This is a post from Alex Carrick's blog that covers the Canadian construction industry.

Since 1985, Mr. Carrick has held the position of Canadian Chief Economist with Reed Construction Data's CanaData, the leading supplier of statistics and forecasting information for the Canadian construction industry.

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Construction Industry Forecasts

Notes from Alex Carrick - Jun 29, 2009

Alex Carrick
The Two Biggest Issues for the World Economy

I’m betting that Ben Bernanke, Mark Carney, Jean-Claude Trichet, Mervyn King and others of their ilk – heads of central banks in the U.S., Canada, Europe and England respectively − are having some sleepless nights these day. The global economy is sailing off into uncharted waters that are full of sea monsters and tempests, with compass readings that are no longer accurate and few comely mermaids to guide them.

This is not your tried and true old economy where everyone knew what to expect in a down cycle, followed by a steady and predictable upturn. Not since the Great Depression has the whole world become embroiled in as deep a well of economic grief as has occurred this time around. The financial sector has become wary about funding the revival, plus it is being held back by new regulations that require it to keep much higher capital reserves. Governments are stepping in to fill the spending gap, but this means increases to the money supply that would never have been countenanced in the past.

Then there is the matter of who is in charge anymore when it comes to global economic leadership. The world traditionally looks to the United States. It is no longer clear that the U.S. will be as dominant as it has been previously. The European Union (EU) is just as big a market by population and Gross Domestic Product (GDP). However, the EU’s largest economy, Germany, is seriously lagging in growth expectations due to durable-goods export weakness. The same is true for Japan. Brazil, India and China − three of the four BRIC nations − are large enough to play important roles. Russia, the fourth BRIC member, will continue to suffer until its oil and natural gas export sales improve.

Is China’s Recovery Real?

I would say that there are two big outstanding issues at this time. There is evidence from the Baltic dry index − a London-based measure of costs on world sea shipping lanes − and commodity prices that China’s economy is awakening. But is this resurgence for real or is it rather due to specific government strategy to position that nation advantageously for the future? That is the first question. The second big question concerns how quickly U.S. consumer spending will turn around. Let’s look at each of these in turn.

There is no doubt that China is positioning itself strategically. It is acquiring vast swathes of land around the world, particularly in Africa, in order to ensure supplies of foodstuff should there be shortages as in the recent past. These acquisitions are in the form of lease holdings and contracts for agribusiness operations as opposed to outright purchases.

China is also making investments in natural resource firms around the world. One of these, the high-profile equity position in some of the operations of Rio Tinto, has fallen through, but many others remain intact. Iron ore and coal are of primary interest in order to fuel Chinese steel production. It has to be remembered, however, that Chinese industrial production is increasingly being geared towards its own economy. Exports are important to China, but they are not everything. Germany is the world’s largest exporter.

Another feature to note about the new world economic order is that the BRIC nations are themselves becoming more interdependent under China’s leadership. Here are some key developments. Brazil’s largest export market is China. Petrobras of Brazil, which needs huge amounts of capital to develop deep-water offshore oil reserves in the Atlantic, has accepted a multi-billion Yuan investment stake by China. The largest exporter to India is now China. And last year, Europe surpassed the U.S. as China’s largest export market.

Is China’s Inflow of Commodity Imports Sustainable?

Is the inflow of commodity imports into China sustainable? If not, then commodity prices are likely to drop down again and the recovery phase will be prolonged. The Chinese government, like many others around the world, has initiated a massive infrastructure spending program. If that is what is driving the raw material imports, then the demand is more secure. But if it is mainly speculation and stockpiling, then the outcome is less certain. In the second event, Chinese domestic consumer demand becomes the issue.

The Chinese government has “requested” (i.e. ordered) that the banking system expand its lending. One result has been that new car sales in China over the last several months have led the world, taking over the number one spot from the U.S., where the recession has rendered the market historically depressed. Wireless internet orders in China, as well as in India, are also outpacing everywhere else in the world. China’s domestic demand is on the march forward and, backstopped by the government, is unlikely to be sidetracked.

U.S. Consumer Spending

As for the second biggest issue, there is certainly an element of China’s prospects that is tied to the U.S. consumer. Many analysts are saying that U.S. consumer spending is set for a long dry spell. Household debt has risen way too high. Consumers have switched their priority to saving rather than spending. It will take years to get balance sheets back into better shape to facilitate the confidence that is needed to go on a buying spree. Credit is no longer as freely available as in the past. Home equity as a source of financing has been dramatically curtailed along with the fall in house prices. More on this in a moment.

This highlights one of the frustrations about economics. It is an inexact science, at best. It is true that consumers are likely to be skittish about spending until job prospects improve and employment growth is a lagging indicator in any economic recovery. As for whether or not consumer spending “habits” are really being altered by this recession, that is a different matter. Have you and I really altered our ways? Are we no longer going to try to keep up with the “Joneses” when we are all feeling a little more financially secure?

There are media stories about how people are being more frugal in their spending choices. “Cheap” is the new chic. Despite the recession, for some products, prices have not come down. For example, food items in grocery stores are alarmingly expensive. And when it comes to entertainment and the latest electronic gadgets, who can keep up with all of the choice that is now available, from smart phones to laptops, netbooks, electronic book readers and so on? But has the desire for these been extinguished? Not likely.

Perhaps the most significant factor holding back consumer spending is home prices. These have fallen steeply in many major markets in the United States. Home equity is the bedrock of individuals’ and families’ wealth estimates. New and existing home sales have stabilized at what is hopefully a floor level. The steep drops in home prices are leading to more bid interest in markets that have suffered the sharpest corrections. Foreclosed properties owned by the banks are starting to move again, but more prime (as opposed to sub-prime) foreclosures are expected. Restoring home ownership to its rightful place as the cornerstone of family finances is likely to be a slow process.

The Obama administration’s health care plan, in whatever form it takes to achieve passage, will also play a significant role in the future of U.S. consumer spending. If it results in employees making larger personal contributions to ensure coverage, it will be inhibiting. But if it provides cheaper protection and leads to assurances that medical care will be available in an emergency, then it will reduce the need for rainy-day savings. The bottom line seems to be that the U.S. consumer spending recovery will be stretched out more than in the past, but a good deal more resilient than is currently widely expected.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.


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