Canada’s Economy Resilient Despite U.S. Financial Woes

By Cheryl Grey, on October 13th, 2008

The trade relationship between the U.S. and Canada is globally unique and intensively intertwined. As the United States’ most significant trading partner, 80% of all Canada’s exports are shipped south (and 21.4% of America’s travel north). In 2007, more goods passed back and forth across just one U.S.-Canadian border crossing—the Ambassador Bridge between Detroit and Windsor—than the U.S. sent to the entire nation of Japan.

The first U.S.-Canadian Free Trade Agreement went into effect in 1989; between 1990 and 2005, Canadian GDP expanded 51.1%.

The Motion

The downside to this extraordinary exchange is that a lot of Canada’s economic eggs are in one basket.

Gross domestic product (GDP) is the measure of all goods and services produced and it’s the universal economic scorecard. With exports supplying approximately one-third of Canadian GDP and exports specifically to the U.S. dominating that contribution, whenever the U.S. economy slows down, historically, Canada has not been far behind. During the current volatile year, as U.S. consumer demand weakened and market after market imploded, economists watched and waited for Canada’s economy to tank.

But like the commercial with the toy bunny that just keeps going, Canada’s economy has proven incredibly resilient. While it’s true that, in the first quarter of 2008, Canadian GDP shrank by 0.8% and in the second quarter it expanded merely by 0.3%, after that point the economy seemed to catch a second wind. In July, the most recent for which data is available, Canada astonished financial markets by a 0.7% surge over June’s performance. Considering the global financial climate, that’s pretty impressive.

The Canadian labor market remains remarkably tight, with the unemployment rate steady at 6.1% in September and jobs continuing to be created even in this climate. In stark contrast, the U.S. job market has declined for nine consecutive months through September, and no one seriously expects that to quit before at least the end of the year.

The Battery

So what’s sustaining the Canadian economy?

Despite opinions to the contrary, NAFTA was never about jobs but all about oil. The greatest percentage of U.S. crude oil imports, around 18% annually, are extracted from Canadian soil, in comparison to 11% each from Mexico and Saudi Arabia. With 99% of all Canada’s crude oil exports flowing south in a steady stream, well, what are a few jobs between friends?

Petroleum cash poured into Canada. The U.S. trade deficit with much of the world is shrinking, mainly due to the recent low value of the greenback and reduced domestic demand for imported products. But in August, the trade deficit with Canada expanded by $200,000,000.

In Alberta, the Texas of Canada, the average annual after-tax family income is $12,000 higher than the average of the other nine provinces.

As the price of oil ballooned through 2007 and the first half of 2008, the value of Canadian exports and, therefore, the Canadian dollar (CAD) surged to follow, climbing 17% against the U.S. dollar (USD) on international foreign exchange markets. Because it then required more USD to purchase Canadian crude, this surge in CAD contributed to the hike in oil prices that climaxed on July 11 at $147.27.

But that weekend, IndyMac was seized by the FDIC and global financial markets turned skittish. Investors backed out of riskier investments and ran for the safety of Treasury notes. Rising demand for USD increased its perceived value, contributing to the popping of commodities prices and the resultant deleveraging.

With the shift in relative values between the two currencies, the flow of funds into Canada began to weaken although the flow of crude into the U.S. barely slowed. When Lehman Brothers fell, the skittishness became panic, and on October 10, the Canadian dollar collapsed against the greenback, along with most other major currencies around the world, as investors exited markets en masse and ran for shelter.

The chart above tracks the depreciation of USD against CAD, beginning in March 2007 at the upper horizontal red line, dropping to an historic low in November 2007 and re-appreciating strongly since the fall of Lehman Brothers.

As long as the U.S. needs crude oil, the Canadian economy will be in no danger of collapsing, although the standard of living in Alberta might not be sustained. Meanwhile, in the U.S., there’s panic over the possible self-destruction of the entire financial system; in Canada the budget may run a deficit for the first time in 11 years.



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Economists Finally Agree: We’ve Been in a Recession Since January

By Evelyn Black, on October 13th, 2008

For at least a year now, ordinary people in the United States (people the press has been referring to as “Main Street”) have known that the economy was starting to slow down at the same time that prices were rising uncomfortably fast.

Now, some economists are finally starting to admit that, yes, the U.S. probably went into recession somewhere around January of 2008. U.S. economic growth is expected to go officially negative by the end of this year, and this negative growth pattern is expected to continue and worsen throughout most of 2009, if not longer, driven by job losses, a continued drop in factory orders, and falling home prices that still have a long way to fall before the housing market stabilizes.

On October 3, the U.S. Labor Department announced that 159,000 jobs were lost in September, much higher than the expected loss of 100,000 jobs. Orders for durable manufactured goods declined by 4%, almost double the 2.5% figure expected by analysts. Even the service sector flat-lined in September, hovering just barely above the 50 point threshold that signals economic growth.

Although the House of Representatives finally did pass the $700 billion credit market rescue package on October 3rd, by the time the bill was at last on its way to the White House for the President Bush’s signature, that same credit crisis had already pushed the State of California into a $7 billion budget shortfall, with the real possibility of not being able to meet payroll this month, and the State of New York into a shortfall of $1.6 billion, expected to worsen next year. California may have to turn to the Federal Reserve to borrow if credit isn’t available by the end of October or else face a total shut down of state government.

It is not at all unusual for economists to declare a recession in retrospect or for consumers to feel the recessionary effects before the experts do. This is partly because economists have varying criteria for labeling an economic slowdown recessionary (two consecutive quarters of negative growth is just one rule-of-thumb) and partly because it takes awhile to accumulate enough data to analyze and declare a trend. So often the effects of a recession are felt long before it is formally announced.

However, this time the economic trouble feels like it runs much deeper; and the unease accompanying the acknowledgment of this trouble feels closer to panic. While caution is almost certainly wise at times like these (Why create panic if taking care with words can restore calm?), it is also true that, at every step of this current economic crisis, experts have erred on the side of minimizing the depth of the turn-down. With each new catastrophe, someone important was out in front of cameras declaring that the housing market was bottoming out and the economy was about to turn around. Each catastrophe was expected to be the last. Until the next catastrophe. The phrase “a river in Egypt” springs to mind.

Eventually, the public quit believing the experts. Soon the public ignored the experts entirely, believing instead that positive spin was all that was really available from such persons: the hard truth was to be found instead in the price of milk, the number of overdrafts in a personal checking account, a declining 401(k) balance marked with a red double-digit loss percentage. Let the experts spin until they puked: the truth is that when the money is gone a week before payday arrives, you don’t need an expert to explain that times are getting tough.

By the time Henry Paulson and a seemingly exhausted, sincerely frightened Ben Bernanke went before Congress (was it really only a couple weeks ago?) with their request for $700 billion right now and a prohibition on any oversight or prosecution, it seemed obvious to all that Wall Street’s unending font of optimism had very suddenly run dry. Wall Street seemed to learn what Main Street had known all year in the space of only a few days. How can that be? Lots of people were asking themselves this same question, all at the same time.

All of which brings me to the current situation and the grotesque chasm that seems to have opened up overnight to separate the folks on Wall Street from the folks on Main Street and to separate Main Street from its supposedly representative democracy. To paraphrase the famous line from Cool Hand Luke, what we have here is not just “…a failure to communicate,” but rather a total breakdown in trust.

So what are we looking at here? A recession similar to the recession of the early 90’s with a light at the end of an admittedly dark tunnel? Or are we instead, as New York Times op-ed columnist and economist Paul Krugman says, truly on “The Edge of the Abyss”?

If you ask Wall Street that question today, you may or may not get an answer that spins. There comes a time when all that is left for anyone to do is breathe and pray and cross their fingers.

If you ask Main Street this question today, you will probably get an earful.

It won’t be pretty.

Neither will the year ahead. Or the one after that. Let’s hope our new leadership has a strong spine and a better plan. We’ll all be needing both.



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Bear Stearns Collapse: Why It May Also Be the End for the SEC

By G.L.C., on October 13th, 2008

The Securities and Exchange Commission (SEC) was set up as a reaction to the stock market crash of 1929 to provide oversight of brokerage firms and protect investors. Last month, Morgan Stanley and Goldman Sachs Group, Inc., filed to become bank holding companies. Now with the sale of Bear Stearns, the bankruptcy of Lehman Brothers Holdings, Inc., and the sale of Merrill Lynch & Co. to Bank of America Corp., the SEC now has no large firms left to oversee.

A recent report by Inspector General David Kotz has concluded that the SEC missed numerous warning signs leading up to the shotgun sale of Bear Stearns Cos. Bear Stearns, one of the most aggressive investment banks, agreed to be sold to J.P. Morgan Chase & Co. According to the report, the SEC failed to require the investment bank to rein in its risk taking. It failed to carry out its mission in its oversight of Bear Stearns. Despite the SEC staff having identified in 2006 precisely the types of risks that evolved into the subprime crisis, the SEC did not exert influence over Bear Stearns to use this experience to add a meltdown of the subprime market to its risk scenarios. There are many who blame the present crisis on years of looser regulations that allowed Wall Street firms to take on greater risks without adequate oversight.

The report details how the SEC made no efforts to require Bear Stearns to reduce its debt or raise money, failed to take steps after identifying numerous shortcomings in Bear Stearns’ risk management of mortgages, and also missed opportunities to push Bear management to address the problems. The report criticized the SEC for allowing internal auditors at Bear Stearns, not external auditors who would presumably be more objective, to perform critical work in reviewing the firm’s risk management. The SEC also did not review Bears Stearns’ strategy for informing investors about its funding plans following the failure of two of its hedge funds in July 2007. The SEC took too long to review Bear Stearns’ 2006 annual report and seek more information from the firm, which would have resulted in Bear disclosing more information about its mortgage portfolio to investors.

The SEC maintains that the failure is a result of the SEC not having enough authority to effectively oversee the banks and that the SEC has already expressed its concerns to Congress. The SEC staff completed its review of Bear Stearns’ 2006 annual report after its collapse.

Another report found that the SEC conducted in-depth reviews for only six of the 146 brokerage firms registered with the agency. The failure to carry out the purpose and goals of the Broker-Dealer Risk Assessment program hinders the SEC’s ability to foresee or respond to weaknesses in the financial markets.

As lawmakers take a second look at financial oversight, these reports could be nails in the coffin for the SEC. The power of the SEC could be dispersed to other agencies, such as the Federal Reserve. These reports document the failure of the SEC to either make its oversight program work or seek authority from Congress so that it could work.



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