What deflation will do to Canada

Where is the Canadian economy headed? The federal finance minister is on the road doing his pre-budget consultations. Expect Jim Flaherty to return with the same complacent views he proclaimed when he left Ottawa; the wording was drawn up for him months ago by the Prime Minister's Office. It reads: the recovery is on track and it is time to cut government spending.

The Harper script for the economy is all about politics and ideology. Liberals want to tax and spend. You can entrust your future to Stephen Harper; unlike Layton and Ignatieff, the Conservative leader will not raise taxes.

Looking at the economy, instead of listening to what the Conservatives say about it, presents a different picture. Real problems lie ahead. Output growth is slowing, and job creation stagnating. GDP growth has slowed, and the number of Canadians no longer looking for work -- there is none to be had -- and exiting the labour force is going up, as Jim Stanford explains.

Because quantities of goods and services demanded by Canadians are slackening, business is not investing in producing more goods and services. Canadian manufacturing exports to the U.S. are hurt by a falling U.S. dollar, and continued weakness south of the border. Municipal and provincial governments are enacting cutbacks.

If the federal government adopts an austerity budget in the spring, as all signs suggest Flaherty intends to do, it will slow the economy further, and make things worse for Canadians. 

When all the needles point down, the economy does not grow, it deflates. Downward pressures are exacerbated by high levels of consumer debt. People trying to pay down what they owe have to cut current spending on goods and services to do it. This "debt deflation" was a root cause of the great depression of the 1930s. Avoiding a further build-up of deflation should be the primary goal of government policy.

When people expect the economy to be depressed, they do not increase spending, because they expect prices to fall. By not spending, consumers depress the economy. This negative circle is what NYT columnist and Princeton economist Paul Krugman calls " the deflationary trap we keep worrying about."

On his Debtwatch blog, the Australian economist Steve Keen has been explaining the role a build-up in personal and family debt played in the American expansion of the 1990s. He points out that yearly increase in net debt allowed the American economy to grow when all but upper income earnings were stagnant.

Now net debt is decreasing, and must be subtracted from current income, in order to get at an accurate picture of overall spending power. When the consumer sector is paying down debt, and the business sector is paying down debt, the public sector needs to compensate for private sector retrenchment by making serious investment plans, and taking on additional debt as necessary.

Even the International Monetary Fund -- the infamous debt collection agency feared by poor nations -- thinks purchasing power needs to be protected by strengthening mechanisms such as unions that reduce income disparities. As Canadian Labour Congress senior economist Andrew Jackson points out, the IMF thinks restoring working-class bargaining power is needed to confront debt problems.

We have yet to hear from the official opposition finance critic Scott Brison that his party understands the dangers of debt deflation, and the deflationary trap. So far the Liberals have done little but accuse the Conservatives of running up the debt irresponsibly.

Canada needs a commitment to redistribute income to people who will spend it, and a process to plan investment on a sectoral basis, using public investment as a lever. Just waiting for the "market" to correct itself will not work. No municipality can improve itself by cutting spending. Economic well-being depends on long term increased public investment by all three levels of government.

Canadians are going to be hard hit by continued deflation. We need governments and/or opposition parties to recognize that the main economic problem is slack demand, falling asset prices, growing unemployment, and expanding numbers of people facing hardships not of their own making. The federal finance minister needs to understand that unless he recognizes the need to reverse severe deflationary pressures, his budget will not be passed by the House of Commons.

Duncan Cameron writes weekly on politics and is president of rabble.ca.

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