12/29/2011 09:56 EST

Canada Economic Forecast 2012: Outlook Murky As Few Dare To Predict Outcome Of Global Problems


OTTAWA - Warning: This economic forecast may be completely off base.

As Canadians close out one of the most unpredictable and tumultuous years of economic activity in recent memory, the future promises only more uncertainty.

In fact, economists attempting to peer into their crystal balls for what 2012 might bring, say Canadians haven't seen anything yet in terms of unpredictability, or possibly, volatility.

It isn't that economic computer-simulations have ceased to function. But the axiom "garbage in, garbage out" has never seemed more appropriate.

Analysts say they cannot be confident that the assumptions they are plugging into their models are the correct ones.

What is referred to as a "binary outcome" is best understood by imagining two trains proceeding on parallel tracks, before heading off in opposite directions.

On one track, Europe's debt problems explode, spraying shrapnel across the global financial landscape. Global credit freezes up, economies slow, commodity prices plunge as they did in 2009, and the world takes trade-invested Canada into a second recession, maybe as deep as what occurred three years ago.

On the other track, European policy-makers are able to stop the hemorrhaging and prevent contagion. Markets rejoice, confidence is restored, cash-rich corporations invest again, commodity prices strengthen, Canadian exports rebound and the economy continues its current modest expansion.

Pick one or the other, economist say, there is almost nothing in between.

"It's not quite a binary outcome, but it's pretty extreme alternative scenarios," Craig Wright, the Royal Bank's chief economist, says of the quandary facing forecasters.

Whatever track forecasters choose, more than reputations are at stake — business and investment decisions follow from their guesses.

Markets have been a perfect illustration of the binary confusion. Investors have been riding the parallel tracks since late July unable to make up their minds, hopping from one track to the other, betting billions of dollars on the latest news or rumour about which track represents the true course.

"If you look at the volatility index, which is referred to as the 'fear gauge,' what we saw in the Lehman Brothers crisis (in 2008) is a huge spike up, and now fear is again elevated," Wright points out. "You see that in weakness in investment and weakness in hiring."

To date, economists, including Bank of Canada governor Mark Carney, have hopped on the train where Europe muddles through, papering over cracks as they appear but somehow avoiding a crash.

That's why the consensus of major forecasting houses see the Canadian economy continuing to grow at about two per cent next year, within a range of 1.5 per cent on the low side and 2.5 per cent on the high. The Bank of Canada is almost in the middle at 1.9.

Under this scenario, Canadians can expect to see jobs being created — between 10,000 and 15,000 a month — less than needed to absorb new entrants into the labour force. Salaries will also remain subdued, barely keeping up with inflation or falling below.

It's not great news, say analysts, but its better than the alternative — a recession and hundreds of thousands of jobs lost. In the 2008-09 slump, economic activity shrank by almost 3.5 per cent and over 400,000 jobs disappeared.

"As long as Europe continues to stumble along, it hasn't proven to be bad for the Canadian economy," says Derek Holt, vice- president of economics with Scotiabank. "We don't have big trade ties, we have minimal banking exposure and we've benefited from Canadian dollar depreciation and lower interest rates."

For 2011, the Canadian's economy is now expected to have grown by 2.3 per cent — despite a spring swoon triggered by the natural disaster in Japan among other things — and employment will likely be up by about 200,000.

Meanwhile, even "bearish" houses like Capital Economics, which have built in the disintegration of the eurozone in their baseline forecasts and a two-year recession for Europe, are stopping short of forecasting a global banking crack-up as occurred in the fall of 2008.

Not that the global economic consulting firm thinks the worst case scenario is such a long shot, says David Madani, the firm's chief Canadian economist. Choosing such an outcome would make projections mere guesswork.

"Once you put on the table a scenario of a global banking crisis, your guess is as good as mine how that effects bank funding costs, borrowing costs for households and business. It's such a wide open unknown, trying to put a number on it is impossible," he explained.

TD Bank chief economist Craig Alexander says the most likely scenario remains that European policy-makers will be smart enough to avoid the worst, since they will be first over the edge.

Even so, Europe is likely already in recession, setting off a chain of events that lead back to Canada. The most direct link is that since Europe is China's biggest export market, the world's most populous country is also headed for a soft landing, which impacts Canada through slower demand and lower prices for commodities such as oil and metals.

Alexander says those who expect a more robust or steady rebound — as many did last year — are probably fooling themselves.

As Bank of Canada governor Mark Carney stressed this month, the world is trying to emerge from a "debt super cycle" that has taken overall debt — government, households and non-financial corporations — across the big G7 economies to about 300 per cent of gross domestic product. Such flagrant irresponsibility will take years to overcome.

Canada is not totally blameless, but is in better position than most.

Statistics Canada has placed household dept at a record 153 per cent of disposable income.

Where Canada fares better is government debt — about 68 per cent of GDP once provinces are included — and in what is virtually a clean sheet in the corporate sector.

The latter fact is why Carney urged Canada's corporate leaders to start spending an estimated $350 billion in cash on hand to improve competitiveness and win markets in the fast-growing emerging world.

"I think we need to be realistic about the prospects going forward," said Alexander. "We know balance sheet (debt) driven recessions are much deeper, they are longer and the economic recoveries tend to take twice as long as normal. Quite frankly I think this one is going to take even more than twice as long."

Wright said he remembers giving a speech a year ago that he titled "An uneven, uncertain and underwhelming recovery."

"I could give the same speech now," he says.

Julian Beltrame, The Canadian Press