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Economic Insight How bad is the commodity downturn? Depends who you ask

Bank of Canada Governor Stephen Poloz has been surprisingly calm about Canada’s economic outlook.

Patrick Doyle/Bloomberg

Here is Wall Street's view of the great oil-and-mining slump: Run for the hills! This is ugly and going to get uglier!

Here's the Bank of Canada perspective: Oh, calm down. By 2020, you'll hardly remember this kerfuffle.

These are, granted, rather liberal translations, but they do capture the essence of a striking and important contrast in attitudes.

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To a large degree, the contrast is about the difference between short-term and long-term thinking. However, the surprise to many people may be just how small the current agony in the oil patch and the mining sector looms when viewed from the perspective of an adaptable national economy.

Those who are tempted to predict imminent doom for Canada should keep the big picture in mind when reading the torrent of negative reports on resource industries.

Wall Street's bearishness was on full display this week with two new reports from leading investment banks that took a hammer to already microscopic expectations for the commodity sector.

Citigroup Inc., the author of one report, had previously ratcheted down its hopes for natural gas and iron ore. Its fresh study explains that it's revising down expectations for oil and industrial metals, as well, because of slowing global growth and ebbing demand.

Investec, the author of the other report, was equally downcast. "Market conditions represent the perfect storm for commodities, given that demand is falling, supply is rising, inventory levels remain stubbornly high and the U.S. dollar stubbornly strong," it wrote. The investment bank suggests that investors do the sensible thing and dump most mining stocks.

Most people are already doing that with a will, thank you very much: The Bloomberg World Mining index, a yardstick for the global mining industry, has lost nearly half its value over the past 12 months. Oil, meanwhile, has sunk to prices not seen since 2003.

To most Canadians, this epic slump in commodity prices looks dire indeed. After all, we've all read for years about how Alberta oil is powering our economic growth. Add in a massive downturn in mining and it's natural to assume that we're headed for a nasty recession or worse.

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But not so fast. A new note from Bank of Canada's research staff explains that the impact of all this bad news for resource industries may be considerably less severe than you think. It also goes a long way to explaining why Stephen Poloz is so surprisingly calm about Canada's economic outlook.

The note is called "The complex adjustment of the Canadian economy to lower commodity prices" and its prose lives up to that plodding title. However, the bottom line is clear: According to the central bank researchers, the huge decline in commodity prices since mid-2014 will knock all of 2 per cent off the level of Canadian gross domestic product by the time the economy has finished adjusting in 2020.

Now, a couple of percentage points is not nothing, but it's also not a lot. Commodity prices have fallen by more than 40 per cent in the past year and a half; it seems nearly miraculous that Canada's economy could shoulder the impact and finish with an economy that would be only slightly smaller than it would have had, if commodity prices had remained in the stratosphere.

But that is the likely outcome, according to the economic model used by the researchers. Yes, there will be a fall in investment in the commodity sector, as well as a decline in real incomes. By the middle half of next year, however, a lower Canadian dollar, as well as the lower interest rates assumed by the researchers, will begin to stimulate activity.

Adjustment will be helped along by the fact that the commodity sector is smaller than most of us realize. Even in better times, it accounted for only about 1.8 per cent of total employment. While the commodity downturn will hit hard within that relatively small segment, it is not the death blow to the national economy many assume it is.

Even after considering indirect effects, the overall impact of the commodity price decline is likely to be an economy that is only slightly smaller than it would otherwise have been, according to the Bank of Canada analysis. The researchers caution that "the uncertainty around our estimates is large," but to those of us who feel overwhelmed by Wall Street's negativity, they offer a useful reminder that there is still reason for hope.

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