What happens when interest rates have been cut as low as they can go, and things still seem to be getting worse? For all those who’ve ever wondered about that worst-case scenario for monetary policy, you’re about to get your answer. If “systemic risk” was the buzzword of the fall, and “fiscal stimulus” dominated the winter, get ready to add “quantitative easing” to your vocabulary.
Here’s the set-up: last week the Bank of Canada cut its benchmark interest rate to an unprecedented low of 0.5 per cent. The bank likely can’t cut any further. So what now? Traditionally, central banks use interest rates and money supply to ensure that commercial banks have enough flexibility and liquidity to lend. Beyond that, they care mainly about keeping inflation in check. But with private investors and commercial banks around the world struggling with plunging asset values, rising loan losses, and slowing trade, the playbook is being rewritten on the fly. Bring on the “quantitative easing.”
This is what TD Securities analyst Eric Lascelles calls the “nuclear option,” and it essentially involves the Bank of Canada (and other central banks) buying private sector assets, such as corporate bonds and asset-backed securities. In theory, this should drive down bond yields, improve liquidity, and generally make it easier for business to operate. Once the worst of the fear passes, the bank will quietly back out of the market and everything will go back to normal. It’s a great theory. It’s also never really been tested on this scale.
In quest movies, a wise old sage gives a mysterious package to the hero with a warning: “This box is very dangerous. Only open it if absolutely necessary. If you do, things could get better, or they could get a lot worse.” Well, central bankers around the world are now reaching for the mysterious box. Soon we’ll all find out what’s inside.
On the bright side, Robert Barro, a professor of economics at Harvard University, estimates that there is a 20 per cent chance the United States (and thus the rest of the world) will fall into a depression. That means there’s an 80 per cent chance we won’t. Those are decent odds, and hey—the mysterious box always works in the movies.
GRAPH OF THE WEEK: The car connection
For 25 years U.S auto sales and Canadian unemployment have moved nearly in lockstep, demonstrating the importance of U.S. consumer spending to the Canadian job market, and suggesting that Canadian unemployment may very well hit 12 per cent by the end of 2010.
THE GOOD NEWS
Signs of life at the mall
After a dismal holiday season, U.S. retailers saw a 0.7 per cent rise in February same-store sales from a year ago. And while department stores, luxury brands and restaurants are suffering, discounters like Wal-Mart are bucking the trend. The world’s biggest retail chain has seen sales rise 5.1 since 2008. Other winners include Costco and Sam’s Club.
Credit card restraint
Weak holiday retail sales in 2008 resulted in a more responsible use of credit cards. The percentage of people more than 90 days behind on their payments fell by 11 per cent in the final quarter of last year.
Hot times in the Citi
Citigroup, which was the world’s biggest bank until the financial crisis slashed over $200 billion from its market value, logged an $8.3-billion profit in the first two months of this year—easing fears that the fallen giant will be nationalized.
You have to be a real nerd to pay attention to the Baltic Dry Index. That’s why nerds are breathing a little easier this week. The BDI tracks the cost of oceanic shipping and is often an early gauge of global trade. This week the index hit 2,200—up threefold from the 22-year low it hit in December (though still far off its May peak of 11,793).
THE BAD NEWS
Take this job and cut it
The American job market continues to be a horror show. First employment firm Challenger Grey & Christmas released its monthly survey showing layoff announcements have surged 158 per cent in the past year. Then came the big bombshell: the U.S. Labor Department announced another 651,000 jobs disappeared south of the border last month, bringing the total number of job losses since the recession began to more than four million. The U.S. unemployment rate is now 8.1 per cent, the highest level since 1983, and many of those who’ve managed to keep their jobs are seeing hours cut and wages frozen. Charmaine Buskas, senior economics strategist with TD Securities, expects the ranks of the unemployed to keep growing. “The worst is not over for job market losses,” she said.
Services & factories slide
The Institute for Supply Management reported that pretty much every aspect of the U.S. economy sank again in February. The gauge of service-sector activity, which accounts for close to 90 per cent of the economy and more than three-quarters of employment, was 41.6. (Anything below 50 indicates contraction.) The ISM manufacturing index, meanwhile, came in at 35.8—the 13th straight month it’s been stuck in negative territory. Just as worrisome: all 18 industry groups reported declines in orders and employment.
Everybody knows that much of the economic data from around the world is grim, but economists continue to be surprised at how much worse things are getting. UBS maintains an index of economic surprises (results that are either better or worse than projections) and that index continues to dive—down by almost 20 per cent since September. The latest number to disappoint: Canadian housing starts. Everybody knew they’d be bad, but not this bad. Home construction is running at less than half the pace of a year ago.
SIGNS OF THE TIMES
- Mortgages continue to plague North American consumers. The Mortgage Bankers Association reports that 11 per cent of U.S. household mortgages are now overdue or in foreclosure, up from eight per cent a year ago. And the backlash to the Obama administration’s plan to use tax money to help struggling homeowners has already started. The Tennessee Republican party last week printed bumper stickers reading: “Honk if you’re paying my mortgage.” Over 4,000 were sold in the first five days.
- Another sign of America’s new frugality: riding the bus. The American Public Transportation Association reported that a combination of economic turmoil and high gas prices drove a four per cent rise in the number of trips taken on public transit last year. At 10.7 billion trips, ridership is now at its highest level in 52 years.
- Even as Western nations are being forced to consider nationalization to shore up their crumbling economic institutions, Syria is moving in the opposite direction. For four decades Syria’s economy was centralized and moribund, as domestic capital fled to more open foreign markets. But this week, the government opened the Damascus Securities Exchange. So far, just six stocks are listed for trading, but it’s seen as a key step in the liberalization of Syria’s economy.
- Not all domestic manufacturers are struggling. The business of selling firearms is booming. Smith & Wesson reported a 40 per cent rise in fourth quarter sales of handguns, and Sturm, Ruger & Co. saw an 81 per cent jump in gun revenue. Well, that’s reassuring.
U.S. auto sales remained mired near historic lows in February, and none of the major manufacturers suffered as much as General Motors, with sales down a stunning 53 per cent from a year ago. The latest results added fuel to the debate over GM’s future: bankruptcy, more bailout money, or outright nationalization?
“Sales at these levels imply horrific cash outflows, which the U.S. automakers simply have no means, on their own, to ride through.” —James Hamilton, an economist with RGE Monitor
“Any money we give to the auto industry must be a lifeline, not life support. This isn’t endless. But there has to be a sign of viability. And this needs to happen, and it needs to happen soon.”—U.S. House of Representatives Speaker Nancy Pelosi
“There would be an economy before a GM liquidation and an economy after. In the latter, we’d be having this conversation with two cans and a string.” —Erich Merkle, an independent auto analyst in Grand Rapids, Mich.
“Although sales have already plunged to 34-year lows, our analysis suggests they have considerably more room to contract . . . Long-term changes in the way Americans drive will mean the good times for the auto industry are never coming back.” —Jeff Rubin, chief economist, CIBC World Markets
“Expecting auto manufacturers’ management to fix their own companies reminds one of the definition of insanity: the same people repeatedly doing the same things but expecting different results.” —Larry Kaufman, a railroad industry consultant, and advocate of temporarily nationalizing GM
THE WEEK AHEAD
Thursday: U.S. retail sales for February will be revealed, with most economists projecting a 0.5 per cent decline. Consumer spending at discount chains seems to have stabilized, but sales of automobiles and luxury goods still appear weak.
Friday: Statistics Canada will report February employment results, with analysts expecting the loss of another 50,000 jobs and rise in the unemployment rate to 7.4 per cent. If analysts’ estimates are correct, that’ll bring cumulative job losses to 263,000 since October.
Monday: U.S. industrial production for February. Forecast: weak.