A temporary setback (probably)

Data released today show that Canada's GDP shrank at a 1.6 percent annualized rate in the second quarter of the year, its worst showing in seven years. Statistics Canada was at pains to point out that the setback was almost entirely due to the impact of the Fort McMurray wildfire back in May.  But for the sharp fall in crude oil output resulting from that catastrophe, GDP would have edged forward at a 0.4 percent annualized rate in the quarter.

Monthly GDP data for June, also released this morning, show that the bounce-back from the impact of the Fort Mac fire began quickly.  Real GDP rose 0.6 percent in the month, the best performance for any month so far in 2016.  Since oil operations in the Fort Mac area only gradually came back online in June -- recall that residents of the city only began to return around the fourth day of the month -- monthly GDP data for July can be reliably expected to show further gains.

Reconstruction work in Fort McMurray itself will accelerate in the coming months; residents of the worst-affected neighbourhoods are only being allowed to return to the city this week.  However,  it is important not to exaggerate the impact on national output data. Fort Mac is a city of about 80,000 people in a country with a population of 36 million and, despite some of the more lurid headlines at the time of the fire, "only" about 10 percent of the city's buildings were destroyed.

In all it seems likely that the fall in quarterly GDP in Q2 will prove a one-off event, and the media have been careful to report it as such, rather than starting to hype up the possibility of a "technical recession".  Still, there are reasons to be concerned about the underlying condition of the economy.  Although the monthly data for June showed a welcome rebound in manufacturing activity, it remains the case that the "rebalancing" of the economy that the decline in the exchange rate was supposed to encourage -- with reduced dependence on resource exports, especially oil, and a greater contribution from manufacturing -- remains difficult to discern.

Record trade deficits during Q2 speak to the failure of non-oil exports to pick up the slack. Some economists are beginning to muse that it may take another bout of exchange rate weakness to get the non-oil economy going again. With the CAD trading almost 30 percent down from its cyclical highs, it's getting very hard to see why this might be expected to work.  

Will she or won't she?

It certainly seems as if she'd like to.  Fed Chair Janet Yellen's speech at the annual Jackson Hole conference this morning made it quite clear that she leans toward a further rate hike in the near future. Although US GDP growth has been moderate and inflation at the consumer level remains contained, consistent gains in the job market have brought the US economy close to what the Fed would consider to be full employment.

It all comes down to timing.  The Fed is generally (though not always) reluctant to make policy changes too close to Election Day, so a move in November, when the FOMC meets just six days before the polls, can probably be ruled out.  That leaves September or December, assuming that Ms Yellen was trying to signal this morning that she favours further tightening before the end of 2016.  Which is likelier?

Ms Yellen is unlikely to be moved either way by the possibility of a political backlash, if she opts for a rate hike in September.  Hillary Clinton would probably seize on any Fed move as proof that the economy is prospering under Democratic Party guidance.  Donald Trump would no doubt dispute that, but since he has already said that he would quickly fire Ms Yellen (simply because she's not a Republican), his likely disapproval would be unlikely to carry any weight at the FOMC.

What's the downside of waiting until December?  It seems unlikely that the economy will shift course dramatically in the next three months or so. Nor is there any real reason to think that keeping rates on hold through the fall will unleash a sudden burst of inflation.  However, one factor that the Fed may want to take into account is the possibility of Donald Trump actually winning the election.  That could trigger turmoil in financial markets, which would make it trickier for the Fed to act. Moreover, given Trump's stated intention to fire Ms Yellen, a December rate hike would be interpreted as a highly political move, the monetary policy equivalent of flipping Trump the bird.

These considerations would seem to favour a rate hike in September, barring a sudden (and very unlikely) deterioration in the economic data in the intervening weeks.  Absent the looming election, a September move would be a near certainty; even with polling day fast approaching, it still seems the most prudent course to take.      

Stimulus, maybe

A big part of the Liberal Party's winning strategy in last year's Canadian Federal election was its promise to increase infrastructure spending in order to boost economic growth. Specific spending plans (and photo ops) are now starting to appear.  Today we learn from the Toronto Star that the Federal Government will give the Toronto Transit Commission $500 million for essential maintenance and repairs.  Sounds good, but there are a couple of caveats.

The TTC is perennially behind on maintenance, resulting in frequent delays. Just last week one of the newest streetcars in the fleet was derailed by debris on the tracks, causing an all-day shutdown on the city's busiest streetcar line (King Street, if you care). So the Federal money is welcome -- but will it really have the desired effect of stimulating the local economy?

Even as he holds out his hand for the Federal largesse, Mayor John Tory -- who is turning out to be all too similar to the late Rob Ford, only with more polish -- is forcing the TTC to cut 2.9 percent from its already-inadequate operating budget.  It's a much smaller amount than the promised Federal grant, just $20 million or so, but the point is this: to the extent that provinces and municipalities figure out ways to use the Federal money to do things that they would normally have to pay for themselves -- and keeping streetcar lines free of debris is surely such a thing -- then there won't be any real, net stimulus to the economy.  The Feds' scheme is supposed to see lower levels of government matching any new funds from the national treasury, but it's a sure bet that municipalities will find all sorts of creative ways around that.

The other caveat is more specific to Toronto.  The late Mayor Ford so successfully convinced the citizenry that the municipal government was a rats' nest of profligacy that no politician dare even think about raising taxes. Toronto's property taxes -- the main source of municipal revenues in Canada -- are far lower than in any of the surrounding regions.  Starved of money, the city is starting to fall apart.  Elsewhere in the Toronto Star today, we read that the city's principal school board, the TDSB, has a maintenance backlog estimated at $3.4 billion.  The city's social housing authority, TCHC is presiding over a similar deterioration in its buildings.

Toronto is, in the aggregate, by far the wealthiest city in Canada and very much the principal economic engine of the entire country.  Yet it stands to be the biggest recipient of Federal handouts, if only because it can spend so much money so quickly.  As Justin Trudeau and his ministers keep popping up for selfies with the voters at the launch of each infrastructure project, voters in less affluent parts of the country may start to wonder why they have to pay for things that Torontonians need but resist paying for.  

Everything you know is wrong

The last dozen or so years have not been especially kind to the economics profession.  There was the financial crisis that few predicted; the realization that tried-and-true policy measures, both fiscal and monetary, don't seem to work any more; and signs that the consensus belief in the virtues of free trade may be set to unravel.

In truth, it's not all of economics that's having problems. Microeconomics is doing just fine; it's macro that's struggling. While it's not true that "nobody" foresaw the financial crisis, it's true to say that those of us who feared something bad was about to happen back in 2006 or so were relying on gut instinct rather than anything in the textbooks. In the aftermath of the crisis, macroeconomics has taken a welcome and overdue shift towards empirical rather than purely theoretical work, but there's been little progress in devising a robust new intellectual basis for the discipline.

Consider free trade, long a matter of near-universal consensus among economists: the freer international trade is, the better.  Thanks to the concept of "comparative advantage", economists have preached that trade makes everyone better off, even if one trading partner is more efficient than the other in producing absolutely everything.  This belief has driven the development of GATT, the WTO and the various regional trading blocs, including the EU, NAFTA and, prospectively, the TPP.

Yet free trade has become increasingly unpopular in wealthier countries, and not just because of populists like Donald Trump. It may be true that "everyone" in an aggregate sense is better off under free trade, but there are inevitably going to be winners and losers. The textbooks will tell you that the winners can afford to compensate the losers, but in practice, that rarely happens: the losers -- GM workers in Flint, Michigan, seeing their jobs literally heading south -- are left to fend for themselves.

The fault in the textbook logic seems to be this. Demonstrations of the principle behind comparative advantage tend to look at a simplified case involving two countries and two goods -- just look again at the article linked above.  In the real world, however, there's another factor at play: who gets to distribute the benefits. If we think again about the auto workers in Flint, they're clearly the losers when the plant closes, but the gainers are not primarily the workers at the new factory in Alabama or Mexico or wherever it may be. Sure, those workers are better off, but the real winner is the corporation that moved the jobs south, which is now able to produce its product at a much cheaper cost.

In the real world, it's not just about the geography, but about who is driving the process and reaping the benefits.  In the very broad aggregate, the world is better off because GM is making cars in Mexico and because free trade has allowed South Korea and others to muscle their way into the market.  However, the benefits are so unevenly distributed, and the costs so heavily concentrated, that it's little wonder that free trade is losing its appeal.

Let's move on to monetary policy.  Those of us who feared that the Greenspan Fed, with its unnecessarily lax policy approach, was paving the way for a huge crisis were proven right, but the crisis certainly did not take the form that most might have feared.  Printing money would inevitably lead to an inflationary spiral, right?  Not at all right, it turns out -- and as we approach the tenth anniversary of the crisis, we find central banks everywhere pumping ever larger amounts of money into the system in a desperate attempt to spark inflation and growth.

Milton Friedman's famous saying that "inflation is always and everywhere a monetary phenomenon" now seems about as valid as the phlogiston theory.  

There's an explanation for why things didn't turn out as they were supposed to, but it's not necessarily a comforting one as we try to figure out what to do next.  The Greenspan Fed, and Greenspan himself in particular, thought that the low inflation rate the US was experiencing in the early years of this century was the result of a rise in US productivity; in truth, it owed a whole lot more to the influx of consumer goods from newly-industrializing countries. The father of the low inflation era wasn't Greenspan, it was Sam Walton.  Keeping interest rates low in these circumstances didn't generate inflation at the consumer level; it just led to rising prices for both financial and non-financial assets, ultimately putting the stability of the global financial system at risk.

Here's the scary part.  Since we don't fully understand what's changed, we can't find the exit. The treatment for a crisis brought about by excessive liquidity creation has been....even more excessive liquidity creation.  You can still find old-guard commentators out there who shake their heads and warn that all this money slopping around the system is bound to create inflation sooner or later.  Maybe it will, but it seems more likely that unsustainable asset price growth will lead to another financial crisis long before consumer prices start getting out of hand.

The central banks seem to know this, of course.  You can sense that the Fed would like to keep raising interest rates, if only in the hope of having a few shots in its locker when the next crisis hits.  Trouble is, events keep getting in the way.  We may be well rid of some of the supposed economic certainties of the past, but having no real intellectual anchors any more is not a comforting feeling.    

The slow growth era: deal with it!

Interesting piece by Neil Irwin in the NYT a week or so ago, examining the pattern of slow global growth that the world seems to have entered more than a decade ago, and now can't seem to get out of.  As Irwin suggests, nobody has all the answers here;  if they did, it might be possible to fix it.  However, it seems to me that there are a number of worthwhile observations that can be made, only some of which Irwin talks about.

•  An aging population.  It's surely no coincidence that the developed economies with the most intractable low-growth problems are those with the slowest population growth, and hence the most rapidly aging population.  Globally, that means Japan; within Europe, Italy. It's chronically difficult to stimulate an economy full of senior citizens, who are way past the spend-and-accumulate part of their life cycle. Thanks to immigration, both the US and Canada (and to some extent the UK) have somewhat faster population growth than the rest of the developed world, so it's no surprise that they are generally better able to sustain at least moderate growth.

•  Inequality. Sustained economic growth ultimately depends on rising demand, and that in turn depends mainly on consumption, which accounts for over 60 percent of GDP in most developed economies (and 70 percent in the US).  As China is discovering, you can't sustain investment-led growth indefinitely, Rich people have a lower propensity to consume than poorer people, so as income inequality grows, consumption tends to stagnate, and eventually so does GDP as a whole. There's a limit to how much economic activity can be generated by building bigger and bigger yachts for the Larry Ellisons and Roman Abramoviches of the world. 

• Measurement problems. For all the angst over slow growth that Irwin describes, there's no real sense of outright economic decline in the developed world. No visitor to Tokyo, Milan, London or New York is likely to see evidence of rapidly rising poverty. Traditional forms of employment (resources, manufacturing) seem to have given way to a highly service-oriented economic base in a relatively seamless way. This may suggest that the notoriously hard-to-measure services sector is being somehow underestimated in compiling GDP estimates.

• History. It's worth considering that the rapid growth seen globally from the late 1940s to the start of the current millennium may be an anomaly.  In general, economic growth in the long term must inevitably be dictated to a large degree by the growth in the labour force,   Periodic positive shocks can provide boosts to productivity from time to time -- the Industrial Revolution, the spread of electrical power, the information revolution -- but such shocks lose their potency in relatively short order. If we are now in an era of slowing global population growth, and if the major impacts of the information revolution are now behind us, then slow growth might be what we have to live with for the foreseeable future. 

These factors are of course inter-related, particularly in today's globalized economy.  Conventional economic policy measures seem unlikely to offer a way out -- and as the limited impact of ultra-easy monetary policy shows, unconventional steps also seem to have limited value.  Boosting consumption is probably the best way to break the logjam, but that would require raising taxes on the wealthy in order to reduce inequality, and there's little evidence that mainstream politicians are ready to do that.  Economic stagnation gives rise to all sorts of problems (arguably including both Brexit and Donald Trump), but the political will to address the issue seems to be woefully lacking.

   

Let the man rest in peace!

Today a court in Toronto dropped all charges against one Sandro Lisi, buddy and possibly minder of late Mayor Rob Ford. The dismissal of the charges means that the publication ban on the notorious video of Ford smoking crack cocaine has been lifted.

Jackpot! The media are falling over themselves to give the video as wide a circulation as possible. None moreso than the Toronto Star, which has splashed the video all over its website and is taking the opportunity to remind readers of the role it played in bringing Ford down. The reporter who actually did most of the digging, Robyn Doolittle, moved on to another paper more than a year ago, but the Star isn't about to let that little detail spoil the bragging.

What's most distasteful is that the headline on the story is "Rob Ford crack video released at last".  At last?  It's unlikely that most people have been sitting around these many months thinking, "Gee, if only I could see the video of a deeply troubled man making a mess of his life, my own life would be complete".  

There is no real public interest in having the public gawk at this video, and certainly no justification at all for the Star's almost celebratory tone. What the impact is on Ford's widow and young family, who have surely suffered enough over the past few years, can scarcely be imagined. For shame!

Canadian economic data: it's all bad

Bad, bad data on the Canadian economy today: a record trade deficit for June, and an unexpected fall in employment in July, even as the US posted another round of solid employment gains. The lingering effects of the Fort McMurray fire certainly explain some of the weakness, but it's clear that the underlying trends in the economy are not good.

Canada's trade performance in the last three months has been unusually weak. In May, the outcome was heavily affected by the Fort Mac fire, and that impact lingered into June, resulting in the largest monthly trade deficit yet recorded -- the previous record having been set just a month earlier!  Although the value of energy exports rose in the month, thanks to higher product prices, the volume fell.  With things back to normal in the oil sands region (though there has been some extensive flooding in the past week), July should see export volumes return to their usual levels, providing some relief to the overall trade picture.

The key message from the data, however, is the continuing absence of any real evidence that the longed-for rebalancing of the economy, away from its long-standing reliance on energy exports, is actually happening.  To take one example, exports of metal and mineral products, which account for about 10 percent of all exports, are down a staggering 16 percent year-on-year. News from the automotive sector is more positive, with a yearly gain of over 10 percent, but just about every auto plant in Canada is under almost daily threat of closure, with the jobs supposedly headed to cheaper, less union-friendly climes.  It's no surprise that the Canadian dollar weakened sharply in response to today's data release.

The employment data are, if anything, even more depressing than the trade numbers, not least because of the sharp contrast with what's happening in the United States. South of the border, the economy added 255,000 jobs in July, far above the Wall Street consensus of 180,000 -- and more importantly, well above the 125,000 per month pace that the Fed seems to see as the minimum requirement for further policy tightening. And in Canada? A loss of 31,000 jobs in the month, far short of analysts' expectations of a 10,000 gain.

The details of the data make equally discouraging reading.  Full-time employment fell by 71,000 in the month, only partially offset by a 40,000 increase in the number of part-time employed.  The job losses were concentrated at the younger end of the labour force.  The national unemployment rate edged up to 6.9 percent -- by contrast, the rate in the US is stable at 4.9 percent, as the improving employment situation there continues to encourage job seekers to return to the workforce.

It's worth recalling that the Canadian employment data are subject to wild fluctuations from one month to the next: the standard error in the estimate of the number of employees, according to StatsCan, is 36,000, significantly larger than the monthly change reported today. Even so, the contrast between the Canadian and US employment pictures is stark. We wait to see whether the Liberal government's much-ballyhoo'd infrastructure spending plans, which should start to see "shovels in the ground" in the next few months, will finally get the labour market back to a more positive trend.

The Bank of England's dilemma

There seems to be very little doubt that the Bank of England will move to cut UK interest rates when its Monetary Policy Committee (MPC) convenes this coming Thursday. All of the recent economic data -- notably the slew of purchasing managers' indices, but also industrial production data and anecdotal evidence from the retail sector -- all suggest that the economy has taken a serious hit in the wake of the Brexit vote on June 23. Seems all those warnings from economists, business groups, trade unions, the IMF et al weren't just fear-mongering after all.

Bank Governor Mark Carney, when he moved over from the Bank of Canada a few years ago, was widely lauded as the best central banker of his generation. As such, he'll probably be certain of one thing when he announces the rate cut: it isn't going to work.

Cutting rates won't do any actual harm to the UK economy, though a likely further fall in Sterling might be unwelcome news at the height of the summer holiday season. But does anyone really think that the price or availability of money is the key thing holding the economy back right now? In the UK and around the world, the most that can be said after several years of rock-bottom interest rates and money printing is that it has probably prevented things from becoming even worse. The "animal spirits" of entrepreneurs were supposed to be kindled by the enticement of free money; instead they seem to have gone into permanent hiding.

Layer the Brexit vote on top of this weak underlying picture and you have a recipe for real trouble. Markets hate uncertainty, and the Brexit vote has delivered that in spades. If the UK had awoken on June 24 to a Remain vote, all would have been fine: that was the expected outcome, even among the Leave campaigners. If the Leave win had seen the UK immediately exit the EU, there would have been a serious hit to the economy, but the clean certainty of such an outcome would have allowed businesses to plan for the new reality and start to move forward.

Instead of these definitive outcomes, the UK has conjured up the worst of all possible worlds. It is now abundantly clear that no-one had made any real plans for a Leave vote. The new government is making it up as it goes along, delaying the formal start of negotiations while it tries to figure out what it actually wants its future relationship with Europe to look like. Chancellor of the Exchequer Philip Hammond has remarked with remarkable insouciance that it could take six years for the actual Brexit to occur.  That means the next general election will take place with the UK still nominally part of the EU.  If that really is the timetable, there is very little that the Bank of England can do policy-wise to mitigate the damage.

Governor Carney will of course cast any move the Bank makes this week in the best possible light. While avoiding any harm to the economy, he will also be aware that the Brexit supporters are watching him like a hawk.  Carney came under attack during the referendum campaign for having the effrontery to warn about the possible impact of a Leave vote. If he were to fail to cut rates now, and the economic data remain weak -- as they surely will -- the Leavers would be quick to accuse the Bank of subverting the will of the people.

It's a tough situation for Carney, whose non-Britishness is still an issue in some quarters.  What will make the decision even more agonizing for him is the realization that he may be spending his limited ammunition a mite too soon. There are ominous signs that the long but slow expansion in the US economy may be starting to lose momentum. That would weigh heavily on the world economy as a whole, very possibly requiring a new round of co-ordinated central bank action. In cutting rates this week to offset the folly of the UK electorate and its leaders, Carney will be well aware that he may not be able to do much to help out if things really do take a turn for the worse.