Canada's Housing Bubble

Dec 31, 2010 Sharon Singleton, QMI Agency torontosun.com

A strong loonie, over-reliance on the U.S. and high consumer debt will continue to drag on the economy in 2011, with the outlook for the next few years sluggish unless Canada switches its focus to emerging markets, economists say.

After roaring into 2010 like a lion with the best economic growth among industrialized nations, Canada’s economy is going out like a lamb. Expansion in the third quarter came in at a disappointing 1%, lagging the U.S., and growth next year is likely to be 2% to 2.7% at best, economists said.

Canada weathered the financial crisis better than most, with strong government finances, robust domestic demand and solid banks, but the recent slowdown has thrown the spotlight on a major problem – Canada’s dependence on the U.S. for almost three-quarters of its trade.

“We have to stop doing what we are familiar with and start investigating the unfamiliar,” Scotiabank chief economist Warren Jestin said. “It’s the emerging market possibilities that will drive growth in Canada in coming years.”

Although recent economic data has indicated that the recovery south of the border may be gaining some traction, growth in the medium term is likely to remain tepid. U.S. Federal Reserve Chairman Ben Bernanke has warned it may take five years to bring down the high unemployment rate, stuck just below 10%.

The hangover from the financial crisis will also take years to unwind, with a huge glut of unsold housing and a federal government budget deficit of about $1.3 trillion.

HSBC economist Stewart Hall called Canada’s reliance on the U.S. an albatross around the neck of the economy. In theory, he said Canada is ideally placed to take advantage of the fast pace of growth in the developing world, but businesses have been slow to wake up to the possibilities.

“We have the magic that is the Canadian population with one in five foreign born,” he said. “It gives Canada a perfect opportunity to tap into high growth areas, we have the ability to drill into these economies on a personal level.”

CIBC chief economist Avery Shenfeld said the U.S. has done much better in developing markets. Quarterly U.S. exports have regained virtually all of the ground lost during the recession, while Canada's real exports are still 15% below their pre-recession peak, he said in a recent report.

On the policy level, the government is taking the right steps, Hall said. Canada recently concluded a free trade agreement with Chile and is in talks with India and the European Union.

With exports still dragging on growth, Canada will continue to rely on domestic demand going into 2011 to drive the economy.

Business investment in Canada has proven resilient and was one bright spot in the third quarter economic report, rising 6.5%. Consumer demand also remained strong, gaining 0.9%.

However, economists are concerned that sooner or later consumers will tighten their purse strings to reduce household debt, which is running at a record of 148% of income.

BMO Capital Markets deputy chief economist Doug Porter predicts that consumer spending will slow to an annual 3% next year.

Another major risk for the economy in 2011 may come from Europe. The Bank of Canada in its December financial review said the risks associated with the euro zone’s sovereign debt crisis are high and rising.

The central bank said concerns other European nations such as Portugal and Spain will join Ireland and Greece in calling on the EU for a bailout could create a new aversion to risk in the financial markets.

That could limit access to capital, which for many small businesses in Canada still has not returned to its pre-crisis levels.