There are three things in life that are certain. The first two are death and taxes. And the third? At some point, the U.S. economy will come roaring back. But are we there yet? Probably not. Let’s review the current states of the U.S. and Canadian economies.

A year ago in August, the subprime mortgage monster climbed out of the collateralized debt swamp and started scaring everybody. The problems spread from homeowners to lending institutions, bond insurers and brokerage firms. Bailouts, huge asset writedowns, loan loss provisions and capital infusions have taken over the headlines in media business reports.

Nor is the financial liquidity crisis over. The stock values of Fannie Mae and Freddie Mac have hit rock bottom as investors have lost confidence in their balance sheets. Federal regulators may have to augment their tacit backing of these entities with actual dollar injections.

Housing starts in the U.S. have been bouncing along on the bottom, just barely on either side of one million units, for the past eight months. This is a decline of nearly 60% versus their peak level of 2.3 million units in January 2008. In Canada, the July level of housing starts dropped by 13% from June, to only 187,000 units, giving an indication that the expected market decline may finally be materializing.

House prices have fallen nearly 20% across the United States, seriously cutting into many individuals’ estimations of their own financial well-being. In Canada, market prices are still climbing at a slow rate in nominal dollars, but are falling back in real inflation-adjusted terms.

A major cornerstone of economic growth is jobs. Job losses in the U.S. since the start of this year have now amounted to nearly half a million. This needs to be put in perspective, however. In the last significant period of employment decline (early 2001 through mid-2003), job losses totaled nearly 3 million before hiring started to pick up again. The U.S. unemployment rate (5.7%) is moving up and now stands at its highest level since March 2004.

Employment in Canada remains at a historically high level, particularly in resource-rich western Canada. For example, Canada’s unemployment rate of 6.1% is near a 30-year low. In the latest month, however, Canada did suffer its largest job loss (-55,000) in many years. Some consolation comes from the fact that these were mainly part-time jobs as opposed to higher paying full-time jobs.

Labor markets impinge directly on consumer spending. Retail spending growth in the U.S. has been gradually trending downward for some time. The chief exception is spending on gasoline, where high prices have caused greater than 20% year-over-year sales gains. Retail auto sales in the U.S. are down almost 10%.

In Canada, overall retail sales growth has dropped below +5% in the last two months and auto-sector retail sales are now -5% versus last year. Canadian truck sales to the U.S. market have taken a particular nosedive, falling by nearly 50%, as measured by export sales in the merchandise trade account.

Year-over-year retail sales by building materials suppliers in the U.S. remain negative, but the decline is growing smaller. In Canada, home center and hardware store sales have fallen to +3.5% from a +15% pace two-and-a-half years ago. No wonder the giants in this industry (e.g., Home Depot and Reno-depot) are reporting poorer financial results than they have been used to.

Inflation in the United States is running at an almost 6% pace. Core inflation (i.e., less food and energy) is 2.5%. In Canada, the respective figures are 3.4% for “headline” inflation and 1.5% for “core”. The upshot of the inflation numbers is that interest rates will probably stay where they are for a while. The need for economic stimulus is being counterbalanced by a level of price increase that is somewhat worrying in its rapidity.

This brings us to non-residential construction starts, which are on the decline in both countries. In the U.S., non-residential building starts have declined 7.4%, January to July 2008 versus January to July 2007, and engineering starts are -3.7%. In the three major sub-categories of non-residential building work, commercial starts are -10.7%, industrial starts are -45.1% and institutional starts are flat at 0.0%.

In Canada, year-to-date non-residential building starts are off by one-quarter or 25% versus the same period last year, as measured in both square footage and dollar value. Commercial work has had the smallest drop (-21% in square footage), followed by institutional (-30%) and industrial (-36%). Canadian engineering construction starts are -30% versus last year, although 2007 included one major hydroelectric project in Québec, with no comparable mega project so far this year.

On the upside, the several-years-long decline in value of the U.S. dollar is finally paying off in strong export sales. These are primarily in the areas of some capital goods and agricultural and mining products. In Canada, the increase in value of the loonie has hurt manufacturing export sales. However, the trade balance has been kept strongly positive thanks to high commodity prices, especially in the field of energy.

The Harsh Reality
Economies, given time, have a tendency to self-correct. The harsh reality is that a period of significant slowdown has been needed to take the swagger out of commodity prices.

Earlier this year, the world price of oil exceeded $140 US per barrel. The consequences have been dramatic in several areas: upping the cost of travel; squeezing out other purchasing options; causing a shift in auto sector demand; and exacerbating family financial strains, already at a breaking point due to mortgage-payment commitments.

As a result of the worldwide slowdown, commodity prices are finally starting to ease. This will relieve inflationary pressures. It will mean that central banks can leave interest rates, which are at relatively low levels, where they are for longer. The U.S. Federal Reserve’s federal funds rate stands at 2.00% and the Bank of Canada’s overnight rate is 3.00%.

The apparent prospects are for a continuation of “muddling through” over the remainder of this year. The clear signal for renewed optimism about the U.S. economy (and Canada’s, by way of the usual “slipstream” effect) will be a generally accepted belief that the problems in the financial sector have finally and assuredly been taken care of.

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