Canadian economy nearing a self-inflicted death spiral thanks to declining loonie

Despite rampant talk of unemployment and the country’s trade deficit, unemployment levels are actually closer to the historical norm after years of steady job gains, and the trade deficit has hit $28 billion over the past six months.

A drought in California has doubled the price of water across the West, prompting concerns about future Canadian trade.

The soaring loonie has also made foreign-made goods more expensive, driving up Canadian inflation and hurting Canada’s competitiveness in the process.

But there is one startling change that economists haven’t been paying much attention to, that could end up putting Liberal Prime Minister Justin Trudeau in his own national employment agency.

Economists and experts consider Canada’s currency an important determinant of inflation, since about half of goods are produced outside the country and priced in Canadian dollars.

In an article titled “Biggest changes to Canadian housing prices since 2000-2004,” National Bank chief economist Stéfane Marion told Maclean’s magazine “The Canadian dollar’s movements reflect trends in inflation. If that inflation is contained and the dollar is stable, that inflation will continue to contribute to pressure on prices.”

Now that crude oil is on the decline, Canada’s dollar is down about 9 percent over the past month, to an average trading level of 72 U.S. cents on Friday. At that rate, Canada’s high household debt level would put increasing strain on consumers across the country.

The freefall in the loonie has one broad potential impact on this country: Increased debt burdens for Canadians. While personal debt levels have been climbing for more than a decade, with nominal figures up an astonishing 115 percent between 2011 and 2016, the debt burdens of the average Canadian were up 52 percent during that period. If Canadians are forced to take on additional debt to pay those debts back, or this country’s economy is negatively impacted by the dropping value of the loonie, pressure will be added on the Canadian government’s debt levels.

As recently as June, the Bank of Canada projected economic growth in the range of 2.5 percent this year and 1.8 percent next year. A year-over-year trade deficit of $28 billion through the second quarter is a headwind for Canada, and a significant interest rate hike by the Bank of Canada is out of the question.

More importantly, a major rate hike would effectively be inflationary, since it makes everything more expensive across the board and puts a big crimp on Canada’s growth and future prosperity. That would place pressure on the Trudeau government to slow their plans for a federal sales tax to help Canadians pay off their federal debt in full.

The loonie is indeed hurting Canada, as an 8.6 percent drop in GDP in the second quarter of this year meant an annualized contraction of 2.2 percent growth in the second quarter.

The loonie’s plunge will impact Canadians and their ability to pay back their family loans. That puts Trudeau’s plan to raise taxes to pay for his costly nationalized program struggles on hold.

As Trudeau’s stubborn adherence to his unbalanced budget eliminates the government’s ability to borrow in the short term, the Canadian economy struggles. If there is no extension on the U.S. market in the foreseeable future, a severe economic contraction would force the Canadian government to cut back on spending and less the number of civil servants. At least the governments of Richard Nixon and Ronald Reagan had the courage to cut back on spending.

As the summer holidays begin, our economy is taking another hard hit with inflation on the rise and weakening trade. Canada’s economy is precariously close to falling off a cliff. Trudeau will pay the price.

Jared Bernstein is vice president of research at the Center on Budget and Policy Priorities and formerly served as chief economist and chief economic adviser to Vice President Joe Biden. You can follow him on Twitter at @JaredBernstein or LinkedIn.

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