How will the world economy get better?
One-on-one with Peter Dungan, professor of business economics, Rotman School of Management and director of U of T’s Policy and Economic Analysis Program
Canadian money. http://www.sxc.hu
The world economies will eventually equilibrate. They will adjust themselves. It may take time, but problems tend to balance themselves out, prices adjust, people’s demands adjust to the production of the economy. It takes time, but the economy wants to get back to the place were it is relatively fully employed. And as long as people don’t keep making mistakes, or new problems don’t come along, economies tend to do that.
Q. How did the economy get into this mess in the first place?
It’s important to understand that the U.S. was confronting problems even before the financial crisis broke a month or so ago.
That problem had to do with the fact that they had built too many houses and had lured too many people into home ownership. There were physically too many houses relative to the number of people who wished to live in them. That in itself has already caused the U.S. gross domestic product to slow down because people aren’t constructing houses the way they used to. That’s had an effect on the consumer sector because a lot of the people who have been tossed out of their houses or have been worried about their houses aren’t buying consumer goods.
Q. What’s the solution to that?
First, there needs to be a reduction in house prices to the point at which they are more affordable, combined with a growth in population to a point where people want to buy houses again. It has nothing to do with finance – finance helps, but there are these fundamental real issues underneath.
Q. When can you see this happening?
Our best guess is that the U.S. will begin a turnaround some time in the middle of next year. This assumes that nobody makes any mistakes – that governments continue to make good decisions about how to stimulate the economy. Today, government, such as the U.S. Federal Reserve, has been doing exactly the right things to offset this – reducing interest rates and ensuring that the financial system is still working and is stable.
Q. You have said that aside from the toxic debt associated with U.S. mortgages, the economic problems stem from “real” problems. What are those “real”problems?
In the U.S., the real issue is housing, in Canada, it’s the value of our dollar, and worldwide, the price of oil.
In terms of housing, the demand for housing is going to eventually increase. There will be an adjustment in housing prices and slowly the demand will also grow. Eventually, there will be a price adjustment. Housing prices will be reduced to a point that people will be able to afford to live in them. Partly it will be because of price adjustment and people getting their credit story back together again and partly it will happen through population growth and immigration and that will cause more houses to be bought. The over-build of houses was in the range of 10 per cent. So with population growth of two to three per cent, after several years, you’ve got people to buy the houses, especially if their prices have fallen. It’s all basically a question of equilibration.
Q. What about Canada’s ‘real problem’ – the value of our dollar.
Canada’s problem is not as serious as the U.S. housing bubble, but our economy has been hit by the fact that the dollar moved up from the 60-70 cents U.S. range to parity very quickly. So where Canada got hit was in terms of exchange rate adjustment. And that caused problems that we know about – in Ontario manufacturing, for example. To top it off, our chief customer — the U.S. — is weak, making the problem worse. So for the Canadian correction to happen, we have to wait for the U.S. to start to get out of their problem. The fact that the Canadian dollar has dropped a lot over the last few months is good news for the Canadian adjustment.
Q. How will the world economy begin getting better?
That has to do with the price of oil. It may have overshot to the downside, but in the last year the price of oil was too high for the world economy to absorb, and that high price now was clearly in price a speculative bubble going on. Currently, the price is going down because the demand for oil is going down. When it was in the $120-$140 per barrel range, there was clearly a speculative bubble at work. It isn’t purely supply and demand that would explain a drop from 140 to 60 dollars per barrel — the world economy is not running at 50 per cent of the capacity it was a few months ago. Now that the bubble has burst and the price of oil is much lower, purchasing of other goods and services in the rest of the world (and in Canada and the US) can pick up (it won’t happen overnight) and central banks, freed of the fear of inflation, can lower interest rates to help out as well.
Q. So what are the ingredients for a turnaround?
We’ve got U.S. housing, we’ve got the exchange rate for Canada and oil prices. The fact that oil has dropped so much helps the whole planet to get moving. But it’s all part of the fact that as long as the markets are free to work, they equilibrate. And so if you get too far ahead of yourself or if you get a problem where something is too high – the price of oil, the dollar, the stock market, you get a downturn. The price falls, and then you get rescued from the downturn. We’ve been hit by a storm of several of these unbalances happening all at once. They’re being rebalanced, and it will take several quarters — probably a good chunk of next year. We project that by the middle of next year, the economy in Canada and the U.S. will start to grow again. It will then take a while just to get back to the level of production they were at before the downturn began – but at least they’ll start to struggle back.
Tags: Behind the Headlines, Peter Dungan, Society
what about the fall of the US dollar? The turn around won’t happen for another 3 or 4 years.
Well everyone is entitled to their opinion. Population does not need to grow in order to fix the economy. Houses are priced for people with reasonably paid workers to purchase. Lay people off work so they lose their house and then the people with money can buy the houses cheap. Many wealthy people today got that way by exploiting the same issues in the Great Depression. When people are out of work we have this nut saying we need more people? Perhaps he is thinking of bringing back the Plantation.