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

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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