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david rosenberg

Just in case I have not made this clear in my prior diatribes, I strongly believe that escalating global economic imbalances have dramatically reduced the resiliency of global economies to absorb and contain shocks.

The chances of a growth relapse in the second half of the year are higher than the equity market, and to a lesser extent the credit market, have priced in.

The U.S. economy is now considerably more vulnerable than it was just a month ago.  A variety of recent U.S. consumer-related reports, including notably the May employment  and retail sales releases, have been disappointing and are casting doubt on the optimistic view that prevailed up until about a month ago.

That mortgage applications for new U.S. home purchases have plunged 40 per cent in the past five weeks to a 13-year low despite a 25-basis-point decline in mortgage rates is, to be polite, disconcerting.  When the equity market was hitting its recovery highs in early spring, it reflected a widespread view that the green shoots of 2009 would turn into sustainable growth.

Moreover, given the massive government intervention across the planet, it's no surprise that economic activity began to recover exactly a year ago.  The recovery in international trade and the reversal of the inventory cycle both contributed to a "V-like" recovery initially and fostered optimism that global economies were well on their way to a sustained recovery. This was not a good assumption back then and not a good one now.

All of the optimism dominating the marketplace over the past year overlooked a significant fact: The problem of debt leverage got worse - not better. The debt problem was merely shifted from the private to the public sector as governments worldwide stepped into the breech with their fists full of stimulus dollars.

The Greek sovereign debt crisis, however, is the proverbial canary in the coal mine, underscoring the view that governments have probed the outer limits of their deficit financing capabilities.  This has important implications for the economic outlook since the recovery has really been one part bailout stimulus to one part fiscal stimulus to one part monetary stimulus to one part inventory renewal.

Now that the boost to growth from the inventory bounce has run its course, the stimulative effects of government fiscal policy will diminish in coming quarters and the growing political realization of the potential consequences of further increases in government debt to income ratios will probably limit further spending initiatives.  As it stands, the arithmetic impact of fiscal policy withdrawal will drain U.S. GDP growth by an estimated 1.5 percentage points next year, and by about two percentage points in Canada.

The bulls would respond with "the private sector has benefited enough from government pump priming that it can take the lead going forward."  Not so fast.

As we started the year, the pundits were all talking about how we were going to benefit from export-led growth as the global economy revived.  Well, look at the world around you and what you see is Europe, almost a 20 per cent share of global GDP, with a huge fiscal squeeze on its hands that stretches far beyond Greece.

China's massive stimulus program increasingly looks like it is running out of gas and in fact the government has been tightening policy this year, which it must do to redress substantial overinvestment in real estate and what may well be an unsustainable bubble. At the very least, China is unlikely to be the engine of global growth to as great an extent as it has been, though there are some who cling to that view.

Meanwhile, the prospects for the consumer to lead the recovery look even less promising, given the hangover from the housing crash, lingering debt issues and job worries out there.

Even if we don't get a double-dip recession, economic growth will probably be so sluggish that the massive amount of global excess capacity will not be absorbed very quickly.

What that means is that the unemployment rate, stubbornly above 8 per cent in Canada and still near double digits in the United States, will remain high for a long while. It also means that inflation and interest rates will remain low for a sustained period of time.  And it means that a stock market priced for peak earnings in 2011 could be in for some disappointment in coming months and quarters as debt-deflation realities set in.

Look, I would like nothing else than to be hopeful, but we need to be realistic.  The tendency among many debtor governments has been to kick the proverbial "debt can" further down the road.  But my reason for caution now is that delays in addressing the global debt problem will only contribute to making it worse over time. As the problem gets bigger, dealing with it will be even more painful, as we Canadians discovered through the 1990s after a wave of credit downgrades forced tremendous fiscal retrenchment down our throats.

While Canada looks pristine next to the rest of the developed world, being a small open economy dependent on exports means the massive structural debt problems outside our borders are also our problems.

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and a guest columnist for Report on Business.

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