An Ill Wind that Blows…Good?
By Peter G Hall
Vice-President and Chief Economist Export Development Canada
Crack open the economic window these days, and the wind blowing in seems an ill one. Oil prices have more than halved. The steel market is wildly oversupplied. Base metal prices are in a tailspin, notably Dr. Copper, the red-metal bellwether of the economy. Equity markets everywhere are gyrating. Currencies are turbulent. And get this: even volatility is volatile. That's right, indexes of market volatility can't decide whether they are up or down. Disarray like this normally spells economic gloom. Is this really an ill wind that blows no good?
Not exactly. In our post-crisis world, we've become quite used to the bizarre, so try this out: in the midst of the disarray, the economy is actually moving up. And not just in isolation. Take the US economy. GDP growth may not look great, as the high greenback squelches export growth, but the domestic economy – housing, consumption, business investment – is strong, and still has a lot of runway. The US leading indicators tied to real activity are pointing north, presaging good things for 2016.
That's not all. Western Europe is catching on, and not just in the last few weeks. This may come as a surprise, but in the Zone, growth has been above-trend for five successive quarters. With the worst of government austerity behind it, pent-up demand in Europe is turning into real activity, and US strength isn't hurting.
For many Canadians, that's comfort enough. However, a growing number are involved in emerging markets, and there is concern that all is not well in that camp – especially the larger ones. Brazil and Russia are struggling with internal problems, but that's not news. In contrast, policy problems notwithstanding, India seems to be churning out decent growth, and Mexico has been capitalizing on US strength. China is more of a worry than usual, with some fearing that a big slowdown could occur. While possible, it doesn't seem likely; the government is adamant that the economy will see 6-7 per cent growth. At that rate, the Chinese economy is adding as much actual GDP as it did back in the 2004-08 period...at 18 per cent growth. That speaks to the size and the absorptive capacity of the economy. Moreover, if China succeeds in shifting growth over to consumption, there is huge potential there to boost the long-term path of the economy.
So, if growth is back, why the disarray? It actually makes sense in the current context. It's now quite obvious that excessive liquidity – low interest rates and multiple doses of quantitative easing – distorted financial markets for many years. As the economy gets back on its feet, there's far more liquidity than needed, so it has to be reeled in. That's why the Fed hiked interest rates in December, and it's why they'll continue to do so in an election year. And it's this reeling in that's causing market mayhem. This is indeed a special moment: for the first time we can all remember, the return of growth actually means falling commodity prices and other key financial market indicators. This time around, you can't have one without the other. A key risk to the world economy is that the blowback of financial sector retrenchment undermines the very growth that is its cause.
Canada's challenge in this environment is to manage the different growth stories. Resource companies are now in restructuring mode, and looking to cut costs; those in the resource supply chain will feel the pinch, although a mild price rebound is expected to nurse some of the pain. Meanwhile, the non-energy manufacturing sector is ramping up, given external growth and the now-weaker loonie. Exports of services should also do well. And it's a good thing, because at the moment Canadian housing, consumption and internal business investment are not in great shape.
What does it all mean? Turbulence isn't going away anytime soon. But don't let it scare you off. Global growth and a weaker currency suggest strong gains for key pockets of Canada's export sector. Look for the growth, and when you find it, know that it's likely part of a bigger, and improving, economic story.
The bottom line? Doubtless there will be many early-year projections that interpret the prevailing winds as a reason to hunker down, lay low and wait out yet another post-crisis storm. There's no harm in preparing for the risks – as long as it doesn't mean retreat from the underlying growth story.