Canada's 2010 Economic outlook

Where is Canada’s economy going in 2010 and 2011, this is not only idle curiosity on my part but also part of my day job. At heart I am agnostic, I believe raw data, but I’m not married to any one indicator, because it is easy for indicators to morph from leading to following, usually when an indicator becomes a policy tool…

My favorite data point is credit creation

(12% per annum – at no time has credit creation in Canada become negative), and number of hours worked (growing in Canada after a dip in 2009), in a deep recession I disregard unemployment numbers as too much can be hidden to make the information useful as a barometer of economic activity (especially since a large percentage of new jobs are created in small and medium size companies – not the large caps). Personal experience/history is also important (history doesn’t repeat itself, but it usually rhymes).

My take: OECD economies are facing two or maybe three contraction drivers: deleveraging by consumers (not by choice), aging baby boomers moving from capital appreciation to capital preservation in their investment strategies, and government deficit as far as the eye can see. Canada is one of two exceptions (the other being Australia). Although Canada’s government debt has risen dramatically during the current recession, 2/3 of the additional debt was backed by marketable assets (Quantitative Easing), which will be sold once the crisis has abated. In fact, the appetite by investors for high quality bond products is almost certain to make this process seamless. In Canada, for every dollar being invested into the stock market, nine are being invested in bond and synthetic bond products.

At a macro level and despite the economic conditions that prevail in the rest of developed economies, Canada has a number of attractive features: low wage inequality, a relatively homogenous population, fair education system and a low cost single payer health care system. As a net energy exporter (Oil, gas, electricity, uranium) and rich in many natural resources: Iron, zinc, copper, wood etc. Canada’s governmental debt is lower than all other OECD countries, around 76% of GDP, against 85% for USA, 80% for Germany, 100% for italy.

Problem arise when you assume that everything else is equal, already Canada’s manufacturing base is being affected by our strong currency – the Canadian dollar is trading about 10% higher than it should, and parity with the US dollar within the next few months is almost a certainty. Consumption accounts for about 50% of Canada’s GDP, exports another 20% and the balance 30% is manufacturing. This segment of the economy could be badly affected.

Our economy is closely tied to that of our southern neighbors. Earlier this week the Bank of Canada’s Monetary Policy Report hedged its bets when it came to the view on the global economic outlook:

“It is possible that the recovery in global demand could be more vigorous than projected, resulting in stronger external demand for Canadian exports.”

“Another important downside risk is that the global recovery could be even more protracted than projected.”

In a nutshell the Bank of Canada is has no firm idea what will happen to the global economy over the near term.

So my predictions:

(1) Nominal GDP growth of less than 3% for 2010 & 2011 – which results in a lot of excess capacity. Most of the “pain” in the economy has been felt by the manufacturing sector, a shrinking part of Canada’s GDP (down from 33% in 1990 to 27% today)

(2) Muted inflation, if natural resources prices rise, the Canadian dollar will also rise, creating a natural inflation hedge

(3) Interest rates remain accommodative for the next 12 months, until the early part of 2011. Historically, the BoC has raised interest rates only after the Feds.

(4) Unemployment remaining high, but slowly falling back from the 8.4% to 8% over the course of the year.

Finally, I hope that I am wrong and that the economy grows more quickly, but the impediments are substantial for such an open economy. Our destiny is out of our hands.