Retail Profits, Inflation and the Bank of Canada

With core inflation running at 2.2%,  the Bank of Canada left interest rates unchanged today – despite the soaring Canadian dollar and its impacts on the struggling manufacturing sector, despite a slowing US economy, and despite tight credit market conditions.

I think the Bank should have matched the recent half percentage point US rate cut to take the froth out of the Canadian dollar. But they do have a problem to the extent that exchange rate appreciation has been slow to feed into consumer prices, keeping the CPI above their target rate of 2%.

True, goods inflation has been very low at 0.8% over the past year. But, with the price of imported goods from the US, China and other Asian producers with currencies closely tied to the US dollar plummeting in Canadian dollar terms, we should have been seeing significant price cuts for imported goods which would have brought down the core CPI to at or below the Bank’s desired level of 2%.

It’s pretty clear that retailers are swallowing a lot of the gains from reduced prices of imported goods. In the last quarter for which we have data (QII of 2007) seasonally adjusted operating profits in the retail sector came in at over $4 Billion ($4.021 Billion.) (That’s in the quarter – its not an annualized number.) That’s just about double the level of 2002 ($2.19 Billion in QII, 2002), and up sharply even from one year ago (QII of 2006) when operating profits were $3.44 Billion. Return on equity in the retail sector was 15.74% in the most recent quarter, up from 11.77% in the same quarter in 2002.  And current return on equity is even higher than in the oil and gas sector (where it was 9.1% in the most recent quarter.)

The same story is true of wholesale trade, where operating profits came in at $4.71 Billion in the most recent quarter compared to $2.55 Billion in the same quarter of 2002, and $4.28 Billion in the same quarter one year ago. Return on equity rose from 12.54% to 14.75% between QII 2002 and QII 2007.

The period of marked exchange rate appreciation since 2002 has been been matched by a steady increase in retail and wholesale profitability. Particularly in 2006 and 2007, return on equity in wholesale and retail trade has jumped to well above average levels.

To the extent that we have an inflation “problem”, the problem is profit-driven inflation. Don’t blame workers – retail hourly wages in fact fell over the past year.

(Corporate profitability data are in CANSIM Table 187-0002.)i

One comment

  • It truly is an amazing beast this Canadian Economy. It would be good if our economic schools would start teaching a course in Canadian Economics as the first chapter would most likely be “Middle Men and the Nature of Oligopolistic Markets” or how bout “Perfectly Elastic Collusionary Effects of Retail and Wholesale Trade and other Nasty Tales from the of the Back Woodsy Economic Land they Call Canada”. So what exactly does the competition bureau in this country do anyway?

    It is quite fascinating to hear the story coming from the Bank of Canada and how they must continue on in its hunt for the phantom inflationary threats and thus cannot reduce interest rates. The logic of it all real makes one wonder how these people actually convince us tax payers to pay their inflated salaries.

    ok lets get this story down

    1) there is some notion that we have a threat of inflation

    – our largest trading partner is in an economic free fall towards recession, housing bubble burst, manufacturing has lost over 2 million jobs since 2002, a war that continues on and they cannot pay for, consumer debt at historic highs, wage and other inequity is rampant, and I could go on. These are not small red flags, they are really bigs ones.

    2) our dollar has appreciated to a rate that it has not been to in over 31 years, in just a short amount of time we have made some serious adjustments to the bottom line of every major exporter to the US.

    Some say it is mainly the time frame that is the problem for the adjustment. I would agree but now we at a point that we have to look at the size as well. .60 to 1.03 and climbing in just short of 4 years and a bit. Unadjustable now matter how innovative, flexible, management cart wheel, worker speed-up, labour standard busting, cost reduction, strategic reaction is implemented.

    3) the one positive of the appreciating dollar is the reduction of import prices for consumption.

    – due to the profit pillaging within the retail and wholesale trade industries as noted above, not much in the way of cost savings are being passed on, that according to the theory should be realized. At first this was just written off as some notion of friction within the market. While it continues on unabated so I am not sure what kind of fluidity parameters we are taking about on these regression models. Kind of ironic that the only pressure that seems apparent on retailers and wholesalers is from the political dimension. Whatever happened to the notion of a market based economy. Maybe the SPP that met recently North of Ottawa is secretly the price planning commission. But there is an exposure going on here that is almost embarrassing. Have we let that much systemic non-competitiveness be built into the Canadian market place within those two industries.

    4) So now the BAnk of Canada states that because we have these import market inefficiencies and we live in an export based economy, prices are threatened by these not so phantom-like forces, called price gouging retailers and wholesalers (pillaging is a preferred word here) and therefore interest rates must stand pat and those hoping for a reduction in the lending costs are out of luck.

    That quite honestly does not make any sense whatsoever. Who pays these people salaries? Oh it is us, forget it.

    At a time when we finally have some maneuvering room given the differentials in the interest rate bands between our two countries, and seeing the hemorrhaging within the manufacturing sector (further underlined today by the unprecedented labour agreement between the CAW and Magna- no comment right now until we see more details) are we not ready for some dollar relief. Potentially that is exactly what the tories n the hill were after, (crisis within the manufacturing sector, pressure the unions and force settlements on them that under other conditions would never be considered, but again no comment)

    These are desparate times for specific sectors of the economy and they just happen to be the ones that offer those that work for a living the highest quality of employment. But I guess guys like Phillip Cross have it all figured out, we no longer will be hewers of wood and fetchers of water. Instead we’ll all be oil drillers and hard rock miners. The problem with that scenario is first it is a bit arrogant, and second, these industries are mainly so capital intensive that the emplyment growth is no match for the lost assets and markets that manufacturing and other industries that are part of this value change that are the heartbeat of our economy. Did somebody say he was one of Statcan’s top economists? Maybe they should be thinking obout some innovation within there own value chain!

    Sorry for the length but these economic events must be dealt with before long.

    Paul

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