Monthly Archive for December, 2008

Outlook for 2009 and Beyond

The outlook for 2009 is unusually certain. The Canadian and US economies will contract over much of the year. The duration of the contraction is difficult to say – perhaps the entire year and perhaps into 2010.  Anyone who forecasts the exact depth and duration is guessing, that is, using the macro models that did not pick up the severity of the deterioration in 2008.

But we can certainly set the limits of the recessionary trends. It will be about a year, or so and the depth is likely to be a several percent.  This would be keeping within the norms of the past. If there are more nasty surpries, the depth and duration would increase somewhat more.

Of course, a depression-like contraction is highly unlikely. The reason it will not tip into some uncontrolled contraction is straightforward: Keynes rules.  First, the central bakers of the world are pouring money into the system.  But as Keynes originally believed, in a serious contraction accompanied by a  pecipitous fall in consumer and investor confidence, governments should directly stimulate demand by increased public spending. Most of the major governments of the planet are doing so or are about to do so. And finally the Canadian government announced it would follow suit. 

The economies will stop falling because the central bankers will use cheap and available money to seduce consumers and businesses to increase spending AND the governments WILL increase spending.  Aggregate demand stabilizes and then starts rising, as does output.  

And no, the Federal Reserve and the other central bankers will not run  out of money, and so therefore the governments will not “run out” either.  Inflation? See below.

As is usual in these cases, media coverage will create the exaggerated impression of the degree of the distress.  Economic activity will “plunge, be in free fall, collapse, fall through the floor or be devastated “.  Then the economy will “crawl forward, inch forward, drift, probe bottom or stagnate”. The recession is likely to be over before the main media notices.

If you want to actually know what is happening, go the the main public statistical websites. Although these statistics are not perfect, there are no more dependable numbers available.

You will also be told repeatedly that the Fed has “lost its power” and that Keynesian stimulation does not work based on the fact that the recession is still underway.  This argument has always been made in past recessions. But no credible scholar ever said these tools work immediately, or even with a precisely defined lag. 

While the Canadian and US economies are likely to fall by similar degrees and perhaps for a similar length of time both with respect to output and employment , the actual distress in the Canada will be less.  This is because employment growth in Canada has been much stronger, as it has been on average since 1960. For example, from 1995 to date, employment in Canada is up about 28 percent and in the US up about 16 percent. Up to November 2008, employment in Canada was still up year over year, while it had already fallen in the US for much of 2008.

This means that while the number of people receiving employment income has been falling in the US, the erosion in Canada has only begun.  When the economies begin expanding again, Canada is still likely to hold the employment growth record.

of course, many persons will suffer severe career damage during this period, especially the young who have just begun their careers or are trying to launch them. There is of course the obvious damage from being terminated from a job you enjoy. But there are other risks.  There are the persons who only took jobs because they seemed like a stepping stone to somewhere else. Now it will take longer to  take that “step”.  That leaves aside the fact that many of these transitional positons were not very well positioned in the best of conditions, never mind today. And of course, many will now to be afraid to move.  As a result, this recession will trap the unwary into jobs they can barely tolerate for the rest of their careers. This is what former recessions did to many of my students, too many.

Others will flee to grad school and not know what to take or what research to do. They then graduate older, poorer and still nowehere nearer their destination, assuming they even had one.

Others will become so anxious they will take any job as a short term survival response.  That might be reasonable in some circumstances, but it should still be the best job available, meaning most likely able to facilitate your next step.  And you should never enter such an expedient job without a careful plan of how to exit to your desired job as soon as possible.  Frighten persons tend not to make good career choices.

For the past several decades, the quality of jobs open to university graduates has deteriorated.  First, most jobs were OK from the point of view of conditions, income and satisfaction, with a few very good jobs and a few which were deadends or slave shops.

Today, the relative number of OK jobs has shrunk, with good and bad jobs both rising in number. In other words, your career is more likely to be bad than OK.  Incidentally, bad often mens working insane hours for a professional wage. [Just do not calculate your hourly rate.] 

As was always true, your best avenue to career success in prosperity or distress is to do the work you love for its own sake.  How else could anyone expect to meet the rising competitive pressures of the global economy? Since this was true in times of strong growth, it becomes urgently true today. What company wants to hire someone adequate given the challenges ahead.  They want excellence, even when they cannot recognize it.

Subsequent postings will discuss strategies for career success in today’s interesting times.


While the outlook for 2008 is virtually a given, the longer term gets truly interesting. Indeed, an understanding of the next several years provides valuable insight for career, investment and opportunities for enterprise and innovation.

Growth in the US for at least the next 5 years will be relatively slow. It cannot be otherwise. Once the economy starts to grow again, the Fed will have little choice but suck the now excess money back to itself.  Otherwise, it will set off an inflationary blowout.  Will it have the nerve to do so, in face of loud opposition? It will of course try to do this in a measured way, but inflationary pressures have their own timetable.  If the Fed responds too slowly, it will put the US dollar under serious downward pressure, provoking another kind of crisis. The most likely outcome over the next 5 years: higher inflation and interest rates than historically normal. That means slower real growth than usual.  Indeed, we just might define a new normal.

In addition, the US deficit will be massive and the government will also have no choice but to reduce it as fast as practical.  As with the Fed, it will be a delicate balancing act.  It will be impossible to avoid raising taxes since the present tax rates cannot support a modern state, never mind one at war. Again, this is a reason to expect slow growth.

There is also going to be massive re-regulation of the marketplace, both in the financial sector and elsewhere.  The failure of the regulatory structure has been so extreme [and so many people are so angry], that the Reagan revolution is about to be undone – emphatically. Those on Wall Street who believe that after the dust settles, it will be back to normal are deluding themselves.  This was just one too many financial disasters.

This still leaves the vexed issue of what the US intends to do with its now nationalized industries in banking and maybe automobiles. There is of course no plan of action yet.

How President Elect Obama plans to execute change will be addressed in a subsequent posting. But it will certainly be government by theatre.

A slowing growing US also creates collateral damage in Canada. However, the diversification of the Canadian economy will be one its key advantages.  When you produce everything from rocks to software, energy to aircraft, your prospects are generally improved. And since Canada’s fiscal position remains strong, there will be no immediate upward pressure on taxes. Compared to the US, Canada’s enviroment for business will be unimpaired. And its past strong employment growth will smooth its path back to growth.  Expect Canada’s foreign trade with non-US markets to slowly grow in relative terms.

I wish you success in the year ahead. Make it your happy new year.



Economic Review 2008

Warning! This site provides competitive advantage to UW students and alumni; other persons must cease reading immediately.

The failure of the global capital markets that began in mid-2007 became systemic through 2008. Not surprisingly, economic activity slowed dramatically in most of the major industrial countries.  At the end of the year, the output of most countries was contracting or about the contract.

The situation deteriorated so swiftly that the world’s central banks and their governments went into full damage control.  Remarkable as this meltdown was, equally remarkable was the coordinated response of the world. Facing a crisis, there was little debate, except for small details.

While the Bank of Canada was responding appropriately, the only government off-side was Canada, whose Prime Minister decided to try for cheap political advantage. This gambit blew up in his face and the anticipated budget is likely to join the fiscal norms of the industrial world by being stimulative.

While we will discuss  how we got into this sorry mess below, let there be no doubt that the financial system, that is the banks, needed to be rescued, and fast.  A modern technologically intensive economy [meaning real people creating real goods and services] cannot trade effectively unless it is sitting on the platform of a smoothly functioning financial system.  It is the lubrication of the marketplace.  Without massive intervention, the financial system would have effectively collapsed and taken the world’s real economies down with it – into distress of extraordinary degree.

Are these bank rescues, bailouts, going to partly reward stupidity, greed, incompetence and some instances of fraud? Yes, but there is no choice. Some of this help will be wasted and some misdirected to the undeserving.  The government of the United States was so taken unawares that it responded with pure crisis management, with no pretense of a plan. And the Secretary of the Treasury is a former Wall Street boy who wanted to tread gently with his old colleagues. This of course  is a recipe for waste and confusion.

The entire argument is reduced to this fact: the financial system cannot be allowed to fail, meaning its major for-profit banks cannot fail.  That is why banks are highly regulated, or supposed to be highly regulated.  And that is how we get into this fiasco.

The great excuse machine in now in full gear.  The financial institutions and their armies of MBA advisors are now claiming that this disaster was impossible to anticipate, like a meteor strike. Yet a financial crisis was anticipated and warnings sounded. The logic was inescapable.

Former students will remember that for at least 6 years, we have had to argue that the course of action of the US economy was unsustainable.  Too much public debt, on top of growing private debt alone dictated a day of reckoning.  President Bush was clearly incapable of understanding the gravity of the situation – actually any situation – and was never prepared to ask for sacrifice for any public purpose, including multiple wars. His original tax cuts removed any margin for error; as was said at the time: “What if something goes wrong”.   A lot was about to go wrong.

No matter the excuses and whining,  the danger of a financial disruption was long known. Massive borrowing, cheap money and declining regulation all contributed to this inevitability. Indeed, for more than five years, the course notes have noted that the newly-formed global capital markets were poorly regulated and that there was a danger of imprudent borrowing being facilitated by the seamlessness of the international capital markets.

What was unknown and difficult to anticipate was the timing and the nature of the crisis. Would it be  sudden and sharp, or slow and relentlessly insidious. And of course, what would the scale of the reckoning be?  Ah, yes, the scale.  That was truly unexpected.

Perversely enough, it is indeed preferable that the crisis is abrupt and deep. Since it had to come, better fast and unambiguous. Otherwise, the remedies would have been long in coming – resisted by every vested interest on earth. Fortunately, that horror has been averted. After all, the degree of this disruption contributed greatly to the election of Mr Obama. After eight lost years, a US President who has discernible intellectual function is a major bonus.

The deregulation of the US financial markets has been underway for a long time – sparked by President Reagan.  It was part of general trend to deregulation. Soon to be lost was any sense that the financial players should not be treated like other industries. Other industries can fail, while banks cannot.

Against the backdrop of falling regulation, the banks went on a binge of innovation, creating a truly toxic product – subprime loans [including Alt A loans].  In doing so they violated the first rule of banking, presented to every former macro student: never lend money to people who need it! Red flags flying everywhere. Then to add gasoline to the fire, they broke the incentive to document how poor the borrowers really were.  By securitizing the loans, the lender passed the loan onto someone else, having pocketed a management fat fee. Warning, warning, danger, danger! this way disaster lies.

But what were investors thinking? What were the banks thinking?  Why did they not know that they were about to blow themselves up? Alan Greenspan, the near perpetual head of the Fed Reserve resisted financial regulation precisely because he expected their self-interest would guard them from danger. It is the great justification for markets.  But of course, people behave stupidly [surprise, surprise], they forget to do due diligence, they respond to the short term and forget the long term. they get greedy. They routinely believe that the laws of economics can be superseded. Keynes, of course, understood this.

Admittedly, making a reasoned judgment about securitized debt [credit swaps, derivative contracts] was render more difficult as the securities themselves were wrapped up in complex legal language and even more complicated mathematics. What it actually meant or contained was never clear. Some issues came with thousands of pages of documentation. Who checked? Surely someone was checking? Of course, only a cynic would suggest that the complicated language was a smoke screen to make it difficult to conduct due diligence, rather than as a precise parsing of risk.

The industry of course said that by pooling risk individual risk fell. Apparently that meant that when something goes wrong we all fail together.  Keynes also noted that so long ago.

Indeed, as the failures became manifest, the fact that the banks literally did not know exactly what they held and how much was toxic merely added to the panic. Investors hate uncertainty. and this was uncertainty to a bizarre degree.

Now it turned into a comic opera. Everyone starting “insuring” everyone else’s loans through even more complicated means [credit swaps, etc]. AIG for example blissfully takes on massive obligations against loan defaults. And then the herd began to run. The US tendency to go over-the-top on everything came into play.  Wall Street was a model to the world.  The big global banks got on the  bank wagon.  Move quickly to take a position before the advantage was lost. No time to think.

[Canadian banks  were too “small’ to play with the big boys in the world, and ended up with literally little junk. Pity that so are so small. ]

As investors lost their wits, they began to believe that the risk reward relationship was no more. Even though competitive conditions were increasing everywhere and technology continued to cascade in unexpected directions, the risk of failure was “thought” to be declining. The risk premium between safe securities, like US treasuries, and private bonds shrunk.  But that violated the economic principle that risk is a cost that was be understood and paid for. Logic now went on a vacation.

Unfortunately, this disaster hit with the US economy already vulnerable. Barely recovered from the internet/dot.bomb bubble, US public finances are out of control. Employment growth has been weak most of the decade. Tax rates are below those that can sustain a modern state. California, of all places, is in a fiscal nightmare. Healthcare expenditures are proportionately the highest in the world, with life expectancy far from the highest.  And there are other issues. This of course limits America’s ability to recover quickly, and consequently affects the entire world.

China, India, Russia and the European Union all face their own heavy challenges.

Canada as a major trading nation is powerfully affected by the distress of its customers. The Canadian economy through much of 2008 saw high job growth, with slowing economic activity. Its financial system has suffered little in relative terms. Its public finances remain prudently managed. Canada remains what it has long been, a small, conservative and properous society, on the margin of the world.

This commentary will look forward to 2009 and beyond in a posting just before the New Year.  Commentary on innovation  and economic updates will begin in January.


Update on Launch

The first commentary on the state of the global economy will be posted just before Christmas.  It will review the year just past and look forward to the tumult that awaits.