January 2009

FRED:  Welcome to the Scotiabank Podcast. I’m Fred Ketchen, Director of Stock Trading for ScotiaMcLeod. These regular podcasts call on some of Scotiabank’s most knowledgeable experts to help you make the most of what you have. Here we’ll discuss strategies designed to put you in the financial driver’s seat.

In today’s episode, I’m joined by Scotiabank’s Chief Economist, Warren Jestin. Warren is going to us through what happened with the global economy in 2008, including how the economic downturn began, specific areas that have been impacted and what’s been done to help stabilize and stimulate the economy.

Warren, 2008 certainly ended differently than it began, and we’re now experiencing what some refer to as the worst economic downturn since the Great Depression. What are the key events that have contributed to the current global climate?

WARREN:  Well, first of all we were on a big rollercoaster ride last year and if you went to the pumps, you know what I mean. Because at one point in time, you were paying almost $1.40 a liter for gas and, of course, by the end of the year it had dropped to around half that level and so you knew something very fundamental was changing. It started out the year seeming to be a U.S. housing problem and U.S. banks were having a big problem but in Canada things were still pretty solid. By the spring, Canada was doing very well, but the U.K., and Europe and Japan were showing signs of weakness; and as we went over the summer, you saw as oil prices were cracking you were simultaneously seeing countries like China and India slowing down. That latter event is very important for Canada because we’re a commodity producer, and when the major demanders of commodities abroad began to suffer hard economic times, the commodities that we were selling were declining in price and declining in demand; and that’s when Canada really got involved. We got sucked into the global economic slowdown because the one thing that was keeping us quite strong, commodity exports began to weaken. Still, in Canada by the end of the year, you had consumer demand still relatively strong, a whole lot better than in the U.S., you had the housing sector in better shape. But as we left December and came into January, you were seeing even those sectors begin to weaken. Now globally, you find that the governments and monetary authorities have done an enormous amount of initiatives in order to get the economy going again. Vastly lower interest rates, huge tax cuts and spending increases that are occurring in the United States and abroad will help stabilize the situation. But fundamentally, we’ve seen a very, very big change in what drives the global economy. It used to be the U.S. consumer, the ”borrow-to-buy” type of demand that really kept the U.S. moving, it’s no longer “borrow-to-buy”. What it is, you have to earn, save and then you can buy; and that suggests much slower growth and certainly a period of economic adjustment there.

FRED:  In the past, it’s been said that “when the U.S. sneezes, Canada catches a cold”. Now this time around, are there any factors to suggest we could weather the storm better than our neighbors to the south?

WARREN:  I think we’ve already weathered the storm better and we will continue to do so. Our financial system is much stronger than in the U.S., in fact, we’re rated the #1 globally for our banks in terms of financial stability. If you look at the governments, they’ve been running surpluses up until now and in the U.S., of course, there’s been mega-deficits, so our governments financial situation is in a whole lot better shape. The third part is that households are in better shape as well. As the U.S. household sector was borrowing against mortgages to fund consumer spending, in Canada the average home owner was actually adding to the equity position. So, if you look at those fundamentals it suggests that things are going to be a lot stronger. At the same time, however, we’re an open economy, we’re an export economy so inevitably some of the things that are happening abroad filter back into Canada; and we’re seeing that in the auto sector, the steel and a variety of other areas. And my suspicion is as we go through 2009, particularly the first half of the year; you’re going to see more of that global economic problem filter back into Canada and impact jobs and layoffs.

FRED:  Warren, we’ve seen unprecedented volatility in global equity markets in recent months. What’s been hit the hardest, in your mind?

WARREN:  Well the one thing about this particular set-back that is truly remarkable is the synchronicity involved in it. All major industrial economies have moved into recession. Most major sectors of the global economy have moved into a period of weakness. So it’s not simply manufacturing, although, that has been hard hit or housing which has been hard hit in Europe and in the U.S., it’s affected a whole lot of industries. The stability, however, that we will see in Canada and in some other countries, of course, is that the hospital sector, educational institutions, government provide much more stability. We are a service focused economy and for that reason, the economy setback, at least, has been limited to the more cyclical export oriented industries.

FRED:  How does all this impact the individual investor, how does impact the individual Canadian resident?

WARREN:  Well, if you’re looking at investors, it’s obviously a very cautious time. The equity markets have suffered an enormous setback and you see volatility continuing I think, through much of 2009 although, hopefully, we are on a better trend. Also, interest rates have come down dramatically. So as a result, if you’re looking for ways of putting your money to work in areas that are much less risky, effectively the rate of return you’re going to get is small. So, it’s much more difficult for the average investor to get the type of return that they need to save for retirement and the like. If you are a consumer, you know that you’ve got an opportunity here because the discounts at the stores are pretty big. You know gas prices have come down a lot so it’s basically a buyer’s market. If you are in business, however, because you’re discounting and because it’s a buyer’s market not a seller’s market, effectively your profits are being constrained, and you’re suggesting that you may not want to expand this year, or that you may indeed be laying off. So, it’s affected various parts of the economy differently but one thing is very, very clear, and that is the economic circumstances have changed dramatically over the past year, and we’re likely to be in a period of transition and tough economic times, in my view, through much of 2009.

FRED:  Well, given that situation we hear about various measures that governments and central banks are taking in order to help stabilize credit markets and to stimulate the global economy. Can you give us your take on what policymakers are really trying to accomplish?

WARREN:  Well, in many countries the stimulus that has been put in the economy has been enormous, particularly in the United States where their deficit may well total a trillion dollars over the next year or so; and that’s up from something well under five hundred billion, still a very high level. In Europe, and the like you’re seeing spending increases, infrastructure projects, huge reductions in interest rates and that will help stabilize some sectors, its mitigating that decline. In Canada, we’re in a rather unique position globally of coming out of a period of strong surplus. So, rather than the U.S. government which is “borrowing to buy” to solve its problems, we are taking the accumulated wiggle room that we have developed over these years of fiscal stimulus to actually add impetus to the economy. And, I think you’re going to find whether it’s at the federal level or the provincial level, governments now will come in and provide some important support. At the same time, of course, the bank of Canada is lowering interest rates and that by itself provide some relief for borrowers.

FRED:  I was just looking back a year ago at some of the statistics that I had recorded and, of course, we had a Canadian dollar that was slightly excess to the U.S. dollar when you’re talking about par; and then, of course, when we got towards the end of the year about a 20% decline. We saw huge swings as a result in the value of the Canadian currency over the course of 2008. Can you explain what’s behind these moves?

WARREN:  Well, the rollercoaster ride in the Canadian dollar reflect the rollercoaster that we’ve been on in the economy particularly, the commodity markets. And, in fact, if you look at last year the currency was as low as 77¢ and as high as slightly above $1.02. So, in a massive range, and quite honestly the year before had an equally large range and the year before that. We’ve got to get use to the fact that the Canadian dollar is a whole lot more volatile than it has been in the past. But the real impact on the Canadian dollar has come from two things; one, globally investors are nervous about what’s going on so the’re looking for safety, security, liquidity; and that in many cases has driven investors into buying U.S. treasury securities bringing their interest rates down but, of course, hitting our Canadian dollar because investments are diverted from Canada. But the most important thing that is really caused the setback most recently, is the fact that commodities prices which were a very, very important driver of the Canadian dollar on the upside have crashed down. Oil prices and a variety of other industrial metals and the like have come down dramatically; and the Canadian dollar has reacted because those earnings that we were making before that increased the demand for the Canadian dollar and drove it higher are now much, much smaller and, therefore, taking away some of the air that was driving the Canadian dollar higher.

FRED:  Thanks Warren, for sharing this overview of what happened in the global economy in 2008. You’ve certainly have succeeded in making me feel a little bit more comfortable. We hope that this discussion has helped you, our listeners better understand those issues that are grabbing headlines these days and what it means for the Canadian economy.

Thank you for joining us. I’m Fred Ketchen. For more information, please visit your local Scotiabank or Scotia McLeod branch. We’ll help you make the most of what you have.