Can Canada Escape the Effects of a U.S. Recession?
When high winds wrenched part of CIBC's logo from atop a Toronto skyscraper last week and sent it crashing to the ground in the heart of the financial district, news editors simply couldn't resist the temptation. "Wind withdraws bank logo," tittered one headline; "Wind knocked out of Bay Street," went another. But if the plummeting debris was at all a portent for where the Canadian economy is headed, you wouldn't know it listening to this country's professional prognosticators.
Earlier the same day, not far from where pieces of an acrylic letter C came to rest, economists from all five big banks gathered to share their outlook for the year ahead. After reading the tea leaves, their message to Canadians was cautious but reassuring. The coming year won't be great, by any means: the booming job market is expected to ease up, and the country's red-hot growth, which has sent the loonie soaring in recent years, will re-enter earth's orbit. But, they assured, any slowdown should be limited. Even the U.S., with all its woes, isn't likely to succumb to an outright RECESSION. And if it does, Canada can still rely on growth in the rest of the world to keep us reasonably healthy. As Sherry Cooper, chief economist at BMO Capital Markets, noted, echoing a popular theme these days, we are witnessing "a very long-term trend away from the hegemony of the U.S. economy and financial system."
It's a relatively sunny and hopeful point of view. But it's also an argument that is fast losing favour among some global economists, especially in light of a recent barrage of foul economic news.
For nearly two years, pundits have preached about the "decoupling" of the global economy, arguing that the fate of the world no longer hinges on the spending habits of Gary and Lousie from Scranton, Pa., but on the teeming middle classes of Russia, China and India. It sounded good, but now the word on everyone's lips is "recoupling." According to a growing chorus of analysts and academics, the U.S. growth machine is simply too important, and its ties to other economies like Canada's and China's too complex, for the effects of a deep U.S. recession not to be felt the world over. As Nouriel Roubini, chairman of research firm RGE Monitor and a man well known for his bearish outlook on the American economy, wrote recently: "Since the U.S. will not just sneeze, but is risking a serious case of protracted and severe pneumonia, the rest of the world should start to worry about a serious viral contagion from this U.S. sickness."
The symptoms of that sickness are all too stark. The U.S. housing crisis continues to worsen by the day, and the infection is spreading. Credit card and automotive loan companies report a growing number of customers aren't paying their bills, while personal bankruptcy filings among Americans shot up 40 per cent in November, as nearly 800,000 consumers threw in the towel that month. And that doesn't even include the over-stretched last-minute Christmas crowd. Making matters worse, job growth in the U.S. has hit the skids. In December, the unemployment rate jumped to a two-year high of five per cent from 4.7 per cent in November, one of the most pronounced spikes in decades.
If the threat of mass layoffs wasn't enough to pinch consumers, the price of oil is near an all-time high of US$100 a barrel, with some predicting it could go as high as US$150. Anxiety over prices at the pumps is putting a final nail in consumer confidence. Most Americans just don't see how their country can escape this morass without suffering a long and painful recession. It's a sentiment shared the world over. When the price of gold broke through US$900 an ounce last week, as the U.S. dollar took yet another plunge, gold bugs gleefully declared it was a sign investors have finally awoken to the weakness of the greenback.
Under the old decoupling theory, of course, none of this was supposed to matter much to those outside America's borders. The idea took hold in 2006 when firms such as Goldman Sachs and JP Morgan sought to calm investor fears about the effects of a possible U.S. slowdown. At the time, the current subprime housing crisis was just the stuff of nightmares for a few thousand mortgage brokers and bankers. Drawing on their best catchphrases, analysts spoke with confidence of how the "locomotive" of global growth was "rotating" away from America to Asia and Europe. Since countries in those regions had greatly reduced their reliance on American consumers for their own growth, the theory went, they would blissfully keep humming along.
And so, hopefully, would the Canadian economy. With thousands of planes, trains and trucks crossing the border with the U.S. each day, Canada has long been held hostage to the gyrations of the American economy. Roughly 75 per cent of all Canadian exports wind up south of the border. A sneeze there, and we usually come down with the flu. If the U.S. catches a cold, well, call up the undertaker. But if the world really did decouple, if Europe and Asia held their own this time around, then big Canadian commodity exports like oil, gas and metals would still be in high demand and would keep us in good stead.
One credit crunch later, and many of the big proponents of the decoupling theory have completely backtracked. Not only is a growing army of analysts now pegging the chance of a U.S. recession at close to 100 per cent (some believe it has already begun), they've all but abandoned hope that the world has somehow detached itself from the States. As Peter Berezin, an economist at Goldman Sachs said in December, "We think 2008 will be the 'year of recoupling.' "
If that sounds like a face-saving exercise, it may well be. The thing is, there was never much evidence that the world decoupled in the first place. Consider, for instance, just how fast the liquidity crisis swept the globe after the U.S. housing market blew up last year. When financial markets seized up in August, it wasn't just a Wall Street phenomenon. Thanks to mind-bending financial engineering strategies that sought to harness the free flow of capital around the world, firms had packaged portfolios of U.S. consumer loans and mortgages and resold them to investors worldwide. Within days of panic gripping New York, hedge funds and investors in Canada, Europe, Asia and Australia all began to register serious problems, and central banks on four continents were forced to inject billions of dollars of liquidity to keep markets from grinding to a halt.
But what started in the abstract world of global finance has quickly morphed into an old-fashioned slump. Britain, with its own collapsing housing market, and Germany, which has been stung by the euro's rise against the greenback, have warned that their economies are buckling. In December, global manufacturing activity fell to a 4½-year low, driven by the slowdown in the U.S. And despite the assurances for Canada that this time it would be different, the country shed 18,700 jobs in December - the most since 2003. The business weekly Barron's recently predicted a sharp correction for the loonie this year as U.S. economic pain spreads. "Economists can talk all they want about decoupling," the paper said, "but the Canadian economy is as inexorably tied to the U.S. economy as maple syrup is to pancakes." Rather than decoupling, the world economy seems as closely tied as ever.
Even as Europe wobbles, though, there are still many analysts holding out hope that emerging markets in Asia will successfully dodge the U.S. recession. For one thing, there's no denying those countries have become powerhouses in their own right. Three countries - China, Russia and India - accounted for half of all global growth last year, according to the International Monetary Fund. And those countries have taken steps to cut their dependence on American shoppers. Last week, analysts at BCA Research in Montreal pointed out that China's share of exports to G7 countries has declined in importance, while exports to other emerging markets are booming. And that should provide some cushion against the effects of a slowdown in Europe and the U.S.
Still, others fear that won't be nearly enough to keep the economy humming. For all the talk of diversifying, the U.S. still accounts for about 20 per cent of China's direct exports, while many of the country's remaining shipments find their way to the U.S. through other nations, and economists are slowly scaling back their projections for China's growth. Meanwhile, many are closely watching to see what happens after the Beijing Olympics this summer. Once the frenzied pace of construction is over, and the cameras turn off, China may be forced to tighten its lending practices to cool its overheated economy. Analysts at Boston-based Global Insight warn there's a 33 per cent chance that will suddenly slow Chinese growth. A U.S. recession would only crank up those odds.
More and more, those who suggest Canada can weather the current economic storm risk looking like Panglossian optimists - in the face of mounting evidence that Canada's exposure to the U.S. will drag us down too, they continue to insist that, somehow, we'll still pull through on the backs of emerging markets. If such a view is proved right, then Canada should, at worst, suffer a mild slowdown before picking up steam again. But if they're wrong, well, just look south of the border to see what's in store.
Maclean's January 28, 2008