Great Recession or New Depression?

(Additions made to this post since first posting.)

The Prime Minister’s optimistic remarks about the prospects for Canada to get out of the recession faster than other countries just as the IMF and World Bank were announcing a Great Recession ring rather hollow (though, in truth, if I were in his shoes I would not be inclined to spread further gloom and despondency either.)

It is worth reflecting on what seem to me to be very weak prospects for a quick turnaround, or superior Canadian performance in what may turn out to be not just a Great Recession but a very extended downturn, a New Depression.

First, the financial crisis is far from resolved, especially in the US, and indeed shows some signs of worsening. Credit channels are still seized up in the US, Canada and much of the world. Dealing with this is an absolute pre condition for global recovery – but how to do so is basically not even on the agenda for the coming G-20 summit since the US is still hoping the Geithner Plan will work out. There is , at a minimum, a big risk that it will not, such that valuable time will be seen to have been wasted.

Second, the US housing crisis has not bottomed out, unemployment in the US is rising very rapidly, and the increase in the US household savings rate and the collapse of private investment seem set to overwhelm even the large Obama stimulus package. This is the key point made by Krugman in his latest column. Even if things do start to bottom out, the medium term is very unlikely to see a significant consumer or private investment led expansion in the US. In short, Canada’s largest export market is unlikely to revive anytime soon – meaning no recovery in forest products, auto and much of the manufacturing sector.

Further, even IF there is a US recovery it is quite likely to be based on US dollar depreciation, increased exports and a reduced trade deficit and/or a big dose of additional stimulus which itself would hugely increase the US governemnt deficit and probably contribute to a depreciation of the US dollar. Any US recovery based on a lower exchange rate is likely to leave Canada relatively out in the cold since (1) the Canadian dollar is likely to appreciate as the flip side of US dollar depreciation and (2) the US market for Canadian made inputs to US manufactured exports is relatively much smaller than US domestic consumption of our traditional exports of lumber, paper, autos etc. Also, Canada and the US compete in global markets in some areas.

And still further, a US reovery may well turn out to be public investment led with a low import content due not least to Buy America policies.

My key point is that what we need to drag Canada out of recession is not a US recovery, but a particular kind of US recovery – a major revival of US domestic demand tilted to the kinds of goods and services which we export. I’m not at all sure that this is the kind of US recovery we will see, if we get one at all.

Third, for all of the talk of sound fundamentals here at home, the Canadian stimulus package seems too small to offset decreased domestic consumption and private investment. As Toby Sanger has noted on this blog, the depressing effects of house price and equity declines will likely be significant. And Canadian households seem to be almost as indebted as our American cousins. The recession may have been largely imported, but many of the underlying problems – rising inequality, wage stagnation, debt fuelled consumption – are shared with the US.

Fourth, to date there seem to be only the most tentative signs that demand from China and other developing countries will lead to a resource industry recovery which would stimulate important sectors of the Canadian economy. It is possible that energy prices will begin to rise, and many agricultural prices are still not too depressed, but increased global commodity prices generally come after a period of global growth, not before.

Fifth, at this point we just don’t know how much Canadian productive capacity has been permanently closed as opposed to temporarily idled waiting for an uptick in external demand. To the extent that we have lost export capabilities, especially in manufacturing, a simple external turnaround may have limited impacts.

In short, I’m a bit skeptical of scenarios that would lead to Canada getting out of this any faster than the US or anybody else …. though I would like to be wrong!