Shaky US Economy Will Eventually Show Up Here

It would seem we all have that proverbial “American cousin.”  Once upon a time there was a Canadian movie by that name.  I never viewed the whole thing.  However as Canadians our love/hate affair with our “American cousins” seemingly never ends.  It’s a relationship steeped in history and many times entwined within families.  Sharing this lucky continent is something to be cherished.

Pierre Trudeau used to say, its like the mouse sleeping with an elephant.  Eventually if the elephant moves over, the mouse is going to get squashed.  He was referring to the interdependence of our respective economies.   Over time the benefits of that have become enormous.  However, when the hiccup comes, it often causes angst on this side of the border.

Clues of that may be found in the current value of the Canadians dollar.  It has plummeted the last few days from its lofty height over 96 cents.  Last Monday it settled at 93.59 cents US.  As Canadians we’ve marveled as the loonie has climbed from under 85 cents in January.  However, we should keep in mind part of the reason it’s gone up so quickly is the American dollar has been depreciating.  The American economy is finding itself on shaky ground.

You might scoff at that.  However, many of you over time must have wondered how the Americans do it.  They produce a lot of stuff but they import even more.  American bombs were/are dropped into Afghanistan and Iraq at a million dollars a pop.  The cost of war is enormous.  To pay for this our American friends borrow from foreigners who have always been enamoured with the great American way.

Is it sustainable?  Probably, however storm signals are certainly on the horizon.  While our loonie has soared the American dollar has been going the other way against other currencies.  It has lost 65% against the Euro and 43% against the British pound since the year 2000.  As the American dollar has declined foreigners holding American assets start the dumping process.  This sends the American greenback lower adding to its woes.

To stem this tide the central reserve has raised interest rates.  By raising rates the flight of foreign capital can be stemmed.  However, in the United States it hasn’t quite worked out that way.  With record low interest rates over the last few years the housing market has boomed.  It was further stimulated by what are called “sub-prime mortgages” or interest only mortgages which I wrote about a few weeks ago.  It works great when interest rates are low but not so much when rates increase.

Problems arose when equity from these housing investments were being used in the stock market.  Housing prices in the US have been falling in many states.  With the equity eroding quickly in these houses, it’s causing much angst in the US stock markets.  With the US still buying over 80% of what we produce, all of this spells future trouble for the Canadian economy.

However something tells me the folks in Calgary, Edmonton and Fort McMurray aren’t looking up as if the sky were falling.  What may be true is that this American slowdown will be bad for Canada, but maybe bad for eastern Canada versus western Canada.  It would seem Ontario and Quebec would be much more at risk of an economic slowdown incubated down south versus the energy rich west.

This creates interesting possibilities for fiscal policy initiatives from both the federal and provincial government.  The big Canadian challenge for any federal finance minister is to manage our “national economy” even though the economic conditions are so different between a Newfoundland, Ontario and Alberta.  On the other hand in Ontario with an election coming in October, I’m sure Premier Dalton McGuinty is feverishly looking for the proverbial rabbit in the economic hat.  The US slowdown will weigh heavy on the manufacturing and agricultural centres in Ontario.

Or am I all wet?  I don’t think so but it is always the unknown variable in the mix you cannot see which either saves the day or in turn upset the apple cart.  Nobody saw September 11th coming with all its economic havoc.  Not a lot of people saw the emergence of the Internet, which increased productivity across the board within the economy.  So the question is what’s going on within this somewhat sour American economic soup in the summer of 2007, which we cannot yet see?  I dunno.

There is much to consider.  Can you imagine an American economy without a war in Iraq or Afghanistan?  I can’t, but eventually it’ll happen.  In the meantime nobody should discount how much that is costing the Americans in both real dollars and prestige and influence abroad.  Mix in the declining greenback and the slumping housing market and it doesn’t look good.  Ditto for Canada.  However, with our Alberta-centric economy percolating, it may take some time before the American slowdown shows up here.