Tuesday, June 19, 2007


2007: Mid-Year In Review

A retrospective look at 2007 reveals that, contrary to many year-end predictions and a few economic forecasts, Real Estate still rolls, Canada is still in one piece, America has not drowned into the worst recession since the disappearance of the dinosaurs and the Twelfth Imam has not landed from the Moon yet.

Things seem to be moving in slow motion this year. We are all still alive and well, when in fact by now we should be all dead and buried - according to some prognostications I was reading all the way back in mid-December 2006, that is.

For the past few years the economies of North America have consistently defied the naysayers. Time and again the Cassandras who predicted trouble – whether a bubble explosion and the consequent crash of housing prices or the collapse in consumer spending followed by the crash of the American Dollar – were proven wrong. This year does not seem to be the exception, at least for now. Particularly the 'bubbleologists' – those individuals who have made the goal of their lives that of exploring the Milky Way with their economic telescopes looking for bubbles ready to collide with our planet – seem to be especially wrong.

To be sure, the housing boom has ended dragging down the pace of overall economic growth. But the housing 'correction' – as analysts are now beginning to call it – did not have calamitous consequences. In particular, we have not seen a recession in 2007 since – as I did anticipate at the end of 2006 – rather than slashing interest rates to stave off a slump, Central Banks both in the United States and Canada have focused more on inflation. Especially in the United States, after twenty-four months of steady interest-rate rises that have ultimately caught up with American serial borrowers, spending is now set to be a lot softer, which is a good thing overall. And the household saving rate, which in the last quarter of 2006 dipped to a negative 0.5 percent, has finally begun to inch up.

Even the so anticipated flood of defaults on mortgages and the consequent rise in loan delinquencies has failed to put a dent in the economy. Most household balance sheets are strong enough to withstand a drop in house prices. With consumer spending lower but not stagnant, overall economic growth this year is forecasted to be a little less than 2 percent for the United States and a little more than 2 percent in Canada – below its potential but not exactly a slump.

So, where does the foregoing scenario leave us and what can we reasonably expect the future to bring in the forthcoming months?

There is no question that 2007 is going to be a sluggish year, and a sluggish year is exactly what we need both to stem external imbalances and keep inflation under control. Allowing the economy to get an even footing through a slowdown of capital appreciation and at the same time allowing real wages to catch up is exactly the tonic needed for a healthy foundation. In general lines spending fuels consumption, which in turn erodes a limited quantity of resources. This is the concept behind inflation in an economy founded on scarcity of goods, which is typical of all capitalistic economies. As a direct and proximate result, therefore, controlling inflation is the key.

Core inflation, which excludes the volatile categories of food and fuel, is well above the 2 percent that Central Banks here in North America deem comfortable. Central Banks, therefore, will need to be extremely vigilant throughout the remainder of the year because the economy's natural 'speed limit' – defined as the rate of GDP growth that can be sustained without fuelling inflation – has slowed down. The two drivers that determine how fast an economy can safely grow – the number of employed workers and their overall productivity – are both flagging.

Unusually rapid productivity growth has been the source of economic strength in Real Estate over the past few years. But in 2006, as the stocks of unsold houses soared, builders cut back sharply after a multi-year construction binge. The pace of residential building fell by a fifth, enough to drag overall output down by one full percentage point. This year, conversely, the slump in construction has eased up already as builders have worked off a good portion of their excessive inventories. Adjusting to the shift in growth may not be easy for everyone, but absolutely necessary in order to avoid a recession.

And on the bright side of things, with growth strong in the rest of the world slower spending in North America can reduce the mammoth trade deficit without a serious dent in the overall global growth.

Luigi Frascati


Real Estate Chronicle


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