The easiest way to understand exactly what is happening in the international recession we find ourselves in – whether it is the plunging car sales, house prices tanking, jobs being slashed, banks going under – is to concentrate on one concept: that of deleveraging.
The concept is neatly discussed by Murray Leith, a VP of Odlum Brown Ltd., in today's article headed By Global Standards, U.S. Economy is in Decent Shape (Globe & Mail March 31 2009).
He puts his finger on the driving force behind the collapses of the auto, home, banking and other industries. He says (unfortunately it is not online):
"The problem in the world today is that there is too little demand and too much supply… Global trade has collapsed because the world's banking system is going through a massive deleveraging process. Indeed, the World Trade Organization predicts that global trade will plunge 9 percent this year, the most since the Second World War."
What is deleveraging? It is the process of banks having to reduce the amount of loans they can make as a ratio of the capital (shareholders equity) they have from the astronomical ratios they had for the past decade or so, to a much lower figure. This means they have to reduce loans, and so there is less money for businesses and individuals to use to make things or buy things.
The leverage in some banking systems was simply mind boggling: the five major US investment banks had an asset to equity leverage of 25 to 35 times, but the overall US banking system was lower (about 12 times). German banks have leverage of 42 times, and UK banks of 27 times.
He says America is actually better positioned to weather the recession than Europe and the other nations, because America (unlike Canada, for example) is far more self-contained – exports account for only 12 percent of US GDP but for 45% of the German GDP and of the Chinese GDP. What does this mean? Simply that a country that depends on exports for a big whack of its national production/wealth will be harder hit by the collapse in global trade than one that is not.
The conclusion we can draw is that Canada is likely to suffer more the next two years than America is, because of our higher reliance on exports for our standard of living.
