LOOKING FOR CLUES ON THE ECONOMY

Executives should always be monitoring the economy. High-profile variables like growth, employment, inflation, interest rates and the Canadian dollar are important considerations in decisions involving just about everything that matters to a business. As such, these variables always warrant serious executive attention. But in this particularly complex and difficult economic environment, so do a number of not so high-profile economic variables. Executives should cast a wide net when it comes to monitoring this economy.

First, savings. For most of us, savings is what we have stored up in stocks, bonds, deposits and even hard assets like a house. For economists, it is the difference between what we take in and spend over a given period of time. The economist’s notion of savings is one of the most important, but also most ignored, economic variables. Savings matters a lot to the performance of an economy and can be a good indicator of where things are headed.

The more we save, the less we spend. That can slow growth and raise unemployment if it is not offset by new government spending or new business investment in plant, equipment, machinery and inventory. All other things equal, rising savings can be bad for an economy in the short term, especially an economy in the kind of deep recession that we are now experiencing. Additionally, savings is the raw material that finances business investment. Troubles on the savings front can be associated with problems getting financing for good projects, rising and volatile interest rates, and widespread fear.

Canadians, like so many throughout the developed world, have increased their savings since the economic crisis hit in the third quarter of 2008. This is hardly surprising and, at the level of the individual, perfectly rational. We all got scared when the financial crisis exploded with the Lehman Brothers’ failure in September 2008 and decided to protect ourselves against a worrisome, uncertain future by cutting back on spending and saving more.

Executives should have savings on the front burner. It will provide valuable clues on the timing and speed of recovery, the behaviour of consumers, the course of interest rates and the willingness of businesses to invest. The latter is particularly important. Investment spending has a multiplier effect on growth and job creation that heightens its impact well beyond its modest share relative to consumption of total economic activity. Cuts to investment spending are usually big going into a slowdown and sometimes even more exaggerated coming out, which can give a down economy a real shot of adrenalin.

Second, trade. The stuff of trade for economists is arguments over current accounts, capital accounts, international capital flows, differential international savings and investment rates and foreign indebtedness. No wonder the executive mind can numb when trade comes up.

But trade at the global level and the speed at which it is growing is a key determinant of when and how strongly the Canadian economy will recover. With one half of one percent of the world’s population and about three percent of its global exports, Canada is critically dependent on the course of global trade. It is not too strong to say that where global trade goes is where Canada goes. That is the curse and the blessing of being one of the world’s great commodity producers.

Global trade is worth an executive’s time. Hopefully, trade is bottoming out and on the road to recovery after some of the worst numbers in decades. But do not ignore protectionism and pay serious attention if it starts to meaningfully pick up. Economists generally lay the blame for the length and depth of the Great Depression of the 1930s at the feet of the 1929 stock market crash, fiscal restraint, tight money and the U.S. Smoot-Hawley Tariff Act of 1930 that ignited protectionism and global trade warfare. Once countries start retaliating against each others’ trade transgressions, there is literally no bottom for the world economy. Rising protectionism is categorically not in Canada’s best interests; we should push hard and everywhere for open, competitive world markets.

Protectionism takes many forms: tariff barriers, import quotas, “Buy Domestic” preference rules, licensing requirements, dumping and anti-dumping rules, product specifications, government subsidies, tax arrangements, ownership rules and exchange rate manipulation. It is early days and too soon to draw conclusions, but Canadian executives should be wincing about the effects on protectionism of the likes of the U.S. stimulus “Buy American” rules, the subsidies to keep North American car manufacturing alive, and widespread currency manipulation. They should be further unnerved by the inflammatory trade rhetoric floating around. Watch the protectionism file. If global trade warfare breaks out, look out below!

Third, the U.S. consumer. The U.S. consumer is about 18 percent of the world economy. No national economy in its entirety comes close to U.S. consumer spending as a share of the world economy. Given our dependence on global trade and our proximity to the U.S., it is clear the U.S. consumer is a big deal for us.

Executives should be watching the U.S. consumer closely. He and she are not in good shape: massive debt and debt service obligations relative to disposable income; rapidly rising unemployment and declining real wages; little accumulated savings and a severe decline in the value of the U.S. consumer’s biggest asset, his/her house; weak confidence; little pent-up demand; very tough credit markets in which to get consumer and mortgage financing on decent terms.

The road to sustainable growth in the Canadian economy goes straight through a financially healthy and confident U.S. consumer; that could be a long while coming. Data to watch include disposable income growth, job growth, spending on big ticket, discretionary durable goods like cars and household furnishings and appliances, consumer confidence and the availability of low cost consumer and mortgage credit.

Fourth, the U.S. budget. The recession and a blizzard of new spending initiatives associated with the new President have exploded U.S. government spending in the face of static tax and other revenues. The 2009 U.S. federal deficit will be about 1.8 trillion or an astonishing 13 percent of U.S. GDP; no one should be surprised if the federal deficit averages over 10 percent of U.S. GDP over the next three years; it is also important to note that many states, including particularly California, are in deep trouble financially. Who would have thought that, as recently as two years ago, the U.S. government will need to raise in the vicinity of 4 trillion dollars from domestic and international capital markets over the next three years. In relative peacetime, this is truly historic.

U.S. government finances should be on every executive’s mind. The scale of U.S. borrowing has the potential to have a huge and unpleasant impact on longer-term interest rates everywhere, including here in Canada. Rising, longer-term interest rates may set the economic recovery back through their effect on the financing of consumer spending, investment spending and job creation. A material part of the U.S. deficit may be financed by selling bonds to the U.S. central bank, the Federal Reserve; called monetization, this is printing money in its purest form and could very well stoke inflation. The U.S. deficit is so large that no one should rule out seriously destabilized global foreign exchange markets; currency instability is the last thing a recovering global economy needs. American politicians may be tempted to fix their deficit problem by raising taxes; rising taxes in the face of recession have a long history of making recessions worse.

The U.S. deficit has the potential to play, in a major way, on the course of the economy, employment, interest rates, exchange rates, consumer spending, investment spending and inflation. Plenty of reasons for executives to watch it closely.

Fifth, the BRIC countries. Most Canadian executives have for years been able to do more or less just fine by focusing on Canada, the so called G7 countries (Canada plus the U.S., Germany, Britain, France, Italy and Japan) and perhaps the OECD countries (a group of 30 developed countries including Canada – the Organization for Economic Cooperation and Development).

Executives would do well to start keeping serious tabs on emerging economies and especially what are called the BRIC countries: Brazil, China, India and Russia. Right now the BRIC countries are about 15 percent of world GDP, but it is not beyond the realm that by the late 2020s, BRIC country total GDP will approximate G7 GDP. That alone makes them worth watching because if that is what happens, the BRIC countries are clearly where a lot of the world’s growth will occur going forward.

In the here and now, the BRIC countries are important to a recovery from this recession. In aggregate, they are high saving and low consumption. To the extent that they consume more and save less, the recovery will be quicker and stronger. The fact the BRIC countries hold over 40 percent of world currency reserves makes them a major factor in interest rates, exchange rates and capital flows. Financial market forecasting that ignores BRIC country positioning is missing an important element.

The BRIC country that matters most for Canada is China, because of its need for Canadian commodities as inputs to its huge finished-goods exports. A jump in commodity prices and demand driven by Chinese needs would be just what the doctor ordered for the Canadian economy.

Interestingly, the BRIC countries had their first summit in the third week of June of this year, in Yekaterinburg, Russia. The agenda included BRIC influence on the world economy and global financial markets, foreign exchange reserves and alternatives to the current U.S. dollar dominated reserve system, and reform of financial regulation. Power is shifting these days and the BRIC countries are on the upswing.

Sixth, debt. This recession has been called the Great Deleveraging, the first debt-driven global downturn since the 1930s. Executives are undoubtedly well aware of the extraordinary levels of debt and the impact thereof on both the recession and prospects for recovery.

What may not be so obvious but is also worth an executive’s attention is the potentially changing nature of debt itself. The Chrysler and General Motors restructurings have, to say the least, shaken up notions of where secured creditors rank in the chain of obligations that corporations have to stakeholders that range from unsecured creditors to pensioners. Whether the GM or Chrysler restructurings are a blip on credit rankings or signify real change remains to be seen, but executives should be on the case because there are potential effects on the cost and availability of various kinds of funds. Anytime long-standing capital market arrangements are thrown up in the air, executives should be aware.

This has not been a garden-variety recession. The recovery is not likely to be garden variety either. Clues for how things will play out may be found in some not-so-traditional places.