Today's economy

It’s a small world after all

By Kevin Press,

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Years ago I was employed at Rogers Media as a magazine journalist. Caroline Cakebread, the popular editor of Canadian Investment Review and a colleague of mine, told me about a new cover story she was running that raised questions about the benefits of global investing. As the global economy has grown increasingly interconnected she explained, the economies in its various regions have begun to move more and more in lockstep. What happens in Asia affects Europe, which triggers a U.S. impact, etc.

The diversification benefits afforded by geography are as much a fundamental of sound portfolio management as are the benefits of investing across different asset classes and different industries. It’s the sort of thing you learn as a novice investor. It’s also intuitive. Don’t bet all your money on China, because things may not turn out the way you think. Spread your money around the world as best you can, so that you won’t be overexposed to a bit of geopolitical upset.

This is part of what Tony Boeckh meant last week when he said: “One of the lessons of the crash of 2008-2009 is that virtually all risk assets had a correlation of one. In other words, they all moved sharply together. People thought they were diversified, and they turned out not to be.” (Boeckh was making a broader observation about diversification.)

It’s more important than ever for Canadians to understand this relatively new global economic reality. It’s possible that we have been lulled into a false sense of security by the fact that our downturn was less severe than the one experienced in the U.S., and by the strength of our recovery so far compared to other countries. The truth is we were impacted by the credit crisis of 2008, not because it happened in the U.S. but because it happened on Wall Street: the centre of the global economy. Similarly, we are not immune to the sovereign debt crisis of 2010, because what happens in Europe can and will impact the global economic recovery. It is only a question of degree.

Nouriel Roubini, American professor of economics at New York University’s Stern School of Business, made this point plainly to Jonathan Sibun at the Telegraph. “The crisis is not over; we are just at the next stage. This is where we move from a private to a public debt problem,” he said. “We socialized part of the private losses by bailing out financial institutions and providing fiscal stimulus to avoid the great recession from turning into a depression. But rising public debt is never a free lunch, eventually you have to pay for it … We have to start to worry about the solvency of governments. What is happening today in Greece is the tip of the iceberg of rising sovereign debt problems in the eurozone, in the U.K., in Japan and in the U.S.”

Boeckh said much the same thing to me, and explained that this emerging view among investors about sovereign debt will force government hands. How that will play out over the next few years is as much a gamble as the 2008 financial institution bailouts were. “Government cutbacks on expenditures and raising taxes is going to be another experiment, and we don’t know if the social fabric is going to take it – whether we’re going to see riots in the streets in other European capitals as those governments cut back. I think the whole thing is kind of tenuous. We just have to watch and see when governments really cut to get their debts under control, whether the social fabric can take the additional deflation and the pain that comes with that. That’s what everybody should be watching closely.”

In fact, the crisis in Greece has already impacted the Canadian economy. Look at our dollar for example. After hovering around parity with the U.S. dollar for much of April, the loonie fell in May. It was trading this morning below 93 cents U.S. And interest rate hikes, which seemed such a safe bet here just a month ago, are now up for debate again. Rate hikes are still likely, but their timing and size aren’t nearly as clear.

There’s much to write about for Cakebread and her colleagues at Canadian Investment Review. She recently led a successful transition of her institutional investment journal from print to digital. Canadian Investment Review’s new website features an excellent stable of bloggers, and much of this country’s important investment research. If you don’t mind the occasional mathematical equation in your investment reading, I highly recommend it.

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