Thursday, October 1, 2009

Canada shielded from recession? A new reliance on government?


While global recession recovery is anticipated, the pace of expansion beyond next year will be constrained by the need to rein in government deficits, by lingering excess capacity in many sectors and by changes to financial regulations that will boost capital requirements, restrict leverage and raise funding costs for higher-risk activities. Yet Canada almost looked impervious to all the economic and financial concerns. Almost.

What makes Canada different?

Canada was initially insulated from the deepening retrenchment in the U.S. and other developed nations by the resilience of its banking system, the relative financial strength of our government and household sectors, and by a huge revenue infusion from booming commodity markets. We could no longer deny recession only when faltering demand from emerging nations triggered a collapse in resource prices and export earnings in the final months of 2008 and even then, the erosion in employment, housing activity and car sales has been far less severe than south of the border.

Home sales and prices have already begun to climb and residential construction is beginning to revive. Firmer employment prospects in 2010 should reinforce the improving trend in housing activity.

Also, as employment and housing income stabilizes, Canadian domestic activity will revive in coming months evidenced with consumers returning to the malls in greater numbers. Meanwhile a myriad of government-funded shovel ready projects will finally get into the ground. As promised, the Bank of Canada will not nudge up interest rates till next year which then should see a speedy spike back to pre-crisis levels once the economy recovers. However, by then, borrowing costs will not be an impediment to the revival of domestic demand.

Since, foreign sales make up one-third of Canadian GDP, the strength of Canada’s rebound will be tied to commodity markets and reversing the recent slide in U.S. sales (easier said than done). Canada is already benefitting from higher commodity prices in response to demand from China and other nations. Prices for oil and most minerals are expected to move higher as global growth gets into gear, although sales of natural gas and forest products to the U.S. will be constrained both by that country’s slow pace of expansion and competition from alternative sources.

Will there be hyper-inflation or even inflation? I am still confident that as demonetization of the money markets occurs, inflation is imminent and will continue to boost the Canadian economy.

While the Loonie is moving towards parity vis-á-vis the U.S. dollar suggesting economic growth, we must remain wary of a double-dip or double recession as credit conditions and balance sheets improve at a slower pace. Bottom line is, Canada is looking better than most countries, but we must continue to strive to be cautious.



REST OF THE WORLD

A glance at share prices or short-term growth forecasts reveals shrinkage of output has stalled in all of the world’s big economies, global stock markets have rallied by 64% since their trough and corporate finance, once frozen, is thawing fast. Yet closer inspection suggests caution.

Unemployment is still rising and much manufacturing capacity remains idle. Many of the sources of today’s growth are temporary and precarious. What we are seeing is a rebuilding of inventories global spending driven by massive fiscal and monetary stimulus which cushions the damage to households’ and banks’ balance-sheets without tackling the underlying problems. Debts are accumulating with no improvements to debt servicing capabilities. New bubbles are being utilized to pull out of recession. Banks still need to bolster their capital. All these suggest consumer spending will be lower and the cost of capital higher than before the crunch.

Does all these so-called analysts not come to these realization? All eyes on the policy makers to pull off several tricky maneuvers: shoring up demand now without wrecking the public finances; containing unemployment without inhibiting the shift of workers from old industries to new ones; and, more than anything else, fostering innovation and trade, the ultimate engines of growth. It is no secret that global spending must be rebalanced: indebted consumers must cut back, while thrifty countries should spend more and save less.

In China this means a stronger currency, bigger social safety-nets and an overhaul of subsidies to increase the share of national income going to workers. Other Asian currencies will also need to appreciate and take over U.S. role for consumption so global recovery can sustain. Germany and Japan need structural reforms to boost spending, especially in services. What has long been lacking is the political will—and here the G20 seemed to make progress and will need to continue. The Pittsburgh communiqué promised to subject members’ economic policies to “peer review”. These reviews may prove toothless, but the commitment to them is a step forward.

Out of this crisis, there is a growing reliance on governments, reflecting the damage done to free markets. This strikes another warning bell as basic fundamental assumptions of economic and financial analysis are violated.

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