For most of the past quarter century, the twin forces of globalization and technological progress have pounded down inflation for durable goods, keeping a lid on prices for things such as vehicles, furniture, home appliances and sporting equipment.
It’s taken less than two years to nearly unwind all that deflation, to the painful surprise of consumers.
The question facing both central banks and households now is whether pricier durable goods will be a temporary quirk of the COVID-19 pandemic, or the start of a new era in which those old trends that held down prices for so long start to wane.
In Canada and the United States, prices for durable goods have rocketed in recent months, helping to drive the overall escalation in consumer prices. In December, durable goods jumped 5.7 per cent in Canada and nearly 17 per cent in the U.S., where, unlike Canada, the red-hot market for used cars and trucks is part of the equation.
That’s sent each country’s consumer price index for durables, which are adjusted to account for product quality improvements over time, to levels not seen since the early 2000s, and not far off their mid-1990s peaks.
In other words, to a time when the North American free-trade agreement was in its infancy, when low-cost retailer Walmart had just ventured into Canada for the first time, before China joined the World Trade Organization and well before Amazon.com ingrained the idea of one-day home delivery for orders from smartphones. Before smartphones, for that matter.
“Almost two decades worth of decline have vanished,” said Sal Guatieri, senior economist at BMO Capital Markets. “It’s a remarkable reversal in a very short period of time.”
Throttled supply chains are a big part of why the prices for durable goods – products that are expected to last three years or more – are climbing so fast. Shutdowns and delays have dramatically driven up transportation costs. The Harper Petersen Charter Rates Index, which reflects worldwide container shipping prices, is up ninefold since July, 2020.
Rising commodity prices are also a factor. Energy prices are up 50 per cent since the start of the pandemic, while metals and minerals have doubled, the Bank of Canada’s commodity price index shows. Wildly-volatile lumber prices have also shown up in furniture sticker shock.
But above all, durable goods manufacturers are grappling with a historic supply and demand mismatch. The economic rebound has been quicker and stronger than almost anyone anticipated in early 2020. Instead of spending money on travel, dining at restaurants and theatres however, consumers stuck at home funnelled money into stuff that made their pandemic lives better – new furniture, appliances, TVs and recreational goods.
In the U.S., for instance, spending on durable goods is 35 per cent higher than it was before the pandemic, while spending on services has barely recovered to its prepandemic peak. Manufacturers were caught completely off guard by the shift and have struggled to catch up.
Anyone who has tried to buy a new or used vehicle lately is aware of this. New vehicle sales saw the largest price appreciation relative to other durable goods. And whatever hope there was for a quick return to normalcy in the industry has vanished, said Rebekah Young, an economist at Scotiabank.
With wait times for new vehicles stretching into months, and some automakers refusing to accept new orders for certain 2022 models, pent-up demand is building. “In Canada and the U.S. alone there were at least two million vehicles people and businesses wanted to buy but couldn’t last year,” Ms. Young said. That’s on top of fresh auto demand in 2022 that’s forecasted to be at pre-COVID levels.
“Auto dealers joke that right now they could sell a ‘dumb car’ that doesn’t even have a USB charger for $100,000,” she said.
During the pandemic, automakers prioritized high-margin vehicles. As cheaper models are gradually made available, that could cool overall inflation in the sector, Ms. Young said. However, the Scotiabank economist doesn’t see supply and demand coming back into balance in the sector until at least 2023, giving dealers the edge in negotiations with car buyers.
Governments around the world have also responded to the microchip shortage by throwing money at new production capacity. In the U.S., President Joe Biden’s sprawling infrastructure proposal includes US$50-billion in subsidies for American chip makers. “We might even have a chip glut when things finally unwind,” Ms. Young said.
But many signs point to durable goods inflation remaining higher for longer than first thought.
For one thing supply chains might be a temporary problem brought on by the pandemic, but their complexity means there will be a severe lag to any fixes. “For that reason we believe supply chain constraints will have a persistent impact on inflation,” said Scotiabank economist Nikita Perevalov, who warned in a research note this week that supply chain problems could “substantially boost inflation for the next two years.”
Inflation expectations are also a powerful driver of consumer purchases of durable goods. If people think the price of something is going to go up, they’re more likely to scramble to buy that item. In the case of college-educated American households, a single percentage point increase in one-year inflation expectations translates into an immediate 19-per-cent jump in spending on durable goods, according to recent research from the Federal Reserve Bank of Boston.
With prices rising at record rates, some consumers are clearly taking that as a signal to buy now, which only adds to spiralling prices.
Likewise, when consumers are consistently forced to spend more, they come to expect their paycheques should be larger, too. “As people see inflation picking up and see input prices increase, employees will likely demand higher wages and so you have a second factor driving inflation,” Mr. Perevalov said.
Even the long-term secular trends that weighed down inflation before COVID-19 are not going to be as strong in future, some economists say.
“We were already seeing some upward pressure on prices before the pandemic as globalization hit its ceiling,” said Sarah House, an economist at Wells Fargo Securities. “We don’t think there’s going to be a reversion to that persistent deflationary trend in durable goods prices.”
She points to the former Trump administration’s trade war with China, which has been kept alive by Donald Trump’s successor. This week, Mr. Biden said he was “uncertain” whether he would lift Trump-era tariffs on Chinese imports.
Protectionist policies that feed higher inflation for durable goods have only intensified during the pandemic. Last June, Prime Minister Justin Trudeau’s Liberal government imposed anti-dumping tariffs of nearly 300 per cent on imported upholstered furniture from China and Vietnam. In November, the Biden administration doubled import tariffs on Canadian softwood lumber. Economists say, in both cases, added costs have been passed on to consumers.
Meanwhile, labour strife, earthquakes and extreme weather in recent years were already causing a rethink of the globally interconnected, just-in-time inventory networks that have evolved over the past two decades. The pandemic has simply accelerated that process, Ms. House said.
As part of that rethink, some companies are bringing parts of their supply chains closer to home, a phenomenon known as near-shoring. Others plan to maintain higher inventories to avoid being caught out in future crises. “If those were cheaper avenues, businesses would be doing that already,” Ms. House said. “These things all come with a cost.”
That doesn’t mean inflation can’t get back to the central banks’ target of around 2 per cent, she said, but it will require policies that boost productivity.
One big unknown in the near term is the effect interest rate hikes will have on household purchases of durable goods. The Bank of Canada and the U.S. Federal Reserve are both expected to start hiking interest rates as early as this week, with the key U.S. policy rate forecast to rise to 1 per cent by the end of the year, and 1.75 per cent in Canada.
Those hikes would still leave interest rates negative in real terms, but they will nevertheless have a cooling effect, Mr. Guatieri said.
He also remains confident that the downward pressures that marked the pre-COVID era for durable goods will reassert themselves in the coming years, even if their effect is not as strong.
“We still have those two long-term dampeners on durable goods inflation of globalization [and] – even more so – automation,” Mr. Guatieri said. “I expect we’ll go back to at least a stabilizing trend for durable goods prices, but I’m not sure we’ll get back to the declining trend we saw in the two decades before the pandemic.”
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