Looking back over 2010, there was no lack of drama. The year began with a bang: news that we ended 2009 with a surge of growth combined with evidence of continuation into the new year. Most were proclaiming recovery. But just as abruptly, the engine stalled in the second quarter as the effects of stimulus faded. Then came the successive waves of sovereign default fears. In all the turbulence, there are many possible candidates for the big surprise. Can we narrow it down to one?
Many immediately cite the developed economies that are on the brink of default. This may well be the shock of the decade, but the risks faced by developed sovereigns were reasonably well known at the beginning of 2010. Some suggest that, after becoming Keynesian all over again in 2009, we are Keynesian no longer, as governments go into fiscal retreat. It is inevitable, and it will be a shock (as you and I foot the bill), but at present, it’s still largely a future event. And in contrast to the late-2008 policy coordination, governments are currently all over the map: some have announced strict austerity plans, others seem undecided, and another group is actually augmenting stimulus spending.
Perhaps more surprising is the rapid response of business, primarily in the US, to the downturn. Contrary to previous cycles, American firms were quick to rationalize operations, and unlike the past, have maintained solid productivity growth during the lean period. Many don’t have a cash problem – US firms are sitting on hoards of it. But the cash doesn’t have many places to go. Slow demand and low utilization of current capacity are dual deterrents to new investment. One place the cash is going is to bonuses, notably in financial firms that were close to the brink just a few months back.
Shareholders demand that all this cash earns a good return. It’s having a hard time earning a return in traditional ways, given the obvious reticence of lenders and the lack of demand for borrowing, both at the business and consumer levels. So where is all the cash ending up? There are a number of possible pockets, but one repository is a recently recurring favourite: commodities.
The key surprise to us in this year’s economy is the resilience of commodity prices. They staged a spectacular collapse as recession set in, and then they surged with the onset of the short-lived rebound. But instead of faltering alongside global demand, they have only firmed through the balance of this year, and many analysts forecast a continued rise. Does this make any sense?
The weak US dollar has helped, but has only accounted for a fraction of most movements. Isolated supply concerns have given prices some boost. Many cite emerging market strength as the reason. Without a doubt, the developing world has outperformed estimates for this year, but even so, growth has not been enough to keep crude oil and base metal inventories from swelling, and by an outlandish pace in certain cases. History shows that prices and inventories rarely move in the same direction for long, and that base commodities are rarely a good long-term investment. It’s a sector that doesn’t quite square with the global story, a zone of instability that we still have to deal with.
The bottom line? The second-round slowdown that occurred earlier this year revealed the underlying fragility of the global economy. Resilient commodity prices were a surprise that spoke more to the nervousness investors felt through the year than to their optimism about the imminence of recovery.
Peter G. Hall is the vice-president and chief economist of Export Development Canada.