February 17, 2010

Economic update

China will stay in driver’s seat

ALEX CARRICK

Chief Economist, CanaData

China is playing a huge role in the future of the world economy with a correspondingly large effect on North American economies and government policy.

With a 10.7 per cent growth rate in the final quarter of last year, that nation is precariously near “boom times.” That has implications for asset price bubbles and strong price inflation. A $600 billion stimulus package and monetary expansion have been effective. Construction has been strong as has domestic demand for cars and homes.

China will continue to be the world’s largest market for metals, minerals and other commodities. Efforts by the Beijing government to slow down demand growth will be only so-so effective.

A runaway horse is hard to rein in. One major consequence will be Chinese firms continuing their treasure hunts for resources.

Some of this will be by way of acquisitions in other countries, which can become tricky. For example, the Australian government has objected to China taking over some of its major companies on the grounds that such action may not be in the nation’s best interests. Australia is the base for several large supplier firms — BHP Billiton and Rio Tinto — that want to remain independent. That is, if they are to get the highest prices for their raw materials.

Look for Chinese foreign acquisitions to target medium-sized and smaller firms.

This will have implications for Canada’s oilsands region, where Chinese firms are starting to take an interest. Chinese enterprises also want to firm up long-term contracts for iron ore, copper and other metals and minerals. Canada has a major stake in supplying product in those areas as well.

In Japan, the concern is still about deflation.

That means the new government, the DPJ (Democratic Party of Japan), will continue to pursue expansionary policies.

This is a problem, since the Japanese government is the most heavily indebted among all major nations. One likely policy shift is devaluation of the yen. This will lower the price of imports into Japan and make Japanese export-oriented firms more competitive. The “recall” problem that Toyota is having with its rogue accelerator pedals seems symptomatic of a Japanese economy that is rudderless.

In the U.S., the consumer is coming back. Personal consumption expenditures in the fourth quarter of 2009 were +2.0 per cent after reaching +2.8 per cent in the third quarter. This is the result of interest rates being kept so low.

The unemployment rate will stay high throughout 2010, but this will be in spite of an improvement in jobs.

As the number of jobs increases, more individuals who once abandoned searching for work will resume the quest.

However, the increase in employment and, therefore, total incomes will be good for economic growth. In the fourth quarter of last year, U.S. GDP rose 5.7 per cent, the fastest rate of increase since the second quarter of 2003.

The government sector has accounted for this recovery in two major ways — record-breaking monetary stimulus and enormous fiscal stimulus. The Moody’s credit rating agency is already warning that if more is not done to rein in Washington’s fiscal deficits next year and out to 2020, there are risks to the nation’s “triple A” treasury bill designation. The current deficit to GDP ratio of more than 10 per cent is the highest since the Second World War.

The Democrats have just lost one of the 60 seats they need to prevent filibusters in the Senate so government policy is likely to become more conservative.

Tough measures to deal with the deficit – in terms of spending cuts and tax increases — may be hard to achieve with the Republicans lambasting both the evils of big government and intervention.

In particular, attempts to truly reform the financial system seem likely to disappear amidst the partisanship wrangling.

For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog. His personal blog is at www.alexcarrick.com

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