November 20, 2011
The world and Canadian economic outlooks
What is one to make of the world economy at this time? In the early months of this year, 2011, there seemed to be clear indications recovery was proceeding in a measured but otherwise healthy manner.
It wasn’t proceeding as quickly as one might have wished, but progress was being made nonetheless. It’s true, there were some warning signs embedded in unique problems not seen before in the early stages of a recovery. For example, the U.S. housing market remained in a coma.
Interest rates were as low as they could possibly go, so there would be no spur to U.S. home demand from further monetary loosening.
U.S. employment remained stuck well below pre-recession levels and that was disappointing. But stock markets were in flight and manufacturing, for a change, was helping to lead the U.S. economy.
Manufacturing’s strength was partly on account of demand from emerging nations for U.S. goods to help with infrastructure projects and farming activities.
Then the world economy tilted off kilter. Debt problems in Europe were part of the cause. Greece slipped near default. Ireland and Portugal were already in difficulty and other nations were dragged into the financial quagmire.
There was a run on Italy’s debt until an austerity budget was quickly ushered through Rome’s legislature. Even France has not escaped the scrutiny of speculators, since French banks are heavily exposed to the debt of some of the region’s most vulnerable economies.
France and Germany together account for half of Euro-area GDP. Growth in both of those nations has ground to a halt. A strong Germany is especially needed to consume product from the so-called peripheral nations that desperately require external demand.
There is legitimate concern Europe may not be able to provide the growth that would help nations such as Greece grow their way out of their current difficulties. Measures to cut government spending have been necessary and right, but austerity on its own won’t fix the problem.
The Arab Spring in many parts of MENA (the Middle East and North Africa) played a role.
While the moves away from dictatorship towards rule by the people in Tunisia, Egypt, Libya and still underway in Syria are heartening to see — both for the citizens of those nations and in terms of easing future dialogue with the Muslim world — they had a detrimental effect in one key area.
The price of oil soared to between $110 and $120 U.S. per barrel. Gasoline prices rose in a corresponding fashion and both took away disposable income to be spent on other items and damaged consumer confidence.
The fragile U.S. economy was a victim. Then the problems of the U.S. were exacerbated by the spectacle of the debt ceiling debate. Republicans and Democrats were unable to reach a compromise on a means to lower the U.S. deficit until the last possible second. Even at that stage, the answer was to shift responsibility to a special committee and there is probably more rancor to come.
The fallout was a downgrade in U.S. debt by Standard & Poor’s from AAA status to AA+. More than being a reflection of how U.S. Treasury notes are viewed by international investors, the drop in their rating is a public criticism of the way things get done in Washington.
The nature of interaction between the two key parties in U.S. politics has deteriorated alarmingly. The rise to prominence of the Tea Party, with a mandate for entrenched stands on many issues, has made accommodation much more difficult.
The political acrimony isn’t likely to improve to any great degree between now and November 2012, the timing of the next vote for President. The U.S. is seemingly always in election mode.
The outlook for the world’s third major economic block, emerging nations led by China, has also been slipping a peg or two. Beijing has felt it necessary to tighten monetary policy in order to rein in inflation. The instruments used have been both interest rate increases and credit reductions.
The concern, probably misplaced, has been that China will suffer a hard landing rather than the soft touch-down it wants to achieve.
There are still reasons to have considerable faith in Chinese double-digit percentage growth. Much of that nation’s economic progress is now based on societal factors. The tremendous shift from subsistence living to middle class existence drives demand for all manner of consumer goods.
Plus Beijing is embarking on an initiative to provide millions of low cost new homes for its citizens, which will result in a great deal of stimulus all on its own.
Finally, March’s tsunami and earthquake damage northeast of Tokyo in Japan also contributed to a downward adjustment in expectations. Supply disruptions, particularly in the electronics and automotive sectors, were a cause of some slowing in world growth in late spring-early summer.
In the midst of such problems, however, the seeds of solutions often appear. One of the great positives of the economy is that self-correcting mechanisms come into play.
The softening in world economic growth means the rapid advance in commodity prices has taken a breather. There has been one notable exception, gold. That’s because buying gold is traditionally considered to be a good hedge against the possibility of harder economic times.
More significantly, the world price of oil has dropped back into the $80 to $85 U.S. per barrel range. While there is considerable stickiness between world oil prices and the amount shown at the pump — on the downside far more than on the upside — there still is some modest cost relief for drivers and for purchasers of all products made with a fossil fuel base.
The U.S. housing sector is in the sixth year of a horrible slump. Is there an upside? Yes. The good news is that U.S. home starts really can’t get any worse. Residential investment will no longer be taking away from the bottom line of GDP and even modest improvement will make a contribution. Also, foreclosure rates are finally dropping.
The euro-zone is being forced to make adjustments that will eventually provide greater financial stability. What form it will take has yet to be determined, but two options are the issuance of Eurobonds and/or fiscal union as the next step beyond the joint currency.
Eurobonds would see euro-nations, solvent and not so solvent, able to raise money by means of debt instruments backed by all euro-member nations. Fiscal union implies that richer nations would financially help out poorer nations through some form of income redistribution.
Either of these options would mean considerable costs imposed on Europe’s strongest economy, Germany, but they are the price that nation may have to pay if it wants the euro to survive. The benefits of the common currency and the accompanying borderless land mass, with all it has meant in terms of transportation cost savings and ease of business and personal travel, have been immense.
There will also be international benefits from Japan’s post-tsunami rebuilding efforts in the second half of this year, 2011.
Where does all of this leave Canada? Throughout this nation’s history, we have been highly dependent on the U.S. economy. While that hasn’t changed, an extra element has been added to the mix.
Canada’s prospects are now also deeply tied to emerging nation demand for raw materials. Included are iron ore and coal for steelmaking; copper, nickel and the full range of base metals that go into building products used in infrastructure projects; potash and other fertilizers to help raise crop yields and alleviate shortfalls in world agricultural production; and so on.
As a reflection of this alteration in emphasis, the value of Canada’s currency increasingly reflects changes in world commodity prices, especially oil.
In the short term, Canada will suffer along with the U.S. economy as it struggles to cut a clearer growth path. Once the U.S. economy begins seeing brighter days again, Canada stands to benefit to at least the same degree.
Further out, the advantages to Canada of its role as one among only a few nations supplying key raw materials to the emerging world will become even more apparent.
Housing starts in Canada are quite strong at present. In July, they climbed back above 200,000 units, seasonally adjusted and annualized, according to Canada Mortgage and Housing Corporation (CMHC). They fell as low as 112,000 units in the depths of the recession.
The recent strength in ground-breakings will mean a carry-over of dollars to be spent into the first half of next year, supporting residential put-in-place (i.e., investment) numbers. However, a period of adjustment in starts is expected, once the present surge of multi-unit projects winds down. This will cause residential investment to tail off in 2013, before rising again when the cycle improves.
Non-residential work is an interesting story. The institutional category in 2011 includes spending on starts that were initiated in 2009 and 2010 thanks to government stimulus efforts. The effects are tapering off. This category will be restrained in 2012 and 2013, before coming back to life in 2014, as demographics cause resumption in demand for health care and educational projects.
Commercial work dropped severely in the recession and is now showing only early stages of recovery. The slowing in the world economy is holding back the speed of improvement this year. It will take firmer hold in 2012.
This category also includes a number of major projects that are “one-offs.” Examples would be facilities for the 2015 Pan Am Games in Toronto and the new football stadium in Regina.
Similar to commercial, the recovery in the industrial construction category is being held back by the general economic malaise. A particular problem has been weak trade with a U.S. economy that remains sluggish, to say the least. But industrial work may be about to break out.
There are a myriad of mining projects in the planning stage. While many of these may better fit in the engineering category, since they mainly involve working the land, there are still enough of them with mine mill buildings and refining capacity to help with the industrial numbers.
Industrial work also has an exceptional project or two up its sleeve. Included here would be mega aluminum refinery expansions in Quebec and B.C. At least one major aluminum company has gone on record with billion-dollar expansion plans once it is assured aluminum prices are on a firm upward trajectory.
Part of the story in the engineering category concerns the switchover from government-financed projects to more involvement by the private sector. The former resulted from public sector spending on infrastructure to sustain the construction industry and help the overall economy during Canada’s recession.
Moving forward, there will be ongoing government spending in such areas as transit work and providing means of access to remote resource locations. But it will be augmented by spending on mines, hydroelectric projects and energy projects in many regions of the country.
Alex Carrick, Chief Economist, CanaData
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