Don’t expect too much from the economy

Patience and prudence are bred in Canadians’ bones. Perhaps never will those characteristics, sometimes derided, serve the country and its people so well as in the year or two ahead.

It is now two years since the spectacular financial fireworks of the Fall of 2008.  Countries around the globe, including Canada, went into varying degrees of recession from which they are now emerging. For Canadian executives, the great question is, “Where to from here?”  My guess is that Canada performs better than most but considerably short of the heady pre-crisis days.  The economy has a different feel to it now. Confidence is shaky, and we will be a while putting the immediate past behind us.

Those certainly were fireworks in the fall of 2008.  Henry M. Paulson was the U.S. Secretary of the Treasury at the time.  For perspective on just how dire the situation was read his book, On the Brink:  Inside the Race to Stop the Collapse of the Global Financial System (2010).

Words like “brink” and “collapse” have not been used by serious people to describe the global financial system since 1929.  But we have not had a Lehman Brothers or AIG adventure since 1929 either.  Two other books that provide insight into the financial crisis and the players involved are Andrew Sorkin’s, Too Big to Fail:  The Inside Story of How Wall Street and Washington Fought to Save the Financial System – and Themselves (2009) and Michael Lewis’ The Big Short:  Inside the Doomsday Machine (2010).

You can’t have 2008-category global financial crisis and not have a global recession.  The surprise is not the recession but that it was as mild, at least statistically, as it was.  At this point, the cynic might question the use of the word “was” and say it may be hasty to call the recession really over; the so called double dip.

The global economy lost 2.5 percent in 2009, with emerging economies like those  of China, India and Brazil gaining 1.0 percent and developed economies losing 3.5 percent.  Think the G20 for developed economies.  Specifically, Canada posted -2.5 percent; the U.S.   -2.4 percent; the Euro area -4.1 percent; the UK -4.9 percent; Japan -5.3 percent; China 8.7 percent; India 7.4 percent; Brazil -0.2 percent and Australia 1.3 percent.

Looking forward, we have a lot going for us in Canada.  First, we are a major commodity exporter.  Commodity demand and price are tied to global growth, and global growth should be in the vicinity of three percent in 2011 and 2012, with emerging economies again substantially outpacing developed economies.

Emerging economies buy Canadian commodities and turn them into finished goods for export.  Emerging economy demand for our commodities is good for us in its own right in that it means more sales; it also puts upward pressure on commodity prices, pushing our commodity revenues up further.  You cannot beat having abundant oil, gas, water, agricultural products, minerals, etc. in a growing world short of resources.

Second, our financial system is healthy.  We do not have the problems they have in the U.S. and Europe.  Health in anything is always partly luck but in the case of our financial system, it is also a consequence of sensible legislation and regulation, good management over the years and old-fashioned Canadian prudence when it comes to money.

We should not underestimate the importance of a properly functioning financial system in economic performance.  It leads to more savings, more investment, lower capital costs and  more stability, all other things equal.  When the financial system works properly, you don’t think about it.  When it doesn’t, it is all you think about.

Third, by developed-economy standards, Canadian government finances are in good shape.  Should recovery falter, Canada has the capacity to stimulate further as needed.  Similar to a properly functioning financial system, sound government finances contribute to economic performance on the savings, investment, capital cost and stability fronts.

Fourth, the Canadian economy has considerable forward momentum.  The rhetoric aside, the recession was modest and the immediate recovery quite robust.  Momentum matters in economics.

Finally, what you are not can be as important in economics as what you are.  Canada does not have the aging demographic problems that, for example, Japan does.  We do not have the social welfare cost/workplace rule issues that Europe does.  We do not have the international obligations that the U.S. does, particularly in the military realm.  We are not as dependent on old-economy manufacturing industries as the U.S. and Europe.  We are not too dependent on one sector for our prosperity; we are a nice mix of manufacturing, resources, services and government.  Our government/political machinery is not as efficient and effective in getting things done as we would like, but it sure seems a good deal better than those of the U.S. and Europe.

That’s the good news for our economy.  It’s important, but it does not diminish the fact that the road ahead is going to be tough.

Our short-term problems are as well known as they are intractable.  First, the U.S. economy is going nowhere fast.  No country is more dependent on a strong U.S. than we are.  Exports to the U.S. are about 25 percent of our economy.

The U.S. recovery is disappointing, especially job creation.  A return to recession cannot be ruled out and uncertainty is increasingly weighing on the downside.  U.S. consumer and government finances are a mess.  The U.S. does not invest nearly enough in plant, equipment, machinery, development, infrastructure, education and training to assure the innovation and productivity required to sustain a high-performance, cutting-edge economy.  The U.S. is living beyond its means; the proof is its huge and chronic current account deficit.

Second, while our economy has been recovering just how much of the recovery is sustainable and how much is due to short-term monetary and fiscal stimulus is an open question.  In any event, very low interest rates and massive government deficits have a way of stoking serious inflation problems if they go on too long. We are approaching the time limit.  Disengaging from a stimulus that by peacetime standards is historic will test the recovery. No one should be surprised if things slow down sharply.  Our policymakers are in for a challenging time.

Third, the U.S. dollar is likely to be indefinitely weak against a number of currencies, including the Canadian dollar.  Reasons include near-zero policy interest rates and massive current account and government spending deficits.  Our own relatively strong fundamentals should add to the upward pressure on our currency.

A strong Canadian dollar is good for Canadian consumers in that it reduces import prices.  But it is bad for our exporters because it makes their products more expensive for Americans and others.  Growth and job creation, especially in manufacturing, would benefit enormously from a stronger U.S. dollar and a stronger U.S. economy.

Fourth, the housing sector in Canada has been a real plus for the economy.  But it is running out of steam.  Pent-up demand is not what it was, rising borrowing costs are taking a toll and Canadian personal debt levels are pushing the limits of prudence.  As housing slows, the economy is likely to slow with it.

Finally, in The General Theory of Employment, Interest and Money (1936) John Maynard Keynes nailed the importance of confidence:  “The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention.”  If we are confident about the economy, we make the kind of consumption, investment and employment decisions that make an economy work well.  Vice versa, if we are not confident.

The financial crisis, recession aftermath and media coverage of how bad things are has been hard on our collective psyche.  Tell people that things are bad often enough and they start to believe it and to act accordingly.  Add to that the fact consumers are up to their ears in debt, short on credit and justifiably worried about their jobs, and you can see why it is not surprising that people are shaky.

Two well-documented biases in the way we think play in our confidence issues.  The availability bias is our tendency, when confronted with a problem, to search for the most immediate experience and apply it, whether it is applicable or not.

In the case of our economy, the most immediate experience is a financial crisis and slowdown.  Whatever unfolds in our economy for the next while will be seen through that financial crisis/slowdown prism and the confidence coming out will be tempered.  Rebuilding the kind of unshakeable confidence that drives strong, sustainable recoveries is a one-positive-step-at-a-time process and that takes time.

The confirmation bias is our tendency to make up our mind on a situation immediately and then to justify our position by considering only the evidence that supports the position we have taken.  What we have just been through has heightened our expectation that the trouble is not over.  The confirmation bias leads us to emphasize information that supports that view.  This is not good for confidence and, as with the availability bias, the only cure is good news over time.

For Canadian executives, the watch words in all this are care and caution.  Really solid footing for our economy is still a ways off. This is an environment that disproportionately punishes the rash and the reckless.  But at the same time, our economy should be better than most and provide considerable opportunity for the prudent and patient.  Until the financial crisis works its way out of our heads, things will not get truly back to normal.  The old expression “This too shall pass” provides good perspective.  But it won’t pass right away.

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact

About the Author

John S. McCallum is Professor of Finance at the I. H. Asper School of Business, University of Manitoba, and former Chairman of Manitoba Hydro. Contact