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Watching the Economy by Clint Burdett CMC® FIMC

December 2010 - "Out With the Old, In With the New "

(See the August 2011 update of this article)

Two seasoned observers offer advice about 2011.

Mark Carney, Governor of the Bank of Canada in a December 13th speech to the Economic Club of Canada said:

Current turbulence in Europe is a reminder that the crisis is not over, but has merely entered a new phase. In a world awash with debt, repairing the balance sheets of banks, households and countries will take years. As a consequence, the pace, pattern and variability of global economic growth is changing, and Canada must adapt.

For the crisis economies, the easy bit of the recovery is now finished. Temporary factors supporting growth in 2010–such as the turn in the inventory cycle and the release of pent-up demand–have largely run their course. Fiscal stimulus is turning to fiscal drag and, for some countries, rapid consolidation has become urgent. Household expenditure can be expected to recover only slowly. This all implies a gradual absorption of the large excess capacity in many advanced economies.

This is not surprising. History suggests that recessions involving financial crises tend to be deeper and have recoveries that take twice as long. In the decade following severe financial crises, growth rates tend to be one percentage point lower and unemployment rates five percentage points higher. The current U.S. recovery is proving no exception.

In such an environment, very low policy rates in the major advanced economies could be in place for a prolonged period–a possibility underscored by the recent extensions of unconventional monetary policies in the United States, Japan and Europe.

This tendency towards low-interest rates is being reinforced by structural forces. The global economy is rapidly becoming multi-polar, with emerging-market economies now driving commodity prices, representing almost one-half of all import growth, and accounting for about two-thirds of global growth.

He then warns about complacency about low interest rates since healthy economies grow with about 2.0% annual inflation. With low short and long term rates, businesses tend to not enforce best practice and increase their risk when the economy starts to expand. His speech is well worth the read.

Reinhart and Reinhart (Aug 2009) point out that housing cycles are longer in duration than the equity market cycles and are intimately connected with a multi-year credit cycle. Worldwide, expect housing prices for at least ten years to be about 15 to 20% below their peak before the Great Recession.

A credit boom that precedes a credit shock takes at least one decade to build, and deleveraging takes as long. The US at Q1 2010 has deleveraged about 20% of GDP (credit/GDP) of its private debt from late 2007, mostly in housing.

So it ain't over ...

David A. Rosenberg from Gluskin Sheff said about the 2011 human nature risks, my term:

  1. Market sentiment is as overly optimistic now as it was pessimistic at the July August lows.
  2. Eurozone fiscal deflationary shock.
  3. Anti-inflation policy restraint in emerging Asia.
  4. Widespread cutbacks at the state and local government level.
  5. Debt ceiling issue triggers major rounds of market volatility.
  6. Tax breaks that are temporary tend to have marginal economic impact with few multiplier impacts, hence GDP revisions will likely be to the downside post-Q1.
  7. Another downleg in home prices undercuts confidence and spending (with around two years’ supply of total vacant inventory backlog).

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