Global Economic Report - The Looney Flies High

Fred: Welcome to the Scotiabank “Find the Money” podcasts. I’m Fred Ketchen, Director of Stock Trading for Scotia McCleod. These monthly podcasts call on some of Scotiabank’s most knowledgeable experts to help you make the most of your money. Here we’ll discuss strategies designed to put you in the financial driver’s seat.

In today’s podcast I’m joined by Scotia Bank Chief Economist, Warren Jestin. Warren is going to take us through a number of topics related to the current and future state of the Canadian Economy including the effects of the U.S. sub-prime mortgage crisis and the flight of the loony.

Warren, economic news out of the United States keeps getting worse. The housing market is in recession, there’s evidence the American consumers are pulling back, how bad is the situation in the United States and, tell me, could it get worse?

Warren: It could always get worse if consumer confidence begins to break down from current levels. But you’ve got to remember the U.S. economy is built on services, nowadays, about 80% of the economy is services and there’s a lot more stability in that segment. So the surprise may well be that the U.S. doesn’t go into recession but that it slows down, and it doesn’t speed up for a long time; and, in fact, that’s part of our forecast.. We believe that the U.S. economy will be growing at a very slow rate next year, and probably still be in a recuperative state of mind through the year 2009 as well. It’s going to be a long haul before we get the housing marking going again.

Fred: So far the global economy seems to be holding up reasonably well. In economic terms you call this “decoupling”, are other countries replacing the United States as the primary growth locomotive?

Warren: U.S. slows down; it’s going to affect many countries around the world, China, India, Canada obviously, Mexico. But the important thing is in many of these countries there’s a lot of other things going for them that will keep them in a growth setting. For example; in China, gains of market share globally gains of market share within Asia, the U.S., Europe but also the very, very strong domestic demand. I mean, China is building a New York City every year. It’s building a highway system bigger than the U.S. and effectively its infrastructural investment is going to keep that economy going probably 10% or better. Similar story for India, although not quite as fast, Russia on the basis of commodities; Canada because we’ve got solid domestic demand… consumers are in better shape here than the U.S. We’ve got fiscal stimulus, the U.S. does not have that and, of course, we’ve got a commodity rich country in a commodity short world and that’s bringing in a lot of revenues into the country as well.

Fred: Closer to home, the Canadian economy also looks to be doing reasonably well as you point out, however, we do know that manufacturers are facing considerable challenges. Can Canada continue to outperform its American counterpart?

Warren: I think Canada will edge out the U.S. in performance next year. We don’t think the U.S. growth will achieve 2%, whereas, we think in Canada it will be a little above 2%. You’ve got to remember in the U.S. the problem is in the domestic economy, the consumer and the housing market. In Canada it’s in exports because of the leapin’ loony. We’ve been as high as a $1.10. We’ve been back below parity; my best bet is we’re probably going to be above parity on average through 2008, but what’s really giving us the strength in the economy is the fact that the domestic part of the economy. Housing starts, fiscal stimulus, as I mentioned, things like that are giving us more stability; and as a result we should be able, right across the country, to record growth; faster growth in the west, B.C. and Alberta, slower growth in Ontario and Quebec but growth nevertheless.

Fred: So it’s still best in the west and least in the east, if we can go back to that old saying that you had a couple of years ago.

Warren: That theme has been with us for the last few years, it’s going to be with us probably for the next five.

Fred: The U.S. Federal Reserve has lowered short term interest rates a percentage point and the Bank of Canada has moved twenty-five basis points, are there more interest rate cuts to come here and maybe in the United States, as well?

Warren: Well, as the economy begins to grow on a slower rate, we’re going to see lower interest rates as well; and that’s really the theme. “Slower and lower” is the theme for North America. Slower growth that we’ve seen in the past implies that the Federal Reserve is going to cut interest rates. They’re worried about the sub-prime crisis, that’s still going to be roiling the markets in the first half of next year. They’re worried about the recession in the housing industry and so, from that point of view, I wouldn’t be surprised if another three quarters of percentage point or more cuts in interest rates occur there. Canada, we’re doing better. I mean we’ve got the lowest unemployment rate in three generations. There’s growth across the country and the domestic economy is in better shape. I still think the Bank of Canada is probably going to cut at least once more before they’re through. But definitely U.S. monetary policy is out of sync with central bank policies around the world; and one of the things that, of course, that leads to is probably a lower U.S. dollar against most major currencies.

Fred: Your theme for your current report is the “leaping loony”. After the Canadian dollar’s meteoric rise to a premium vis-à-vis of the U.S. greenback, where remember we’ve had its low back in February, it has pulled back to just below parity. Over the next year, will a Canadian dollar be leaping or will it be limping?

Warren: Well, the reality is that it will be leaping, but it will leaping up and down because we’re dealing in very volatile markets. In fact, that’s one of the constants we’re going to see in the financial markets over the next few years a lot more volatility than in the past and certainly the currency markets are going to be there. We believe that the U.S. dollar is going to come under downward pressure because they simply can’t get their trade deficit under control. It’s too much involved with energy, too much involved with low cost imports from Asia; and in the Canadian case we’ve got some things going for us. We’ve got a more conscious monetary policy, we’ve got fiscal surpluses, we’ve got trade surpluses which are based in the resource sector; and globally, wherever, I travel we’re seen a resource-rich country in a resource-short world and that brings investment into this country. As the investment comes in, I think, the trend in the Canadian dollar is higher. A lot of volatility around that trend but, nevertheless, I think businesses, consumers, Canadians in general, have to get use to the fact that our currency is probably going to be around parity and may well be above parity in the next few years.

Fred: We may go up, we may go down, what really has been and will continue to be in your estimation a choppy environment.

Warren: Very choppy in the financial markets through the first half of next year, particularly as the sub-prime crisis continues to generate unexpected after-shocks. The second half of the year probably a little more stability in the financial markets, a little more certainty but the main-street issues, the problems in the housing market in the U.S. are going to go on well beyond the first half of the year because you’ve effectively undercut consumer confidence south of the border; and when you undercut confidence, people become a lot more cautious about spending.

Fred: To wrap it up, Warren, what do you consider the three biggest issues facing Canadian investors in the year ahead?

Warren: Well, the volatility in the market is unquestionably the toughest thing to deal with because it always makes investors nervous. The financial markets also will be volatile against the backdrop for Canadians of a rising currency. And, of course, from a global perspective Canadians want to be invested and diversified but, of course, if the U.S. dollar is going down that has some short-term pain in terms of their portfolios.

And the third issue, I think more than anything else, is that investors have to come to grips with the fact that globally we’re dealing in an entirely different world. Where the U.S., Europe, Japan, even Canada is in the slow lane, relatively slow growth. Whereas we’ve got emerging economies that are growing four to five times as fast and in there lies opportunity. We’ve just got to be able to seize that opportunity, understand how to take advantage of it.

Fred: Thanks Warren for sharing your views about what these complex factors mean for Canada. We hope that this discussion has helped you better understand those issues that are grabbing headlines these days, what it means for Canada and all of us as investors.

I’m Fred Ketchen, next time join us as we talk about the importance of your RSP in securing your financial future. And for more information, please drop by your local Scotiabank branch, we’d love to have the opportunity to talk with you.