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Friday, April 18, 2014

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Economist finds silver lining in tough times

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It’s hard to find a silver lining in a situation as grim as the current lackluster recovery, but economist Benjamin Tal may have found one for both the United States and Israel.

Benjamin Tal

Unlike previous economic recoveries, which were fuelled largely by consumer spending, the current modest uptick in the United States is being led by exports and the manufacturing sector, which is booming.

That’s good news for manufacturers, who are in the middle of “something close to a renaissance,” said Tal, deputy chief economist at CIBC World Markets. Thanks to capital intensive investments in knowledge-based industries, they are becoming leaner and more able to compete in the world economy.

That’s the silver lining. The bad news is that workers who once earned a living making things won’t be needed as much in the new, machine-intensive environment. That means Americans can look forward to high unemployment as the new normal in their economic landscape.

In a wide-ranging interview in his downtown Toronto office, Tal noted that Israel is well positioned to take advantage of this emerging economic reality. That’s the other silver lining.

“I see growing supply chain opportunities for Israel with U.S. high-tech companies,” he said.

Israel, which is already cultivating markets in China and India, would do well to ride the Americans’ coattails as it increases its export exposure around the world.

Israel’s economy is based to a large extent on high-tech, IT, medical innovation and cutting-edge developments in green technology. Because of of Israel’s free trade agreement with the United States, the extensive presence of major U.S. corporations in Israel and its reputation for advanced technology products, “Israel will be a big winner” as the United States’ manufacturing sector makes inroads into emerging markets, he said.

Israel’s economy has performed relatively well in recent years, handily outstripping North American economies.  (The Bank of Israel projects four per cent growth in 2010 and 3.8 per cent in 2011. CIBC predicts Canada’s GDP will rise by only three per cent in 2010 and 1.9 per cent in 2011.)

But for every silver lining there seems to be a dark cloud: for Israel, economic growth is largely confined to three or four large cities, with the rest of the country not doing so well. Towns like “Dimona, Yerucham and Sderot are not sharing in that growth,” Tal said.

Unlike Canada, Israel can’t rely on natural resource extraction to produce wealth and jobs. Outside Israel’s main cities, “there is no significant employer,” he said.

As for Canada, business here has not made the investments in productivity-enhancing technology that American companies have, and that, combined with a high loonie, will make it hard to compete with U.S. firms in the future.

The United States, meanwhile, has experienced a recovery unlike any other in the past 40 years, Tal continued. Coming out of a recession, rapid growth is generally followed by a levelling off, but there’s been little growth in the current recovery, which has depended on low interest rates and unprecedented levels of government stimulus.

“The private sector is not spending.” Banks are not lending, and consumers, whose buying accounts for 70 per cent of GDP, are not spending, he noted.

On the contrary, U.S. consumers are hunkering down and “deleveraging” – reducing the amount of debt they are carrying. The current savings rate stands at six per cent, one per cent higher than the long-term average. People are worried about their jobs and whether they can afford to borrow, Tal said.

Wages and income have fallen in the last couple of years as more people have been laid off. Government spending, which has been based on infusions of cash from the Fed, cannot go on as it has. The situation, Tal said, “is unsustainable.”

Avery Shenfeld, chief economist at CIBC World Markets, said that “it’s a recovery, but one that may be disappointing for the next year and a half.”

Housing starts in the United States have paused and prices are cooling.

The U.S. recovery has seen government employment and infrastructure construction lead the way, but unemployment is high and people are unwilling to take on too much debt, even though interest rates are low. Governments, he said, “need to get deficits under control, but not so abruptly as to slow the recovery. We need a pause in interest rate hikes for a while.”

Both Shenfeld and Tal forecast that the United States will retain at least some of the income, dividend and capital gain tax cuts implemented under President George Bush that are set to expire in January.

Assuming the Republicans take control of the Congress in the upcoming mid-term elections, Shenfeld expects “wheeling and dealing” on tax policy.

“We don’t believe American legislators will pursue a suicidal policy by letting all taxes go up,” he said.

Turning to Canada, Tal said we have weathered the downturn better than the United States, with consumer confidence north of the border stronger than in the south. As a result, Canadians are more likely to borrow at current low rates and that  kind of spending adds to economic growth.

Nevertheless, Tal entered another note of caution: “The housing market has been overshooting,” with prices above their fair market value (based on comparable rents, incomes and demographic considerations).

“The question is whether that leads to a crash.”

Tal answered his own question by suggestion few mortgage loans in Canada were of the sub-prime variety that led to the collapse of the U.S. housing market. (He predicted prices there will continue to fall.)

With only 4.7 per cent of Canadian mortgages considered sub-prime compared to 33 per cent in the United States, and with interest rates likely remaining low for a year or two, he saw no danger of a housing collapse.

Still, he forecast a historically “slow” housing market with prices falling, “reflecting the fact the economy is slowing” and because many potential buyers leapt into the market earlier than they might have to avoid the HST.

The Bank of Canada will have to be cautious when hiking rates, he warned. The debt-to-income ratio has been rising for the last eight years and stands at 146 per cent.

“That means when interest rates go up, the surprise will be how little it will take to slow down the consumer. The Bank of Canada has to be careful not to raise rates now, and be careful in the future.”

 

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