Maclean's SPECIAL REPORT

WHAT THE FALLOUT MEANS TO YOU

Tighten your belt, and be wary of the market. The recession is upon us.

MARY JANIGAN October 8 2001
Maclean's SPECIAL REPORT

WHAT THE FALLOUT MEANS TO YOU

Tighten your belt, and be wary of the market. The recession is upon us.

MARY JANIGAN October 8 2001

WHAT THE FALLOUT MEANS TO YOU

Tighten your belt, and be wary of the market. The recession is upon us.

MARY JANIGAN

John DeMont

John Intini

Ken MacQueen

Maclean's SPECIAL REPORT

THE ECONOMY

In the beginning, the sheer horror of the terrorist attacks obscured the ominous signs of recession. On the weekend after the Sept. 11 assaults, drummer Cassius Pereira could not perform with the Jeff Healey Band at three blues festivals in Denmark and Norway because the groups flight from Toronto to Amsterdam was cancelled. On the next weekend, when he played with another band in Rouyn-Noranda, Que., the crowd was less-than-capacity—even though every ticket had been sold prior to the show— and the mood was sadly restrained. No one could escape reminders of the tragedy; any economic repercussions seemed trivial in comparison. After all, it’s only rock ’n’ roll. “But we finally talked about it on the drive up to Rouyn,” says Pereira. “I imagine some bigger festivals may be cancelled. And I did lose money when the European trip was off. But the entertainment industry does better in wars or depressions. People need a distraction in times like this.”

It won’t be official until the final numbers are tallied next year—but Canada has almost certainly toppled into recession. And times like this are going to be tough. The economy was stagnant before the terrorist attacks on the World Trade Center and the Pentagon: in the second quarter of this year, GDP expanded by a measly 0.4 per cent; it shrank by one-tenth of a percentage point in July. But the catastrophe has surely nudged the fragile economy into outright decline—which means rising unemployment and what economists tactfully call “negative growth.”

The signs are everywhere. Canadian exporters are still struggling with delays at the border because of security concerns and the slump in U.S. and global demand for their products. Both British Columbia and Alberta have already announced cuts in provincial spending. Key economic sectors such as aviation and tourism have been devastated: last week Air Canada laid off 5,000 employees. Stock markets have been on a breathtaking roller-coaster ride of hideous downs and starding ups. The dollar closed at 63.35 (U.S.) cents last week— barely above its record-low close of 63.11. The Toronto-Dominion Bank predicted that “2001 is shaping up to be the poorest year for provincial economies since 1992.” It pegged Alberta as the fastest-growing province at four per cent—and noted that the industrial powerhouse of Ontario would be the lowest at 0.8 per cent.

FROM GOOD TIMES TO BAD Governments are struggling to come to grips with a world in which adequate security measures are not only necessary for individual citizens’ safety but for everyone’s prosperity. Canadian consumers, who kept the economy afloat during the first half of this year, are curbing their purchases—because their confidence has been shaken or their jobs are imperilled or they simply don’t have the heart to shop. At upscale Bib ’N Tucker Children’s Wear in Elalifax, sales somehow held firm last week—and co-owner Jane Cooley is holding her breath. “People were blue,” she says. “But I feel that during a recession people don’t buy big things: they buy small things, especially for their children, to make themselves feel better.”

Such chaos and caution will likely combine in both Canada and the U.S. to produce the technical definition of a recession: two or more consecutive quarters of negative growth. “It looks terrible for the rest of this year,” says TD Bank chief economist Don Drummond. “It is not the terrorist attacks alone that have done this. But they have taken us from one edge of the knife to the other.” He noted that the ripple effects from the U.S. slowdown are only starting to be felt overseas: “The European economies have slowed dramatically and Japan is in an outright recession.”

To add to the unsettling climate, experts are unable to predict with confidence how bad it could get. They have virtually no numbers yet that measure the state of the Canadian economy after the attacks: when Statistics Canada announced last week that retail sales dropped by half a percentage point in July, the bad news created scarcely a ripple. That was so then. Worse, no one can predict the outcome of the campaign against the terrorists. Will there be a prolonged war? Will the terrorists strike again? The uncertainties could determine the difference between a relatively small contraction over two or three quarters and a prolonged and wrenching downturn. “We don’t know the shape of the U.S. response and the full impact that this will have on consumer confidence,” says Ted Carmichael, chief economist at J. P Morgan Canada. “This has been a very significant blow—and there could be a serious contraction.”

That prospect has made it all the more important that Canada satisfy U.S. concerns about its security measures—and get border traffic flowing again. Last week, Ottawa unveiled measures ranging from tougher vigilance to the faster introduction of fraud-proof immigration identification cards to protect itself and mollify its neighbour. But more will likely be required—if only because two-way trade before the attack was $1.7 billion per day and 70 per cent went by land. “There is an old line the Scandinavians used to use about the Russians: ‘Above all, we have to have defence against help,’ ” says Canadian political scientist Tom Axworthy, public policy lecturer at Harvard University’s John F. Kennedy School of Government. “In other words, if we don’t do it, we will have help. So we have got to do it.”

The downturn has also put severe pressure on Finance Minister Paul Martin. Last May, in his economic update, the minister took pains to explain that even the most pessimistic private-sector forecasts predicted economic growth of 1.6 per cent this year. Today, that figure seems positively sunny: most economists believe the economy dwindled in the third quarter—and will shrink even more in the fourth.

That leaves the minister, who finally conquered Canada’s enormous deficit in 1997-1998, with a huge challenge: although earlier this year he had accumulated a hefty surplus of $10.7 billion, revenues are now declining at a time when the cost of those security measures could soar. When asked if he would be forced to slip into deficit again, Martin was vehement. “We are right now in the middle of a global slowdown,” he told Macleans. “To think that massive tax cuts or massive spending in Canada would turn that around would be a mistake. We are not going to spend ourselves into a deficit.”

The minister was equally adamant that he would not tamper with scheduled tax cuts or transfer payments to the provinces for health and education. And he tried to bolster nervous consumers with the assurance that this is the “best time” to buy whatever they need because interest rates are low. “We have got a very tough third and probably a tough fourth quarter ahead of us,” Martin said. “But the long-term trend is upward—and that should give Canadians an enormous amount of confidence. The terrorists can cause huge human tragedy. But they cannot derail the underlying strength of this economy.” Still, it was hard to avoid the uncertainty. In Surrey, B.C., Deanna and Kyle Johnson took nervous stock of their situation.

Deanna, 29, is on maternity leave from her job as a merchandiser with Sears Canada Inc. “I hope our jobs are secure,” she says, bouncing infant son Aidan on her knee. “I work for a pretty well-established company.” Her husband, Kyle, 29, the manager of Kelsey’s restaurant in Langley, B.C., is equally hopeful because his diners are not usually tourists but loyal locals attracted by the atmosphere of “casual family dining.”

The problem is that the Johnsons are dependent on consumer spending. And the strength of that demand is entwined in a chain of economic events that stretches back into last year. The current crisis really began when U.S. and Canadian manufacturers overestimated the needs of their customers last fall. Saddled with excess inventories, they started to cut back. U.S. manufacturers slashed their production. In Canada, the amount of stock in relation to sales actually grew during the first six months of this year—if only because sales were falling even faster than inventories.

Things were so bad that the manufacturing sector was in recession during the first six months of this year, and shipments dropped again in July. Business investment rose marginally in the second quarter after contracting for three consecutive quarters. With corporate profits in an abysmal state, it is now unlikely to rebound any time soon. Jayson Myers, chief economist with Canadian Manufacturers & Exporters, predicted last week that the manufacturing sector would stay in recession “at least well into next year and perhaps 2003.”

Still, throughout the crisis in the manufacturing sector, there were areas of surprising resilience and ingenuity. Construction stayed relatively hardy, with housing starts rising in August. Through the adroit use of incentives, automobile manufacturers cut profit margins to the bone—and managed to reduce their hefty inventories. And although consumer confidence was ebbing in a climate of rising unemployment and low household savings rates, it remained a tottery beacon of hope.

Now all bets are off. Last week, the U.S. Conference Board announced that consumer confidence plummeted in September—and the decline began even before the attacks. Canada has almost certainly mirrored that trend. In Burnaby, B.C., Dairn Peters, assistant pastor of the evangelical Kingsway Foursquare Church, can see how his flock’s distress at the calamity could have an economic impact. “I have talked to quite a few people who were almost paralyzed by what is going on, shaken and in fear,” he says. “I’m not sure about the economic fallout, but it’s pretty severe to have the markets shut down and not looking good when they opened back up.” Key sectors are reeling. Jim Watson, president of the Canadian Tourism Commission, saw his own staff members cancel a trip to Tokyo this month for a meeting of the Canada-Japan Tourism Council—because the meeting was indefinitely postponed. “There is a significant downturn in bookings—and a significant upturn in cancellations,” he says. Lately, he spends most of his time taking calls from worried travel and tourism operators who represent a $54-billion sector that employs 550,000 people. “Unfortunately,” he adds, “it is very difficult to tell them what the future holds. ” The automotive sector may also face new troubles. Although the Bank of Canada has taken its key overnight rate down to 3.5 per cent, consumers are not likely to buy cars if their jobs are on the line. Last week, General Motors of Canada Ltd. announced that it will shut down its light-vehicle production plant in SteThérèse, Que., next year. A day later, both DaimlerChrysler Canada Inc. and Ford Motor Co. of Canada Ltd. revealed temporary layoffs. In its autumn update, DesRosiers Automotive Consultants Inc. warns that more than 90 per cent of Canadian auto-parts output is exported to the U.S. and Mexico. “If the U.S. consumer backs out of the vehicle market,” it concludes, “Canadian automotive production is hurt, which hurts the Canadian economy and thus Canadian vehicle sales.”

In other words, just after it pulled itself out of one slide, the automotive sector may face another. Jim McManes, 51, the president of Calgary-based Eastside Dodge Chrysler Jeep, figures interest rate cuts will ensure strong sales at his Alberta dealerships because most buyers finance their cars. But business has been “a little tougher” at his Manitoba and B.C. dealerships. “There is some general uncertainty about jobs,” he says. “But I think this will even out.”

The financial sector has been hard hit. Trading revenues and commissions are drying up. Markets are erratic: the 14.3-percent plunge in the Dow Jones industrial average the week after the attack was the worst since 1933; then it rallied last week. So did the Toronto Stock Exchange 300 composite index, though it was still down about seven per cent since the attacks. “You don’t want to sell into this market,” says Katherine Beattie, a technical analyst at Standard & Poor’s MMS. “Military and political uncertainty is going to continue to overhang the markets. It’s a whole new ball game.” Even before the attacks, there had been a stampede out of equities to the safety of cash in Canada and the United States. In the immediate aftermath of the attack, $75 billion (U.S.) flowed into money-market instruments like Treasury bills, almost eight times the normal weekly amount. “Even before Sept. 11, cash actually outperformed stocks,” says David Rosenberg, chief economist at Merrill Lynch Canada Inc., who was one of the first Bay Street heavyweights to declare that Canada had slipped into recession. “Money market funds are not just a place to park cash now: they may be an asset class in themselves. Cash is king.” He says that he has been advising investors to be very cautious about equities: “The watchwords are conservatism, defensiveness, quality and a focus on income such as dividend yields.”

Such advice may come a little too late for even the cagiest investors. In the immediate aftermath of the tragedy, Steve Guest, a 42-year-old senior manager with KPMG Consulting in Toronto, checked to see if it had affected his $250,000 RRSP portfolio. “The impact was instantaneous,” he says. “It was pretty scary.” Although he had split the money among nine very different funds, his own portfolio was down $10,000 when the markets reopened two days later. By late last week, it had not rebounded. But he isn’t selling. “I’m going to wait for a couple of months before doing anything,” he says. Then he bravely adds: “With prices down right now, I’m able to buy more units.”

A trace of such stubborn optimism still winds through parts of the economy. Catherine Swift, president of the 100,000member Canadian Federation of Independent Business, has 180 field representatives visiting 3,000 businesses each week. Although segments such as tourism have been devastated, there hasn’t been a huge retrenchment. “We have not heard of most small businesses totally changing their plans,” she says. “And we would know.”

Similarly, the housing sector has remained surprisingly strong. Joy Garrick, a high-profile sales representative with Royal LePage Real Estate Services Ltd. in Toronto, says houses aren’t sitting on the market—unless they are overpriced—and multiple offers are still happening. A westend house listed at $659,000 sold for $670,000 on Sept. 17. “Everyone is waiting for a fallout,” she says. “But so far, it seems like business as usual.”

That sector may stay firm. Philippe Le Goff, senior economist at Canada Mortgage and Housing Corp., forecasts 156,000 new housing starts next year— barely down from 160,000 this year. Demand will stay relatively strong, he says, because vacancy rates are so low in almost every major city. “And we hope the job situation will not deteriorate to the point that

demand will suddenly drop,” he says.

But just as the terrorists jarred every Canadian’s notion of personal security, they have also changed the basic premises of the nation itself. Hershell Ezrin, chairman of communications consulting firm GPC International, was marooned in Chicago when the attack occurred. Two days later, after he drove across the Ambassador Bridge from Detroit, he passed two lines of stranded 18-wheel trucks, pointed south, stretching for more than 20 km. He realized that governments must harmonize some border activities to get traffic moving again.

But he also recognized that the change was far more fundamental. “Those attacks were a seminal moment,” he says. “In the 1980s and 1990s, the icons were business leaders. Now, government has all of a sudden become relevant again.” In a terrorist-sparked recession, Ezrin expects that Canadians will look to their government for leadership— and inspiration. If nothing else, the recovery could depend upon it.