August 15, 2011


Title: European debt concerns create uncertainly in Canada

Sub-title: Businesses and investors tend to hold back when they are not sure about how things will unfold.


Just as the world was starting to breathe easier after Congress agreed to raise the US debt ceiling ending a multi-week crisis earlier this month, new worries are now emerging on the other side of the pond.


Last week the European Central Bank was forced to put out another fire initiating the purchase of Spanish and Italian bonds, to stop the continent’s sovereign debt crisis from spreading. The move came on the heels of difficulties in Ireland, Malta, Portugal and Greece.


In many ways European troubles are more worrying than those of other debtor nations says one expert. “In the case of Greece, one could argue that its euro debt is more akin to foreign currency debt,” explains Avery Shenfeld, an economist with CIBC WorldMarkets, in a recent note to clients. “It lacks a central bank that can buy the government debt in exchange for printed money.”


Shenfeld has a point. In fact governments (like Canada’s in the 1980s and early 1990s) spend and borrow their way into trouble all the time. However in a pinch, those with their own currencies, like the United States, can just print up a few truckloads of cash to pay it off – though they may have to put up with some inflation as a result.


In short, European countries’ lack of options is making investors in Canada and around the world nervous. That uncertainty can be particularly toxic, because if investors can’t get a read on the future, they stop putting g up money for new projects. That means job creations slows, and if the situation persists, economies slide into recession.


Uncertainty reigns

As a result, the most immediate consequence of the European debt crisis in Canada is the uncertainly it poses. That’s particularly true with respect to the contagion effect that a default might spread throughout the financial system. Canadian financial institutions are not required to release detailed lists of their assets, so nobody really knows how much money European countries owe them.


Just as puzzling though may be Canadian companies’ exposure to counterparty risks. For example, even if our banks don’t lose money on European defaults, if those defaults end up bankrupting other financial institutions that owe money to Canadian banks, and they can’t pay, then that could our financial system at risk. 


One positive though is that Europe is a far smaller trading partner for Canada than the United States. As a result, any damage caused by sovereign debt issues to the European economy would likely hurt Canada far less than troubles with our southern neighbour would.


But there too, the situation is more complicated than it might appear at first glance. Because Europe is a major US trading partner, and if a recession in Europe hurt the United States, then it would eventually roll over and hurt us too.


US debt crisis

A good way to assess the sort of dilemma facing stakeholders in the Canadian economy is to look at the advice that Craig Alexander, chief economist at TD Economics, gave its clients in the weeks leading up to the US debt ceiling negotiations. In a paper released in late July, Alexander outlined four possible scenarios ranging from the debt ceiling being raised, to the crisis forcing the US Treasury into technical default.


“Depending on the outcome of the debate, the impact on Canada could range from a hiccup to one in which we are thrown back into a recession that could have a global reach,” concluded Alexander.


Yet while Alexander outlined four possible US scenarios, the possible courses of events in Europe, that includes the 17 countries that use the euro or the more than two dozen that are in the European Union, are nearly endless. 


True, Canada has a lot going for it right now. Our unemployment rate is far lower than that of our southern neighbour, our economy is growing at a good clip, our banks are in good shape as is our housing market. 


That said, how sure can we be that this will all continue?



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