Decoupling

[Dinner]

Originally posted by KrazyHorse


Commodity prices rise during expansions. Over-reliance on commodities would imply a stronger cycle for the Canadian economy, not weaker. This was the classic pattern observed up into the 90s. Something has happened since then.

That "something" is Asian demand. Canada is exporting more raw materials to Asia so even as the US economy goes into recession Asian demand is still keeping raw materials prices high along with demand high. This just means Canada isn't overly dependent on the US like it used to be.

[DanS]

Originally posted by RedFred
Still sleepy this morning? Several rebuttals: 1 is that oil is far from the entire commodity market, 2 is that the hedge funds were betting heavily on higher oil prices and they accerated the price movement both on the way up and on the way down, and 3 is that I said the price fall would have been larger if not for other economies, not that it was not large.

Your rebuttal fails.

1) Natural gas has fallen by 55% over the last 3 months. Copper 56%. Soybean 44%. Lumber 28%. Corn 52%.

2) Has no bearing on what you said.

3) No, you said that commodities "can't fall as far and as fast as was the case when the US dominated the world economy to a greater extent." Still patently ridiculous. It's falling just about as far and as fast as possible.

[KrazyHorse]

Still patently ridiculous. It's falling just about as far and as fast as possible.

Take it easy, Dan. It's the naive answer which occurred to me too, but knowing the numbers makes it impossible.

Also, do you agree with me that this phenomenon is very strange?

[KrazyHorse]

Over the last year or so the Canadian economy has basically plateaued (both on output as well as on labour measures) near its highest ever point (between 64 and 65% employment rate among 16+) while the US economy has undergone the classic labour market contraction (while on output measures it has not dropped significantly yet, but that is doubtless going to change in the coming quarter or two).

This seems to imply, for whatever reason, that Canadian and American labour are no longer close substitutes for each other. Yet the labour force characteristics have not changed (though I might note that American productivity has increased significantly faster than Canadian productivity over the last 10 years). All while economic integration has increased.

[KrazyHorse]

By the way, I might note that this means that it's been almost 20 years since Canada's actually undergone a recession.

[DanS]

If anything, the rise of the Chinese and Indian economies will make the commodities markets more volatile because the demand from these countries is more volatile.

[DanS]

Originally posted by KrazyHorse
Also, do you agree with me that this phenomenon is very strange?

Decoupling?

[KrazyHorse]

Originally posted by DanS
If anything, the rise of the Chinese and Indian economies will make the commodities markets more volatile because the demand from these countries is more volatile.

Only if their demand is correlated with US demand. Which it appears to be, at least this time around.

[KrazyHorse]

Originally posted by DanS


Decoupling?

The fact that decoupling seems to have arisen in an era of increased economic integration.

[DanS]

Off the top of my head, the answer would probably lie in interest rates. Admittedly, this is something of a cop-out, because interest rates are where all of the strands in the economy are tied together.

[KrazyHorse]

Do you have any further explanation of what you mean by "interest rates"?

The BoC has been doing inflation targeting since about the same time the Fed started under Volker. One would think that identical methodologies would lead to identical results.

Or do you mean that perhaps the US' status as the major reserve currency restricts the Fed's effectiveness in pulling the monetary levers? This is a possibility. The status of CAD as a commodity currency tends to act as an automatic stabilizer (in bad times the CAD drops, increasing exports) while the USD actually increases, meaning that it's an automatic destabilizer. I'm not sure. This is an interesting hypothesis.

[KrazyHorse]

It would also imply that perhaps the Fed should overshoot on interest rate changes. Go to 4% inflation in bad times and 1% inflation in good times, instead of aiming for 2.5% all the time

[DanS]

I don't know how Canada sets interest rates, but the Federal Reserve has a dual mandate of price stability and economic growth. In practice, this seems to lead to a less mechanical method of setting interest rates. Sometimes, although perhaps rarely, this dual mandate provides a better outcome. The ECB, which only has a price stability mandate, is probably about a year too late in cutting interest rates aggressively, as one example.

In any event, Canada and the US have different needs with regard to interest rates. The US has had three asset bubbles in the last ten years, at least two of which were pricked by high interest rates. Perhaps Canada did not have at least two of these bubbles (dot.com and real estate), or dealt with the bubbles differently than did the Fed.

Interest rates act as gravity in the economic world, so to understand the ebbs and flows of the economy on a standalone or comparative basis, interest rates would be the first place that I would look.

[KrazyHorse]

Originally posted by DanS
I don't know how Canada sets interest rates, but the Federal Reserve has a dual mandate of price stability and economic growth.

I'm aware. And sometimes this leads to excessive looseness, IMO. See the late 90s and mid-00s

The BoC has an explicit inflation target of 2-3% (core inflation)

[KrazyHorse]

More evidence of decoupling from Stephen Gordon:

http://worthwhile.typepad.com/.a/6a00d83451688169e2010535e2fc3b970c-pi