Author: Karthik Sankaran, Senior Market Strategist, Corpay Cross-Border
The last two years have thrown one curveball after another at North American business—Covid, supply chain disruption, rising US-China tensions, and the biggest war in Europe since 1945. These events have heightened uncertainty and raised the specter of a return to 1970s stagflation--or worse. But these fears are overblown. While there will be imbalances to work off, both the US and Canada are well-placed to emerge stronger from these trials.
For all the grumbling about America needing a new Paul Volcker, the world has changed too much to make a relentless upward spiral in wages and prices likely. Businesses do face labor shortages and wage increases, but they are mostly negotiating with individuals and not with organized labor. Unionization rates have fallen dramatically over the last 50 years, particularly in the US. According to data from the Congressional Research Service and the Bureau of Labor Statistics, roughly one in four workers in the US belonged to a union in 1970; that rate is now one in ten, and only one in sixteen in the private sector.
Meanwhile, a Federal Reserve caught unawares by the jump in prices earlier this year keeps insisting it will not rest until it pushes inflation back down. These assurances seem to be effective.
The University of Michigan’s Surveys of Consumers show that people believe prices will rise at an annual rate under 3 percent five years from now, hardly an indication that recent history has permanently scarred expectations and behavior.
But beyond intangible credibility, there is one vital difference between now and the heyday of disco and bell-bottoms—the massive increase in North American energy production. Both the 1970s and the early 2000s were marked by relentless selloffs in the dollar as the US import bill soared with rising oil prices. This vicious circle raised concerns about the currency’s viability as a store of international value, exacerbating inflation panic. But the shale revolution has restored the dollar’s cachet as a hard currency, just as the geopolitics of energy are becoming ever more tense. Markets understand that Canada is part of this story too, helping make the loonie more resilient than its peers in the face of a rampant dollar.
If there is little chance of the redux of 1970s malaise, are we headed for a deep recession? Despite two consecutive quarters of negative GDP recorded in the US, the underlying economy seems more robust with unemployment still near record lows. A slowdown – the intended outcome of Fed policy – is certainly likely, but it need not be particularly deep or prolonged. Outside some overhyped precincts of the technology sector, businesses are optimistic enough to talk up capital investment plans in their quarterly calls. While China’s embedded industrial and logistical capabilities make a complete decoupling unlikely, the US government is ramping up incentives for locating new plant in critical industries in North America.
Canada will be a major partner in these initiatives as an integral part of the US’s advanced technology and automotive ecosystems. A public-private push for climate, energy and security resilience will support growth for years on both sides of the 49th parallel.
If the outlook is relatively good for the US and Canada, what about economic contagion from more troubled parts of the world? The European economy has been hit hard by spiking energy prices and worries of a sudden halt in Russian gas exports. An unhealthy energy codependence may prevent a total shutoff for now, though that is not much of a consolation. Even so, Europe’s quest to diversify its energy supply will mean opportunities for producers just across the Atlantic. The silver lining of this crisis lies in fresh efforts in the creation of new fiscal instruments and monetary backstops to support members of the European Union, and the further retreat of calls for Euro exit to the fringes of politics. The last decade has seen EU members (since, and perhaps because of, Brexit) act repeatedly on Benjamin Franklin’s maxim--“We must all hang together, or…we shall all hang separately.”
China has different worries. Official missteps over Covid Zero policies rippled around the world, but authorities in Beijing are finally moving to increase vaccinations among the elderly. Beyond the pandemic, the country also needs a different growth strategy as the costs of debt-funded infrastructure and real estate investment outweigh the benefits. That means cracking elite resistance to broadening the safety net, and raising incomes and consumption. It remains to be seen if the political system can do that.
Nevertheless, China is very different from other developing countries. Its spectacular ascent in global manufacturing gives it a heft that comes from the size of its economy and the extent of its trading links. China’s oversize stock of domestic debt is largely denominated in its currency, and its controls on capital flows make it less likely to succumb to “classic” emerging markets shocks.
Thus the major components of the global economy outside North America have their problems, but in the realm of “muddle-through” rather than catastrophe. By comparison, the US and Canada are growing and more self-sufficient. Will this lead to large capital inflows and excessive dollar and loonie appreciation? Perhaps not. The dollar surge thus far has been driven by strong growth, a Fed racing to catch-up to inflationary pressures, and the limited effects of the energy price shock on the US trade balance. But most of the impetus from those factors could be behind us. The dollar may catch a second wind, but the headlong pace of its appreciation in early 2022 is unlikely to be repeated.
This does not mean all will be all smooth sailing in the US and Canada. Even if we don’t see a return to the 1970s, we don’t know how sharp a slowdown is needed to bring inflation back down to 2 percent. And the easy money of the Covid era has fueled asset price runs that need to be undone. Some of this has already happened relatively painlessly, as the excesses of meme-stock mania are being unwound. Housing markets, particularly in Canada, are another matter, but the short length of the steep ramp in housing prices since Covid began suggests a lower likelihood of broader systemic issues when the air escapes that bubble.
So, for all the ructions in the markets and in commentary about them, there is hope that the coming years will allow us to cast a jaded eye on the asset market cycles of boom, doom, gloom and just watch the real economy bloom.
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