Animal Spirits Spook the Economy

Animal Spirits Spook the Economy

EDC’s latest Global Export Forecast looks at both the fundamentals and wild market swings that are impacting the world economy – and when we might claw our way back to recovery.

Depression-era economist John Maynard Keynes coined “animal spirits” to characterize how markets can be driven by herd-like shifts in sentiment to euphoria or panic with serious economic consequences. EDC’s latest Global Export Forecast looks at both the fundamentals and wild market swings that are impacting the world economy – and when we might claw our way back to recovery. Summarized from EDC’s Global Export Forecast, Fall 2011.

Over the past year, the world economy has struggled to return to growth, but performance has been flat. Unfortunately, “flat” is probably the best we can do for a while.

The global economy generated a gigantic pile of excesses, particularly in housing and debt, at the end of the last growth cycle, and we are still working them down. Stimulus created the illusion of a true recovery partway through the process, but we have since resumed dealing with the excesses. The good news is that we are getting closer to the balance point that will usher in true recovery.

Beset by shocks

An unhappy reality of a sideways economy is that it is particularly vulnerable to shocks. Two have been especially disruptive this year. First, with little or no warning, political turbulence hit North African nations early in the year and quickly spread to the Middle East. Oil production was put at risk, and prices soared, an untimely hit to consumers and businesses everywhere.

Second, a sequence of natural disasters has plagued world growth. The most serious was the devastating earthquake and tsunami in Japan, which arrested critical supply chains in the automotive, machinery and high-technology industries. Widespread floods, droughts and storms have further compromised the global food supply and delivery of key industrial commodities.

In more normal conditions, such supply shocks would merely delay growth. But in today’s tentative economy, these disruptions can actually precipitate more serious and pervasive demand shocks.

Then came Europe

Adding to the general turmoil, the sovereign debt crisis in peripheral Europe worsened as a result of the unforeseen political and environmental shocks; market turmoil sent government bond yields to very high levels, while the winding down of stimulus programs dampened growth across the Eurozone.

In addition, lavish stimulus spending and collapsing revenues had caused public debt to rise to unthinkable levels in the world’s largest economies. Faced with debt downgrades, many of those countries are now cutting overall government spending despite continued economic weakness. It is hardly surprising, then, that stock markets are in a tailspin, commodity prices are dropping and confidence is in freefall.

High spirits to herd mentality

There are a few signs that some temporary restraints on global growth appear to be loosening. Japanese production and exports seem to be emerging from their post-tsunami collapses. And, factory orders everywhere have been rising. It is still too early to tell whether these trends will continue, but they suggest that fundamental growth is perhaps not as weak as some of the more dramatic indicators would have us believe.

Mixed signals from market shocks, however, seem to be feeding the volatility. Highly uncertain of the economy’s next move, markets attempt to protect assets or capitalize on upward movements. They can end up taking actions, often irrational, that gain herd-like momentum – leading to serious economic consequences.

John Maynard Keynes referred to this phenomenon in the 1930s as “animal spirits,” characterizing the means by which a depressed economy could restart itself. It applies equally well to how negative reactions in a highly nervous economy could create a vicious circle. Precariously indebted sovereign states are vulnerable to these same forces – as well as the countries and financial institutions most closely linked to them. This poses a threat to short-term global growth.

The good news: consumers are reducing their debt and setting themselves up for more normal spending. Housing markets are slowly healing. Banks are less tight with lending. Production may be vulnerable to low confidence, but appears to be increasing. Those lamenting low employment growth and stingy business investment forget that these indicators always lag behind a rise in basic activity.

Rising momentum in key industries and other healing factors could bring the global economy into a greater state of balance by the latter half of 2012.


Our outlook expects that the world economy will capitalize on the current increase in underlying activity, and continue to find remedies for the shocks and weaknesses that beset near-term growth, tiding the economy through to better times.

Momentum is forecast to increase throughout 2012, lifting growth in developed markets from 1.6 per cent in 2011 to 2.6 per cent next year. The U.S. economy will take the lead, with a decent contribution from Japan as reconstruction boosts 2012 growth. Austerity will confine Western Europe to the back seat.

Emerging markets, by contrast, will rack up gains of 5.9 per cent this and next year. Consequently, global growth is forecast to accelerate modestly from 3.7 per cent in 2011 to 4.3 per cent in 2012 – a decent performance, all things considered.

What about Canada?

Throughout the global turmoil, Canada has been blessed with relatively strong domestic demand. Vibrant performance in the commodity sector has helped, but other areas of business have also rebounded from 2009 lows. Canada’s fiscal policy was well managed going into the recession, and our banking sector has remained solid through the downturn.

Temporary factors will keep 2011 growth to 2.3 per cent, but Canada will be able to ride U.S. momentum next year, and post a moderate increase to 2.4 per cent in 2012. Exports will make a key contribution, with gains of 10.6 per cent and 6.6 per cent this year and next, respectively.

Commodity price volatility is going to result in a mixed performance in exports by industrial sector. Shipments of oil, gas and metals will suffer from lower commodity prices in 2012, although they will continue to grow in volume. Momentum in the U.S. economy will see exports in the auto sector growing at a double-digit pace next year.

Delayed orders have suppressed shipments in the aerospace sector this year, but we expect these exports should increase by 22 per cent in 2012.

Touching on some provinces, export growth will be strongest in Saskatchewan, thanks to the performance of fertilizer and agri-food sectors. Alberta, more dependent on the energy sector, will see growth moderate in 2012, while Ontario will generate growth in the middle of the pack.

The bottom line

Volatility is becoming today’s norm, and with good reason. Underneath the chaos, there is a world economy that is righting itself. If it can continue to withstand the inevitable shocks that accompany a period of flat growth, and the animal spirits that are roiling markets, we may all be getting on with building the next global growth cycle in the latter half of 2012.


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