Sidekick or Leading Actor? Canada Must Decide (Part 1)

At least the word ‘dismal’ isn’t being used. We’re fortunate in that regard. Not everyone is so lucky.

Among industrialized nations, Russia – due to plummeting oil prices, a sinking ruble and double-digit inflation − is the poster boy for sorry outlooks.

Neither does the adjective ‘exceptional’ spring to mind, though, and that’s too bad, given all the assets that should be at our command.

To the degree that Canada’s gross domestic product (GDP) growth will outperform most other nations, credit will be due the United States.

The American economy is surging ahead. Third quarter annualized “real” (i.e., inflation-adjusted) GDP growth south of the border was 5.0%, on top of a 4.6% gain in the second quarter.

In America, profit and investment levels will suffer in the energy sector, but throughout the rest of the economy, lower transportation and heating/cooling costs will offer significant stimulus. Consumer spending and revitalized manufacturing are expected to become economic drivers.

Various explanations have been advanced for why world oil prices have fallen so dramatically.

Some would contend that it’s due to a demand shortfall, brought on by flaccid global economic activity and increasingly effective conservation efforts.

Others say it’s because there is a supply glut on account of the remarkable success the U.S. has been achieving in developing its shale-rock fossil fuel deposits.

Then there’s the Saudi Arabia factor. That nation, with its abundant reserves and low cost production has traditionally been the price setter.

On many occasions in the past, Saudi Arabia has adjusted output to support a targeted price level; but not this time.

Instead, the faucets are being kept open. Initially, analysts believed this was a ploy to render U.S. shale-oil developers more hesitant about undertaking new investments.

More recently, the explanation has veered off into the geopolitical arena, focusing on the two major religious streams within Islam, Sunni and Shia. (Much of the commentary which follows will seem reminiscent of Protestant-Catholic conflicts of an earlier era.)

The split emanated centuries ago when there was contention over who was the rightful heir to carry on the teachings of the prophet Muhammad.

The population of Saudi Arabia is mainly comprised of followers who adhere to the Sunni faction. The Wahhabi branch, important in Saudi affairs, is one of the most orthodox sub-sects.

Iran, mainly Shia, is the other major power broker in the Arab world. Iran has been extending its influence into Iraq and Syria.

In Iraq, a Shia majority is facing opposition from a portion of the Sunni minority that is finding its most extreme expression in ISIS, also known as ISIL (the Islamic State of Iraq and Syria/or Iraq and the Levant), whose fighters were once backed by al-Qaeda but who are now propagating new levels of terror all on their own.

(The Western-sponsored Shia government in Iraq has so far proven ineffective because it has been more interested in settling the score with and redressing the wrongs perpetrated by former leader Saddam Hussein’s Sunni-oriented Ba’athist Party regime than in governing for all the people.)

The Kurds in the northwest of the country are a separate ethnic group. With respect to their Muslim faith, they are mainly Sunni.

In Syria, the Bashar al-Assad family and its followers adhere to the Alawite offshoot of the Shia faith, although the country in total has a Sunni majority, based in the center and the east.

Iran’s economy, devastated by sanctions that are meant to curb its aspirations for nuclear weaponry, desperately needs oil revenue more than does Saudi Arabia.

By keeping the price of oil low, Saudi Arabia is sending a painful economic rebuke to Iran.

The negative impact on Russia, as collateral damage, is an added bonus. Mr. Putin’s role in assisting the al-Assad regime in Syria has been duly noted and chastised.

If this scenario is indeed true, it doesn’t lack irony. Should the day eventually come when Iran signs a nuclear-containment agreement with the UN Security Council and Germany, a lessening of sanctions will free the country to sell oil in more markets, adding to the supply excess.

On the global scene, the drop in the global price of crude has revived the “deflation” boogeyman.

A fear of deflation (i.e., a drop in the general price level) engenders two problems: 1) everyone puts off purchases in the expectation prices will fall further; and 2) debt becomes harder to repay.

The threat from deflation is being exaggerated. That’s because shifts in currency values aren’t being factored in to a sufficient degree.

While the subject of deflation is being most widely discussed in Europe, the U.S. would also seem susceptible. Due to its soaring growth path, the value of the greenback is eclipsing all other currencies. Not only are energy prices in America on the downslide, but so are import prices.

At the same time, however, the nation’s labor market is approaching full employment (i.e., a jobless rate of 5.5% or lower versus a current level of 5.8%). Rising earnings will put a floor under costs.

In much of the rest of the world, exchange rate declines will support consumer price index (CPI) increases through higher importation costs.

Canada’s resource wealth was a source of strength in the mid-00s and even a saving grace in the early stages of the 2008-09 recession.

Now the nation is experiencing the flip side, with world-wide commodities demand and pricing in retreat.

The drop in value of the “loonie” (Canada’s currency) is supposed to come to the rescue through the compensating mechanism of stronger manufactured-goods export sales.

To a significant degree, that is what’s happening. It’s part of the explanation for why Canada’s economy will do okay, if not outstanding, in 2015.

But there are some disturbing trends that need examining under a brighter light – shadows, as it were, that need illumination − if unsettling “critters” are to be shooed away.

Stay tuned for Part 2…