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US recession: merely very bad or catastrophic?

In almost every respect – the jobs market, the government deficit picture, the housing market – Canada is in better shape than the US and most of Europe. But even on this side of the border, economic growth is slowing.


August 29, 2011
by TODD HIRSCH, ECONOMIST

As the global economy continues on its wild ride, it feels like danger is lurking everywhere.

Within one minute of opening on the morning of Aug. 19, the Toronto Stock Exchange plunged another 100 points, and it was looking to be a repeat of the previous day’s near 400 point loss. However, 15 minutes later, investors completely changed their minds and pushed the TSX above its opening level. It was a wild triple-digit loss – and then gain – in the time it takes to buy a coffee.

The previous week saw more than its share of equity market ups and downs. Gold hit new record highs, reflecting investors’ lack of confidence and a last-ditch effort to run for cover. Commodities such as oil and copper were batted about.

The wobbling markets and slumping economy have become such a worry that Canada’s federal parliament Standing Committee on Finance summoned Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty to help explain how the current global economic mayhem will affect Canada.

Flaherty was trying to walk the fine line between being realistic, while giving markets some comfort. He peppered his remarks with phrases like: global turmoil will “inevitably” impact Canada, economy will be “softer” than anticipated, and the economy is “fragile.” However, at the same time he emphasized that Canada has a “great advantage” over other countries, and re-iterated that “fiscal discipline is important.” He also pointed out that Canada has the strongest financial system in the world.

Bank of Canada Governor Mark Carney stated that the European debt crisis has intensified, and that the US is facing the weakest economic recovery in decades. The spill-over onto the Canadian financial markets has been “notable.” Headwinds are now blowing harder. Many of the potential downside risks that the Bank of Canada had identified in its most recent outlook have been realized in July and August.

During his appearance to the Standing Committee on Finance, Minister Flaherty was questioned about a worst-case scenario: another major recession in the US and Europe. Would the federal government rise to the occasion with another round of stimulus?

Flaherty responded that the government would “do what is needed to protect our jobs and our economy and our families in Canada, as we have done successfully previously and recently.” The markets will take this as a hint (albeit a very small one) that the government of Canada would step in with more rounds of stimulus spending, similar to what was done in 2008 and 2009 with the “Canada’s Economic Action Plan.” At that time, the government spent some $20 billion on infrastructure spending over two years.

The central question on which most economists and politicians are fixed these days is: will the US economy go back into recession?

The most recent data are not encouraging. On Aug. 18, the Federal Reserve Bank of Philadelphia’s general economic index nose-dived to -30.7 in August, the lowest since the pit of the last recession in March 2009. The unemployment rate remains stubbornly lodged above nine per cent. And the housing market has yet to show any convincing signs of life. In short, there are few encouraging bits of data out there.

On the other hand, there are still some economic pillars in place. Interest rates in the US will remain at rock-bottom. The price of US government treasuries rose last week, pushing the yield on 10-year treasury notes to a record low of 1.9735% (albeit the rush to treasuries was prompted by bad economic news). The falling yield on the 10-year notes pushed mortgage rates in the US to an average rate of 4.15% for a 30-year fixed loan. That’s the lowest in more than half a century, and will help support the millions of American households that aren’t in any financial trouble.

Will the US slide back into recession? It’s a bit of an academic question. If an outright contraction is not imminent, America is in for a long period of meagre growth. The question isn’t “Recession or not?” but rather “catastrophic, or merely very bad?”

As Carney and Flaherty pointed out, Canada can’t avoid the global economic malaise. In almost every respect – the jobs market, the government deficit picture, the housing market – Canada is in better shape than the US and most of Europe. But even on this side of the border, economic growth is slowing. And depending on how strong and cold those headwinds from the US blow, our economy could quite easily stall.

But while Canada is well-advised to prepare for some economic dangers, there is never any reason to panic. Canadians should be reassured that we remain one of the few safe havens in the global economy.

Danger? Yes. Death? Not if we’re careful.

Todd Hirsch is senior economist with ATB Financial in Edmonton.