An adjustment in the economy south of the border would affect B.C. as well
Michael Kane
Sun
Spendthrift American consumers have set the stage for a dramatic economic slowdown that will spill across the Canadian border, a bank economist said Thursday.
Even if U.S. house prices don’t contract but simply increase at a more normal pace, the waning “wealth effect” will have a big impact on consumer spending, TD Bank’s Beata Caranci said.
That will hurt Canadian exports from lumber to manufactured goods and services, like tourism, although the impact on B.C. will be partly cushioned by trade links with Asia.
“Our economy is so intimately tied with that of the United States that any significant change in their economic performance will usually be reflected on this side of the border,” said Werner Knittel, B.C. vice-president of Canadian Manufacturers and Exporters. “They are our single biggest customer, so if they slow down, our folks are going to slow down. B.C. is little more diversified than other parts of Canada, but if the U.S. consumer stops spending, the chances are we are going to see a fairly significant hit.”
Both Knittel and John Winter, president and CEO of the B.C. Chamber of Commerce, said the study highlights the need for businesses to reduce their reliance on the U.S. and develop other markets.
Winter noted that B.C. exports machinery, plastics and finished products to the U.S., as well as lumber. He said tourism, already being hurt by relatively high gas prices, will suffer more if Americans sit on their wallets.
Caranci argues the U.S. expansion is on “borrowed time” because rising interest rates will increasingly pinch consumer budgets and moderate home refinancing, which has accounted for as much as half of the growth in real consumer spending over the past two-and-a-half years.
At best, she says higher interest rates will slow the U.S. economy by the second half of 2006. But if consumer confidence is seriously undermined, or if a protracted house price correction takes hold, she says U.S. economic growth could slow to a crawl.
Unlike previous house price corrections, Caranci acknowledges there is no housing glut and demand is underpinned by low interest rates, low inflation and low unemployment, although affordability is already eroding in a number of regions.
However, she said the size of personal debt burdens and credit — made easy through interest-only loans and home equity lines of credit — is one variable not prevalent in prior boom cycles. “This introduces an entirely new element of risk that has yet to be tested.”
Other economists are more optimistic. Patti Croft, who first warned about a U.S. housing bubble more than a year ago, said consumers account for 70 per cent of U.S. economic activity, and will eventually slow spending to Canada‘s detriment. But she said the conditions that usually prompt a real estate decline — tighter monetary policy, rising mortgage rates and rising unemployment — are not in place.
Croft, chief economist at Vancouver-based Phillips, Hager & North, noted that U.S. borrowers can write off the interest on mortgage loans, and about 75 per cent of their outstanding debt is at fixed rates which makes them less vulnerable to the current tightening cycle in short-term rates.
“The other thing with houses is that prices don’t normally collapse. So when we talk about a bubble bursting, it is not like the stock market where the bottom literally falls out,” Croft said. “Ordinarily, when you do get a correction in housing, it is more of a drift as opposed to a collapse, so that’s a mitigating factor as well.”
Helmut Pastrick, chief economist at the B.C. Credit Union Central, said U.S. interest rates are not expected to rise rapidly because the goal of the U.S. Federal Reserve is engineer a “soft landing” and slow growth.
“There are concerns that housing has had such a long run in the U.S. that it could be due for a correction but that remains to be seen,” Pastrick said. “Housing has surprised everybody on the upside and low rates have been the main reason for that. I don’t think they will shoot up to critical levels.”
Laura Jones, B.C. vice-president of the Canadian Federation of Independent Business, described the TD study as “a bit of a cloud on the horizon, but nothing to get too alarmed about.” And forests analyst Craig Campbell said there is nothing to cause a spike in U.S. interest rates and slow down the general demand for housing.
“There is a lot of speculation and conjecture about the so-called housing bubble but the fundamentals do not support that,” said Campbell, a partner with PricewaterhouseCoopers in Vancouver.
He noted that U.S. homes are getting bigger, and remodelling and renovations are at record levels. Much of the spending is by older baby boomers who are relatively financially secure.
© The Vancouver Sun 2005