World Trade on the Ropes 

07/09/2009 9:47 am EST

Focus: GLOBAL

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

Rising protectionism poses a grave threat to recovery hopes, warns Gordon Pape in the Internet Wealth Builder.

Investor optimism is still running ahead of reality. Until the two come into some kind of equilibrium, we can expect to see huge swings in the market, driven in large part by the latest news and statistics.

Here are three sobering facts to keep in mind for the next few months.

First, the recession is not over. Although many people seem to believe that the worst is behind us, all we can say with any certainty is that things are deteriorating at a reduced pace.

Second, growth in 2010 will be very weak. The OECD issued a revised forecast for the world economy [recently]. The good news was that the outlook was brighter than previously. The bad news was that average growth next year is expected to be only 0.7% (Canada was projected to be right on that average). In normal times, a growth rate of 0.7% would be considered terrible. These days, we seem to want to cheer it. 

Third, growing protectionism could prolong the downturn by months or even years. The news that the US and the European Union have filed a complaint against China with the World Trade Organization for hoarding key commodities was just the latest salvo in a dangerously escalating situation. Countries around the world are creating impediments to trade that are contributing to a dramatic fall-off in international commerce. Canada's exports were down 44% year over year in the first quarter of this year (expressed in US dollars). That was worse than the average decline of slightly more than 30% for all OECD members.

Lest we forget, a seize-up in world trade was one of the main reasons why the Great Depression went on for so long.

Speaking of the Depression, if you want to see some really scary comparisons between then and now, pay a visit to where Barry Eichengreen, professor of economics and political science at the University of California, Berkeley and a former senior policy advisor at the International Monetary Fund, and Kevin H. O'Rourke, professor of economics at Trinity College, Dublin have analyzed several key economic indicators. Their conclusion: "This is a Depression-sized event."

"Globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports, or equity valuations," they write. "That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline."

Governments and central banks around the world have responded with stimulus packages (paid for by huge deficits), drastic interest rate cuts, and increases to the money supply. These policies are very different from those of the Great Depression era, the authors say. The question is: will they work?

We have no answers yet. The slowing rate of decline is encouraging but there's a long way to go. That uncertainty is why markets will continue to zig zag for the next few months.

This means that caution should continue to be the watchword for the rest of the summer. That's not to say you should stay out of the market. However, I suggest you do your buying on the pullbacks. We are going to see more of them as we go forward, corrections that may be even more severe than the one we just experienced. If there are stocks you've been waiting to buy, those dips will offer the best opportunities.

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