Tuesday, December 21, 2010

Inflation Pressures remain strong in Canada

Not entirely surprisingly, inflation pressures in Canada continue to be at the upper limit of the BoC’s comfort zone. Proof, as if any was needed, that capacity utilisation probably higher than the Bank of Canada has estimated. Obviously, if you consider that the BoC’s estimate for capacity utilisation is based on derived data. Several economists beleive that the BoC has a tendency to underestimate capacity utilisation, and hence inflation pressures.

On a seasonally adjusted monthly basis, consumer prices rose 0.2% in November, after increasing 0.7% in October. The transportation index advanced 1.8%, while the household operations, furnishings and equipment index rose 0.3%. However, the shelter index decreased 0.2% while the food index fell 0.3%.

Worrying is that aside from clothing and footwear, all segments of the pricing complex rose in November.

Wednesday, December 15, 2010

Mark Carney scared the crap out of me

Two days ago, the BoC governor spoke at the Economic Club of Canada (see here).  Several comments he made make me very nervous about the state of the world, or at the very least very nervous about the BoC’s world views.  Below are a few highlighted segments:
[…] by the recent extensions of unconventional monetary policies in the United States, Japan and Europe.
With currency tensions rising, some fear a repeat of the competitive devaluations […] countries left the gold standard in order to ease monetary policy, and the system became more flexible.  Today the process is working in reverse.
Ultimately, excessive [foreign currency] reserve accumulation will prove futile. Structural changes in the global economy will yield important adjustments in real exchange rates. If nominal exchange rates do not change, the adjustment will come through inflation in emerging economies and disinflation in major advanced economies.
Historically low policy rates, even if appropriate to achieve the inflation target, create their own risks. […] Canadian authorities will need to remain as vigilant as they have been in the past to the possibility of financial imbalances […].
First I should say that I largely agree with Carney’s world views.  I’m a little surprised how pessimistic his positions are with regards to the state of the world.  Foremost is Carney’s commentary about how Europe, America and Japan are all using unconventional (read: untested) policy tools.  Starting with America’s failed QE2 program: long term interest rates have actually risen back to their July 2010 level, to Europe which appears to confuse a solvency crisis with a liquidity crisis.  The BoC remarks that the insistence of all the players to maintain the status quo will lead to disinflation and deflation in the G7 counties and inflation in the surplus countries. 

Sounds familiar no?  China, India face rising inflation pressures, while America, Europe and Japan are facing disinflation, and deflation. 

Starbucks Bucks– a travel card?

Funny blog entry on Worthwhile Canadian Initiative, a Canadian economics blog about using your Starbucks bucks (Sbucks) card to get rid of your spare change at airports.  You know the drill you are traveling to country XYZ and you have a couple of Euro or pound coins in your pocket, and the notional value of coins in Europe can be rather high. 

I’ve always dismissed Sbucks as a promotional gimmick, but it turns out that your Sbucks are good all over the world; Starbucks takes care of calculating the exchange rate.  So if you are at Heathrow airport with a few pound coins and a few bills you can load-up your Sbucks card to use back home.  Brilliant!

I guess I will start drinking Starbucks coffee – maybe McDonald will eventually have the same idea?  Interestingly, the use of Sbucks increases the money supply (I don’t know maybe we should call it M9).  It reminds me of a story: many years ago a colleague tried to pay a Bangkok stripper with Canadian Tire dollars – didn’t work! So maybe Canadian Tire and Starbucks dollars not really part of the money supply.…

Tuesday, December 14, 2010

Interesting data point: Falling energy consumption

Riddle me this; which country saw back to back reduction in total energy consumption in 2008 and in 2009?  Of course the answer in Canada (BTW in 2008 GDP shrank by .089% and by 1.08% in 2009).  In 2009, Canada’s total energy consumption dropped 1.9% (2.1% in 2008).  Energy consumption was 7,650 petajoule (Petajoule = Joule x 1015).  Canada is the world 8th largest energy consumer (just ahead of the U.S.), but behind several Middle Eastern countries and surprisingly Luxembourg (Don’t know why Luxemburg, it has relatively mild climate, but its 65% higher than Belgium).

Interesting facts:

  • Oil sands now account for 70% of all oil production in Canada
  • Canada represents 20% of all oil imported into the U.S (largest)
  • 67% of all oil produced in Canada is exported to the U.S.
  • Quebec, Ontario and Alberta account for 72% of all energy demand in Canada
  • Natural Gas production declined by 4% and exports by 7%
  • Coal consumption dropped by 20% and 10% respectively in 2009 and 2008, while production was down 10% and 8% for the same periods.

I love this diagram -- Health care as a Percentage of GDP

Bottom line the figures for ALL countries is a problem because the implication is that healthcare takes a greater and greater proportion of the GDP, eventually, it will be 100%.

Something happened in the US in 1984 (aside from the election of Ronald Reagan), cost as a percentage of GDP exploded.

Early signal that Canada’s Q4 GDP will be disappointing?

October vehicle sales were down 0.3%, not a huge amount but it still amounts to a continuation of a trend that began emerging in September.  Canada’s economy has stalled – in fact aside for Quebec, vehicle sales were off in every province with Alberta the winner at -8%.

One question not addressed here, is the change in VAT tax in certain provinces, which may have accelerated vehicle purchase in the summer of 2010 to take advantage of the lower tax level. 

Although the figures are not seasonally adjusted, in 2007, 2008 and 2009, vehicle sales actually rose in the closing months of the year (it makes sense as dealers try to unload “previous years’ model”).  Anyway, September was flat and October was down slightly (against trend).

History doesn’t repeat itself, but it often rhymes (Twain)

Looking over the slow developing disaster that is America (now you know my bias), I decided that the best way to get a sense of what the implosion of an Empire looks like was to study another empire that, through no outside forces, when the way of the dodos. Initially, I though that I could look at the decline of some 18th or 19th century European empires, but I realized that these did not so much decline as they were superseded.  In other words they present a poor example of an implosion.

The solution, it turns out was something I’ve already been reading about, a few months ago While watching a Daily Show interview with Robert O’Connell, an American historian who wrote the Ghost of Cannae – about the darkest hours of the Roman republic (in fact the point at which the republic lost its “democratic” footing).  So yesterday I downloaded Gibbons: The History o Decline and Fall of the Roman Empire, paradoxically published in 1776.  It is a massive work, which according to friends is a difficult read (thanks Nameede for suggesting instead Margarete Yourcenar’s Memoirs of an Emperor, but it's not available on Kindle) which comes in six volumes… on the kindle it has 89,000 “pages”, and I’m about at page 100 (the intro alone was 40 pages).

Certain amazing facts are already emerging (out of the intro):

  • The decline was slow, over centuries (so it could take a while for America to decline)
  • Roman citizens slowly gave up their rights to improve the security of the empire (sounds familiar with the new rules and regulations after 9/11)
  • Roman citizens believed they had a God given right to rule the world (well you know…)
Anyway, page 100, so I’ve got some reading to do here, thanks to a few long flights and the Christmas break, I should be able to make a large dent in the story.  Don’t know if I will have the fortitude to read the entire thing – by the way, I purchased my copy for 99¢ on Amazon (but if I purchased each volume, on the kindle, it was $2 per volume ), it could be free on the Gutenberg project, but this version was re-edited.

Good times 

Monday, December 13, 2010

Canada’s net worth rises

In the third quarter, Canada’s Net Worth rose by 2.7% -- this is almost entirely due to the strength of the Canadian stock market – which is up 9.5% for the year (small percentage due to the increase in the value of the housing stock).  Kind of a boring week for economic data, thank God our southern neighbors are providing such entertainment (e.g. healthcare reform unconstitutional, renewal of Bush tax cuts). 

Following the BoC financial strength review (last Thursday) the Bank of Canada’s Governor further pressed the issue of Canadians excessive private borrowing, especially in an environment of ultra low interest rates -- rates may change and there is a strong likelihood that they will rise above the prevailing inflation rate.  Personal indebtedness is the only endogenous risk factors identified by the BoC -- the only area where policy may have an impact.  Canada is, in fact, the only OECD country encouraging its citizen to borrow less and save more.  The question is will be the Bank back these statements with action?

The bank has five tools in its arsenal:

(1)               Interest rates
(2)               Open market operations
(3)               Reserves
(4)               Capital adequacy rules
(5)               Moral suasion.

Right now the Bank is emphasizing moral suasion, because the other tools are mostly unavailable:  Interest rate policy is locked-in at 1% until then of spring 2011. Money market intervention trough the Repo market (where the Bank sells government bonds, to soak up available liquidity), has been actively used, but with heavy foreign demand for Canadian sovereign bonds, it has limited impact on the money supply. Reserves and capital adequacy rules can be used, but they are almost “nuclear options”, moreover, after two excellent years the banks’ capital adequacy is well beyond the “policy level” as for reserves the banks tend to maintain excess reserves with the Bank.

Above is a table showing the growth of M1, M2 and M3 (Source: StatsCan & Bank of Canada).  In early 2009, the BoC began removing the excess liquidity it had introduced following the  capital markets freezing   following the Lehman bankruptcy.  This operation was completed in late 2009, since then M2 & M3 have grown at similar levels. 

Thankfully, the BoC has allies in its quest to reduce personal credit; OSFI has been a willing tool of monetary policy by requiring Canada’s banks to increase their Tier 1 capital (reducing the banks ability to issue Tier 2 capital in the form of subordinated debt).  Requiring high minimum down payments on mortgages, reducing the term of loans from 35 years to 25 years, and employing stricter “interest rate” test on income.

Will all this work?  The BoC instruments are relatively blunt, and like the pilot of a supertanker, must allow for time lag between policy change and impact on the economy.  The housing market cooled this year, but it’s not entirely clear if this is the result of the over-build during 2009 and early 2010 or a result of the shift in lending requirements (which were introduced during the summer). 

No Canadian economic news today

Actually, the entire week is "lite" for Canada.  The US is a different story, but up here no much is expected...

Predictions & Projections

Last year, I predicted that Canada’s 2010 GDP growth would be around 3.2% (although the final tally is not in yet, the number appears to be around 3.0%), so I was too optimistic.  My forecast was tempered by the reversal in housing; 2009 saw an over-stimulated housing market, and that sector retrenched in 2010 (creating a drag on GDP).  Of course, I never saw the weakness of the U.S. recovery as a critical factor.

The BoC 2011 GDP forecast is for growth of 2.5% because the Bank sees a many potential headwinds.  Thankfully for Canada, Pres Obama decided to kick the can down the road, by agreeing with the GOP on extending all American tax cuts creates a massive boost to “income” that “should” translate into additional spending.  In view of this pure Keynesian stimulus package (and I thought the GOP were solid Austrian economists… the joke is on me!).  In my opinion the BoC’s 2011 forecast appears to be too pessimistic.  I take the view that GDP growth will be closer to 3% (and maybe even slightly higher).  The reasons:

(1)               After a pause the housing (new build) market is rising again.
(2)               Massive capital spending by Canada’s corporation will lead to important productivity gains in Q1 or Q2, negating the impact of a strong currency.
(3)               Canadian dollar which is driven by natural resource prices will remain in the (overvalued) .97/.99 range as oil price continue to drift up (towards $100),
(4)               Inflation will remain above trend, but the BoC has little room to maneuver for higher rates.
(5)               Federal elections are almost certain in the spring; the government’s budget will be, at worse neutral, at best expansionary.

The second part of these predictions is 10 & 30 T-Bill rates.  Demand for CAD sovereign bonds is unlikely to slacken, especially if the federal government remains in control of expenditure and revenue continue on their current (positive) trend.  The 30 year bond will remain below 4%, but is unlikely to drop below 3.5%, the 10 year is going to remain in the 2.95/3.30 range.  The wide range on the 10 year T-Bill is because of my concerns with inflation.

Finally, Obama’s decision to extend the tax cuts has long term implication on America’s solvency.  Since neither Republicans nor Democrats have any interest/desire in cutting expenses, this decision will lead America to ruins.  It will probably take some time, especially since the US Dollar is a reserve currency, but the damage from this government massive operating deficit, will eventually have to be addressed.  Canada has to think long and hard how it addresses this risk.  My suspicion is that it is this risk that keeps Mark Carney up at night…

Friday, December 10, 2010

Canada Vs. USA 30 year bond rate differential

For a first hand look at the impact of Keynesian fiscal and monetary policy:

20 year look-back at the differential interest rates on 30 year T-Bills in Canada and the U.S.  In 1994, the Canadian government facing a budget deficit of nearly 10% of GDP took drastic action, and cut governmental spending dramatically, which resulted in federal government surplus between 1999 and 2007, which is reflected in the confidence shown by Canadian bond holders.  

As of 2002, Canada has seen its 30 T-Bill trading inside the American government's rate, and the trend appears to be accelerating.  Canada's Bank of Canada is convince that fighting inflation is difficult and requires persistent effort on the part of the government of the day and the central bank (Compared that to Bernake's 60 minute comment of last Sunday).

Over the past 3 weeks, the trend has gotten even more pronounced, one suspect that the market was buying the rumor of QE2 and "selling the news" ever since (especially since the market was expecting/hopping for a bigger number than $600 billion).  The swap rate on 30 years T-Bill has risen by nearly 70 bps since QE2 was enacted.

Canada is the only OECD country pushing for restrictive monetary policy (ok not very restrictive).

Canada’s trade deficit shrinks

There is less here than meets the eye, unfortunately!  Canada's merchandise exports rose 3.1% to $33.8 billion in October, on the strength of industrial goods and materials, as exports of precious metals and copper ores reached record highs.  Exports of agricultural and fishing products as well as automotive products grew in October. In contrast, declines were recorded in exports of machinery and equipment and energy products.  Oil exports continue to grow, but natural gas shrank.

The end result is that exports rose by 3% while import only grew by 1.2% (volume was up 1.7% but prices declined by 0.5% -- which speaks volume about the “inflation risk” in the U.S.).  So Canada’s October trade deficit narrowed to $1.7billion from $2.3 billion in September.  One sector which saw tremendous growth is the automobile parts business, which saw a 3.5% increase in October, but this is after an 11% decline in September… these numbers have to be taken into perspective.  Moreover, this segment of the export market has nothing to do with “Canada’s performance” the auto segment in North American is 100% integrated, the driver here is entirely driven by America’s demand for new automobiles.

In terms of overall trade flows the interesting aspect is that the Canada /USA trade is moving swiftly towards balance (which should eventually help in the event of anti-trade legislation in Congress – It is harder to invoke “unfair trade” when the flows are roughly balanced…), Canada’s trade surplus with the U.S. has shrunk from $1.4 billion in September to $1.1 billion in October.

Thursday, December 9, 2010

Financial System Review – December 2010

Twice a year the Bank of Canada undertakes a review of the major risks facing Canada’s financial system, being the arbiter between a small open economy and the rest of the world, the Bank looks at where the “trouble” could emerge.  The December commentary (here) makes for somewhat disturbing reading.

The BoC has three main concerns:  First, Europe’s debt market disintegration, second the growing “imbalances” across the world.  Finally, the Bank is concerned with the level of personal debt in Canada.  Their fear is that any one of these three elements could cause a demand shock in Canada, that these risks are more important today then they were six months ago, and that this could have consequences for the stability of Canada’s financial system.

The instability which the BoC refers to is driven first by America’s decision to follow Keynesian “pump priming” fiscal and monetary policies, which at best are only delaying the inevitable, and a worse make the situation even more precarious and difficult to resolve.  Specifically, the BoC suggest that America needs to reduce consumption (increase savings) and that China & Germany (biggest surplus countries) need to implement policies that encourage domestic consumption (Every surplus is a deficit elsewhere).  The Bank’s blunt assessment arises from Canada’s fear (as the U.S. largest trade partner) that it will be caught in the cross-fire of a trade war brewing between the U.S. and China.

Ireland and Greece are already beyond redemption with debt/GDP at levels that will eventually require write offs (ok the BoC doesn’t actually say that, because they cannot). More debt will not resolve the problem of excessive debt!  For those who though the problems would only have to be addressed in 2013 (when the ECB credit facilities expire) as of this morning 100% of the Irish, and Greek bond market’s bids are from the ECB, no one else is buying (see here).  The question is what happens if Belgium and Spain get sucked under (each accounting for more than 10% of Europe GDP – and with bond markets beyond the ability of the ECB to intervene).

The third element of the Bank’s worries gravitated over the level of Canadians’ indebtedness.  It has been widely reported that Canadians continue to borrow more quickly than their incomes are rising (partly fueling a very “healthy” housing market).  This is the one puzzle piece over which the Bank has some ability to affect changes.  I would not be surprised; following discreet conversation between the Bank and Canada’s banking executives, if there was not some tightening of lending standards. If this doesn’t work, the bank can always force Canadian banks to increase reserves.  Their final tool, and the bluntest, would be for the Bank of Canada to raise interest rates, although in view of the global weakness, this tool is probably off the table until March 2011.

New home prices up again!

The resilience of the Canadian housing market is at times astonishing.  According to Statscan, new house prices "edged up again in October".  Year on year data shows that new house prices rose by 2.4%, which is in line with general inflation, and marks the 3 month in a row where prices rose.

Canada's housing sector remains very healthy, and the new home segment is just a further indication of its health. Mortgage securitiziation (that plagued the US housing system) was not prevalent among Canada's largest banks, only the secondary players in Canada's housing market availed themselves of this option (since they didn't have access to retail deposits).

Moreover, Canada mortgage registration system is very different than in the U.S., so none of the American problem could occur -- there is a central registry (in each province) of all liabilities against a property, and there is no concept of limited recourse borrowing in Canada's mortgage market.

As I often discussed, the progression of house prices in Canada going back to 1987 (using the Economist model) show that Canadian house prices are still lower (200) in Canada than in the US (250 FHFA or 225 Case Shiller), moreover, whereas income has been stagnant in the U.S. it has been rising in Canada (high correlation between Income and house prices).

Wednesday, December 8, 2010

Very Strange

Several months ago, I added the Google Analytic functionality to my blog. The idea was to see who read my stupid thoughts.  I began this blog principally as a way of formulating my ideas outside of work environment.  Although my clients like to know what I think about Canada’s economy, they usually have their own economist on staff that will tell them their own view of the world.

I started this endeavor because so little is written about Canada and its economy (aside when there is a big buyout as was the case a few weeks ago).  Until recently, I averaged between 5-15 readers per day.  I don’t publicize this website, and I keep it intentionally anonymous.  Not because I speak of my work, in fact I never even cite my own firm’s research (not that it’s not good, it’s just that I only take publicly available information – some research I access is proprietary, to avoid problems I maintain a complete embargo).  Over the past few days/weeks (actually it stared November 15) the web traffic to my website has grown dramatically, I’m not talking about from 5 to 10 readers per day, I’m talking from 5 to 75 readers per day.

I though I should give you my biases:

  • I consider myself a terrible market economist.
  • I’m more often wrong than right
    • I was right on inflation for 2010 (Stay muted throughout 2010)
    • I was too optimistic on GDP growth for 2010 (0.2% too high)
    • I was wrong on capital market performance (market did great)
    • I was wrong on energy costs (they rose)
    • I was wrong on potential for early federal elections (didn’t happen)
    • I was wrong on the US midterm elections
    • I never thought that gold would hit $1,400 in 2010 

  •  I tend to be excessively bearish (I’m working on this)

  • I consider Canada’s economy marginally successful, but compared to the rest of the OECD, Canada is      a paragon of virtues.

  • I suspect that Canada will face stagflation in 2011 and maybe 2012

  • I believe that the Euro will not survive (in its current incarnation) beyond 2012

  • I believe that the US is facing massive fiscal problems.

Anyway, thanks for reading!

PISA 2009 Ranking

Today, the OECD published the PISA 2009 ranking of 15 year olds (Report here).  This takes the scores of students across the nation and compares them to other countries.  The reason we are making a fuss about this in Canada is that our ranking are high.  Of course some of the data is less useful than other pieces.  As an example Shanghai dominates all three tested areas (Reading, math and Science), with a population of nearly 20 million, it is a fair comparison with Canada in terms of population, but not an accurate representation of China (which is probably correct) since Shanghai easily compares with any first world (maybe exceeds) capital city.

Before looking at Canada a few comments about the US (its ranking remains unchanged -- in reading the one tested for the past 10 years) over the observed 10 year period.  

  • America, in absolute term, has the most expensive schooling system, the US spends more per student then any other country observed (except for Luxembourg, go figure).  
  • America has the most educated parents
  • Disadvantaged student numbers are about the same for the US than for other countries tested
  • America has the 6th largest emigration population 
  • At the top end of the curve, Americans are better at reading, but poor at math and science
Canada, is a very different story.  In fact, its "Top 10" position is very new, in the 1980s and 1990s Canada was not considered highly in international ranking.  It some strange and quirky features:
  • The Canadian system is also internationally distinctive for its efforts to balance respect for diversity of language and religious affiliation with province-wide educational goals.
  • Canadian children are more likely to read "for pleasure" than in any other OECD country
  • Centralized testing only began in the 1980s,
  • Although province control education, standards across the country are very similar (Federal government has no role in the education system).
  • High success level with immigrants' children.
  • Spending on education has not changed (as a percentage of GDP) over the past decade.
All this indicated two things:  (1) Money is often not the solution, (2) the US federal education department could be abolished (assuming that the states take over).  One massive difference between Canada and the US (despite the Federal Education Department) is the wide gap in standards between states.  Moreover, the politicization of the education process in the US.

anyway, interesting stuff

Tuesday, December 7, 2010


 By David Rossenberg (Gluskin Sheff)

An extract of David's Letter of December 7th 2010.  
There was little doubt that the Bank of Canada was going to stay on the sidelines at today’s policy meeting and provided a strong hint that the rate-hiking cycle was a three-strikes-and-you’re-out affair, just as the V-shaped recovery in the Canadian economy was a three-quarter bounce-back. Economic growth is slowing below forecast at the current time and underlying inflation is hardly an issue either. Moreover, the “output gap”, which measures the degree of excess capacity in the broad economy, remains high at 2.9%, though nowhere near the deflationary 3.6% levels prevailing in mid-2009.
As it turns out, and despite my earlier doubts, the Bank turned out to be 100% correct in hiking rates early as to defuse what was possibly becoming a housing bubble in Canada. So far, it looks like it has let the air out of the balloon gently without having to burst it.
There’s never a reason to become complacent, but hopefully the folks at the Bank of Canada will take some time to reflect on their success. After all, this gathering of the monetary policy clan occurs after the release of two of the most important pieces of economic data that underscored just how well the Canadian macro landscape is performing, particularly in light of the turmoil in so many other parts of the world.
Think about that for a second. The Bank of Canada did not triple the size of its balance sheet. In contrast to most of the major central banks around the world, from the Federal Reserve, to the Bank of Japan, to the ECB, to the Bank of England, the Bank of Canada never did embark on a course of jeopardizing the sanctity of its balance sheet through quantitative easing measures. And here we have Ben Bernanke on 60 Minutes already contemplating QE3.
The Bank did not allow policy rates to stay near-zero indefinitely, having boosted them three times since early summer. The Bank has not ratified a depreciating currency to stimulate the economy either. The Canadian dollar has actually been remarkably stable in recent months despite all the global financial and policy crosscurrents. In addition, the Federal government did not make repeated attempts to sustain growth as has been the case south of the border. We see just how fragile the U.S. recovery really is now that the entire outlook comes down to whether a tax cut that always had a 10-year shelf life should be extended. So, even without all the massive doses of policy steroids that seem to keep the U.S. economy afloat, it has been the Canadian economy that has been the one to not just reclaim but actually pierce the pre-recession peaks in both employment and real output.
Not only that, but we are starting to finally see some signs that Canada is catching on to classic ‘supply side’ economics, which will lead to a more sustainable growth path than the government and consumption-led model the United States is attempting to nurture through its ongoing array of Keynesian-style demand policies. In fact, it was the lingering weakness in the U.S. economy that was the principal cause of Canada’s low 1% annualized GDP growth rate in the third quarter. If not for a sharp deterioration in our net exports, real GDP would have actually posted an impressive 4.5% expansion.
The key factor behind this performance is business investment in machinery and equipment, which surged at a 28.7% annual rate and on the heels of a 32.7% run-up in the second quarter and a 17.8% boost in the first quarter. You have to go back at least 13 years to see the last time Canadian companies made this sort of spending commitment to the economy. Capital spending, of all the major components of the economy, is the one that exerts the most durable and perpetual impact on the economy, via job creation and productivity.
While Canada has lagged the United States for much of the past decade in terms of productivity performance, it is looking increasingly as though we are on the precipice of an important reversal. Productivity growth, while still low, is showing signs of accelerating, as one would expect with business capital spending rising as a share of GDP for three quarters in a row, and at nearly 9%, heading close to a record high. Our research shows that there is about a 4 to 5 quarter lag before stronger productivity growth begins to kick in and this will be crucial in future Bank of Canada decisions if it means that Canada’s non-inflationary growth potential has improved. Based on some preliminary in-house research of our own, it looks as though the positive supply-side investment shock that Canada is now experiencing could soon result in Canada’s “potential” GDP growth rate rising into a 3-4% range which would be very constructive for return on equity, the long end of the Government of Canada bond curve as well as the Canadian dollar.
Indeed, some early and positive signs are coming to the surface. Think about it. Over the past year, the Canadian economy expanded 3.4% and yet this growth performance still managed to coincide with a decline in the “core” (excluding food, energy and indirect taxes) inflation rate to 1.1% from 1.3% a year ago.
The reprint is because, David said it best, and I need to acknowledge his thought process


What happens to Canada if the US gets into real economic trouble?

Last night president Obama made a deal with the GOP to make the Bush tax cuts permanent.  Sure the extension is for two years, but the employment situation in American will not improve (estimates are for unemployment rates to drop by 0.3% and 0.6% they are at 9.8% now) and the likelihood that Obama will win a second mandate (there could even be a challenger for his job) appear much lower.  Democrats feel betrayed (he ran on a platform of no extensions), and independents now realize that the GOP has the real power so may as well give them the whole thing after all!

Republicans are very bad at cutting spending, Social Security, Medicare and Defense are off the table for the GOP (in view of their supporter’s demographics and philosophy), problem is that with interest expenses these four items account for 77% of the U.S. government total budget.  Moreover, healthcare costs are rising at more than 4 times the rate of inflation.  Renewing the "Bush" tax cuts (rechristen "the tax cuts" since they are also Obama's now) sends the Federal deficit the 10% of GDP threshold, the same as Greece.

Now America is not Greece, but eventually the reality of massive deficit will hamper America’s ability in financing its deficit.  My guess is that Canada has about a decade before things come to a head.  Canada has been warned – America will not take any strategic decision unless its back is against the wall. 

Should Canada economic policy encourage exporters to diversify export destination away from America

There are a number of step that the Canadian government can take, most will actually generate savings:

(1)               Instruct Canada’s Export development Corporation that it should apply more stringent solvency tests when dealing with American Importers.
(2)               Facilitate the growth of trade with Asia (which is already occurring).
(3)               Provide “translation” grants so that Canadian corporations can offset some of the foreign language translation costs.
(4)               Improve the scope of Canada’s trade missions in Asia 
(5)               Promote the construction of an additional pipeline to the West Coast to support the export of Oil and gas products to other markets (instead of building an additional pipeline to the US).

Language barriers are a key issue for Canadian corporation dealing with non-North American consumer.  Moreover, the focus of these efforts can be limited to manufactured goods, since raw material and energy are fungible.

Thankfully, America’s elected officials are almost certain to help in this process.  Anti trade legislation is making its way through congress, with broad support from both parties – who have different constituencies but similar agendas.

Canada has a decade to reduce its dependency on the American market, already over the past 15 years the importance of America as our trading partners has grown for 2/3 of all exports to ¾.

Soft Commodities: Wheat

Winter has finally arrived across Canada, and the Agricultural department finalized the harvest number for the 2010 season.  First, production is down 4.6& (global) against 2009, most affected was wheat which saw a 15% drop in production.  The canola harvest was also well below the 2009 level (-20%).  Obviously, the markets were already well aware of the “projected” production for 2010, add to this the very poor season in Russia (intense heat and fires) and the high wheat prices are easy to explain.

At 9 am the bank of Canada’s rates decision will be announced, rates at 99% certain to remain at their current 1.0% level.

Monday, December 6, 2010

Canadian Interest rates

This is an easy one, tomorrow (Tuesday) the Bank of Canada will announce that interest rate remain unchanged, and will remain at 1%.  The BIG question tomorrow is for how long they will stay there?  It is generally assumed that the rates will stay where they are until March  2011, but after that there is a wide range of opinions -- all they way from a possible cut in interest rates -- because Canada's economy is slowing, to the idea that rates could be as high as  2.25% by the end of 2011.

Personally, I have no opinion, frankly there are too many external  factors at play here (decision over which Canada's main actors have no input -- are price takers).  First, commodity prices (Copper, Oil and Gas etc) are high and rising, that has an immediate impact on the Canadian economy -- since so may of our exports are raw material (or at the very least lightly processed).

Our giant next door is another issue, there is a growing possibility that the congress will not agree to the extension of the Bush Tax cuts -- its improbable, but not impossible. If the tax cuts are not renewed the impact on the US economy could be important (however, the extension would also mark the U.S. as one of the countries with the highest deficit  - as a percentage of GDP).

If the "emerging" economies are indeed slowing, weak global growth translates into a drop in energy prices, which means higher "imported" inflation for Canada (lower CAD will add to inflation )....

That most market economists disagree as to where rates are going speaks volume as to the perceived direction of Canada's economy.  They key facts are as follows: (1) The economy is weaker than the BoC wants, (2) Canadian dollar is stronger than it should (3) inflation is higher than desired, and (4) housing will depress GDP growth over the next 18-24 months -- a result of an overbuild during the 2008-2009 period.

Anyway, it matter not so much, the 2 year swap is still assuming a yield of 1.63% down from 1.75% a few weeks ago.  The long end (30 year) has hardly moved -- so expectation are only on the shorter end

Friday, December 3, 2010

Canadian unemployment dropped to 7.6%

Apparently in November America created only 39,000 jobs (market was hoping for 150/200k), whereas in Canada 15,000 were created (Canada’s economy is roughly 1/10 that of the U.S.). Canadian unemployment rate drop to 7.6%, mainly because of a drop in the labor force, mainly because of youth participation dropping (a seasonal factor).  Over the past 12 months, nearly 318,000 jobs were created (+1.9%). 

(Source: StatsCan)

Underlying numbers were less stellar as all the growth in jobs was from part time work, full time employment actually declined:  Not entirely surprising the bulk of the cuts came from the manufacturing sector – even when the economy recovers it is more than likely that manufacturing is permanently displacing workers (as attested by the dramatic (+30%) surge in plant and equipment investments over the past 2 quarters).  Services (Insurance and finance were also targeted)

In terms of regional differences, the biggest winner was Ontario, with Quebec and Manitoba loosing employment.  The other showed virtually no shift in employment.

The most interesting aspect to emerge from the data is that number of hours worked rose by 0.7% (which is good) and wage bill rose by 0.5%, another indicator that the economy is doing well.  

(Source: national Bank of Canada)

What is hurting Canada’s open economy is the strength of the Canadian dollar that is once again flirting with parity this morning – the two most important factors affecting the Canadian dollar is the price of oil and the S&P 500 (positive correlation in both cases).  At the very least the employment picture seems to support a stronger GDP (than in September) for the 4th quarter.  Income is growing; obviously the employment picture would be better if it were full time jobs that were created.  Finally, Canada’s 7.6% unemployment rate is still elevated, but the recovery is proceeding well.

[Note:  Canadian Unemployment Statistics:  American and Canadian unemployment levels are measured differently, in a like for like comparison, 0.9% must be removed from the Canadian figures to compare “apples with apples”]

Thursday, December 2, 2010

Why I'm talking Smack

Basically, as the year winds down there's little economic data which is of interest. I don't talk about companies performance, although the three Canadian banks which have reported results did OK.  Finally, and out of boredom, I found that the two most popular blogs I wrote over the past year (total 143) are:  U.S. Level 3 Assets and the Chinese "64 million" apartments.

Go figure, I focus 99% of my energy on the Canadian market and what get the most airplay are two non-Canadian topics.   What shame!  Which reminds me that I'm about to start doing research on Level 3 assets again.

Amazon Rules!

Who goes to the stores anymore?  Tuesday after I called my sister to wish here a Happy Birthday, and at the same time she asked, can you order a specific DVD for me?  She doesn't live in Canada, hence the request.  So Tuesday afternoon I order this DVD, and it arrived a few minutes ago, total time 36 hours.

My question is why would anyone go shopping when your fingers can do the job?

Let me know: frozeninthenorth at gmail doc com

Surprise! 93% of market economist believe that BoC will keep interest rates unchanged next week

Not making this up, Canada's respectable Financial Post wrote an article that indicated that 93% of market economist "believed" that interest rates were going to remain at 1% next week when the board of the Bank of Canada meets. 

Part of the problem is that the article is about Canada's "economist" when the journalist really doesn't address the fundamental problem for Canada next week:  Weak 3rd quarter GDP numbers, with negative GDP growth in September, and very high producer price inflation.

What could have been interesting is th discuss the dilemma faced by the BoC; price stability is core to its mission (BoC is not independent from the Canadian government's policy -- as the latter can overrule the decision of the bank), and there are serious worries there.   Service inflation is substantially above the core target, and has been for some time, the core CPI is on the 2% threshold,  but CPI (including food & energy) is above that 2% target. It is widely assumed that there will be some feed trough of producer prices, and these are very high at more than 5.8%

The writer's only saving grace was to mention that the BoC would probably refrain from raising interest rate until early 2011 -- but then, it's more than obvious since that would coincide with the BoC's next board meeting.  the failure here is to make the readers believe that Canada's "market economist" have some kind of magic 8-ball available to tell them the actions the BoC will take. Sloppy journalism, on an important topic.  Although I guess that if you are uncomfortable with your subject -- interest rate policy, talking about what other people believe is the easiest.  

My take on interest rates:  The BoC is waiting period derived from the main economic indicators:  
  1. The BoC will be glad that industry is investing heavily in plant and equipment, and indication that Canadian companies are taking the CAD/USD parity issue seriously, and not as a temporary issue (should lead to improved productivity).
  2. Energy & food inflation are peripheral issue for the BoC, with a perception that we are nearly done, and that it will have limited impact on the economy (some of the increase in price will be absorbed by a stronger dollar -- which is deflationary)
  3. Housing is set for a correction, especially if the Asian slow down is for real -- this could provide the BoC's with some support (but this outcome is the opposite of higher energy price risk).
  4. Canada's economy is slowing much more quickly than the BoC had "anticipated" earlier this year.  However, most of this slow down has been caused by external factors (exports) over which Canada has no control.  The BoC's fear there will be that higher interest rate will put additional burden on Canada's economy (although everyone recognizes that current interest rates are very accommodative).
Certain of these factor cancel each other out.  But for Canada, as a very open economy, the BoC will be looking at external factors.  Should the much discussed Asian recession fail to materialize, then the BoC will consider raising rates by 25-50 bps over the next 6/9 months.  

Note that if U.S. interest remain at the current 0.25% and Canadian rates go above 1.25%, this would be the largest EVER interest rate differential between Canada and the US -- such differential has huge implications for Canada. 

Wednesday, December 1, 2010

Non-Economic rant: Tom Flanagan and his Fatwa against Julian Assange

Tom Flanagan is was a senior advisor to Stephen Harper Canada's Prime Minister.  On Monday, he joined Aytollah Khomeini (against Salman Rushdie for his book) in proclaiming a "Fatwa" against Julian Assange (the Wikileak guy), and that he should be killed.

is words were:  
I think Assange should be assassinated, actually," Flanagan said with a laugh, and when asked to expand upon his answer, added that he "wouldn't be unhappy" if Assange "disappeared."
When the CBC's Solomon commented that his position was "pretty harsh stuff," Flanagan, who is known for his off-the-cuff sense of humour and often brings props to panel interviews, replied: "I'm feeling very manly today, Evan."
   (Source: here) 

Now Flanagan is part of Harper's inner circle, originally from the University of Calgary (don't laugh it’s actually a good school).  This guy has been professor of political science since 1968, so the man knows "what is what", and yet he went on national TV and said something so incredibly stupid and unwarranted, that it begs the question: Is this guy for real?

There are a few issues here: First, Wikileaks revelations are mostly embarrassing, the kind of High School bitchy gossip comments about all kind of worldly politicians.  Second, Assange has probably not broken any laws, contrary to what some believed, Assange did not commit treason, since he's not American he owes no allegiance to America!

What it does expose is a streak among certain politicians to deal with dissent in a way that is at the extreme opposite of our democracies are about.  Mr. Flanagan's comments would be acceptable in a repressive regime, but here this is not the case. 

The most charitable way of looking at this incident is that he’s an out of touch angry old man.  Less charitable is that is the kind of guy who shoots the messenger!

Amazing Analysis of the European political / economic landscape

Prof Pettis


Some "Money Shots"

"For ten years I have used mainly an economic argument to explain why I believed the euro would have great difficulty surviving more than a decade or two.  It seemed to me that the lack or fiscal centrality and full labor mobility (and even some frictional limits on capital mobility) would create distortions among countries that could not be resolved except by unacceptably high levels of debt and unemployment or by abandoning the euro.  My skepticism was strengthened by the historical argument – no fiscally fragmented currency union had ever survived a real global liquidity contraction."
 The point I was trying to make in the passage is an obvious historical one – that the resolution of Europe’s crisis will inevitably involve a difficult political debate over apportioning the cost of the resolution.  In one of my favorite history books (The Financial History of Western Europe), Charles Kindleberger argued that the political structure of Europe after the First World War guaranteed that different economic interests would necessarily struggle over income distribution.
When it came to deciding how countries would adjust to currency and debt misalignments of the 1920s and 1930s, the main issue, according to Kindleberger, was “whether deflation and unemployment would saddle a major share of the load on the working class, as contrasted with the rentier.”  He goes on: “Keynes observed in 1922 that the choice between inflation and deflation comes down to the agonizing outcome of a struggle among interest groups.”

Read the full blog, really worth it!