The Catch 22

While the world is still in the midst of recovery and at risk of falling into a double-dip recession, there is one nation who not only survived the market crash better than anyone, but has now become one of the first to true recovery: Canada

Last week was a wonderful and well deserved break for all of us. After the chaos we experienced over the last few years, it’s nice to finally feel a little more at ease.

But that doesn’t mean that the markets are stable. As a matter of fact, the world economy is still in a very volatile space. The only difference this time around is that we’ve heard it all before. From market crash to inflationary woes, we have taken just about everything the financial world can throw at us.

While the world is still in the midst of recovery and at risk of falling into a double-dip recession, there is one nation who not only survived the market crash better than anyone, but has now become one of the first to true recovery: Canada

Canada’s unemployment rate dipped below eight per cent in June and Statistics Canada said Friday the economy added a whopping 93,200 jobs in the month.

The gains in jobs mean that, in less than a year, Canada has almost made up all the jobs lost during the recession that began in the last quarter of 2008!

But there’s a problem.

While Canada’s labour force appears to be back on track, it stood in stark contrast to the United States, where 125,000 jobs were lost last month. It was the first monthly job loss in the U.S. this year, furthering speculation by analysts and economists that the US economic recovery has run out of steam.

The United States hasn’t run out of steam. Its running out of money…

No More Money, No More Jobs…Just More Debt

Since the crash, President Obama has done nothing but spend money in hopes that the economy will work itself out. His administration has held benchmark overnight interest rates close to zero since December 2008 and has pumped well over $1 trillion into the economy. For the most part, it appears his plan has worked. Stocks have rebounded from their lows and panic has turned into passive sentiment.

But once you start peeling back the layers, the beautiful apple on the outside hides nothing more than a rotten core.

The US is probably six months or more into a so-called economic recovery but the rate of unemployment has remained high. So while last month’s jobs report actually showed a drop in US unemployment rate, despite losing 125,000 jobs, the drop was mostly due to people giving up on looking for work. Worse, the job report showed that the time it is taking for people to find a job continues to go up. Almost half of all the jobless Americans have been without a job for 6 months or more.

Yet the benefits keep coming and the unemployment budget keeps stretching.

We are in a difficult situation. The US has no more political power to create another stimulus program. Even if they did, it probably won’t work. Heck, if more than a trillion dollars isn’t enough…what is?

The Catch 22

If the U.S. wants to get out of this mess, it needs to take a page out of Canada’s books. It needs to instil confidence back into its citizens – starting with the banks.

Without the banks and credit flows, a true economic recovery cannot happen. And that’s the catch 22.

Banks won’t lend until consumers and the economy are clearly back on their feet. But consumers and the economy can’t get back on their feet without credit from the banks. Credit creates spending, spending creates jobs, and jobs create growth. Without credit, a recovery just can’t happen.

At the same time, it’s difficult for the banks to step up lending when borrowers are walking away from their mortgages every day.

The option ARMS debacle (see The Story Without a Happy Ending) is still happening and many US citizens could care less about their credit given the amount of money they lost in housing and in stocks.

I was in Las Vegas for the 4th of July weekend and met many US homeowners from around the country who are living in homes…without paying their mortgages.

One woman I met hasn’t paid a dime for over 12 months! Their theory is simple: Force me out if you can!

With so many foreclosures, the banks are having trouble dealing with all of them. It’s at the point where the banks will take any amount of payment they can get. Heck, a few hundred dollars here and there is better than a few thousand dollars lost trying to foreclose (see Owners Stop Paying Mortgages.)

More Jobs Means More Taxes?

Next up, the U.S. needs its corporations to start hiring. But U.S. employers are hoarding cash because, like the banks, they remain pessimistic and lack confidence in their Government. They are worried about higher taxes that may be needed in the future to tame the trillion-dollar budget shortfalls Congress is racking up on an annual basis. If you are a company and you are looking to invest, you have to factor in the cost of future tax changes.

For example, many corporations have already been scared off with the recent health care package (see A Scary Reality Check) costing millions of dollars that could have gone into hiring new workers. What’s to stop the government from adding more taxes?

If corporations begin to hire and the unemployment rate drops, it would signal an economic recovery. But as soon as the current U.S. government smells recovery, rates get hiked, and they may implement new tax laws which will ultimately hurt the bottom line for these corporations.

Yet, another catch 22.

It was a similar story after the end of the tech bubble. Firms hoarded cash while they trimmed inventories but they didn’t really start spending and hiring until the housing bubble took over, lifting consumer spending and convincing businesses profits could be made by growing.

Only this time around, there is no housing bubble…

The Bottom Line

The strong employment numbers out of Canada adds to the theory that the Bank of Canada will move to hike its benchmark interest rate for the second straight time at its next policy meeting on July 20. This Canadian recovery will mean higher rates and a stronger dollar for Canadians – which will ultimately lead to lower housing prices and lower exports.

Employment numbers in Canada will eventually come to a standstill if the Loonie maintains its high value, as exports from Canada decline. Much like China, Canada needs to keep its currency down in the long-term if it wants to keep foreign investments flowing into the country.

The U.S., on the other hand, is still in troubled waters. Regardless of any new government interventions, the U.S. will maintain high unemployment numbers for the rest of 2010 and probably much of 2011.

But there is great news.

Light At the End of the Tunnel

Although this recovery will take lots of time, it certainly does not mean the stock markets are done. Instead, these current environments provide a suitable playing ground for not only short term traders, but a great playing field for the long term investor.

In the end, when the econom
y truly recovers a few years from now, the markets will eventually be far higher than where they are today and we will more than likely see new record highs.

Bluechip companies such as Research in Motion (TSX: RIM) are being considered grossly undervalued by many fund managers and analysts at current prices. A few years from now, we wouldn’t be surprised to see this one back to its old highs of well over $100/share. (disclosure: we own shares in RIM)

Remember, it’s hard to foresee a future where Canada is doing great and the U.S. foundering. The recent unemployment numbers out of Canada are encouraging, but it doesn’t mean we’re back to normal.

So stay prepared and invest wisely.

Until next time,

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