Global Slowdown and the Domino Effect - April 26, 2006
By Stephen S. Poloz, Senior Vice-President, Financing Products Group, Export Development CanadaA game of dominoes can be played on two levels – one where the player sets a row of dominoes upright and then watches them fall in sequence, and the other more strategic where one must play to win. Both are useful metaphors for the current state of the world economy.
Begin with the simpler game. The world’s dominoes are lined up perfectly, but the economy has begun to moderate. Evidence of a global slowdown is not yet compelling, but only when there is a single catalyst for slowdown is this ever the case. This one is happening the old fashioned way – central banks have been leaning into the expansion to prevent overheating. The U.K. was first, then Australia, and now the signs of slowing are there in the U.S.
U.S. growth is forecast to fall to 2.7% in 2007, the first time since 2002 that growth has averaged less than 3%. Slower U.S. growth will spread like falling dominoes, permeating countries and sectors in sequence. Growth will moderate to 2.7% in Canada and 3.2% in Mexico. China will ease to about 9%, India to 7% and Russia to 5%. South America’s growth will slip below 4%.
All of these numbers are still quite good. And growth will be rebounding in the U.K., steady in the Eurozone and the moderation will be barely perceptible in Japan and in Africa. Global growth will remain solid in 2007, at 4.1%, after 4.3% and 4.5% in 2006 and 2005, respectively. Nevertheless, the quality of the expansion will change noticeably. With considerable new investment in supply capacity of everything from consumer goods to machinery to copper, competitive pressures will multiply, inflation pressures will abate, commodity prices will ease and profit margins will shrink.
The sound of falling dominoes will be loudest in the world’s financial markets, as investors reduce their leverage and retreat from risk. Bond yield spreads will widen against corporate credits and against emerging markets, but inflation risks will ease. Stock markets will need to adjust to lower corporate earnings expectations. Commodity prices will move lower. The U.S. dollar will be firm; the Canadian dollar should ease to 83-84 cents by year-end, and to 80-81 cents by late 2007.
In the more strategic game of dominoes, two important cross-currents will be at play. The first is energy security. Oil prices will decline but will remain high. This will see more complex geopolitical moves, as Russia flexes its energy muscles, India and Iran dance the nuclear two-step, and China continues to snap up resource-rich assets in the Americas and Africa.
The second strategic cross-current is trade protectionism. Protectionism has surged recently even though the world economy is in the best shape it has been since the mid-1990s. One can only presume that even more protectionism will be forthcoming as the economic environment becomes more difficult. Companies will need to adjust their global strategies accordingly.
The bottom line? Export growth will slow to 3% in 2006 and to 1% in 2007, and the continued pressures from high energy prices and a strong Canadian dollar will make conditions worse for some. More of a return to reality than a calamity, but not much to look forward to, either.
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