Is Canada immune to another US downturn?

“It is true that we are in excellent financial and fiscal shape if you compare us with any of our trading partners, but that doesn’t mean we are going to be exempt from any negative implications arising in the global economy,” says Queen’s University economics professor Tom Courchene.

Canadians are rightfully asking themselves whether the Canadian economy is headed for a cliff if the United States falls to recession so soon after the last one. Do we hit the rocks together, or is our safety net still holding?

While Prime Minister Stephen Harper and Finance Minister Jim Flaherty warn of tough times ahead, they also point to the last recession a few years ago and how Canada walked away with a few bruises but no broken bones, like the Americans. Don’t panic now, they say.

But the pain train is revving if the hobbled U.S. economy is heading to what is called a double-dip recession, Europe continues its nose-dive and other global markets struggle.

Fear also drives down the economy as consumers tighten their belts, hold off on purchases and, in some cases, unload their stocks to seek a safe haven – which many are doing by buying American greenbacks, and that is driving down the value of the high-flying loonie.

The surge in the popularity of U.S. currency is a sign of international confidence in the U.S. in the face of one rating agency’s decision to lower Washington’s triple-A credit rating last week. Source: (1) Toronto Sun

It should read “Why is Canadas recession on the way?”

Here is why: When the US recession began, BOC dropped interest rate to 0% to encourage spending, which is what we did, racking up a record 1.5 trillion dollars. As a side note, Canada’s GDP is 65% consumer sending.

BOC also instructed the CHMC to approve as many high risk mortgages as possible, so that along with record low interest rates drove up home prices to record highs. Everything in the housing industry was booming, an industry that is 20% of Canada’s GDP.

Rising home prices created the “wealth effect”, where people think they are richer than they are. This stat is staggering, 46,000$ is the average Home equity loan to buy more stuff we cant afford.

The remaining boom was a result of the stimulus spending.

So now here is the million dollar question; the one no one has the balls to ask, is scared to face and BOC sees coming and is sounding the dept bell. If we have record dept and people cant buy more stuff they cant afford (65% GDP), including housing new housing (20% GDP), record low rate go up making dept service harder/impossible, and the stimulus runs out this year (all stimulus has to be spent by October 2011), than what will happen?

What miracle will fill the void that almost 85% of GDP relies on? It wont be exports thats for sure, our trading partners are down for the count and our expensive dollar is not helping.

Canadians are getting superficial and (intentionally?) misleading analysis from their chief economic analyst. He says “Canadian households had strong balance sheets going into the downturn” but neglects to remark on the level of individual and government indebtedness and the fact that ‘Housing values” on the balance sheet are subject to likely downward revisions, and more importantly, that the balance sheet of the nation as a whole is very badly affected by the deficit spending at federal and provincial level.

Nearly anyone can avoid a reduction in lifestyle (ie spending) when their income is cut if they sell off assets or borrow, but obviously that state of affairs is temporary. If you believe the income cut is temporary you may justify the borrowing, but if the income cut is protracted, you are going to hit the wall unless you cut your spending to match your income. Your balance sheet has been impaired by the borrowing. The “milder downturn” did not take us down to sustainable levels of expenditure.

Canadians are still spending beyond teir means. They have some relief from the fact that commodity exports, to Asia in particular, are currently strong, yet this cannot be relied on to persist indefinitely, and, in any case, are not sufficient to keep us from having a negative balance of trade, another indication that we are living beyond our means.

On a related note, GDP is a poor measure of ability to create wealth and to repay debt. GDP rises when government spending (borrowing) increases, but this places the nation in a worse situation since this government borrowing does not create capital goods or otherwise facilitate wealth creation.

They are not through this yet. Their biggest trading partner has an irretrievably bad balance sheet and this is already recognized by those who formerly purchased Treasury securities. Now, through the smokescreen of Quantitative Easing, the vast majority of the US Govt borrowing needs are being met by money ‘printing’.

This is going to end badly.