Watch for warning signs the economy is on a sugar high: Don Pittis

From strongjob creation to roaring stock markets, North Americaunder U.S. President Donald Trump is continuing toshowsigns of vigour, despite Friday's gloomy U.S. GDP numbers.

It's not just a U.S. phenomenon. The giant Ontario economy is exhibiting signs of life as tax receipts rise, and some experts say the western oil slump has been overdone.

But there are reasons to be wary. There is a danger that, like a three-year-old child high on sugary treats, the economy may be getting overstimulated. And as any parent knows, sucheuphoria can come to a bad end.

Inflation has been tame

This week Federal Reserve chair Janet Yellen,who has often seemed like the single voice of restraint on the effervescentU.S. economy, presents the central bank's latest outlook. In spite of a surge in something called the employment cost index an indicator of plentiful jobsandgrowing wages inflation has been unexpectedly tame.

Just as for our own central banker, Stephen Poloz,weak core inflation may offerYellen a good excuse to keep rates lower for longer.

Market-based predictionsfor U.S.price inflation, as indicated by bond prices, had been climbing but have nowretreated well below the Fed's twopercent target.

In many ways that is good. With U.S. unemployment bumping along near record lows, rising wages in the face of low general price inflation may finally begin to offer employees a bigger share of productivity gains, allowing themto buy more with their weekly pay.

Whether intentionally or by accident, that would go some way to fulfillingTrump's promise of a better deal for U.S. working people.

It's not entirely clear why inflation has remained so low. It is certainly not what manyhave been predicting.

As economic analyst Mike Patton wrote in Forbes two years ago in an article titledWhy Inflation Is Low, Despite The Fed's Massive Monetary Expansion, something seemed amiss.

Just wait

Patton put the possible blameon aweak global economy, falling oil prices after the 2014 price bust, or the possibility that the money being created by central banks just wasn't making its way into the economy.Others have suggested it has something to do with hidden effects of technology or the sudden addition of the developing world to global industrial capacity.

Polozinsists low interest rates really are stimulative and that we just have to wait a little longer to see theireffect. He says Canada will close the output gapthe point where the economy begins to use up its available resources of labour and capitalby early 2018.

If Poloz is right, holding interest rates near historic lows in Canada and the United States is only one of many things that may be soupingup the economy.

In Canada the federal government has an official policy of fiscal stimulus, the promise to spendmore than it collects in revenue so as to invest in Canadian jobs.

Provincial budgets have done something similar. In Ontario, despite a surging economy that has boosted revenues from income tax, land transfer taxes and sales taxes, the government has promised to add fuel to the fire by pouring it all, plus money from asset sales, back into the economy.

Wealth effect

Canada's hot housing market,responsible for Ontario's transfer tax windfall, is also stimulating the economy, partly through the wealth effect where people who feel real-estate-rich decidethey can spend freely and partly through the realized gains of those who sell and movesomeplace cheaper.

Cheap oil and a low loonie have hadstimulating effects of their own.

In the U.S.there is even more stimulus on the way, provided that Trump can get his proposalto cut taxes from 35 to 15 per cent and his promised market deregulation through Congress. A first-quarter growth rate of just 0.7 per cent may strengthen that resolve.

In theory, tax cuts could be neutral if they move money from government to private hands. But Trump has promised not to roll back spending. That means borrowing from the future to stimulate now.

U.S. big business is framing the deregulation plan as productive rather than stimulative because less red tape makes business more efficient. But if it opens the door to the kinds of irresponsible practicesseen in the U.S. sub-primecrisis, it too will be borrowing from the future the costs of patching up the next meltdown.

Although the causes may bedifferent, Canada facesits own sub-prime crisis as trouble at Home Capital threatens an important part of the Canadian mortgage market.

If, as so many people have suggested, housing is a bubble nearing its end, that stimulative effectincluding the Canadianconstruction boommay be on the wane.

Stimulus is not meant to be a persistent economic strategy. Like giving sweets to a three-year-old, it is only a temporary solution.

But watch out when the sugar high ends.

Follow Don on Twitter @don_pittis

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