EMAIL DETAILS

Dear Clients,

Attached please find our latest report, “The Outlook for the Canadian Economy.” Key conclusions in the report include:
• The Canadian economy outperformed the US economy again in 2011, and could grow in the 2.5-3.0% range in 2012
• A strong Canadian currency is driving job losses in the manufacturing sector and leading to large trading deficits for manufactured goods
• Large price gains in Toronto and Vancouver—especially for condominiums—are driving Canadian house prices higher nationwide
• Alberta and Saskatchewan were the provincial growth leaders in 2011, and both should see continued strength in 2012
• The new Canadian budget aims to reduce the country’s debt-to-GDP ratio to 31.6% of GDP by 2015 and raises the retirement age to sixty-seven by 2029

As always, we welcome any questions or comments.

Best regards,
David Hale
Chairman

David Hale Global Economics, Inc.

847-386-6009 (tel)
847-386-6011 (fax)
davidhale@davidhaleweb.com

http://davidhaleweb.com
http://whatsnextbook.com


NEWS: Yale University Press has published “What’s Next?” Unconventional Wisdom about the World Economy, by David Hale and Lyric Hughes Hale, available now

About "What's Next?":http://whatsnextbook.com

This email and any attachments to it may be confidential and are intended solely for the use of the individual to whom it is addressed. Any views or opinions expressed are solely those of the author and do not necessarily represent those of David Hale Global Economics, Inc.

If you are not the intended recipient of this email, you must neither take any action based upon its contents, nor copy or show it to anyone. Please contact the sender if you believe you have received this email in error.


THE CANADIAN ECONOMY CONTINUED TO OUTPERFORM THE US IN 2011

The Canadian economy continued its recent pattern of outperforming the US economy during 2011. Real GDP grew by 2.5% compared to 1.7% in the US. The Canadian economy should be able to perform at least as well as the US economy during 2012 with a growth rate in the 2.5-3.0% range. The consensus forecast among Canadian economists is for a growth rate closer to 2.0%.

The Canadian economy has been producing mixed signals during the early months of 2012. It grew at a 1.8% annual rate during the fourth quarter of 2011 compared to 4.2% during the third quarter when auto output recovered from supply disruptions during the spring. There was a 2.1% gain in domestic final sales and upturn in exports offset by a sharp decline in government spending. Real GDP grew by 0.5% during December, but weakened during January as wholesale sales declined for the second time in the past three months. Real GDP grew by only 0.1% during January led by a 0.7% gain manufacturing output.

The Canadian economy generated 82,300 new jobs in March, beating market forecasts. The goods producing sector added 24,900 jobs while the service producing sector added 57,500. The official unemployment rate fell to a post-recession low of 7.2% from 7.4%. The Canadian economy added only 2,000 jobs per month from August 2011 through February 2012, so the most recent data will bolster optimism about the economy’s growth rate for the year as a whole.

Retail sales rose 0.5% in January, led by the largest gains in the auto sector since 2009. Sales at general merchandise stores also rose 1.7% after declining during December. The RBC purchasing managers’ index increased to 52.4 in March from 50.6 in January, but remained below the peak of 54.0 during December. The index benefited from gains in new orders and output.

Statistics Canada conducted a survey of capital spending intentions during February which was generally upbeat about 2012. Private enterprises plan to increase non-residential investment by 10.6% compared to 9.6% during 2011. The increase in private sector spending will be led by the mining and energy sectors (17.7%), transportation and warehousing (21.5%), and utilities (14.6%). Manufacturers expect to increase capital spending 6.6% after a surge of 21.5% during 2011. The public sector will also increase investment by 6.3% after a minimal gain of 1.1% during 2011. The strong Canadian dollar has encouraged many firms to purchase more capital goods from the US. The Canadian corporate sector is able to boost investment because it has enjoyed a healthy profit rebound and reduced its leverage to a record low.

IS THE STRONG LOONIE DESTROYING CANADIAN MANUFACTURING?

There is growing concern about the impact of the strong Canadian dollar on the competitiveness of the Canadian manufacturing industry. Ontario Premier Dalton McGuinty warned that the oil sands boom in Alberta is pushing up the currency and threatening to crowd out manufacturing. He believes that Canada is suffering from the “Dutch Disease.” The new leader of the NDP, Thomas Mulcair, says that the Harper government is killing Canada's manufacturing sector by overemphasizing natural resource development. Their comments were inspired in part by a decision of Caterpillar Inc. to move a factory from Ontario to Indiana after the workers rejected a request for large pay cuts. The Canadian wages were twice as high as those Caterpillar planned to offer at the Indiana plant. Caterpillar could afford high nominal wages when the Canadian dollar was worth 0.65-0.75 vis-à-vis the US dollar, but it could not sustain them when the currency achieved parity. The loss of manufacturing jobs in Ontario during the past three decades has been broadly comparable to that in the US. The share of jobs in manufacturing has fallen from 22% in 1973 to 10% at the start of 2012. In the US, manufacturing jobs have fallen from 24% in 1973 to 9% today. Manufacturing employment has declined in both the US and Canada for similar reasons. Technology has made possible a large increase in output with fewer workers.

The strong dollar has encouraged a major change in the composition of Canadian trade. Canada last year had a $119.3 billion trade deficit in manufactured goods compared to $26.8 billion in 2001. The offset to this deficit was a trade surplus of $120.7 billion in commodities compared to $97.4 billion in 2001. The surplus in crude oil has increased to $39.4 billion from $2.6 billion. The surplus in base metals has grown to $20.8 billion from $10.1 billion. The surplus in fertilizers has increased from $3.4 billion in 2001 to $9.1 billion in 2011. One of the biggest losers has been the auto industry. It now runs a $12 billion trade deficit compared to a surplus of $20 billion ten years ago. Canadian auto output is now 2.1 million cars compared to 1.5 million during the recession and over 3.0 million in 1999. The Canadian government contributed $14.4 billion to the 2009 financial rescue of GM and Chrysler in order to lessen the risk of Ontario losing more auto output and employment. The big Detroit firms are now asking the Canadian auto workers to accept more of their pay in the form of profit sharing rather than high wages. The Canadian auto industry now employs 55,000 workers compared to 73,000 before the 2008 downturn.

Canada is now pursuing new free trade agreements in order to improve its competitive position. It created an FTA with the US during the late 1980s and Mexico during the mid-1990s. It is about to complete one with Europe. It has signed FTAs with Chile, Peru, Colombia, and several Central American countries. It has expressed an interest in joining the US-sponsored Trans Pacific Partnership, which could open the door to greater trade with Australia, Vietnam, and Japan. China recently proposed that it should negotiate an FTA with Canada. China has invested $11.5 billion in the Albertan tar sands sector and wants to improve its political relations with Canada. Ottawa is now keen to build a pipeline across northern British Columbia to ship oil to China because President Obama deferred a decision on the Keystone XL Pipeline, which would have sent Albertan oil to Texas.

CAN CANADIAN HOUSE PRICES CONTINUE TRENDING UPWARDS?

The other great concern of Canadian policy makers is rising house prices and consumer debt. House prices have increased around 130% since 2000 and 30% since February 2007 compared to a 33% price decline in the US since 2006. As the Bank of Canada has slashed interest rates, household mortgage payments remain near historical averages even though house prices have jumped to around 4.5 times household disposable income compared to a historical average of 3.0. The current average mortgage payment is equal to 28.7% of disposable personal income compared to a peak of 35.1% in 2007. Canada's mortgage delinquency rate is only 0.38% compared to over 5.0% in the US.

Some of the largest price gains have been in Vancouver and Toronto and reflect Asian demand. Much of this demand has been for condominium apartments. As a result, multifamily housing starts now account for 57% of all Canadian housing starts compared to less than 40% ten years ago. Housing starts plummeted to 150,000 during 2009 from over 220,000 during 2007, but they have rebounded to 185,000. Most Canadian economists believe they could increase to 210,000 by 2014. The government is discussing plans to curtail mortgage lending by enforcing a cap on the insurance written by Canada Mortgage and Housing Corp, a Crown corporation which insures mortgages. The government increased the cap on the amount of insurance the company could offer from $350 billion in 2007 to $450 billion and then to $600 billion. It now wants the company to increase its balance sheet by only $30.8 billion during 2011-14 compared to $170 billion between 2007 and 2010.

Canadian house prices were still increasing in February. In the greater Toronto area, they rose by 7.3% year on year compared to 9.0% in October. Prices rose 6.0% year on year in Vancouver compared to just under 20% in 2010. Calgary had year-on-year price gains of only 2.5% while Montreal eked out a 1.6% gain.

The market value of Canadian household net worth increased by $58 billion during the fourth quarter. Rising equity prices increased the total value of household assets to $7.9 trillion. Total household liabilities grew by $22 billion led by a $16 billion gain in mortgage debt and $5 billion in other forms of consumer credit. The year-on-year growth of consumer credit has slowed to 4.0%, or the slowest pace of debt accumulation since early 2002. The slowdown in consumer debt is apparent in the data for consumer spending. The growth rate slowed to 2.2% during 2011 from 3.3% during 2010. Canadian economists expect it to grow by 2.8% this year. The Bank of Canada has described consumer debt as the econo-my's leading domestic risk, so it is happy that the growth rate is slowing down despite the Bank's decision to keep its core lending rate at 1.0%. The Bank has put monetary policy on hold because of uncertainty about the global economy and a desire to restrain the appreciation of the Canadian dollar.

WESTERN PROVINCES ARE NOW DRIVING CANADIAN GROWTH

The strength of the commodity markets has given a strong western tilt to Cana-da's growth leadership by province. Alberta had a growth rate of 4.2% during 2011 and could have a growth rate of 3.9% this year. Saskatchewan had a growth rate of 4.3% during 2011 and it could increase to 4.6% this year. Both provinces are benefiting from business investment and employment creation. In 2011, Alberta produced 99,000 jobs, or more than half the gains for all of Canada. British Columbia is benefiting from increased forest product exports to China while Vancouver-based Seaspan Marine received an $8 billion contract for seven non-combat ships from the federal government. British Columbia's growth rate should be 2.6% this year. Ontario's growth rate could rise to 2.5% this year from 1.9% in 2011 as auto exports to the US increase. Local governments also plan to boost investment after a contraction during 2011. Quebec is the laggard. The growth rate was 1.6% during 2011 and is unlikely to improve this year. Quebec has been losing jobs and the unemployment rate increased to 8.7% in December. The government has announced an ambitious program to develop the north, and plans to support it with equity investments. New Brunswick and Nova Scotia are also relatively lackluster. Their growth rates will be only 1.6% this year, but Nova Scotia will soon benefit from a $25 billion federal contract for new naval vessels and offshore oil exploration by Shell. The growth rate of Nova Scotia could rise to 3.2% or higher in 2013. One of the legacies of the recent recession is that all provinces except Saskatchewan have fiscal deficits. The finance minister of Ontario recently introduced a tough budget to reduce the province's deficit of $15.3 billion by one-third. Quebec also introduced a new budget to reduce its deficit from $3.3 billion to $1.5 billion. The Ontario deficit is equal to 2.4% of provincial GDP while the Quebec deficit is 1.0% of GDP.

FEDERAL BUDGET AIMS TO REDUCE COUNTRY’S DEBT-TO-GDP RATIO

The new federal budget aims to reduce Ottawa's deficit to $1.3 billion by fiscal 2014/15. The government expects the deficit in the fiscal year just ended to be $24.9 billion compared to a forecast in November of $31.0 billion. It is expecting the deficit in the new fiscal year to be $21.1 billion compared to a November forecast of $27.4 billion. It is projecting that expenditures will grow by 2.2% on average over the next five years, or a level close to the inflation rate. This spending plan will reduce government expenditures to the pre-recession level of 13% of GDP from the recent peak of 16%. The government will lay off 19,500 civil servants over three years. The government is expecting tax receipts to grow at a 4.7% average annual rate, or a bit faster than nominal GDP growth. As the budget assumes only 2.1% real GDP growth this year, there could be positive revenue surprises. The government expects to reduce the federal debt from 34.4% of GDP in the current fiscal year to 31.6% by 2014/15. The government proposes to raise the retirement age to sixty-seven years between 2023 and 2029. Those born in 1962 or later will be subject to the new retirement age. The finance minister also announced that the Canadian mint will cease producing penny coins this autumn.

The major wildcard in the Canadian outlook continues to be the US economy. As many Canadian economists expect only 2% output growth in the US this year, they have similar forecasts for Canada. The recent positive surprises for US employment growth and retail sales suggest that US output growth could be in the 2.5-3.0% range during 2012. If the US can achieve a growth rate above 2.5%, it will also boost Canadian growth to a higher level.

©2012 David Hale Global Economics, Inc.
All rights reserved. This document may not be quoted, forwarded, disseminated, distributed, or published without the express written consent of David Hale Global Economics, In