Recovery at risk

OTTAWA — Looking into the economic crystal ball, the vast majority of private sector and institution forecasts agree that the scary global recession of last year is past and that normal times are just around the corner.

OTTAWA — Looking into the economic crystal ball, the vast majority of private sector and institution forecasts agree that the scary global recession of last year is past and that normal times are just around the corner.

It could still go horribly wrong.

Forecasters caution that the degree of uncertainty and doubt about their baseline forecasts — or most likely scenarios — has seldom been higher.

In fact, many, including the world’s central bankers, say substantial risks lurk around that beckoning corner and some are serious enough to send the whole edifice of economic stability crumbling.

Bank of Canada governor Mark Carney refers to the economic landscape as filled with ”significant fragilities“ which encompass everything from steady growth going forward to a second recession.

“It’s a pretty dangerous economy out there,” agrees TD Bank’s chief economist Don Drummond.

“This should be the easiest of times to do a forecast because you are at the bottom, so you know which direction you are going to go. But I do think there’s almost an unparalleled degree of uncertainty out there.”

First the baseline. No matter which source is consulted, from the Bank of Canada to the U.S. Federal Reserve, the International Monetary Fund or any number of private-sector forecasters, 2010 is the year Canadians, Americans and the world get their economic mojo back.

The recession ended some time in the second half of 2009, the logic goes, and with trillions of government money still being poured into global economies, growth in 2010 appears as certain as the sun rising in the east.

Growth rates vary from country to country, but the important thing is that they are all positive. In Canada, forecasts fall in the 2.5-per-cent to three-per-cent range — not a big rebound given that last year’s slump knocked $30 billion off the economy’s bottom line.

But those are baseline, most-likely forecasts. Things could also turn ugly again, economists caution.

“I’d say there’s about a one in five chance of a double dip recession, or a hard W as we call it,” said Nariman Behravesh, chief economist with one of the world largest forecasting firm, IHS Global Insight of Lexington, Mass.

What could go wrong? From interviews with a half-dozen economists from Canada and the U.S., here are the five most dangerous pitfalls:

— Inflation: It seems absurd to worry about inflation right now. Canada’s is at one per cent and the Bank of Canada says it isn’t worried about it reaching its target of two per cent for another year or two.

But the world’s printing presses have been busy flooding financial markets with money, and governments have been spending like drunken sailors in an effort to keep the Great Recession from becoming the second Great Depression. It worked, with a cost.

“I don’t see how we can increase the money supply the way we are increasing it and avoid inflation,” says James Gillies, professor emeritus at York University’s Schulich School of Business.

“I can see it happening everywhere around the world, and with heavy, heavy inflation, we’ll see rapidly rising interest rates,” he adds. Gillies believes that will bring the recovery to a grinding halt, possibly as early as the end of 2010.

Other economists also worry about inflation, but say it will take longer to exert itself. The end result is the same, however.

High inflation triggers a policy response from central banks in the form of high interest rates, which causes businesses to stop borrowing and consumers to stop buying. That’s how the recessions of the early 1980s and 1990s started.

— Policy-makers get it wrong: The flip side to real inflation is that the fear of inflation will cause governments and central banks to stop stimulating the economy too soon.

The growth that currently exists in many economies, particularly those of the U.S. and Europe, is due to unprecedented levels of government spending, bank and industry bailouts, super-low interest rates and money market liquidity infusions.

Nobody knows for sure when the private sector economy will be ready to stand on its own two feet and how it will react when the public sector crutches are removed, as G20 leaders are already discussing.

“They can make a mistake on both sides. They can withdraw the stimulus too early and we get something like a double-dip… as soon as late next year,” said Douglas Porter, deputy chief economist with the Bank of Montreal.

“The other side is they leave the stimulus too long and we end up with an inflation.”

Drummond says deciding when to exit from stimulus will require almost “surgical precision.”

The trouble is, governments and central banks have never attempted the surgery before, which is cold comfort to the patient.

— The United States economy suffers a repeat pratfall: America is going great guns now, but again that’s based on temporary government largesse and the need to refill empty warehouses.

That doesn’t mean anyone will buy the products once the inventories are replenished.

Scotiabank vice-president of economics Derek Holt says he believes the U.S. economy will slow to about two per cent growth in the latter half of next year, and if the inventory restock is too aggressive, a double-dip is not out of the question.

“What could happen is we go through a temporary growth spurt and then it’s the Emperor has no clothes all over again and the consumer is exposed,” Holt explained.

Behravesh also calls the U.S. consumer the biggest wild card for the next year or two. Households may come to the realization that the wealth hit they took when their home values collapsed is permanent, and continuing high unemployment may spook them into hibernation.

For Canada, a second collapse in U.S. consumption will devastate the export sector, the auto industry in particular, and derail the recovery, Holt said.

— Global imbalances: Buyer economies like the U.S. are transferring unsustainable amounts of wealth to seller economies like China, which become the world’s pre-eminent creditors, until a reckoning comes and the indebted nations can no longer borrow.

The recession was supposed to help resolve the problem, and to some extent it has. U.S. exports have risen and imports have fallen, which is one reason Canada fell into a slump.

But the U.S. still imports way more than it exports, and Drummond says Washington’s response to the recession has added a second front to the imbalance.

“Those global imbalances are worse now than they were before,” he said. “The U.S. consumer did fall back, but the U.S. government more than filled the vacuum. U.S. debt is even higher than it was two years ago.”

Many industrialized countries have mortgaged their futures. Japan’s debt to gross domestic product now stands at 227 per cent; Italy at 120 per cent, the U.S. and the United Kingdom are at 94 per cent, Germany and France at 83 per cent.

— Financial market shock: The collapse of Wall Street investment house Lehman Brothers is credited, or blamed, for being the final straw that broke the global economy’s back last September.

Nothing of that magnitude has occurred since, although Dubai World’s surprise request for a standstill on payments of about US$50 billion briefly sent shivers through overseas stock markets in late November.

Dubai proved a false alarm. But Peter Morici, the former chief economist at the U.S. International Trade Commission, says there are enough ghosts in the closets of the U.S. financial sector to keep policy-makers awake at night.

“The banks are back to their old tricks, at any point in time the banks here can be counted on to cook up some kind of scheme that will collapse on them,” he said.

One danger signal starting to emerge revolves around the troubled U.S. commercial real estate market, which could spark another round of losses for banks in 2010. Most economists, however, say it won’t be as serious as the 2007 subprime mortgage meltdown in residential real estate, but financial institutions are also less able to withstand shocks now.

Most of the risks identified by economists would emerge, if they do, from beyond Canada’s borders, particularly in the U.S., economists say. But that is also how the 2008-2009 recession happened, they point out.

“Canada’s exposure to the U.S. economy has diminished a little bit from what it was in the past, but you guys will still get clobbered if we go down the tubes,” noted Behravesh.

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