With oil prices at US$50-plus a barrel and expected to stay above US$40, downside risk to economic growth has increased.

High oil prices are not, of course, bad for Canada as a whole; they benefit the Western provinces while the rest of the country takes a hit. It is, however, a definite negative for the U.S., a large net importer, — and what happens in the U.S. affects Canada through exports.

Nor is oil the only thing to worry about. There are signs of rising inflation in the U.S. while the Conference Board’s U.S. leading index continues to drop. That could force the U.S.
Federal Reserve Board to continue raising interest rates, even if economic conditions don’t warrant it. There’s also Federal Reserve chairman Alan Greenspan’s warning that if the U.S. doesn’t bring down its fiscal deficit, the economy could “at some point stagnate — or worse.”

Nevertheless, many economists believe the U.S. will continue to grow at a good pace — by 3.5%-4% this year and 3%-3.5% in 2006.
They put their faith in the U.S. consumer, whom they think will continue to spend, albeit at a slower pace, because of increases in jobs and real wages.

Those same economists expect Canada to chug along at 2.5%-3% this year and accelerate a little in 2006, as the negative effects of the high Canadian dollar — assuming it doesn’t climb further — wane.

There are some dissenters. National Bank Financial Ltd. thinks U.S. growth will slow to 2.4% next year, as increases in interest rates force consumers to be cautious. The University of Toronto’s Institute for Policy Analysis believes Canadian growth will be just 1.6% this year, but says this is a temporary blip, resulting from the need to moderate production to bring down high inventory levels, rather than a slowing U.S.
economy. It sees growth of 2.6% in 2006.

There are only a few mavericks, including Ross Healy, president of Toronto-based Strategic Analysis Corp.. Healy has been warning for a number of years that a major recession in the U.S. is inevitable given the high and, in his view, unsustainable levels of consumer, corporate and government debt.

Nevertheless, it looks increasingly as if we are sitting on a pile of wood that could catch fire if any of a number of possibilities materializes. That doesn’t mean it will happen soon, or even ever. But it does mean there are problems that must be considered, and factors beyond anyone’s control that could provide the spark.

Further complicating the situation is that some of the risks impinge upon others. For example, U.S. interest rates may have to increase to quell rising inflation from high oil prices.

Here’s a look at the major risks:

> U.S. consumers. U.S. consumers have kept growth going in the past few years. New sources of extra spending money keep turning up, including tax rebates, mortgage refinancings and home equity loans. But, at the same time, the debt load keeps rising.
The question is: how close are consumers to the edge, both financially and psychologically? How much can they afford in higher debt-servicing charges, and higher fuel and gasoline costs, without having to curtail other expenditures? How much of a downturn in the housing or equity markets would it take to cause them to draw in their horns? Increased net worth, fuelled by strong housing prices, is what has made more debt seem affordable.

> Oil. Prices are now expected to remain above US$40 a barrel, with some economists thinking they will stay around US$50 and a few predicting even higher prices. CIBC World Markets, for example, believes oil prices could climb to more than US$100 in the next five years — unless there is a global recession, but that would only delay the rise. Surprisingly, CIBC World Markets thinks a recession could be avoided with very low U.S. interest rates.

It’s probably reasonable to think that oil in the low US$40 range — which is the area in which Bank of Montreal and TD Economics think it will be next year — would not cause U.S. consumers to temper their spending.
But what about oil prices staying around US$50, as the Canadian subsidiary of economic consulting firm Global Insight Inc. expects?

Global Insight believes the Federal
Reserve’s discount rate will reach 4.25% by
the end of this year, another negative for highly leveraged consumers, as it will increase their debt-servicing costs. Both oil prices and interest rates will slow U.S.
growth next year, it predicts. Senior economist Wojciech Szadurski says there is a risk of a consumer collapse, although he doesn’t think it will happen.