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Monday, November 11, 2013

Canada: Debalancing, Not Rebalancing

The Canadian Labour Force Survey is noisy month-to-month, but the trends in the data point towards a debalancing, not a rebalancing, of the Canadian economy. This poses an acute problem for policymakers; their working assumption is that the economy would reduce its dependence upon consumer-debt fueled growth as the business sector recovered from the financial crisis. Unfortunately, the consumer-facing sectors are the most labour intensive sectors, and they remain the driver for job creation.

Canada is currently stuck in an "equilibrium" of sluggish growth, with the housing market losing upward momentum, but construction levels remaining at unsustainably high levels. There is a risk that the economy will fall into a "bad equilibrium", with the consumer sector retrenching (as happened in the United States), but there is no obvious way to guess when such a switch of equilibrium might occur. This considerable uncertainty poses obvious problems for equity investors, given that equities react violently to the previous quarter's earnings. Being too forward-looking poses too much career risk. However, the Government of Canada bond curve poses interesting risk characteristics versus other developed markets - there is a gradual renormalisation of rates priced into the curve, but the economy is showing little sign of acceleration.

Although Construction fell in October 2013, it still remains one of the larger drivers of job creation over the previous year (October 2012 - October 2013). In fact, if we look at the most "consumer-facing" sectors, we see  the following annual job growth (figures are annual changes for the seasonally adjusted series):
  • Accommodation and food services (+77.8k),
  • Construction (+66.4k),
  • Retail & Wholesale Trade (+47.9k),
  • Finance, insurance, real estate and leasing (+17.9k).
 The total contribution of these sectors was 210,000 jobs last year, which is almost the same as the total job growth in Canada (+213,800 jobs). In other words, all the other sectors netted out to produce roughly no jobs. Manufacturing, which was hoped to become an engine of growth, lost 82,000 jobs over that period. If the rest of the economy cannot produce jobs when the economy is expanding, it is hard to be optimistic as to what will happen when construction jobs start disappearing.

The chart above shows how the economy has debalanced over time. Construction and finance rode a bubble in the early 1990's, retrenched, but their shares of the total have again returned to extreme levels. Manufacturing jobs have dropped in importance over the decades; and this has not been affected by the recent cycle.

Finally, the bottom panel underlines a key potential source of risk in the Canadian financial system. The Canadian provinces are at the front line in terms of providing welfare state services, such as education and health. The secular rise of health care demands (due to an aging population) means that this spending keeps rising in importance in provincial budgets. However, the provinces lack direct access to the central bank, and are therefore analogous to countries in the eurozone. A sustained downturn will put immense pressure on their budgets. Although policymakers are unlikely to repeat the error of the Great Depression (the Federal government let the province of Alberta default), politically-motivated austerity campaigns remain a possibility. Such a policy tilt would mean that the recovery from the next recession would be extremely slow.

(c) Brian Romanchuk 2013

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