Friday, April 08, 2005



As oil becomes scarcer and more expensive there is a high probability that the economic shock waves will hit hard throughout the economy. Petroleum is a basic raw material used in the manufacturing of many products including chemicals, paints, plastics and synthetic textiles. Other industries-steel, aluminum, electric power-use large quantities of oil and oil derivatives in the course of their production. When petroleum supplies become pinched and prices push up, these industries may well be forced to restrict output and raise prices, thus putting even more inflationary pressure on the economy. These past few weeks there have been these chilling hints, mostly in our neighbor to the South, of what the future holds, by reflection, also in Canada:

  1. the price of electricity showed signs of sharp rise, especially on the East Coast;
  2. the cost of housing materials jumped, led by a twenty percent increase in the price of plywood;
  3. domestic airlines, acting under a Government fuel allocation plan that began in March, have eliminated hundreds of flights.
  4. new housing construction in many States is down sharply compared to just December, 2004 and real estate sales are beginning to lose steam in many States.

Scarcely any enterprise is immune to the oil squeeze, as the lessons of the ‘70’s and the ‘80’s teach, and real estate is definitely no exception. With the economic shock waves reverberating through secondary industries not directly connected to oil consumption, shortages may also arise in such disparate items as lipsticks, nylon stockings, records, toys, garbage bags, hair curlers and innumerable other products that use petrochemicals. One such example, perhaps the biggest, is the auto industry which since the ‘60’s has increased the amount of plastics in the average car from 20 lbs. to 138 lbs. The Big Three - GM, Ford and Chrysler - have lately drawn up contingency plans for going back to using metal body parts if plastic cannot be obtained. As shortage of supply is typically followed by price increase in many economic models, there is a general consensus in many circle that the inflationary cycle will start all over again, prompting the Federal Reserve Bank to hike interest rates. This process has begun already, as interest rates are slowly oozing upwards. An increase in the prime rate means typically a subsequent increase in both passive and active banking rates, that is the rates banks charge for mortgages, credit cards and consumer loans as well as the interest they pay on bond, term deposits and certificates of investment. Mortgage rate increases normally signal a cooling off of real estate inventory sales, as demand for real estate products typically slows down.
While nobody wants to be alarmist in this respect, the prudent consumer will want to monitor interest rates closely in the forthcoming months.

Luigi Frascati

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