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History’s Not What It Used to Be

Nov 18, 2014

The quarter to quarter U.S. “real” (i.e., inflation-adjusted) gross domestic product (GDP) increase in this year’s Q3 was 3.5% annualized, after an even greater expansion of 4.6% in Q2, but a contraction of 2.1% in Q1.

2014 11 18 US Foreign Trade Graphic

The level of third-quarter U.S. constant-dollar GDP was 2.3% higher than at the same time last year. Full-year 2014 GDP versus full-year 2013 will probably be close to that same rate of gain.  

Most projections of U.S. GDP growth next year bump up the increase into the 2.5% to 3.5% range. There are reasons to think such forecasts may be conservative.

October’s Purchasing Managers’ Index (PMI) of the Institute of Supply Management (ISM) was 59.0%. That’s about as high as the PMI ever climbs. Its peak level since the turn of the century was 61.4% in May 2004.

In the commentary accompanying the release of the latest PMI figure, the ISM says that a reading of 59.0% corresponds with a 5.2% annual jump in real GDP.

Such a strong number implies a considerable acceleration in the year ahead. Plus, there’s something else important to consider. The ISM says it has calculated the admittedly-temporary 5.2% GDP growth rate “based on the past relationship between the PMI and the overall economy”.

The “past relationship” model may hold only limited validity. Today’s economy isn’t what it used to be and there have been at least a couple of significant shifts that would imply a tendency towards faster growth.

While nobody thinks 5.1% is sustainable, a figure above 3.5% does appear achievable.

Thanks to “fracking”, the U.S. is greatly reducing its dependence on foreign oil and gas. As a result, the nation’s traditional huge deficit in foreign trade has been reduced by about one-third. This is clearly shown in accompanying Graph 1.

An improvement in the foreign trade balance, including a reduction in the deficit, makes a positive contribution to GDP’s bottom line.

Also, no prior expansion has ever had the benefit of proceeding within such a stimulatory interest rate framework as is currently in place. The Federal Reserve’s trend-setting yield is barely above 0.00% and hawkish sentiments (i.e., a hike) aren’t expected to prevail until next summer.

Graphs 2 and 3 demonstrate why Canada’s economic outlook is more muted than America’s.

It was easy to be bullish on Canada’s resource-based economy when China’s GDP was advancing from 10% to 12% annually in the middle of the 00s. At that time, China’s demand for all manner of raw materials was insatiable.  

China’s growth has since dimmed to a “measly” 6.0%, however, and some structural weaknesses have become apparent in the Canadian economy.  

Ontario’s mighty manufacturing sector has been deeply wounded. The Canadian dollar is falling again and that will help with export sales, but some major international investment swings have already occurred and won’t be easy to reverse.

For example, motor vehicle plants located in Mexico are shipping far more product to the U.S. now than are Canadian operations.

There are also legitimate worries about the future availability of electricity in the province. To paraphrase Star Trek’s famous line, power prices appear headed “where no electron has gone before”.

Skipping west to Alberta, that province’s energy sector still doesn’t have pipeline access to a tidewater port and the extra emissions to produce crude from the Oil Sands as opposed to conventional sources (and even shale rock) present a huge target for environmentalists to take aim at with the their longbows and wooden, not carbon-fiber, arrows.

Canada’s economic growth rate in 2015 will be adequate at between 2.0% and 2.5%, but for it to be anything more than that will require the U.S. GDP change to be super-sized.

U.S. foreign trade: goods and services balance
2014 11 18 United States
Based on seasonally adjusted monthly figures, projected at an annual rate.
Analysis of the U.S. foreign trade position usually focuses on goods and services exports minus goods and services imports.
Data source: U.S. Bureau of the Census/Chart: CMD.
Canada’s foreign trade: the merchandise trade balance
Canada’s foreign trade: the merchandise trade balance
Based on seasonally adjusted monthly figures, projected at an annual rate.
Analysis of Canada's foreign trade position usually focuses on the Merchandise Trade Balance which is goods exports minus goods imports.
Data source: Statistics Canada / Chart: CMD.
Commodity price indices (as calculated by the Bank of Canada)
Commodity price indices (as calculated by the Bank of Canada)
Data source: Bank of Canada / Chart: CMD.

 

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