Economic analysis

How Canada’s economy went from boom to recession so fast

An in-depth look at the perfect storm that pushed Canada into recession

Two hours before the street racing movie Fast and Furious 7 was released in China in April, Tang Wentian, a 21-year-old man, wrecked his Lamborghini driving the streets of central Beijing at speeds of up to 179 km/h. Locals were enraged at what they thought were spoiled, second-generation rich kids at play, but the parents of the man came forward saying they weren’t wealthy at all. And their son didn’t even have a job. Rather, he bought the luxury vehicle with money he made speculating on stocks.

Today it’s the Chinese stock market itself that’s a mangled wreck. In a country that does everything big, close to US$3 trillion of wealth has been obliterated in a matter of weeks, as panicked investors ran for the exits. The stock market rout quickly spread to commodities, accelerating declines that had already been hammering resource-producing countries, like Canada. Copper, widely viewed as a gauge of global economic health because of its use in so many industries, plunged to a six-year low, while at one point the price of iron ore fell 11 per cent in a single day, leading one analyst to note that the price of steel in China—of which iron ore is a key ingredient—was “cheaper per tonne than cabbage.”

But the crash has done something else: it has laid bare serious problems with the narrative of China’s growth miracle, and the health of resource countries that increasingly depend on it. It’s also raised questions about Beijing’s revered ability to successfully manage the levers of its economy. While the extreme and desperate measures taken by officials to arrest China’s stock crash—from jailing short sellers to imposing outright bans on stock sales by large shareholders—brought calm (albeit likely only temporarily), it has left the world to wonder how much worse things could get. And it’s flashed warning signs about what’s in store for Canada as China continues to slump.

As if Canadians needed more reasons to be worried. The collapse in oil prices that began more than a year ago, and has resumed of late, snuffed out Alberta’s energy boom more quickly and deeply than anyone expected. This week, Bank of Canada governor Stephen Poloz trimmed the benchmark lending rate by a quarter point to 0.5 per cent, the second such cut in six months, and slashed the central bank’s growth outlook for the remainder of 2015. The bank effectively confirmed suspicions that the economy entered a recession by noting in a statement that “real GDP is now projected to have contracted modestly in the first half of the year.”

Related: Maclean’s A-to-Z encyclopedia of the oil crash

While Canadian consumers have so far helped offset the damage by their seemingly unending willingness to borrow and spend, the resulting debt that households have piled on now represents an economic risk in its own right—particularly if job and wage growth weaken. Moreover, much of that borrowed cash has been sunk into real estate, a relatively non-productive sector of the economy, resulting in home prices that are as much as 63 per cent overvalued, according to Deutsche Bank. No wonder some believe Canada is tiptoeing around the edge of the abyss. “You have a resource economy that’s been blown apart sitting on top of a housing bubble,” says Marc Cohodes, a well-known Wall Street short seller who’s betting against Canadian mortgage lenders. “That’s a toxic mix.”

Now, the debate is how long and deep Canada’s downturn could be. And yet, with an election on the horizon, Ottawa seems in denial. Earlier this month, federal Finance Minister Joe Oliver told reporters the economy “was not in a recession,” while Prime Minister Stephen Harper later blamed any slowdown on overseas events beyond Canada’s control, declining to elaborate on just how Canada allowed itself to become so exposed in the first place. The hope continues to be, as it has since commodity prices began to tumble, that the U.S. economy will fuel our rebound—except that, so far, that’s not happened either. For deep structural reasons, Canadian manufacturing has been slow to recover, despite a weakening loonie making our exports, at least in theory, more attractive. To top it all off, last week the International Monetary Fund cut America’s growth forecast for 2015, while also slashing its outlook for Canada.

In just a few short years, Canada went from being one of the developed world’s most resilient economies to among the most vulnerable. And, unfortunately for heavily indebted Canadians, there are plenty of storms gathering in faraway places that threaten to push us under.

Policy-makers won’t know for sure whether the country slipped back into recession—defined as two consecutive quarters of shrinking GDP growth—until Sept 1., when Statistics Canada releases figures for the April-June quarter. But it hardly matters. The economy shrank for at least four months in a row at the start of the year, the first time that has happened since the 2008-09 crisis. That’s despite Poloz’s surprise decision in January to cut the central bank’s benchmark lending rate by one quarter of a percentage point to 0.75 per cent, a move he compared to performing life-saving surgery on a dying patient.

As it turns out, the diagnosis failed to capture how serious the patient’s illness actually is. As recently as April, the Bank of Canada was suggesting growth in the first half of this year would be around one per cent. Now, it’s looking more like the economy shrank by that much. “Canadian forecasters consistently underestimated the impact of the sharp decline of oil prices on the Canadian economy,” wrote Randall Bartlett, a senior economist at TD Economics, in a recent report. Bartlett added that GDP growth for the remainder of the year is also likely to be weaker than expected, coming in around 1.2 per cent, which would “mark the weakest pace of real GDP growth outside of a recession in over 20 years.”

Leaving town: Workers are fleeing Fort McMurray, Alta., formerly the economic engine of Canada, as unemployment there has doubled. (Ian Willms/Getty Images)

Leaving town: Workers are fleeing Fort McMurray, Alta., formerly the economic engine of Canada, as unemployment there has doubled. (Ian Willms/Getty Images)

In Fort McMurray, Alta., once hailed as the epicentre of Canada’s economic engine, evidence of the oil bust is everywhere. Restaurant tables sit empty, apartment vacancies are climbing and the local airport is no longer packed with workers flying in and out of the tiny community. Meanwhile, the unemployment rate has more than doubled to 8.6 per cent as dozens of massive oil sands projects are shelved by operators. The latest setback involved Teck Resources, the country’s largest metals and mining company, which has delayed the planned start of its 260,000-barrel-per-day Frontier bitumen mine by five years to 2026. The Canadian Association of Petroleum Producers, meanwhile, estimates that spending on exploration and development will be down 40 per cent this year over last. In a telling sign of the times, Irving Shipbuilding of Halifax held a job fair in Fort Mac in the hopes of luring back workers disillusioned by the Western Canadian dream. They didn’t have to look far. “I just want to be somewhere relaxed,” Jennifer Tulk told a local newspaper. “Somewhere where we know [my husband’s] job is secure, we don’t need to worry from day to day what the price of oil is.” As the price of oil drops further—thanks to America’s nuclear deal with oil-rich Iran and rising production in the U.S. and OPEC—economists at ATB Financial slashed their growth forecasts for the province to a barely-there 0.4 per cent for 2015.

RELATED: Canadian Business: Yes, we’re in a recession. Here’s why you shouldn’t panic about it

As for those waiting for the good times to return (meaning the US$80-per-barrel oil price that many oil sands projects need to be economically viable), Goldman Sachs commodities head Jeff Currie has some bad news—the world is stuck in a “negative feedback loop,” he told Bloomberg, in which the strengthening U.S. dollar relative to the rest of the world has reduced the costs of production in several emerging markets, encouraging producers to continue pumping and adding to the glut. Some U.S. oil companies are also taking advantage of cheap credit to drill new shale wells to be exploited with hydraulic fracturing, or “fracking”—the phenomenon that helped contribute to the world’s over-supply problem in the first place. “I would argue we’re in a slump that could take five or 10 years” to reverse, Currie warned.

For Canada, the current economic predicament would have seemed unimaginable just a few years ago. It was only in 2006 that Prime Minister Harper described the country as an emerging energy superpower, and economists gushed about the commodities-driven “supercycle.” The rhetoric was driven mostly by a rapidly industrializing China and its insatiable demand for raw materials—a phenomenon that was supposed to buoy Canada for generations to come. For several years, it seemed true. China went construction-mad by erecting factories, airports, super-malls, high-speed rail, massive hydro dams and even entire cities. In doing so, the country’s builders sucked up the global supply of metals, wood and fuel, driving prices into the stratosphere. (One seldom hears anymore of copper thieves stripping the metal from electrical installations, a crime that left at least seven Canadians dead when copper was worth $10,000 a tonne; it’s now back to $6,000.)

“It was [Canada’s] saviour during the financial crisis,” says former BMO chief economist Sherry Cooper, now chief economist of Dominion Lending Centres. “The resource sector continued to boom even though the rest of the economy was in the tank.”

These days, however, the China chatter is more likely to centre on the country’s massive debt bubble and empty factories, which, in turn, have led to falling prices and idle workers. There’s already been a property crash in China that the government rushed to fix. But patching up the stock market proved much more difficult for Beijing’s technocrats to remedy—and that, more than anything, is what should have Canadians worried.

Like so much of China’s otherworldly economy, the country’s equities market never made much sense. It was fuelled by massive amounts of “margin debt”—essentially money borrowed from brokers to buy stocks—and was actively promoted by the government at every turn. At a time when China’s industrial growth was slowing rapidly, Beijing saw the stock market as a key way for people to make money, thereby helping to transition the emerging economy from its reliance on exports and infrastructure investment to a more modern economy based on consumption.

The Shanghai index enjoyed a 150 per cent gain over the past year as mostly uneducated “mom and pop” investors jumped on board. There were even stories of villages where farmers spent all day trading stocks and then resumed tending to their fields once the closing bell rang. More alarming: some Chinese industrial companies became increasingly reliant on trading equities to deliver profits as demand for their goods and services waned.

ut the euphoric rally hit a wall in mid-June. By early July, it was all over. When a 29-year-old allegedly began spreading rumours on social media that people were jumping off buildings in Shanghai, he was swiftly arrested by authorities as they scrambled to calm investors. By the time the smoke cleared, nearly $3.2 trillion had been wiped off the Chinese stock market—or, about twice the value of India’s entire stock market value. Put another way: Greece’s total government debt—the cause of austerity measures, panicked bailout renegotiations, and even a referendum—is only $375 billion, or about one-10th the amount lost by Chinese stock traders.

Investors look at computer screens in front of an electronic board showing stock information at a brokerage house in Shanghai, China, July 14, 2015. Asian shares and the euro were tentatively higher on Tuesday on hopes that Greece's conditional bailout agreement would bring to an end that country's debt crisis, though caution kept broad gains in check. REUTERS/Aly Song - RTX1K9IM

Investors look at computer screens in front of an electronic board showing stock information at a brokerage house in Shanghai, China, July 14, 2015. Asian shares and the euro were tentatively higher on Tuesday on hopes that Greece’s conditional bailout agreement would bring to an end that country’s debt crisis, though caution kept broad gains in check. REUTERS/Aly Song – RTX1K9IM

Though a number of analysts insist that the Chinese stock market is a poor proxy for the Chinese economy—the index’s meteoric rise came against the backdrop of slowing GDP growth, after all—there are nevertheless concerns about what the crash will do to the psyche of Chinese consumers who are now expected to provide the country’s economic muscle. “How much political unrest is this going to generate?” Cooper asks. “If Chinese were allowed to tweet, I bet we’d know a whole lot more about how upset people are.”

If Beijing’s economic transition plans don’t go as planned, that could translate into big problems for Canada’s resource-heavy and export-driven economy. China’s share of global oil consumption doubled to 12 per cent between 2000 and 2014, and the country ranks as one of Canada’s fastest growing export markets. More importantly, China has played an outsized role in determining the price of global raw materials price, which is why the recent Shanghai stock market crash also impacted the share prices of Canadian mining companies like Goldcorp, Barrick Gold, Silver Wheaton and Newmont Mining, to name a few. Altogether, the resource sector and related industries account for about a fifth of Canada’s total GDP.

Perhaps the most alarming element of China’s recent market crash, though, was how powerless Beijing seemed to be at stopping it. Officials compelled brokers to pour billions into the market while companies halted IPOs and thousands suspended trading of their shares. China even tried letting people use their houses as collateral to buy stocks—a desperate policy given the ongoing concerns about the country’s real estate bubble. “The [Chinese] government is throwing everything it can at the market to stabilize it,” says former Morgan Stanley chief economist Stephen Roach, author of Unbalanced: The Codependency of America and China. “Maybe it works. Maybe it doesn’t. It’s really going to be difficult to arrest the bursting of the speculative bubble the magnitude of which China has experienced.”

Last year Roach predicted much of what’s unfolded in Canada when he warned that resource-based economies counting on China’s never-ending growth were in for a rude awakening. “China’s been a great bet for 35 years, but they’ve telegraphed this,” Roach explains. “They’ve told the world, roughly 7½ years ago, the model they had was not sustainable and they needed to change it.”

Yet, as recently as December 2013, the Bank of Canada was still touting rapid Chinese economic growth as a reason why oil prices would continue to rise and benefit the Canadian economy. It may also help explain why Poloz has been so nonchalant about Canada’s housing and consumer debt bubbles: he and bank officials may have assumed China would keep on doing what it had done for more than a decade. Eighteen months later, house prices continue to rise across the country, albeit now driven mainly by the hyperactive markets of Toronto and Vancouver, but there’s no longer a strong resource sector in place to support all those giant mortgages taken out on million-dollar homes. And with average households owing $1.63 for every dollar of disposable income they earn, even real estate agents—people who depend on fat commissions from rising house prices to keep their Audi gas tanks full—are balking at the possibility of further interest rate cuts. Royal LePage this week warned that lower interest rates could overstimulate “a perfectly manageable major market expansion” and result in “a more difficult correction, as price levels decouple from more household incomes.”

Many economists are inclined to agree. “Persistent gains in house prices and housing activity are a risk to financial stability,” argues Emanuella Enenajor, an economist at Bank of America Merrill Lynch, in a July 2 report. “Growth driven by interest rate-sensitive domestic demand is not a sustainable growth model for the economy, at least not one that can survive a Bank of Canada rate-hike cycle.”

Julie Gordon/Reuters

Julie Gordon/Reuters

A Canadian housing downturn would be as painful as the slump in oil prices—perhaps worse. By some estimates, the real estate sector in Canada makes up more than a quarter of the country’s annual GDP and nearly half its growth since 2005, when related industries like financing and insurance are taken into account. So far, however, most big bank economists have downplayed the possibility of a crash by noting the main risks to affordability are rising interest rates or a sudden spike in unemployment—neither of which appear to be in the cards for the immediate future. But jobs and wage growth haven’t been anything to get excited about either—certainly not enough to justify double-digit increases in home prices—and the latest signs have been more negative than positive. Employers added 33,000 positions in the second quarter of this year, according to StatsCan, fewer than the 63,000 positions added during the first three months of the year.

Of course, lost jobs and rising interest rates aren’t the only things that could bring an end to booming real estate. A sudden evaporation of credit could have the same effect. That’s the main risk of the ongoing debt crisis in Greece, which, despite the recent 11th-hour bailout deal, still threatens to destabilize the eurozone and spook bond markets.

Another threat lies in the mindset of consumers themselves. If Canadians suddenly begin to worry that they’ve borrowed too much, there could be a cooling of the market that picks up speed as homeowners race to limit their exposure. “It just starts to happen,” says Cohodes. “No one’s going to tap you on the shoulder and say, ‘Hey, the housing market is coming unglued.’ ”

If and when the unwinding of the Canadian housing market finally occurs, it will send shock waves throughout the entire economy. Deutsche Bank estimates that seven per cent of the Canadian workforce is employed in construction, which is about double the share in the U.S. Falling house prices will also have a big impact on consumer spending as the net worth of Canadians takes a hit.

Already there are signs consumers are tapped out. A recent study by Nielsen recorded a six-percentage-point drop in consumers’ immediate spending intentions, to the lowest level since 2012. As for Canadians’ sentiment about the job market, it’s fallen to a level not seen since the Great Recession.

A Chrysler Group LLC employee inspects an engine on the production line of the company's Jefferson North Assembly Plant in Detroit, Michigan, U.S., on Thursday, April 28, 2011. Chrysler Group LLC, the automaker run by Fiat SpA, plans to repay $7.53 billion in loans from U.S. and Canadian governments this quarter as it moves toward an initial public offering and merger with its Italian partner. ( Jeff Kowalsky/Bloomberg/Getty Images)

A Chrysler Group LLC employee inspects an engine on the production line of the company’s Jefferson North Assembly Plant in Detroit, Michigan, U.S., on Thursday, April 28, 2011. Chrysler Group LLC, the automaker run by Fiat SpA, plans to repay $7.53 billion in loans from U.S. and Canadian governments this quarter as it moves toward an initial public offering and merger with its Italian partner. ( Jeff Kowalsky/Bloomberg/Getty Images)

Given the relentless headwinds Canada faces, it’s no wonder economists have become fixated on the one bright spot in the global economy: America. As Canada’s largest trading partner recovers, the thinking goes, Canada will be able to seamlessly transition its economy from one that was driven by bitumen upgraders in the hinterlands of northern Alberta and Saskatchewan, to one powered by high-tech factories in southern Ontario and Quebec. The switchover would be made possible by the rapidly falling Canadian dollar, which promises to make exports more competitive. There were even suggestions at one point that Bank of Canada governor Stephen Poloz was deliberately trying to “talk the dollar lower” in order to give the country’s economy a lift.

But, so far at least, the country’s rust belt renaissance has sputtered. Recent numbers from Statistics Canada show that exports to the U.S. dropped by 0.3 per cent in May to $32 billion, while imports from the U.S. grew by 0.5 per cent to $30 billion, contributing to a $3.34-billion trade deficit for the month, and putting us on track to post a record trade deficit in the second quarter.

There’s not a bunch of factories in southwestern Ontario with modern, up-to-date equipment just waiting for somebody to turn the lights on,” says Mike Moffatt, an assistant professor at Western University’s Ivey Business School. “It’s not the case if oil drops by $20 a barrel then we just slow down the production of [oil] and move those workers to southwestern Ontario to a bunch of equipment and machinery that already exist.”

At the same time, those manufacturers who weren’t forced out of business by the loonie’s rise above par took steps to insulate themselves from currency fluctuations—either by diversifying their customer base or relocating some production south of the border. That means they’re less likely to benefit when the dollar drops—and even if they do, who is going to risk a big expansion that could be unwound with another rapid rise in the loonie’s value? “No manufacturer is going to massively expand just because the dollar is low, because you’re never sure it’s going to stay that low or not,” Moffatt says. “We had a number of manufacturers in the late ’90s overexpand when the loonie was at 70 cents, betting on it staying that low for a very long time. Well, in the early 2000s, the loonie started going up and up, and a lot of those companies either went out of business or moved to the United States.”

The attention now being focused on the manufacturing sector is, in some respects, too little, too late. When the global price of oil was above US$100 a barrel, Ottawa was fixated on finding new ways to move tar-like oil sands bitumen from northern Alberta to international markets, pushing projects like TransCanada’s Keystone XL pipeline. All the while, Canadian manufacturers continued to suffer from low productivity and weak demand for their products—with one notable exception: those companies that focused on the oil and gas industry, or had retooled their operations to take advantage of growth in the sector. “Take a look at the province that created the most jobs in manufacturing since the end of the recession. It’s not Ontario or Quebec. It’s Alberta,” Enenajor says.

So what will pull Canada out of the mire? The service industry could be a bright spot, according to Enenajor. Or perhaps the health care sector, soon to be saddled with aging Baby Boomers. “It’s really not obvious what’s going to develop at the same scale as oil and gas and mining,” Moffatt says. “That’s a serious concern for this country.”

Like that jobless, 21-year-old stock trader in Beijing with the wrecked sports car, Canada’s wild economic ride has come to a sudden, unexpected halt in 2015. Now we’re left picking up the pieces and wondering where it all went wrong.

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