Canadian Recession: Why Australia is Next in Line

Canada is officially in recession.

The Canadian economy contracted 0.5% in the quarter to June. This came on the back of an 0.8% contraction in the first quarter of the year. But it could have been worse. The slump actually bettered expectations for a 1% decline in growth.

The net result, however, remains the same. With two consecutive quarters of falling growth, a recession was unavoidable.

If you’re an Aussie reading this, it should give you some serious food for thought. Canada is the closest thing we have to a model for the Aussie economy. Why?

Like Australia, Canada’s prosperity is built on commodity exports.

Both nations are rich, and of relatively similar size in population. Both are progressive, and open to immigration. Together they rank among the most business-friendly nations. Most importantly, both live and die by what they sell to the rest of the world. For Aussie iron ore and coal, think Canadian oil.

That makes Canada the perfect case study for our own economy. And it’s why this recession is so telling.

Canada’s economy entered recession for two reasons primarily. For one, its balance of trade is worsening amid falling oil prices. At the same time, business investments are falling, stalling economic growth. Both of these stem from slowdowns in the global economy, led by China.

However, Canada can expect oil prices to recover at some point in the mid-term. Australia, meanwhile, can’t rely on rebounding iron ore prices anytime soon. Because of this, we now stand on the brink of our first recession in 23 years.

Declining GDP driven by weak trading terms

We are living, once again, in a time of ongoing global economic stability’ — Stephen Harper, Canadian Prime Minister

Harpers comment came in the immediate aftermath of Canada’s slide into recession.

Yet it’s easy to see Tony Abbot evoking similar sentiments in a few months’ time. After all, the prospect for an Australian recession has never been higher.

Just today, Aussie GDP growth for the second quarter came in a disappointing 0.2%. Economists had predicted 0.4% in the weeks leading up to the announcement. At 0.2%, it represents the slowest quarterly growth since 2011. And it’s a far cry from the 0.9% growth from the first quarter. In the year to June, the economy grew at a paltry 2%.

Another decline in Q3, and we’d find ourselves in the same position as Canada.

Canada’s economic slump came as a result of worsening trade and investment. Australia’s recession will come in exactly the same manner.

Declining trade and weak investment is underpinning Australia’s poor growth this year.

The current account deficit dropped 41% in the June quarter, to $19 billion. In other words, the value of imports exceeded exports by a huge margin.

At the same time, ABS figures show investment levels are plunging. Capital expenditures fell 4% in the June quarter. Business investments are down 10.5% on last year.

In Canada’s case, business investment fell by an annualised 7.9%. As in Australia, capital expenditure is down amid weak growth prospects.

Meanwhile, Canada’s resource sector shrank 4.5% amid plunging oil prices. Prices of the commodity have halved in the space of 12 months alone. Canada’s budget has been left decimated as a result.

As a result, both economies relied on consumer spending to lift growth in the first half of the year. But clearly consumers can’t make up for the shortfalls in exports.

No China to save Australia from recession this time

Canada has now entered recession twice in the space of 7 years. The first time was at the back end of the global financial crisis in 2009. Australia, as you’ll know, weathered that storm. But there was a good reason why we didn’t follow Canada into recession during the GFC.

China was still undergoing rapid growth at the time. It’s appetite for steel ensured iron ore demand didn’t waver.

But that’s where the problem lies.

China’s demand for Aussie commodities is falling. The construction boom is slowing, and China is readjusting to weaker growth. We’re not so lucky this time around, because we have no key selling point anymore. We’re just one in a pack of many commodity exporters feeling the brunt of this global slowdown.

Canada’s recession is merely a reflection of the sickly state of the global economy.

But it provides the perfect analogy for Australia’s own future. China kept Australia out of recession seven years ago. This time, we won’t be so fortunate.

A brighter future for Canada?

Despite the recession, some observers believe the worst is behind Canada. BMO Capital Markets economist Doug Porter noted:

While far from good news, the decline in Q2 GDP was a bit less nasty than expected. [The] good news is that the economy contraction looks to be in the rear-view mirror’.

Here’s Stephen Harper with his take on this:

Obviously there has been challenges…in energy and some commodity sectors because of falling prices. But the fact of the matter is over 80% of the Canadian economy has been growing’.

There’s truth to this belief that a Canadian recovery is around the corner. But it’s dependent on a significant upturn in oil prices.

For now, the ‘fact of the matter’ is that oil prices are depressed. You can’t argue the economy is growing if your export sector is shrinking. It’s one of the most basic laws of economics.

What goes out must be greater, or equal to, what comes in. In other words, exports need to, at worst, match imports. This is important because it keeps national debts, and budgets, healthy.

Of course, trade deficits aren’t the be all and end all. Rich countries regularly run up deficits even during times of rising prosperity. But they have to borrow this money from abroad. Unless these loans end up as investments benefiting the economy, they’re counterproductive. It means that these loans, or debts, end up financing consumption. That, in the long run, threatens to leave nations under ever increasing piles of debt.

That’s exactly what’s happening in both Canada and Australia.

You can easily develop an economy without anything supporting this growth. All you have to do is jack up credit and flood the entire system with cash. Then just sit back and watch consumer spending rise. You can keep this ruse up for years; decades even. But eventually this ploy collapses in on itself. And it really unwinds once the balance between exports and imports gets out of hand.

The good news for Canada is that this imbalance could improve in the coming years. There’s a likelihood that this recession proves but a temporary blip. Why? Because there’s a strong likelihood that oil prices will rebound soon.

Unfortunately, this also means Australia’s own recession won’t have a happy ending.

No Aussie commodity rebound on the horizon

Unlike coal and iron ore, oil prices won’t stay at present lows for much longer. We know this because Saudi Arabia, the second largest oil producer, is suffering of its own accord. The Saudis influence global oil prices through OPEC. They’ve used OPEC to suppress oil prices. In doing so, they hoped to destroy the US shale industry.

That hasn’t worked out as planned.

Saudi budgets are coming under increasing stress of late. They know that sooner, rather than later, prices will have to rise again.

The same can’t be said of iron ore, or indeed coal. Goldman Sachs predicts iron ore prices will remain at present lows for the next four years. The investment bank even forecasts prices bottoming out at US$40 a tonne. That’s a hefty drop from prices of US$180 a tonne at its peak in 2012.

It’s not a tough call to make on Goldman’s part. After all, iron ore doesn’t have the kind of steady global demand oil does. From rich to poor, most economies require oil in abundance.

But iron ore depends on rampant construction. It’s reliant on on emerging economies taking up most of the slack. That’s when building activity is at a frenzy, and demand for steel goes through the roof.

Of course, Chinese steel demand may remain robust, at least by global standards. But the point here is that it won’t rebound to levels seen when iron ore prices peaked. And it’s not likely to improve over the next few years. In a best case scenario, prices will remain low for the next few months. By that point, Australia may already be in a recession.

The saving grace for Canada then is that the situation in oil markets could change. Once oil prices start rising — and they will — its bottom line will improve. That could be enough to get the Canadian economy back on track.

For Australia, the best hope for avoiding recession might be the drastic Q2 slump. Remember, the economy only grew at 0.2% in the second quarter. It would have to drop below this point in Q3 to qualify as a technical recession.

Yet at this stage, even that can’t be ruled out.

Either way, Australia is set for a challenging second half to 2015. According to Markets and Money’s Greg Canavan, a recession is all but guaranteed. As one of Australia’s leading investment analysts, Greg warns we’re sleepwalking into our first recession in 23 years.

In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals why economic growth is going to fall again in the three months to September.

Falling mining revenues, and higher trade deficits, are already taking their toll on the economy. Government revenues are down, household debt is up, and business spending is falling too.

But there are actions you can take right now to lessen the blows of the coming recession.

Download your free copy today to learn how to protect your wealth from the fallout of the crash. To find out how to download his free report right now, click here.

Mat Spasic,

Contributor, Markets and Money

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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