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Slumdog trillionaire

Sherry Cooper

United States

The worst financial crisis since the 1930s continues to wreak havoc on the global economy. Most major economies are contracting sharply, and emerging markets are submerging. World-wide credit losses have topped $1 trillion, less than half of what the IMF estimates will be the final bill. U.S. bank losses to date tally about 5% of GDP, more than the 3% hit in the Savings & Loan crisis.

The U.S. recession is digging in its heels. Real GDP contracted almost 4% annualized in Q4, and will likely shrink even faster in Q1. Layoffs are accelerating, with half of the 3.6 million job losses to date coming in just the past three months. Auto sales have crashed below 10 million annualized for the first time in a quarter century. Even venerable Toyota has lost its top credit rating, and unless demand revives soon (which is highly unlikely), GM and Chrysler may need more government support.

Faced with rising layoffs, evaporating wealth, tightening credit and record-low confidence, consumers are retrenching at a 3%-to-4% clip, the worst slump since 1980. Business capital spending is falling the fastest in half a century.

There are few, if any, signs of economic recovery. Except for purchases of cheap foreclosed properties, housing demand remains depressed. Credit spreads, though well off their record highs of last fall, remain far wider than normal. Mortgage delinquencies remain aloft. While housing affordability is the best in decades, price declines appear to be overshooting in response to a still large overhang of unsold properties (we estimate an excess of 700,000 vacant homes for sale).

The economy is expected to contract 2.3% in 2009 and more than 3% from the peak, marking the longest downturn since the Depression. The unemployment rate has risen more than 3 percentage points from its trough, and is expected to climb another two points to a quarter-century high above 9% by early next year. On a proportional basis, fewer Americans are working today than at any time in the past two decades. Business bankruptcies are mounting, notably for retailers selling high-priced discretionary items, and made worse by rising private-label credit-card losses. This will keep mall vacancy rates high and commercial real estate in the dumpster.

Fingers crossed, a modest recovery could begin at year end in response to the Fed’s zero-rate policy and high-powered lending programs, a fiscal stimulus package amounting to $787 billion (or 6% of GDP), a massive effort to stabilize the banking sector and slow the rate of foreclosures. A recent positive sign is that a few large corporations have been able to issue bonds at low rates without government backing, and some plan to use the funds for acquisitions and investments.

But the expected recovery will remain muted for several years. The hangover from a debt binge can be long-lasting, as Japan can attest. Consumers will need to increase savings from less than 2% of income last year to 6% to return their fiscal house to more manageable pre-boom levels.

The downside risks to the economy include possible further pronounced declines in house prices, a delay in the fiscal stimulus package, a further increase in long-term Treasury rates (on mounting supply concerns), and continued adverse feedback between weak labour markets and weak housing and credit markets. Deflation remains a near-term risk, and will tempt the Fed to start “monetizing” the debt by purchasing Treasuries.

Short-term interest rates should remain at rock bottom this year, rising only gradually next year as the economy recovers. Long-term rates have been pressured slightly higher by a budget deficit that could top $1½ trillion this year, and by renewed investor interest in corporate bonds. Rates should ease in the near term as the recession plays out, before climbing in anticipation of the recovery later this year, leading to a steeper yield curve.


After standing proud for most of 2008, Canada’s economy has done a face plant, falling into its first recession in 17 years. Real GDP likely contracted at a 4% pace around the turn of the year. The first synchronized global recession in the post-war period has dealt a serious blow to even the once-sturdy western provinces. The commodities bust has sliced the value of Canada’s exports, damping national income and domestic demand. Housing is headed for the cellar, with sales and starts down sharply and prices off 13% from their peak. As wealth reverses and layoffs mount, consumers are braking hard, with auto sales careening 25% y/y in January to 10-year lows. Business investment has also hit a severe dry spell. Mines are closing and oil sands projects have been scaled back.

Job losses have vaulted above 200,000 in the past three months, with more than half in January alone. The unemployment rate has risen more than a percentage point to 7.2%, its highest level in four years. Ontario’s rate has ballooned to 8.0%, an 11-year high, amid a devastated auto sector. We expect an additional 200,000 job losses this year, pushing the unemployment rate above 8%.

Real GDP is expected to contract 2.0% in 2009 and 2.7% from its peak, a worse prognosis than anticipated earlier this year. However, the currentdownturn is expected to be milder than the last two recessions when peak-totrough declines in GDP were 3½%-to-5% and the jobless rate topped 12%.

The economy is expected to turn up late this year in response to:
• aggressive monetary easing, with the BoC already slicing rates 350 bps to a record-low 1.0% and expected to trim to 0.50% in coming months;
• sizeable fiscal stimulus, with $40 billion of spending and tax-cut measures in Budget 2009 boosting activity more than one percent this year;
• past weakness in the Canadian dollar; and - firmer U.S. demand.
The economy continues to benefit from a relatively healthy banking sector, resulting in narrower credit spreads and sustained credit growth. Household debt, though up sharply in recent years, is lower than in the U.S.

The risks to Canada’s economy largely stem from outside its borders, with the possibility that the U.S. downturn could last longer than anticipated and that commodity prices (which have steadied recently) could fall further.