September 30th, 2008


Title: Will recent market developments be cathartic?

Sub-title: Though stock and bond markets appear to be in turmoil, one expert argues that there may be an upside.


Recent weeks have seen unprecedented volatility in global financial markets. Stocks have fluctuated wildly, credit markets have seized and many prestigious companies have been either bought out or gone under.  Tempting as it may be to imagine that these problems have no effect on ordinary folk, in today’s interconnected economy Canadian housing sector stakeholders will no doubt feel the pinch too.


However last week, while many experts stood around pondering doomsday, one senior monetary policy official argued that the current turmoil may actually have a bright side.


“Even (the recent) ferocious storm has a silver lining,” said Mark Carney, governor of the Bank of Canada, in a speech to the Canadian Club in Montreal. “Its cathartic nature and the decisive policy response it is prompting could mark the beginning of the end of a 14-month crisis that has gripped the global financial system. A restructuring that for some countries took a decade is now likely to take only a few years in total in the United States.”


Japan’s lost decade

What Carney, -- an excellent student of economic history,-- is apparently alluding to, is the hope that by taking corrective action quickly, the United States can avoid the long turmoil that Japan went through following the implosion of its own asset bubble two decades ago.


The asset bubble that Japan went through has several parallels with America’s current travails.  By the late 1980s, Japan’s Nikkei stock index had doubled in a few short years and Tokyo real estate prices had shot up so high, that the land beneath the Imperial Palace (which is located right across the street from the Canadian embassy) was estimated to be worth more than then entire state of California.


However Japanese politicians initially refused to restructure the country’s banks (which had made most of the loans that financed that country’s real estate bubble). With all those bad loans on their books, those banks thus had no room to lend more. As a result, despite the fact that the Bank of Japan’s policy rate remained at close to zero, it was hard for many consumers and businesses to get new credit.


The upshot was that Japan, entered what is known there as a “lost decade.” After growing by close to 4.0 percent per year during the 1980s, Japanese average annual real GDP growth slipped to just 1.5 percent between 1991 and 1999. Furthermore, even today, the Nikkei index remains in the 11,000 range, down more than 70 percent from its levels of the late 1980s. Real estate prices there have also yet to fully recover.  It is precisely this scenario that Carney implies that the United States and by extension Canada, can avoid.


Forget decoupling

That said, Carney did brush aside the “decoupling,” theory, which holds that some markets may not be too affected by turmoil in the United States. In fact Carney argues that the planet is now grappling with three major shocks, all of which have important effects on the Canadian economy: America’s first consumer-led recession in almost two decades, the rising cost of capital and its decreasing availability and the commodities “super-cycle,” which has seen average raw material prices double.


Yet despite all of the recent turmoil, real Canadian GDP unexpectedly advanced by 0.7% in July. The July surge, which was the largest monthly gain since March 2004, was a stark improvement from June’s 0.1% gain. This recent strength in the Canadian economy also manifested itself in the number housing starts in August, which rose to a seasonally adjusted pace of 211,000 units, up from 186,500 units the month before.


Housing sector weakening

However according to the Canada Mortgage Housing Corporation the recent strength is likely just a blip. In fact the CMHC now forecasts that for full year 2008, housing starts will slip to 215,000 units from 228,000 units the year before.


Existing home sales data also hasn’t been looking quite so hot. According to the Canadian Real Estate Association the average price of residential properties sold during August fell to $316,052, down 5.1 percent from the levels of August last year.


However the good news is that if Carney is right, Canada’s and America’s troubles will be far shorter than those of that great Asian power. “The months ahead will bring more financial losses, significant consolidation in the financial industry and further increase in the cost of capital,” said Carney.


However a quick restructuring in the U.S. financial sector, (unlike the long and drawn out one that Japan went through) “will greatly reduce the cost in terms of lost output and employment, as well as the negative spill-overs to the rest of the world.”


Let’s just hope that that includes Canada.


Peter Diekmeyer ( is a freelance business and economics writer.




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