On the other hand, I would say there’s also a risk of persistently high inflation.
The rate hikes are designed to push inflation down.
However, there are many opposite forces pushing inflation up such as a super tight labour market, high GDP growth, continuous global supply chain issues…
If the upward forces are stronger, we are going to see high inflation for a while.
“Inflation in our own business, it’s extraordinary how much we’ve seen,” Warren Buffett recently said. “For two years the prices have kept coming in higher.”
“Inflation swindles the bond investor… it swindles the person who keeps their cash under their mattress, it swindles almost everybody”.
Nobody knows which way things would go, so what’s the best thing to do now?
I would stick to Warren Buffett’s timeless wisdom.
“Nobody buys a farm based on whether they think it’s going to rain next year. They buy it because they think it’s a good investment over 10 or 20 years.”
Invest in something that you believe would give you a competitive advantage over the long term.
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