Going Green - Don't Plan on Business as Usual

Fred Ketchen: Welcome to the Scotiabank “Find the Money” podcasts. I’m Fred Ketchen, Director of Stock Trading for ScotiaMcCLeod. These monthly podcasts call on some of Scotiabank’s most knowledgeable experts to help you make the most of your money. Here we’ll discuss strategies designed to put you in the financial driver’s seat.

Fred: In this podcast, we’ll be discussing the strengths and weaknesses in the Canadian economy and our major trading partners, and how governments in major developed nations are implementing changes in order to achieve environmental and energy conservation targets. This is all covered in Scotia economics’ latest global outlook report entitled “Going Green, Don’t Plan on Business as Usual”. Joining us today is Warren Jestin, Scotiabank Senior Vice President and Chief Economist.

And Warren, let me begin by asking you has Scotia economics changed its view of the global economy, is it still growing at a good clip?

Warren Jestin: For the next couple of years, we’re going to see decent growth in most industrial economies. The U.S. is slowing down a bit because of problems in the housing market, and in Canada the average growth rate will be a little lower at 2% as it will be in the U.S. If you look at Europe and Japan, a little better than 2% as well, it’s a very even pattern at least if you look at the macro numbers. But if you go beyond those economies into places like China or India, parts of Asia, you’re finding a much stronger performance. In fact in China there’s been surprise after surprise where the beginning of this year growth in the first quarter was over 11%, and we think on a go-forward basis probably 9 to 10% compared to in Canada… even in years coming up when we see a little stronger performance it’s probably going to be under 3% growth on average.

Fred: Has the outlook for the U.S. and the Canadian economies changed, and in particular, you mention the housing slowdown in the U.S… will that housing slowdown there intensify and will the resource boom continue to push up growth here in Canada?

Warren: Well, I think the U.S. is not through the worse of the housing market cycle and you’re probably going to see a very cautious consumer going forward. One of the reasons why you may see the federal reserve in the U.S. lower interest rates as we go through the year; in Canada if we look at the average things we look very similar in performance to the U.S. But in reality Ontario, for example is growing at 2% or less, Quebec is reasonably slow as well and then you go out west B.C., Alberta, Saskatchewan, resource producing regions are doing very, very well and that reflects two things; It reflects the intense competition coming out of places like Asia which are causing manufacturing to restructure and it’s also showing the extraordinary demand for commodities coming out of those countries which is keeping copper, nickel, zinc, oil, gas, uranium very strong. It’s basically tilted the whole platform of growth towards the west.

Fred: Your latest global outlook report, Warren, focuses on the environment. What are the macro economic implications for Canada going green, and what it will mean for global competitiveness if we proceed along that path?

Warren: Well, we’re not the only country doing a lot on the environmental front and literally trillion of dollars are being spent around the world in environmental remediation and trying to produce more energy-efficient processes and vehicles and the like. What it means is very complex, because effectively there’s going to be industries that have to make big adjustments to reduce the intensity of pollutants. Other industries, however, are going to do very well because they are going to be part of the solution. In fact, I would argue that the environmental industry per say, and the industries related to energy efficiency are going to be the fastest growing industries in the world. And if you look at where that’s going to impact, well every business, their process, how the consumers react to higher gas prices, for example is going to change the entire market situation. What it means for Canada, a lot of expenditure, a lot of change in industry again, but at the end of the day I still think we will be able to move forward in this and keep growth in a reasonable range of 2½ to 3% over the next few years.

Fred: When we look at our economy and we see higher prices and obviously we’re witnessing some substantial growth, inflation comes up as one of the problems and inflation seems to be a growing concern here at home and abroad. What’s driving the increased price pressures and have inflation expectation risen, is there any sign of them easing any time soon?

Warren: Well the governor of the Bank of Canada is talking about inflation averaging about 2% next year. And its been in the 2% range for some time but recently its moved above that critical threshold. This is very important because effectively when it goes above that level, the Bank of Canada is going to be more cautious. And that’s one of the reasons why we don’t think interest rates here will follow U.S. interest rates down, we’re basically on hold. If inflation accelerates any more we may see interest rates go up. The reasons for it are multi-faceted, you’ve got energy prices moving up again, oil prices, gasoline prices because of refinery issues. One thing we haven’t seen in the past, however, which may be lurking out on the horizon is the fact that with bio-fuel use, you’re beginning to see agricultural prices going up. It,s not only food on the farm, it’s a source of energy as well. So we may well see over the next couple of years or so that we have a new source of inflation that we really haven’t anticipated and that’s coming out of agricultural products. But at the same time, remember computer prices are going down, consumer electronics that the kids love are going down, the cost of phones, you know the wireless phone and things like that are going down. So a lot of things are going up but there’s a whole lot of things going down as well, and I think on balance we’ll still be in a world where inflation is going nowhere fast.

Fred: What is your assessment of monetary policy changes internationally? Let me begin by asking you will Europe and Japan tighten further?

Warren: Well, I think you’re going to find that in Europe in particular the bias is higher but only a little bit higher, you know a quarter of percentage point, a half of percentage point in Europe and the U.K. In Japan, when you talk about an increase in interest rates, I mean basically it’s coming off as zero interest rate policy so rates remain relatively low. In Canada we are on the side-lines, as I said in the U.S. may have a tendency to go down if the housing market deteriorates further. At the end of the day, however, you’re not seeing much of a change in interest rates. I think looking over the next year or more, the environment is going to be one where short-term interest rates that the Federal Reserve and other central banks control show very little change. Bond yields are going to be volatile as they have, there may be a slight bias-up, but there’s no big change in interest rates coming. Where the big story is, I think, is in the exchange rates. In the type of environment I’m talking about where energy demand is strong, where U.S. rates go down at a time where Canadian rates won’t follow suit and where we’ve got a solid monetary and a reasonable good fiscal policy position. You will probably find the Canadian dollar staying high and may even go higher and you may find that the U.S. dollar continues to go down against the euro, the yen and a variety of other currencies.

Fred: Let me look at China just for a second, what is your view on China’s recent and prospective policy and adjustments, in an economy which as you’ve pointed out, continues to be exceedingly strong?

Warren: On the exchange rate front they’ll probably let their currency go up a little bit, but not a lot. You’ve got to remember that China is gaining market share in the U.S., it’s gaining market in Europe and that’s going to continue. They haven’t even made a footprint in the auto sector in any big way in North America and that is coming. At the same time they’re growing in their own market. Asia, which is a market that’s one and half times the size of NAFTA and growing twice as fast, but most importantly they have this massive population internally, which is just beginning to consume products… whether it’s cars, or consumer electronics and the like in a huge way, and that’s going to generate a lot of growth on a go-forward basis. So my bottom line for a country like China is it stays in the fast lane, it has to stay in the fast lane in order to accommodate domestic requirements. A little different story for India, but you’ve to remember that’s a country with an enormous size and growth potential. To give you an idea while China’s got more population it only had 16 million babies born last year, as opposed to India where there were 26 million babies born. It gives you an idea of the massive size but also the relative growth that’s occurring in those two countries which represents one out of three people on the planet.

Fred: More recently the Canadian dollar has been very, very strong continued on for, I guess, a number of months now, and its gone through the lower 90 cent level. I guess I can see some reasons why we’ve had strong March retail sales, wholesale trade in March rose by l.9% compared with analyst estimates of 1/2 of l%. What is the driving factor other than those things, and do you think that this kind of activity will continue?

Warren: Well, the best forecast I can give you is that the Canadian dollars will continue to go up and down. And the one thing if you look over the last few years is the un-precedented volatility in our currency. Its been this year already below 85 cents and recently moving towards 92 cents and that’s a huge range. But that range is similar to what it was the last couple of years and even a smaller range than it was in the preceding two years before that. I think through that volatility, however, the strength in the commodity side, the prudence that we’re showing on our monetary policy, the fact that we are seen as a resource-rich country in a resource-short world... the fact that the U.S. has a lot of problems with their trade deficit all point to the currency bias being flat-to-up as opposed to down.

Fred: Will the strengthening in many of the overseas currencies short-circuit their recoveries, and with the strong Canadian dollar, what does that do to our on-going economic strength, particularly of course, as it comes in the exporting businesses?

Warren: Yeah, I mean we’re looking for the euro to go up fairly significantly still and a variety of other currencies to appreciate, but I think it’s going to be in a controlled way. I mean, their central banks have lots of reserves and they really don’t want huge adjustments against the U.S. dollar. They don’t want the U.S. dollar to fall out of bed basically because it would hurt the global economy. So I think a managed depreciation will occur, hurts their growth a little bit but not a lot. In the case of Canada, it points to me to a continuous re-adjustment and re-positioning of manufacturing in the country. We’re re-positioning against competition out of the U.S. but at the end of the day, five years from now, ten years from now it’s not the Canada, U.S. exchange rate… it’s competition Canada finds itself in with respect to Eastern European firms or firms out of Brazil or Mexico or out of Asia. So we’re going to have competitive problems because of the exchange rate going up, but that’s not the only issue of competitiveness. Am I optimistic manufacturing will find a way out as I talked to companies across the country? I’m finding them already adjusting… you know getting into distribution in areas they can’t compete and concentrating in the areas they specialize in, plugging into the global supply chain. And out west, well, you’ve got manufacturing adjusting and some service industries adjusting too, but you’ve got a huge amount of cash going into that resource sector simply because of the demands that exist globally.

Fred: Well this all sounds reasonably optimistic to me, Warren, and optimistic, of course, with a bit of a cautionary outlook. And I do want to thank you for sharing your valuable insights with us today and we hope that this comprehensive view of the economic impact of “going green” has been helpful.

I’m Fred Ketchen, join us for a new podcast next month. And for more information, please drop by your local Scotiabank branch, we’d love to have the opportunity to talk with you.