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The economic landscape over the next decade will see a return to inflation in the U.S., a Canadian dollar above par, a solid run for stocks and resource prices, and the emergence of Asian consumer spending, finds a new economic outlook report from CIBC World Markets Inc.
The report dubs the next decade the teenage years, and like teenagers, it expects financial markets and the economy could be moody and unpredictable early on, but ultimately, grow and mature. It notes that while equities have plenty of room for a longer term rally over the next ten years, investors will have to steer their portfolios to align with a very different mix of growth, both in North America and globally.
Excess leveraging in this decade needn’t mean that deleveraging dooms us to lower potential overall GDP growth in the teen years, only that the composition of both U.S. and global growth has to change,” says Avery Shenfeld, Chief Economist and co-author of the report. “The U.S., and perhaps to a lesser extent, Canada, will become a bit more China-like in the teen years . We’ll see more of a contribution from exports and related capital spending, and less from housing or consumption.”
Mr. Shenfeld expects that greater consumer spending from regions that had been running outsized savings rates over the past decade, particularly China and the oil-exporting economies, will pick up the economic slack from lower U.S. spending. In fact, he believes that a fall in the savings rate in the developing world could add far more to global consumption spending than will be lost in the adjustment to a higher savings rate in the U.S., Canada and the rest of the OECD. The key driver in this will be a drop in the value of the overinflated U.S. greenback.
The report notes that the quantitative easing by the U.S. Federal Reserve Board will continue to be more aggressive than in other jurisdictions and if the Fed decides to ensure the recovery is well in hand before constraining money growth, the weight of the extra dollars will depreciate the greenback both at home, through inflation, and abroad, through currency devaluation.
Mr. Shenfeld expects the U.S. dollar to tumble by 20 per cent on a trade-weighted basis, a move that will see the Canadian dollar averaging stronger than parity in the coming decade. More importantly, he sees a weaker U.S. dollar as the key to unlocking wallets overseas.
Stronger currencies in East Asia and, if there is an unpegging as we expect, in the Persian Gulf oil economies, will be one step toward improving the real purchasing power of consumers in these regions,” he adds. “Moreover, the longer countries like China and India see improving economic conditions, the more households will be confident that their newfound wealth is not ephemeral, allowing them to reduce precautionary savings.”
While U.S. consumers will be cutting back on spending and saving more to pay down debt, Mr. Shenfeld does not expect tax hikes to be the full solution to the growing weight of government debt. He expects inflation may be part of the answer to both the public and private debt excesses of our southern neighbours.
Letting inflation run at five per cent for a few years in the early part of the decade would go a long way to digging the U.S. out of its debt mountain. The debt/GDP ratio has nominal GDP in the denominator-so raising inflation lowers the debt burden. And higher inflation would help stabilize or even boost nominal house prices, key to allowing a return to positive home equity for those with mortgages that now threaten to exceed the house price.
Since Canada< will not face nearly America’s debt burden, nor its underwater mortgages, letting inflation run above the central bank’s two percent target will be much less tempting. A strong Canadian dollar will also dampen import price inflation. Expect an inflation gap to see Treasury yields well above those on Canadian bonds in the first half of the next decade as a result.”
U.S. dollar devaluation and higher U.S. inflation will help boost commodity prices and Canada’s corporate bottom line, particularly given that economic development in the Far East tends to be more resource intensive than the more services-oriented economies of North America.
For the U.S., a weaker dollar will be key to promoting both net exports and capital spending at home, by making “Made in America” less of a cost disadvantage. The weakening of the U.S. dollar prior to its rebound last year had saw net exports account for 20 per cent of 2007 real GDP growth.
For the Canadian economy, these shifts will mean a leaner decade for segments of the economy leveraged to American consumer spending (like automotive equipment, newsprint, lumber for U.S. housing). Reduced Canadian leveraging will also see housing starts average a tame 170,000 in the decade of the teens, after having averaged near 200,000 for the current decade to date. Instead, faster growth will be driven in sectors (technology, materials) linked to either North American capital spending or Asian consumption. Financial services will earn their keep by helping Canadians manage a newly growing pool of savings.
While the Canadian dollar will climb as the U.S. dollar weakens and hurt manufacturing competitiveness, rising resource prices will reignite capital-intensive development of the oil sands, natural gas projects, and metal mines. That will allow private investment spending to increase its share of the economy as governments pull back on public infrastructure. The firmer Canadian dollar will also give Canadian households added import spending power.
“Add it up, and the teen years will, like teenagers, have a lot of drama,” adds Mr. Shenfeld. “And, as unpredictable as teens can be, likely a few surprises relative to these very long-term calls.”
