Blogs & Comment

Risk is a global game, Finance Minister

Ottawa had better start considering the return of negative economic conditions, and fast.

Jim Flaherty marches to budget battle (CP/Adrian Wyld)

It is hard to imagine Canadian Finance Minister Jim Flaherty actually coming out and stating that he thinks the risk of another global recession is growing daily. But that’s what plenty of market watchers are worried about these days, which is why it isn’t easy to buy into Flaherty’s economic optimism. 

A worldwide financial meltdown would crash government revenues along with stock valuations. But like bullish LinkedIn shareholders who don’t seem to fear an economic disruption to the social networking company’s lofty share price before it can be justified by real revenue instead of potential future income, Canada’s budget chief thinks his plan to balance Ottawa’s budget over the next few years faces limited risk from external factors.

At the recent International Forum of the Americas, Flaherty pointed out that Canada’s financial planners revised private-sector forecasts downward, factoring in the possible loss of $1.5 billion in annual revenue. “We’ve taken some concrete steps to recognize the risks that are out there,” he said, noting he has some concerns over weak consumer confidence in the United States and what he called “softness” in that country’s real estate market.

What Ottawa isn’t considering, at least not publicly, is the return of economic conditions that would dramatically impact government revenue, not to mention a total financial meltdown that would require emergency stimulus spending (or a political need to meet calls for stimulus).

According to Flaherty, risk of the U.S. triggering another North American recession is not great. But that, of course, depends on your definition of “great.” It also ignores the fact that risk is a global game.

Nobody knows the exact odds of another recession or financial crisis. What is clear, however, is that threats to the world’s economic recovery exist worldwide and are greater today than when Flaherty triggered an election with the first version of his budget in March. And we are not talking just about the recent rise in lipstick sales at Estée Lauder, which is considered by some to be a hot-red indicator of economic trouble (at least on slow news days) on the horizon because consumers tend to turn to less expensive indulgences when losing confidence in the future.

When the world’s third-largest economy took a massive hit from an earthquake-generated tsunami and nuclear disaster, many economists expected a quick recovery with little external impact. Since then, supply disruptions have spread to manufacturing operations across the globe and Japanese economic growth has been almost totally wiped out.

The World Bank now projects the Asian nation’s GDP to expand by just 0.1% this year, down from an estimated 4% in 2010. The WB’s forecast for the global economy is more positive. It says growth will likely ease to 3.2% in 2011 from 3.8% in 2010, before picking up to 3.6% in 2012 and 2013. Then again, it must be taken with a mountain of salt. After all, according to the projections released in June, “the recovery in the United States has gained strength over the past 6 months and shows signs of becoming more self-sustaining.” And that is open to debate.

The Federal Reserve’s bid to solidify a recovery via a second round of so-called quantitative easing is coming to an end as some troubling signs appear. Pending home sales were down 11.6% in April and consumer confidence currently sits at record lows for this period in an economic expansion. In May, U.S. payrolls grew by just 54,000, which was well below already-downgraded analyst expectations of 170,000, while the unemployment rate increased 0.3% to 9.1%, instead of falling, as expected, to 8.9%.

Wall Street certainly isn’t hiring. According to the New York Post, traders and brokers are bracing themselves as “the hatchet man cometh.” In a report on looming layoffs, the paper said financial institutions are “weighing staff cuts or actually paring payroll as they struggle to rein in costs and eke out profits in a choppy market.” Total industry jobs cuts, it says, “could run into the thousands as firms assess the impact on their bottom lines of sweeping regulatory reform and a balky economic recovery.”

As for housing prices, which supports consumer spending, the picture remains bleak. According to CoreLogic, 22.7% of all U.S. residential properties with a mortgage were in negative equity at the end of the first quarter, down slightly from 23.1% in the fourth quarter of 2010. That’s going in the right direction. But housing prices are still falling. Indeed, the seasonally adjusted S&P/Case-Shiller index of housing prices in 20 American cities has now fallen for nine months in a row.

As Bloomberg reports, there is no reason to conclude U.S. house valuations are headed for a cliff. Nevertheless, calling the U.S. real estate market soft could prove to be an understatement. After all, a steady decline in home prices continues, with the total drop in value from April 2006, the peak of the bubble, greater that what was brought on by the Great Depression.

“Cooling off” is the best thing you can say about the U.S. economy, says a recent commentary by David Rosenberg, chief economist with Toronto wealth manager Gluskin Sheff.

Meanwhile, political turmoil in Yemen, Qatar and Bahrain still threatens to disrupt the transportation of almost 50% of the world’s seaborne oil. And let’s not forget the sovereign debt situation in the European Union, which has zero chance of being resolved in an non-disruptive manner any time soon.

Protests in Greece have already turned deadly, and public discontent is expected to increase as unemployment (above 16%) continues to rise thanks to unpopular austerity measures. But the EU isn’t even looking for a solution that would be considered acceptable to Greek protesters, who see themselves as the European cousin to members of the Arab Spring movement. Indeed, EU politicians and central bankers currently are trying to find a way to kick the problem down the road. And they are even squabbling over how to do it.

The risk of a Greek default is great. And as pointed out in another Canadian Business blog, a default could lead the global economy to meltdown faster than Anthony Weiner’s reputation as a New York politician.