By Peter Hall, EDC
This is getting frustrating. Almost four years beyond the global recession, and the world economy is still going sideways. And for three of those years, an annoying pattern has hobbled the world’s efforts to recover: momentum early on, softening in the summer months, but giving way to a late-year upturn that spills into the next year, only to be hit with a summer spoiler again. Repetition has convinced many that the best we can expect is more of the same. Are they right?
They themselves might determine the answer. The economy’s failure to maintain higher growth has weighed heavily on confidence. Americans have been stuck in a recessionary gloom since 2009 — very unusual psychology for them — and pessimism is growing at an alarming pace in Europe. Immune until recently, emerging markets have recently joined in the dirge, thanks to a worrisome slowdown. The collective sense of gloom is in itself risky, as it can – and has – provoked overreactions to new economic and political developments.
Another key weight on confidence is the list of significant risks that the world economy could trip up on. Spanning Europe’s fiscal tightrope is still a tricky business, and the high-wire act will have to endure further gusts of wind before reaching the other side. Any slip-up would have serious consequences for the continent’s banking system, which is highly exposed to European government bonds. A third global risk is political instability. Discontent in the Middle East and North Africa is again surging, manifest in protests that are now engaging a broader global theatre. Recent developments have resurrected a fourth risk. Geopolitical tensions have raised fuel prices, and drought conditions affecting key agricultural zones have caused prices of key grains to skyrocket. Developed countries will barely notice the change, but emerging economies could experience significant economic and political disruption. Any one of these risks could quickly quash economic momentum, further prolonging a proper recovery.
The situation is further complicated by the opposing forces in the global economy. The foremost is probably the episodic push-and-pull of growth and stagnation, mentioned above. Second, there’s the tension between the faster-growing countries and the slow ones. Third, policy measures are pulling in different directions. Europe is rapidly reeling in government spending in an effort to prevent debt spirals, while at the same time, emerging markets are spending more, and additional monetary easing is in the works in a number of countries. Fourth, the public sector, generally in decline, is at odds with a business sector eager to put the recession behind it. And finally, we can’t forget the juxtaposition of a corporate sector sitting on mountains of cash, and investment in plant and equipment which remains lacklustre.
These tensions point to a world economy seemingly unable to break out of a sideways trend – the same dilemma it faced during the Great Depression. At that time it was observed that the economy remained well below normal levels of activity long after the excesses of the Roaring ‘20s were exhausted. What the economy needed then was a psychological reset – and deficit financing was born as a strategy that gave governments the fiscal firepower to kick-start ailing business activity.
This time around, shock-and-awe government spending measures were used across the world in a collective program that for size, speed and synchronization was unlike none other in history. The spending program was aided by an extreme dose of monetary policy, and when historically low interest rates proved insufficient, quantitative easing made its international debut.
History will likely conclude that spending programs were initiated too soon in the cycle. We had barely begun to chip away at the massive excesses of the past growth phase before vast public cash hit the economy. At first, it seemed very effective, creating what looked like a dramatic recovery. But when the initial effects of the new money wore off, we were back to dealing with those pre-recession excesses. Now, the economy is showing signs of being back in balance – but there’s hardly any policy ammunition left to provide the needed push into the next growth cycle. Where, then, will it come from?
If anything, it is likely to originate in a country or region of the world. Is Europe a possibility? Saddled with heavy government austerity and weak growth fundamentals, Western Europe seems anything but a global spark plug in the near term. And as long as its growth prospects remain soft, the financing requirements of Europe’s weakest governments will continue to periodically incite fear in global financial markets. When it comes to potential growth engines, this 20 per cent chunk of global GDP – slated to recede by 0.5 per cent this year and to rise in 2013 by just 0.7 per cent – is looking elsewhere in the world.
A casual glance at Japan’s recent performance, and one might see hope. However, a large part of this year’s 2.2 per cent gain is due to substantial earthquake/tsunami reconstruction money. Without the same boost, 2013 growth is expected to ease to 1.5 per cent, taking the world’s number three economy out of the running.
Many have hailed the large, fast-growing emerging markets as global growth engines. Their dramatic growth is certainly lifting global average performance significantly, but at present, they are hardly pulling the rest of the world along. Among these economies, growth is static at best, but India, China and Brazil are each battling significant slowdown, highlighting their dependence on growth in the developed world and their own hefty stimulus programs. Together, emerging markets will continue to outpace the developed world by a large margin, averaging 5.3 per cent in 2012 and 5.6 per cent in 2013, but to date have not matured enough to launch the next growth cycle.
We are fast running out of options. With all the bad news about US fiscal finances both now and in the future, America hardly appears to be the world’s great hope. However, its beleaguered housing market – in many ways, an icon of the current global debacle – is on the rise, and gaining momentum. New life in this market is pulling along the US consumer. Fears of a European meltdown early in the summer saw this awakening 70 per cent chunk of the US economy nod off again, but only briefly. Spending is again rising aggressively, and this time around it is sustainable. Resurgence in the domestic economy and decent international trade performance have fired up the American production machine, lifting total industrial capacity utilization right back to peak levels seen at the end of the last growth cycle. The US economy won’t be able to grow much more before it needs to expand productive capacity – suggesting that the mountain of cash corporations are currently sitting on is just about to be unleashed into the economy.
So, if the picture is this rosy for the world’s largest economy, why does the forecast only call for 2.3 per cent growth this year and 2.8 per cent in 2013? Like Europe, the US is also weathering extensive government cutbacks. In an austerity environment, to get growth like America’s requires an underlying economy growing at roughly 4 per cent, which is more than achievable, and indeed, is occurring as we speak. It is this underlying pace of growth, originating in the private sector, that singles out the US economy as the most likely global growth engine, enabling the world economy to accelerate from growth of 3.4 per cent in 2012 to 3.9 per cent next year.
Commodity prices are forecast to retreat as world growth gains momentum. That might seem counter-intuitive as demand for commodities picks up again. While brief gains may occur, the vast amounts of stranded cash across the world – some of which has been invested in commodities – will make its way back into more normal investments, sending prices for base metals and energy products downward.
Weaker prices will actually bring relief on the currency front. The Canadian dollar is forecast to dip from parity this year to 97 US cents in 2013.
The timing is good for Canadian exporters. The rest of the economy will be looking to exporters for growth, as Canada’s domestic sectors run out of steam. Consumers are overstretched, running up debts to historic heights during the recession years, and government spending is in retreat. Unlike the US, Canada’s housing markets are oversupplied. Will exporters come through?
Strong overseas demand for raw materials will combine with rising US demand and the continuation of a decade-long diversification of sales into fast-growing emerging markets, to lift merchandise exports growth from 4.9 per cent this year to 6.7 per cent in 2013.
In spite of weaker prices, strong volume sales will vault energy exports ahead by just under 11 per cent. Also into double digits are the agri-food and fertilizer industries, where strong prices and volume shipments are the story. Strong product sales will lift the aerospace and industrial machinery sectors above 8 per cent growth. Laggard industries include metals, which will sustain large price drops, advanced technology (a perennial weak spot) and the auto sector, which will be constrained by capacity.
Strength in commodity industries will be widespread, but will have the most notable impact on the Western provinces. Central Canada will benefit from higher machinery exports, but weakness in the auto sector will weigh on Ontario’s performance. Atlantic Canada’s growth will be conditioned by the effects of large projects. Strong growth in US sales will revive the region’s beleaguered wood products industry.
After considerable volatility in the last 4 years, Canadian exports of goods and services are expected to rise 5 per cent in 2012 and an additional 6 per cent in 2013. Averaging at parity for this year, the loonie continues to present competitiveness challenges for exporters. Next year, the dollar will fall back to USD 0.97, providing some reprieve for Canadian exporters. Export volumes are expected to rise 4 per cent next year, as US GDP growth reaches 2.8 per cent, Europe exits recession and crude production ramps up. Goods exports should finally recover to pre-2009 levels early next year, a feat accomplished by the services sector back in 2011.
Forestry, supported by US housing starts of 1.05 million, will be the best performing sector in 2013. Growth in energy exports will nearly double, to 11 per cent, lifted by higher oil production and natural gas prices. Food prices are also expected to increase which, when added to skyrocketing emerging market demand, will result in 10 per cent expansions for both agri-food and fertilizers exports. Higher valued-added industries, such as aircraft and parts, industrial M&E and to a lesser extent services, are also expected to have a good year in 2013. Growth is being muted by the relatively high base established last year, as exports of motor vehicles and parts were boosted by the recovery from the Japanese eart ake and tsunami. Capacity constraints are also weighing against export growth in this sector. Metals and ores will be the only sector recording an outright drop in foreign sales.
Merchandise exports to the US are expected to grow 7 per cent in 2013. Exports to Canada’s number two market, Western Europe, will fall 2 per cent on falling metals prices, offsetting modest improvements in other sectors. Finally, sales to emerging markets should rise 10 per cent, led by agri-food and fertilizers. Exports to the emerging markets will account for 12.4 per cent of total Canadian exports next year, versus 11.5 per cent in 2011, as growth to emerging markets outpaces growth to developed economies in 10 of 11 sectors.
In addition to the adverse impact of the high loonie on Canadian competitiveness, exporters are also feeling the sting of softer metals and energy prices alongside weaker demand from key markets. We also adjust for unexpected local circumstances that have limited local production capacity. As a result, EDC Economics has made a number of revisions to the provincial outlooks since our Spring 2012 forecast. In most cases, the forecast for this year has been lowered; however, the outlooks vary by sector for each province. We expect export growth to accelerate next year, albeit at a somewhat more modest pace than was expected in the Spring.
British Columbia’s export outlook for 2012 has been revised down as forestry, energy and industrial goods exports all contract; robust M&E sales will not be sufficient to bring overall trade into positive territory this year, but a broad-based rebound is expected in 2013. Alberta’s performance is roughly on target this year, and improvement next year will be driven by increased energy and agricultural sales. Agri-food and energy sales will also lead the way for Saskatchewan, which will see good growth this year and next. By contrast, Manitoba should see softer export growth in 2012 – linked to weaker agri-food and M&E gains, while industrial goods exports are depressed due to a mine closure.
A weaker-than-expected showing for industrial goods this year will leave Ontario’s export performance short of our Spring outlook. In 2013, growth will decelerate due primarily to a slowing automotive sector. Quebec’s export growth fortunes have been roughly halved in both years as industrial goods, M&E, forestry and transportation sector sales to foreign markets soften. Next year, the province will see more broad-based gains by sector.
The Atlantic provinces will see a mixed outcome. Prince Edward Island is in the midst of much stronger export growth this year, driven by improved agri-food and greatly improved M&E and transportation gains — a feature uniquely tied to the province’s aircraft overhaul sector. Newfoundland and Labrador has seen its export performance drop into negative territory this year due to energy-related shut-downs, but as capacity comes back on line this sector will drive a large gain next year. Soft commodity prices and some production-related issues have hampered New Brunswick’s export fortunes this year; however, next year a reversal of these two factors will add to growth. Finally, Nova Scotia saw this year’s exports dragged lower due to a much weaker energy sector alongside paper mill shut-downs. Next year, export growth will bounce back.
On a relative basis, Emerging Europe has been the region hardest hit by the global recession and financial crisis, given its exposure to the economies of Western Europe. That region may take some time to recover to pre-crisis levels of activity. The retreat of global capital and a somewhat cash-strapped government have also severely impacted India’s performance. But despite current weakness, the country’s mid- to longer-term growth trajectory is still respectable at 4 per cent.
Still-sluggish global growth and the net withdrawal of massive fiscal stimulus continue to weigh on China’s economy, impacting the entire Asia-Pacific region. Over our forecast horizon, growth in China will remain below 8 per cent, the threshold generally accepted as the level required to maintain social, political and economic stability in that country. That said, however, Chinese Communist Party (CCP) leaders will do what is needed to minimize any anxieties ahead of the once-in-a-decade leadership change currently under way.
Growth in Latin America has varied considerably between countries; however, as a heavy resource supplier into the global production chain, economic activity has been hard hit. Looking to 2013 we see improving prospects for the region, thanks in part to successful structural adjustments that have helped insulate many countries from the commodity boom/bust cycles of the past.
Africa is a region that has traditionally remained somewhat insulated from the capriciousness of global economic cycles, due to its generally poor integration into global trade and capital markets. However, as a region, Africa and the Middle East will post relatively stable growth numbers going forward and boast some of the world’s fastest-growing economies.
While it must be stressed that there are numerous and significant risks, EDC Economics expects to see global growth hit 3.4 per cent this year, down only slightly from last year’s 3.9 per cent growth. As momentum picks up, and if our assumptions on the US and Europe hold true, we anticipate growth pushing closer to the 4 per cent mark next year. For us, 2013 is the year when we start seeing a true recovery set in.
Notwithstanding this relatively upbeat outlook, commodity prices are not expected to strengthen going forward. In fact, we believe that this will be one of those rare recoveries where commodity prices may even pull back. Because if fiscal and monetary stimulus has helped support current commodity price levels, either by encouraging activity or generating a search for yield, it follows that a withdrawal of this stimulus should precipitate a correction of prices.
While the fear factor continues to play a key role for energy pricing, our expectation is that heightened tensions related to Iran’s nuclear program and the threat of escalated conflict will remain just that. Meanwhile, the Brent price premium should continue to linger as a result of ongoing geopolitical risk concerns in the Middle East and Africa. However, barring any major new threats to global supply, EDC Economics expects the price of WTI crude to average USD 96/bbl in 2012 and USD 95/bbl in 2013.
The pricing dynamics facing the industrial metals complex are largely the same. In the absence of incremental monetary easing next year by the US Fed or the European Central Bank, much of the froth is expected to come off the market and exert downward pressure on prices. While the fundamentals for certain metals are somewhat supportive of higher prices, in general we expect prices to fall. This trend is being further influenced by increased supply as new projects go from construction to production over the medium term.
What does this mean for the price of Canadian trade? The Canadian dollar has been range-bound throughout most of 2012, hovering between USD 0.96 and USD 1.03. Our commodity price scenario, while not necessarily bullish for producers, implies some protection for export-oriented companies. As a result, we expect the dollar to average USD 1.00 this year, before falling back to USD 0.97 in 2013. This will benefit all Canadians, not just exporters, as we expect the Canadian economy to rely more on the trade side over the next few years, with domestic drivers softening somewhat.
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