Statistics Canada
Symbol of the Government of Canada

Section 3: Feature article

Warning View the most recent version.

Archived Content

Information identified as archived is provided for reference, research or recordkeeping purposes. It is not subject to the Government of Canada Web Standards and has not been altered or updated since it was archived. Please "contact us" to request a format other than those available.

2008 in Review

by Philip Cross 1 

While every year is unique, the economy in 2008 was unlike any other in recent memory. Analytically the year was easily divided in two. In the first seven months, commodity prices soared to record levels amid slow growth in North America and steady gains in Asia in the aftermath of the initial disruption of credit markets late in 2007. However, global demand and commodity prices began to falter late in the summer, and fell precipitously after credit markets seized up in mid-September. These events quickly spilled over into the real economy of output and jobs.

One widely commented-on feature of the current downturn was the speed of its onset and how quickly it was transmitted across the globe. The year started with concerns about food shortages and riots in Africa and Asia 2  , and inflation dominated headlines for much of the first half of the year while Canada’s trade surplus set records. But by year-end, output was contracting and prices falling in many parts of the OECD, while growth had slowed markedly in China and India. Financial crises were triggered from Russia and much of eastern Europe to countries as diverse as Brazil, Pakistan and Iceland, usually involving their exposure to debt.

Since the economy at year-end was so different from the start, this review of 2008 does not focus on annual averages. Instead, it looks at how the global economy changed in the second half of year in response to the turmoil emanating from US financial markets and why this impacted Canada (and the world) so rapidly.

The real economy

Most countries were able to sustain slow but still positive GDP growth in the first half of 2008, including the US and the EU. Canada’s real GDP rebounded from a dip in the first quarter, which was aggravated by supply disruptions (including record snowfall, a new February holiday in some provinces, and unscheduled maintenance in the oilpatch). Employment growth slowed, but remained positive in the first three quarters of 2008 in Canada, including a record burst of job growth in September 2008. However, GDP contracted sharply in the fourth quarter as global demand retrenched.

The downturn in Canada was driven by a sudden drop in exports. Export earnings had already begun to soften over the summer of 2008 as commodity prices dipped, but the decline became a rout in the three months after October, with exports shrinking a record 25%. Employment and GDP levelled off in October, before turning down decisively in November and December. By November, both exports and imports were falling rapidly, as international trade around the world shrank in unison. The daily turbulence in financial markets and mounting layoffs led anxious households to suddenly curtail purchases of homes starting in October and autos in November, even as labour income grew steadily through year end.

Chart 3.1

Most importantly for Canada, the seven-year boom in commodity prices ended, with energy and metals quickly sliding to multi-year lows (although most remain well above their lows before the recent boom began late in 2002). Other export-dependent industries posted large declines, notably for autos and lumber, which were already struggling after over a year of slower sales in the US.

Commodity prices fell sharply in the second half of 2008. Led by a drop of over $100 a barrel in the price of crude oil, commodity prices fell by over half in just five months. The severity and the speed of the drop in commodity prices, after their record run-up over the previous five years, marked a new high in the volatility of what has always been a cyclical sector.

While the value of natural resource exports tumbled after July 2008, two-thirds of the decline was due to lower prices. The volume of resource exports was less affected, as some are necessities (notably food and energy, where the volume of exports actually rose slightly). Other items like lumber and metals saw export volumes retreat sharply, putting them in the same boat as autos.

Household balance sheet data clearly show the impact of the resource and housing boom that sent household wealth climbing before 2008, and the drops in the second half of 2008 that erased some, but far from all, of these gains. From 2002 to the second quarter of 2008, household net worth rose 56% or $2.1 trillion. Two-thirds ($1.2 trillion) came from investments related to the soaring stock market and about one-third ($0.8 billion) from rising homeowner net equity. The slump in stock markets and house prices erased 7.3% of household net worth in the second half of 2008 — painful, but far short of the 20% reduction in the US since mid-2007 (when the US stock and housing markets began to falter). As a result, household wealth in Canada has expanded almost twice as fast as the US since 2002 (45% versus 27%).

The pattern of net lending by sector in Canada shows that the fourth quarter represented a discontinuity and not an extension of how 2008 had been evolving. In the first three quarters of 2008, corporations, governments and the external sector all recorded higher surpluses (continuing a trend that began early this decade), while the household sector increased its borrowing from late in 2007. These trends were all abruptly reversed in the fourth quarter: government and the external sector swung into deficit (for the first time since 2003 and 1999 respectively), firms posted their smallest surplus since the commodity boom began, while suddenly cautious households curtailed net borrowing to its lowest level since 2005 (in Figure 4, net lending by non-residents is the measure of Canada’s external trade balance).

Canadian investors quickly changed their strategies in response to the upheaval in global financial markets. After increasing their portfolio investments abroad (mostly stocks and bonds) for 29 years in a row, these investments suddenly dropped in 2008 as funds were re-patriated to the security of assets in Canada.

The Bank of Canada provided significant liquidity in the fourth quarter of 2008. As investors re-patriated funds to Canada to buy short-term bills and bonds, the Bank provided liquidity through the increased use of purchase and resale agreements with financial institutions as well as the sale of Treasury bills. In the fourth quarter, the largest increase ever in National Housing Act mortgage-backed securities was recorded, half of which was linked to the Insured Mortgage Purchase Program whereby the federal government acquired significant amounts of mortgage-backed securities from financial institutions. 3  This improved the balance sheet of these firms by trading illiquid for liquid assets.

Autos and Housing

Autos and housing often have been at the centre of cyclical downturns in the past, and 2008 was no exception in North America. Given their importance in last years’ retrenchment, this section looks more closely at the impact of autos and housing on output and exports.

The year was a watershed for the auto industry. The steep decline in assemblies that began in December 2007 accelerated sharply throughout 2008. Sales in the US fell steadily in 2008 to a 17-year low, lowered in the first half by record high gasoline prices and in the second half by the drying-up of credit and consumer confidence. As a result, by the end of 2008 auto sales were nearly 50% below their recent peak, with the largest declines for trucks and SUVs, segments dominated by the three Detroit-based producers, which overall lost market share for the 15th straight year.

Many of the numerous closings of auto plants in North America had their origin in long-term trends in consumer preferences. This shift propelled the market share of import nameplates to over half of all sales in Canada for the first time ever. While import nameplates are more popular, these vehicles are increasingly made in North America, keeping the share of sales produced in North America steady at about 80%. Auto production at Canada’s 11 assembly plants fell 20% (or the equivalent of the annual output of two plants) to 2.0 million vehicles. Canada’s share of North American output has been steady at 16% since 2000, while its above-average share of investment in the auto industry bodes well for its long-term future when the current restructuring is completed. 4 

Chart 3.7

The end of the commodity boom was reflected in a slump in the housing market in western Canada. After years of double-digit increases for home prices, especially in BC and Alberta, housing prices turned down sharply by year end. This was reflected in lower housing starts. By February 2009, starts in western Canada were three-quarters below their peak in the fall of 2007, while the drop in the rest of Canada was less than one-half.

Existing home sales in Canada peaked in July 2007, the month before the onset of the global financial crisis. Since then, unit sales fell 34% by December 2008, with about half the drop occurring by September 2008 and the other half just in the last three months of the year. The sharpest declines occurred in BC (-60%) and Alberta (-47%). The bulk of BC’s reversal occurred before September 2008, as its housing boom unwound steadily in 2008 amid steady losses for lumber and metals. Conversely, almost all of Alberta’s retreat happened in the last three months of 2008, when energy prices fell sharply. By contrast, sales fell only 36% in central Canada.

The combination of slumping domestic and external housing demand has severely depressed the lumber industry. Manufactured wood sales fell from $3.0 billion early in 2006 to less than $1.5 billion late in 2008. After being one of Canada’s export staples for over a century, lumber accounted for less than 2% of exports in January 2009.

Adding to the troubles of the forestry industry was the downsizing of the newspaper industry, which was most advanced in the US. Several large newspaper chains went bankrupt last year, while others reduced their print size. This accelerated the recent drop in newspaper consumption, which has seen Canada’s newsprint exports tumble by one-half since 2001.

Chart 3.8

The slump in auto, lumber and newsprint exports has had a profound impact on the structure of Canada’s exports. The share of autos and forestry products continued its decade-long slide, falling to 17.7% last year, under half its most recent high of 37.2% less than a decade ago in 1999. Two-thirds of this drop originated in autos, and one-third in forestry products. However, between 2007 and 2008, the 5.3 point drop in the share of forestry exports exceeded the 4.2 point loss for autos. This trend continued early into 2009, with their combined share in January tumbling to 14.9% due to accelerating losses in autos and lumber. The share of value-added exports moved considerably lower (probably under 10%), as autos have a large import content. The falling share of autos and forestry exports was offset by gains for other resources, notably energy and metals.

The US recession

In the US, the slowdown in real GDP in the first three quarters was followed by a 1.5% decline in the fourth quarter, the largest quarterly drop since 1982. Employment losses more than tripled from an average of 137,000 in the first eight months of the year to 469,000 in the next four months (and nearly 700,000 in the first two months of 2009). Just as significant was a sharp jump in involuntary part-time workers, which increased in number faster than the unemployed (2.1 million versus 1.5 million between August and December) as full-time jobs disappeared rapidly. This coincided with a marked shift in the source of the drop in jobs: before September, it was mostly due to a lower hiring rate, while layoffs dominated after September.

The 2008 downturn in the US was the most severe since 1981-82, and so most comparisons are made between these two recessions. While the recessions in both 1974-75 and 1981-82 saw real GDP in the US fall about 3%, the better template for the 2008-09 recession might be 1974-75. Like the current downturn, the 1974 recession began as a mild slump lasting almost a year in an environment of rising commodity prices. The drop in output was so muted, and lingering concerns about pervasive shortages seen in 1973 so high, that employment grew slowly but steadily during the initial phase of this slump.

However, the 1974 recession turned markedly worse after the Franklin National Bank went insolvent in October 1974, one of four major banks to disappear during the recession. The real economy quickly unraveled. Employment fell 2.8% between October 1974 and April 1975, the worst six months in post-war history (exceeding the 2.4% drop from August 2008 to February 2009).

As noted in last month’s article in the CEO, the severity of the US recession in 1974-75 triggered a 12% drop in the volume of Canada’s exports, by far its largest loss during any post-war US recession. But Canada escaped with only a mild recession, due to steady gains in domestic demand.

Unlike 1974-75, however, the Canadian economy in 2008 was profoundly affected by the deepening slump in the US and around the world. The greater impact now compared with 1974-75 largely reflects how Canada, like most nations, is more deeply intertwined with the global economy. Exports as a share of GDP were over half as large in 2008 as 1975 (35% versus 22%). As well, commodity prices fell faster in 2008.

Financial markets

The year was dominated by the growing turmoil in global financial markets. From its onset in August 2007 when an investment fund revealed its exposure to subprime mortgages, the crisis mutated in September 2008 to a sudden aversion to many types of non-government debt by investors worldwide.

The abundance of cheap debt led all domestic sectors of the US economy to increase their borrowing after 2002. Household debt as a share of GDP rose 10 points to 97.3% between 2002 and mid-2008, fuelled by the housing boom in the mid-2000s. When mortgage debt growth slowed after 2005, corporations increased their debt even faster, including commercial banks within the financial system. And of course government debt expanded steadily. Overall, the indebtedness of households, corporations and governments in the US rose from 269% of GDP in 2002 to 329% in 2008. More important than the growth of debt in recent years was the erosion of the quality of assets lenders accepted to sustain the expansion. 5  By 2006, 34% of new mortgages in the US were below prime quality.

By comparison, Canada avoided a similar increase in debt held by its domestic sector, which rose from 228% to 255% of GDP from 2002 to 2008, less than half the 60-point increase in the US. Household debt rose to 85% of GDP over the last six years, while non-financial corporations and governments paid down their debt. The Canadian financial system had debt equivalent to 60% of GDP in 2008, half the American level, while avoiding the corrosive impact on debt quality seen in the US from subprime mortgages. Unlike the US, Canada consistently ran large trade surpluses over the past decade. Canadians invested much of this surplus in direct investment abroad, helping it avoid a wholesale reliance on investing in opaque financial instruments. As a result of the steady string of trade surpluses, by the end of 2008 Canada had no net external indebtedness for the first time on record since 1926.

Chart 3.12
Chart 3.13

The failure of the Lehman Brothers investment bank on September 15 was the catalyst for a deepening of the global financial market crisis and the ensuing tailspin in the real economy around the world. This reflected a very sharp increase in interest rates paid by many households and businesses and a complete freeze in some credit markets, as fear of default led investors to rapidly shift their money to the security of government bills and bonds. 6  Over the next two months, the Toronto stock market plunged to 49% below its peak, mirroring similar or even steeper declines in markets around the world. Meanwhile, commodity prices tumbled nearly 50% and the Canadian dollar fell from near parity with the US greenback to 80 cents (US) by year end.

The financial upheaval changed the landscape of the global financial system. The US financial system was completely transformed. Fannie Mae and Freddie Mac, the two largest issuers of mortgages, were nationalized in early September. All five large investment banks disappeared into insolvency, were absorbed into larger banks with stable deposit bases or became bank holding companies. Two of the six large banks at the start of the year were forced to merge with other banks by the Federal Deposit Insurance Corporation. Several banks in Europe were also taken over by government or merged with stronger banks. 7  By comparison, banks in Canada were a rock of stability.

The Federal Reserve Board responded to the financial turmoil with numerous programs to help credit markets, over and above its steady cuts to interest rates.  8  Before September, Fed actions were confined to changing the composition but not the level of its assets; after September, both the composition and the level changed radically as the Fed allowed a wide range of financial and even industrial firms to borrow directly from it (previously, only commercial banks had access to the Fed). 9  The Bank of Canada’s balance sheet also underwent a significant transformation in size and composition after September.

Conclusion

While the speed with which global financial markets impacted Canada’s real economy was a break from past cycles, the pattern of output and job losses so far has been typical of past cyclical downturns. The recession accelerated the ongoing slump in the auto and forestry sectors, while reversing the boom in our resource sector. Canada had enjoyed a surge in commodity prices for 7 years and had gone a record 16 years since the last downturn in Canada. This implies that for a whole generation of investors and workers, this is their first experience with a recession.

Governments and businesses in Canada ran large financial surpluses in the past decade, while households were restrained in their borrowing. Canada’s financial institutions have held up well despite the turmoil in many other nations. This leaves Canada well-positioned to take advantage of a recovery of the global economy, when that occurs.

Next | Previous