Canadian economic picture far brighter than it appears

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Niccolo and Donkey
Canadian economic picture far brighter than it appears

The Globe and Mail

David Rosenberg

December 6, 2010

The Bank of Canada is nearly certain to leave interest rates unchanged at Tuesday’s policy meeting. Canada’s economic growth is slowing below the bank’s forecast, underlying inflation is hardly an issue and the escalating debt crisis in Europe is just one of several international concerns. These are definitely not the conditions in which to hike interest rates.
But step away from the immediate concerns and the bigger picture looks far brighter than you may realize. Whatever short-term stresses there may be, Canada is doing better than the United States. And a big part of the credit goes to our central bank and our federal government.

Despite my earlier doubts, the bank turned out to be 100 per cent correct in hiking interest rates early so as to defuse what was becoming a housing bubble in Canada. So far, it looks like it has let the air out of the balloon without having to burst it.

While Friday's jobs report did have its share of blemishes, the 15,200 increase in jobs pushed the level of Canadian employment to a new all-time high of 17.23 million. That is quite an accomplishment, especially considering that in the U.S., payrolls are still 7.5 million jobs shy of where they stood before the Great Recession began in late 2007.

Much the same is true of the granddaddy number of them all, Gross Domestic Product. Despite a slowdown in the rate of growth, Canada’s real economic activity hit a record high of $1.32-trillion in the third quarter. Compare that to the U.S., where real GDP is still 0.6 per cent below where it was at the prerecession peak in the fourth quarter of 2007.

Canada has not just reclaimed but actually pierced pre-recession peaks in both employment and real output without having to resort to quantitative easing, massive government deficits or any of the other policy steroids that have kept the U.S. economy from collapsing.

And Canada appears to be building the foundation for faster growth ahead. The key factor is business investment in machinery and equipment, which surged at a 28.7-per-cent annual rate in the third quarter, following strong gains in the previous two quarters. You have to go back at least 13 years to see the last time Canadian companies made this type of spending commitment to the economy.

Of all the major components of the economy, capital spending is the one that exerts the most durable impact on the economy by creating jobs and improving productivity. While Canada has lagged the United States for much of the past decade in terms of improving productivity, we appear to be on the brink of an important reversal. Canada’s productivity growth, while still low, is showing signs of accelerating.

If there is one financial variable that is responsible for this success, it is the Canadian dollar. While a strong currency is a competitive hurdle for domestic manufacturers, because it raises the selling price of their goods on international markets, the loonie's new buying power has benefits for any firm that wants to invest in foreign-made machinery and equipment to boost its productivity.

The stronger Canadian dollar has dramatically reduced the prices of imported equipment and machinery in loonie terms. In fact, the cost of imported capital goods, on average, is about 20 per cent less today than it was a decade ago when the loonie was sinking toward the 60 cents (U.S.) threshold.

Canada’s widespread investment in new equipment is laying the groundwork for future productivity gains. And the fact that Ottawa did not blow a hole in our fiscal situation means that declining corporate tax rates can help nurture an investment-led revival in the economy.

All of this is good news for the long-term outlook for the Canadian economy. In fact, I’m growing increasingly confident that the TSX will continue to beat the S&P 500.