The world economy can blow hot and cold, just like the weather. Markets like it best when things are not too hot, and not too cold – but it looks like
the temperature is starting to drop decisively.
Consider Dr. Copper, so named because markets long ago bestowed a PhD in economics on the red metal because of its record of predicting
both upturns and downturns in the economy.
Just a year ago, copper was $5,000 per tonne, but during the first few months of 2006 the price soared to over $8,500.
Since then, the price has fluctuated in a declining channel, tracing out a big top, and in the past month, the declines have picked up speed (now around $5,600) as speculators head for the exits.
The fundamental reason?
Global economic growth is decelerating, led by the collapse in U.S.
housing, a big user of copper.
How much more of a correction we experience in coming weeks remains to be seen, but the downside potential is large.
Consider next the price of oil. Oil has come down a lot since OPEC announced that it would limit production in order to defend a price of $60 per barrel. Many have attributed recent price declines to warm weather, which has reduced demand in the crucial U.S. northeast.
Weather is undoubtedly contributing to the situation, but the fact remains that OPEC has already cut production significantly, and has not been able to maintain the $60 price. That is
because the world economy has been moderating for some months.
To add to this, the excess delivery capacity that is created by each cut in OPEC production creates a bigger cushion to guard against supply
shortfalls that might emerge for
geopolitical reasons.
Hence, the price is falling for two fundamental, self-reinforcing reasons.
And then there is the currency
market. The U.S. dollar, measured on a trade-weighted basis, hit a low point in early December that was only slightly
higher than that in May of 2006.
During the past six to eight weeks, the dollar has
recovered nearly two per cent in value overall, with most currencies retreating in its wake.
This is often a sign of unease in global capital
markets. Slower growth will mean volatile exchange rates, stock markets (emerging market stocks have started the
year badly) and bond markets,
particularly in emerging economies, and typically this all means a stronger dollar.
Taken together, these indicators
suggest that the world economy began to decelerate in May 2006, and that there is a more pronounced slowdown in the offing.
Canadian exporters can feel the effects, as exports have been on a
decelerating trend for close to
12 months now.
This is why the recent declines in the Canadian dollar, while welcome, must be seen in context.
The lower dollar is
related to falling commodity prices and a stronger U.S. dollar, which in turn are due to a softer world
economy. Canadian exporters are driving over
a pothole in the road; the recent decline in the Canadian dollar will act as
a shock absorber, but the pothole is still there.
In other words, exports are likely to remain soft despite the dollar’s recent retreat.
The bottom line?
The signs of slower economic growth at the global level are
beginning to solidify.
The good news is that exchange rates appear to be following those
fundamentals.
(Stephen Poloz is a senior vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)