October 20, 2009
"As The World Turns" A Talk of Sense and Sensibility
For over a year now picking up the business section of any newspaper or tuning into television business reports, the news has been as volatile as the markets themselves. Not surprising really, but the noise of all that hyperbole has made it a tad difficult to get a real grasp on what’s been going on.
So those who braved a blustery October morning to head to the Marriott Courtyard to catch Warren Jestin’s presentation were in for a rare treat. Scotiabank’s Chief Economist, who in addition to his 26 years at that bank has worked with the Bank of Canada and lectures frequently at universities, is a refreshingly lucid voice. What he called his “As the World Turns” talk could easily have been subtitled “Sense and Sensibility.”
He began by explaining why Scotiabank, initially among one of the more pessimistic organizations in the financial world, began to change its tune back in June, seeing signs for optimism to believe that the recession may be ending. The sensibility element comes into a very convincing argument that while yes, Canada is in relatively better shape than the United States in no small part because of the banking regulations in this country that now so many seem to envy, the recovering economies of the world will not resemble the ones we knew in the past. So it’s time to think ahead and plan for a very different world. “We are not going back to where we were.”
So if the recovery in the U.S. is not going to be robust, more like a partial recovery and if the U.S. has to grapple with a 1.5 trillion dollar deficit, it’s equivalent to over 10% U.S. GDP. In comparison, Canada’s deficit is around 3.5% of our GDP, a big difference. When will U.S. tax revenue show some growth? Given the tax loss carried forwards, not for a while. Margins will recover slowly and revenues won’t return for a couple of years.
While the automobile sector shows signs of recovery, be forewarned that in 2015, the car market in Canada, the U.S., Europe and Japan combined will have fewer sales than in the last really good year of 2006. Yet, the emerging car markets of China, India, Brazil and elsewhere in Latin America are growing rapidly. Where will we likely see investment? In stagnant markets where labour costs are high? GM, Nissan and Toyota are moving into emerging markets. So the automobile sector will not help Ontario recover.
Overall, by and large interests will stay low into next year — at least until the second half. But there are other factors at work. We’ve been bouncing along the bottom for a while with very low returns on bonds, but investors are beginning to see change. They’ll start talking about a better rate of return and begin to look at equity markets again, maybe getting out of the U.S. dollar assets, maybe going to China, Europe, even Canada. Who knows? But what does that mean? U.S. rates will go up and the U.S. dollar will go down. The sad fact though, by next June long-term interest rates will be going up. The good news is that for well-qualified borrowers, the spreads are coming down. But for marginal borrowers, those spreads remain wide and rates will go higher.
Commodity prices are coming back up and Canada will have a merchandise trade surplus, so expect the Canadian dollar to stay high. The world’s financial markets are more complex and volatile than they were but expect the trend for the dollar to stay high. Mark Carney of the Bank of Canada and Jim Flaherty have been talking about getting the dollar down, but for Dr. Jestin, they don’t have a lot of power unless they adopt extraordinarily bad monetary and fiscal policies. Unlikely.
The big problem for our neighbours to the south is getting the enormous U.S. deficit down. One thing that will undermine the ability to bring down the deficit is the spending on health care. The U.S. spends 16% of GDP on health care. So the options are either substantially higher taxes or deep spending cuts.
There are three megatrends. One, the emerging world is going to be much more important and will change our lives. Two, we’re getting older with major effects on health and social costs. We used to have skills shortages, we solved that by putting the economy in a tailspin. But with recovery we will have those shortages. Job one for the government is investing in skills and education. We need a world-class educational infrastructure. “This is not rocket science, it’s not training more economists, we need people who can actually do something in the world.” The final one is the fact that if we do everything right with carbon taxes and LEEDS platinum buildings, greenhouse gas emissions in 2030 will be substantially higher then they are now, because China, India and Brazil are the fastest growing car markets. The regulatory environment is going to change radically. The good news is that the fastest growth area will be in environmental remediation industries. A lot of jobs will be created. So as the world turns, some good sense and sensibility from Warren Jestin.