Wednesday, July 29, 2009

Economic Recovery Will Be Slow

There are some limited signs that some key aspects of our current economic challenges are beginning to shift. Car sales, especially in Western Canada, are again growing but are not back to the boom levels of 2008. Shipbuilding is stimulated by a major purchase from the Government of Canada. Houses are selling and mortgages are being offered. Some areas of retail – especially fast food and cinema going – are also recovering. Oil prices are settling at around $65 a barrel, though are subject to fluctuation. But, as the Canadian Minister of Finance, Jim Flaherty observed, this is not a recovery, these are just “green shoots”. Economic bears can trample green shoots.

There are signs of the bears trampling around the Canadian economy. Manufacturing, especially in Ontario, continues to be troubling. Protectionism, which world leaders condemned at the April G20 summit, continues to grow and is impacting steel and lumber. Some industries face permanent structural change – the forest industries, car manufacture, technology and financial services. There are new regulatory and tax issues facing business – significant new restrictions and controls on banks and financial services, carbon taxation and environmental regulations, new reporting requirements, such as carbon footprint labeling or life-time tracking of animals in the food chain.

It is also likely that other actions of government, required to respond to their growing indebtedness, will have an impact on the economy. Cuts to government services and tax increases, labour disputes over contracts and a significant attempt to raise new funds in the bond markets will all take their toll on the economy. One key outcome of government action is likely to be inflation. The more bonds being sold to pay for the debts and deficits incurred in the attempt to “stimulate” the economies of the world, the more bond buyers will be able to demand better rates of return. As bond rates increase so do base rates and inflation follows. Interest rates for mortgages and borrowing will then rise. As this cycle continues, inflation occurs. Inflation will show or, worse, stall the recovery.

Another possible development is what is known as a jobless recovery. Companies have laid off workers to survive the recession. As the economy recovers and firms begin to see profits return, they realize that they can operate without having to incur the same labour costs they incurred during the 2007-8 boom. The unemployed remain jobless while companies grow. This is especially the case in some service sectors and in manufacturing. As some sectors consolidate – companies merge or acquire their rivals in an effort to grow their way out of difficulties – fewer jobs are required as duplication and inefficiencies are removed from the market.

Banks are cautious and need to continue to be cautious. They have some toxic assets on their books and need to restore their margins and manage their loan portfolios carefully. They should not be lending to people or businesses who have less than a strong opportunity to meet the conditions of their loans. This is a good thing, despite the pressure from governments to increase lending. Responsible lending is the hallmark of sound banking.

It will take time for the economy to rebalance itself, though it is already recovering faster than many predicted in the early months of 2009. What is clear is that recovery does not mean going back to the way it was before the recession. We are seeing is a major correction of the economy and the industries and firms within it. When the next shoe drops – paying for all of the government actions to stimulate the economy – there will be further adjustments. We are likely to see a period of austerity before we see the return of the good times. This is why savings are growing and why the recovery will be slower than many hope for.

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