By R. Bruce Striegler
Against a backdrop of lukewarm reports and analysis on global economic affairs, Peter G. Hall, Vice-President and Chief Economist at Export Development Canada (EDC) said during a recent webcast, “Countries don’t know how to handle growth, don’t like having to deal with economic decline, and like flat economies even less. There are some out there who call our forecasts audacious when it comes to our view that the U.S. economy will be the engine that pulls the world economy back into a growth mode.”
His point of view was echoed, however, by the November 27, 2012 economic outlook from the Organization for Economic Co-operation and Development (OEDC) which expects U.S. growth will speed up faster than Canada’s at 2 per cent, reaching 2.8 per cent in 2014. The OECD outlook projects Canada’s economy will grow by 1.5 per cent in the final three months of this year, advancing to 1.8 per cent in 2013. Although next year’s projection is half a point below the Bank of Canada’s forecast, both organizations agree that in 2014, growth will rise to 2.4 per cent.
Hall affirms global economies over the last few years have been lacklustre, but notes this was preceded by a protracted period of global growth lasting about 16 years. “That was a heyday period. This was where we proved we really didn’t know how to handle that much growth because we created a mountain of global excesses which gave rise to the deepest recession since the Great Depression.”
He says while the past four years have been marked by ups and downs, the general nature of the current global economy is “sideways,” adding, “If we don’t know how to handle up, and we don’t know how to handle down, we really are not wired to handle flat. It runs cross-grain to our psychology. It’s difficult to know how to strategize in this environment.” He says one solution is to stand back and look for the reasons, to understand where we’ve come from, to understand where we are right now. “If we don’t understand these things, we haven’t a hope of even guessing at where we are going to go.”
“The excesses are not what are keeping things flat presently,” says Hall. While the primary reason for the extended flat period is due to absorbing the five years worth of accumulated financial overload, the world economy has had time to wear those excesses down and economists agree it is approaching a more balanced state. Nevertheless, almost four years since the global recession was declared over, for many the world economy is still going sideways. The period has been marked by annual patterns; momentum early on, softening in the summer months, but giving way to a late-year return which spills into the next year followed by a summer spoiler again.
The ‘new normal’ and human pessimism
Other conditions contributing to the uncertain economy include geopolitical events including the Arab Spring and resulting spike in oil prices, a string of natural disasters around the world as well as factors like the European debt crises and the Greek elections in May. Hall says, “For the first time in this continuum there wasn’t actually a driver in that truck heading for a precipice, everybody lost their collective cool and shut things down.” He added that the U.S. sovereign debt problems also jolted people and added to financial uncertainty.
“So there was a big pause but there were many factors which indicated these conditions as temporary. We felt if the world did have any momentum, the pause would be short-lived. Well, these were temporary factors, but they’ve actually held the world economy back. But by their very definition, temporary factors don’t last. So we have to ask, if not the excesses that led to the great recession, if not the temporary factors, what is keeping us back now?”
“When you see a great recession and a protracted period of flat activity, it wreaks havoc with our psychology. One key manifestation is that pessimism rises, it mushrooms inside of the economy.” Mr. Hall says that pessimism sells, both in person-to-person communication but also through the media, both working in concert to spread the gloom, and he says that it can actually be self-fulfilling.
“We can talk ourselves into a flat economy by just being convinced that is our paradigm, this is what we have to deal with. This is why some have characterized this flat growth as the ‘new normal’.” He agrees that there is slower overall growth but says ‘new normal’ would suggest a very different kind of global economic cycle, and he asks whether that really is the case. “Have we talked ourselves into a perpetual flat state globally or can we expect we can break out?”
Financial stimulus and quantitative easing not enough
Hall says the situation seems similar to that of the Great Depression, when years after the crash the economy seemed unable to break out of the sideways trend, continuing economic activity well below normal levels after the depression. “Enough time had gone by to get rid of the excesses of the Roaring ‘20’s, but the economy needed a psychological reset. It was then that the notion of deficit financing was conceived with the government getting involved, getting into some debt, priming the pump of the economy to get it back on its feet again and then paying itself back through higher taxes and lower spending once the world economy got to growth.”
Hall says that not only have we used up the fiscal stimulus earlier in the cycle, but we have used up all the monetary stimulus, citing low interest rates and rounds of quantitative easing. (A government monetary policy used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital, in an effort to promote increased lending and liquidity.) He adds that there is considerable cynicism about how many more rounds of quantitative easing could be effective.
“This presents us with a huge problem. We have significant risks on the table of the world economy, and these negative forces are still pushing hard against coming out of this situation.” Some of the key risks Hall refer to include sovereign debt worries in developed economies including Europe and Japan, and the big topic, the U.S. ‘fiscal cliff.’ Added to financial issues is political strife particularly in the Middle East combined with volatile prices around the world. Hall says that all these conditions are happening in a context of pessimism which means that when risk events happen in the world, we over-react.
Looking for the champion of new economic growth
“We’ve never seen pessimism that is as protracted as it is at this time.” With little in the way of policy initiatives left, the question remains as to how the world breaks out. Hall says that policy hasn’t done it and he doubts that any single industry will provide the answer either. “We believe it’s going to be a region of the world or an individual economy that is going to do it. Europe has been in recession for four quarters. For all intents and purposes, Europe decided to have a recession. When one looks at the amount of fiscal austerity, it is greater on average than Europe’s capacity to grow in the long term.”
Hall suggests that when the austerity was imposed, the results were almost self-fulfilling, and it signals that Europe isn’t going to pull the world out of the financial doldrums. He adds that some worry Europe will be the one to push the rest of the world over some kind of fiscal precipice. “What we’ve actually seen is that every time Europe gets to significant dates with respect to a bond roll-over or a re-issue of debt and there isn’t enough money in the system to cover it, when it hits that point, there are a sequence of events that happen.”
Markets panic, ratings agencies get worried but it brings the parties to the table. Out of that comes a creative solution. Hall says that it is never entirely certain how things will work out, but it is clear after going through this cycle repeatedly that Europe will continue to operate this way until someone else comes along and provides higher growth for the world economy.
Touching on the Japanese economy, Hall notes its growth, a 2.2 per cent gain, has rivalled that of the U.S., but is due to earthquake and tsunami reconstruction funds and will not last. He explains that in order to fund those reconstruction activities, Japan has had to once again run a significant deficit which has taken its overall debt position to “a very scary level.” Mr. Hall says that the end of stimulus isn’t going to be all that holds the Japanese economy back, but paying the debt will, projecting 2013 growth slowing to 1.5 per cent, taking the world’s number three economy out of the running to be the area which pulls the globe out of its sideways situation.
“We’re running out of candidates to take on this mission. Europe is somewhere between 17 and 20 per cent of world GDP, Japan is up to another nine per cent of world GDP.” He says that while many have hailed the large, fast-growing emerging markets as global growth engines, 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. Collectively, emerging markets add up to about 45 per cent of world GDP, so we are rapidly taking a lot off the table.”
Hall then turns to the United States. “You may be thinking that it can’t possibly be the U.S. economy that will lead us out of these problems. Daily we hear news of politicians in Washington who cannot get together to make basic fiscal decisions to keep from going over financial cliffs or missing significant debt dates, and we hear that Americans have very big future liabilities around healthcare and public pension issues, so it doesn’t look like the American economy has the stuff to lead the rest of the world economy forward.”
Enter the U.S. private market
He points out that all the issues getting so much attention are in the public sector. “It has never been the public sector that has led the U.S. economy forward. It is led by a very robust private sector and it is here where we see the most exciting data I believe anywhere in the world.” He begins with the housing market, enjoying a revival that he says is very vigorous, noting that housing starts are up 42 per cent on a year-over-year basis. “That’s a very remarkable number, and we believe that is going to continue because even with this rate of growth U.S. housing starts are far below the basic requirements of the economy.”
Hall’s assertion is that the housing market, which has been underwater, has been in that position long enough to get rid of the enormous excesses that piled up prior to the recession and says the market is now in balance. He takes on the notion that low job growth is a counter to the rising housing market. “Job growth in the U.S. has never been a precursor to a revived housing market. Many people have been sitting on the sidelines. They have incomes but have not gotten into the market because prices have been going down. They haven’t wanted to lose their shirts on their investment. Now prices have turned around and the dynamic has changed, and all those people on the sidelines want to plunge into the market while the getting is good.” All housing markers are showing positive growth including sales in the existing market, new market and sales across the U.S. show inventory levels are going down.
“What is exciting about this is that housing is a leading indicator of economic activity and is one of the first indicators to actually turn upward. It doesn’t need a job recovery in order to do that. It takes off and other things follow in its train.” Hall says that while housing starts are rising 42 per cent now, in a few months housing completions will begin rising by the same amount and all the appliances, furniture and other requirements that go into houses will also begin to rise equally and that is a much bigger part of overall GDP. “That is an exciting movement in the U.S. economy.”
Housing market to lead the rest of the economy
Hall says that consumer spending which is 70 per cent of the U.S. economy, corroborates what is going on in the housing market. Retail sales dipped briefly through the summer, but have risen steadily at 7.5 per cent for some months now as Americans continue to restructure their debts. “Their debt to income ratio has come down well below the 163 per cent peak, and is continuing to fall fast.”
On the business side of the private U.S. economy, Hall says there has been some frustration as U.S. businesses have been stocking up cash on their bottom lines at an enormous rate, especially since 2008. “The total amount of money between financial and non-financial institutions at the moment is 5.7 trillion dollars, which represents 36 per cent of U.S. GDP. You don’t need very much of that to actually create a frenzy of activity in American private investment.” So Hall translates the resurgence in the domestic economy and decent international trade performance as the keys which will fire up the American production machine, which in turn will lift total industrial capacity utilization right back to peak levels seen at the end of the last growth cycle.
“The U.S. economy won’t be able to grow much more before it needs to expand productive capacity, and that the mountain of cash corporations are currently sitting on is just about to be unleashed into the economy.” Like Europe, the U.S. is also weathering extensive government cutbacks. In an austerity environment, to get growth like America’s requires an underlying economy growing at roughly four per cent, which Mr. Hall says is more than achievable, and indeed, is occurring right now. It is this underlying pace of growth, originating in the private sector that singles out the U.S. 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.
“This final push that is happening in the world economy is starting in the United States economy and it is doing it on its own.” Hall reiterates that it is the natural mechanisms of the economy that is bringing the financial system back to normal levels of activity and what is even more reassuring is that it’s happening in an environment of abject pessimism. “It’s happening in spite of the fact we don’t believe that it can happen.”