Forecast mostly sunny, slight chance of a calamitous crash

Nobel-prize-winning economist Paul Samuelson once quipped that economists predicted nine out of the last five recessions. With that in mind, Yukonomist won't make any predictions for 2010.

Nobel-prize-winning economist Paul Samuelson once quipped that economists predicted nine out of the last five recessions.

With that in mind, Yukonomist won’t make any predictions for 2010. But, as we wait to see if the global financial crisis peters out or gets even worse, here are a few things to watch for.

The first is continued uncertainty. There will be lots of “news” and economic forecasts, some positive and some negative. But the only thing that’s certain is that most of the prognostications we hear from politicians, economists and taxi drivers will be wrong.

The current consensus outlook for the Canadian economy is mildly positive, with expectations of solidifying economic growth in 2010. The Bank of Canada summed it up in its usual turgid way in December: “While significant fragilities remain, global economic developments have been slightly more positive and the global outlook has improved modestly.”

But since no economic forecast is complete without an “on the other hand,” the Bank provided this caveat: “Overall risks … are tilted slightly to the downside.”

Bay Street analysts, who watch the loan loss performance of the big Canadian banks carefully, have also suggested the worst may be almost behind us. Scotiabank’s analysts believe loan loss provisions are now at peak levels, with declines coming in later 2010.

In addition to economic growth forecasts and loan losses, exchange rates will be high on the agenda in 2010. The Canadian dollar is fluctuating within striking distance of par with its US counterpart. That is up significantly from around 82 cents at the end of 2008. While this is great for trips to Juneau, it puts heavy pressure on the politically influential Eastern Canadian manufacturing sector.

This brings up the US dollar. To us, the Canadian dollar may seem to be on steroids. But in fact, it has risen only modestly against other currencies such as the Euro. What is really happening is a slide in the US dollar. This is to be expected from an economy which needs to consume less and save more.

The outlook for the US economy, a decisive factor for our own, is also highly uncertain. On the one hand, house prices and unemployment appear to be stabilizing in many regions. TheEconomist magazine reports that the ratio of house prices to rents, a measure sort of like the famous “price/earnings ratio” in the stock market, has fallen back to more normal levels.

On the other hand, consumer finances remain shaky and more commercial and real estate bankruptcies may loom in 2010. The US government’s finances are also deeply in the red, with a deficit of over $1 trillion expected in fiscal 2010. Piled onto the Bush deficits and the whopping 2009 deficit of almost $2 trillion, the US national debt is reaching levels not seen since the aftermath of the Second World War (as a percentage of the US economy).

The fiscal policies of the US and Canadian governments will also be hot topics as they deal with their deficits. The Canadian government has rolled out a big stimulus spending package, but now is signaling a period of retrenchment in order to reduce the deficit. You can expect tighter budgets for routine government operations and fewer flagship projects, although this won’t be noticeable immediately since many of the stimulus projects have only been just announced and not started.

Prominent Canadian economist Dale Orr has pointed out that, while the Canadian government says it plans no “tax hikes,” its budget documents show large increases in employment insurance fees are planned in coming years. This is effectively an employment tax, although the government is likely to position it as an “insurance premium.”

Orr estimates that each worker will have to pay an extra $632 over four years, with the share paid by employers being a bit higher. The odd thing about this tax increase is that it will discourage hiring in a recession, and will fall disproportionately on lower-paid workers.

Of course it is not certain the moderately optimistic view expressed by the Bank of Canada is correct and that the economy will make a steady, if slow, recovery.

Unfortunately, there is a chance something worse could happen. There are a couple of possibilities that keep policy makers awake at economic conferences.

The first is a Chinese banking crisis. So far the Chinese economy has weathered the crisis relatively well, thanks in part to an enormous stimulus budget. But many Chinese firms are known to be struggling as international export markets weaken. The big question is whether this problem is big enough to take down the state-controlled banks that lent vast sums to large, well-connected Chinese companies over the last few years.

The seriousness of the issue is impossible to gauge from the outside given the opacity of Chinese statistics. Even the politburo may not have robust facts on loan losses and bank stability. But the utterances of Chinese leaders show they are aware of the issue. Indeed, the Communist party’s grip on power depends on providing stable economic growth. A banking crisis would bring that to an abrupt halt. The reluctance of the Chinese government to allow its currency to rise in value, a major irritant for European and US leaders, is likely connected to this issue.

Strong reported statistics, plus China’s enormous foreign currency reserves, give some cause for comfort. But we don’t really know what might happen in 2010.

The other big story in 2010 could be a US debt crisis, linked to a run on the dollar. With the US government borrowing such vast amounts from foreigners, any sort of worry about a dramatic fall in the dollar could turn into a self-fulfilling prophecy. The severity and consequences of this are difficult to predict, and Canada would not be immune.

Fortunately, the chances of this, at least according to current market indicators, are slight.

But you could have said the same about the sub-prime crisis in late 2006.

Have a happy 2010.

Keith Halliday is a Yukon economist and author of the Aurore of

the Yukon series of historical

children’s adventure novels.

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