Reflections of Canada by Dennis Jarvis

While the United States is fighting with extremely high debt and a downgraded rating and while the European Union is considering major changes in its financial system due to progressive debt crisis in the Eurozone, Canada seems to be a safe haven for investors. What is the secret behind Canada’s success? And what could threaten Canada’s economy in the future?

Recession: Over Faster Than Expected

Canada and the US has developed a trade relationship that is the closest and most extensive in the world. Comparing growth of their GDP, both countries are closely connected: when the GDP grows in the US, it also grows in Canada. So when the housing bubble burst in the US, economists were worried about Canada’s economy as well. Canadians didn’t avoid the crisis, but it really wasn’t devastating.

Canada’s GDP barely shrunk at all; Canada’s recession began in October 2008 and ended in July 2009. In the US, however, the recession lasted eighteen months. Moreover, Canada is the only industrialized country in the world to have survived the recent crisis years without any bank failures. But for what reason?

Banking system: Conservative and Safe

Some specialists consider Canada’s banking system to be boring. However, due to its conservative regulations, Canada escaped from the recession very quickly. Mark J. Perry, Professor of Finance and Business Economics, stated several advantages of Canadian banking, from its strict regulations and more common mortgage insurance to its concentrating on five major banks.

The truth is that the Canadian banking system is the soundest in the world. The World Economic Forum decided about that in September 2010 for the third consecutive year. When the economy can safely rely on a country’s banks, no crisis can be as devastating as the recent crisis in the US.

Natural Resources and China’s Investments: Canadian Pillars

Canada is a net exporter of energy and raw materials, agricultural products, energy, forestry, and mining products — which account for more than half of its total export. It ranks twelfth in the list of countries by export. Strengthening trade with commodities supported the Canadian dollar, and today, it’s worth about US $1.02. National producers had to become stronger and more efficient in fighting foreign traders. "If commodity prices fall and the loonie, as the currency is known, takes a tumble, Canadian producers of cars and machinery will gain competitiveness and should be able to expand their output,“ stated the Economists in the commentary.
China’s investments, e.g. Sinopec in Alberta also played a significant role in Canada’s recovery.

All That Glitters Is Not Gold

“In relative terms, Canada could hardly be positioned better,” says Finn Poschmann, an economist at the C.D. Howe Institute. However, there are worries about the economy’s prospects. Firstly, Canada is on the edge of a housing market collapse. That doesn’t mean that Canadians will have to face the same scramble as their American neighbours, though. Canada’s housing is now overvalued as prices have been rapidly growing for nearly a decade.

“Relative to disposable income per capita, our calculations suggest that housing is around 25 per cent overvalued, which is approaching the level of excess that the U.S. market reached at its peak in 2006,” said Capital Economics in their Canada Economic Outlook.

Personal income is very low compared to home prices, so at least a modest price correction is unavoidable. However, modest or rapid decrease may lead to short-term panic over stocks because investors will lose confidence in the loonie.

Secondly, Canada’s last economic statistics weren’t stellar. According to Statistics Canada, the country’s GDP fell by 0.1 per cent in the second quarter, largely caused by a 2.1 per cent decrease in exportation. This is the first time the economy has faced a decline since the second quarter of 2009. "The U.S. economy still managed to grow 1.0% in the second quarter, despite being arguably in much worse shape than Canada,“ noticed the Financial Post. Japan’s tsunami/earthquake and decreased US demand are probably the main reasons for the decline.

Thirdly, Canada still strongly depends on the rest of the world. “Canada is not an island,” said Jim Flaherty, finance minister. “We are a trading nation.” If the world is in trouble, Canada won’t be a miraculous exception.