It was one of those rare coincidences which cause the view to completely change. The same week in early November that the loonie hit a record high of US$1.10, Canada reported a record quarterly drop in its trade surplus — it fell by more than a third to $10.7-billion in the third quarter ended Sept. 30.
Um… is it a coincidence if one event is the cause of the other, or is it a consequence? If it was entirely forseeable that the rise in the Canadian dollar would lead to lower exports, how could it be a coincidence? The only coincidence seems to be the actual timing of the announcement of the trade surplus, and even that seems tenuous, given that these two events happened not on the same day, but rather “in the same week.” If it’s a coincidence, it’s hardly a rare one — more at the level of running into someone you know at a subway station near where they work.
Canadian economists are, understandably, occupied by examining whether the Canadian economy can veer off onto its own path if the US really goes south. TD Bank published an interesting paper on decoupling, concluding that the Canadian economy can and may partially decouple from the US in the event of ongoing weakness there, thanks to our natural bounty:
if commodity prices continued to boom, this would make
the case for strength in the resources sector – offset par-
tially by a presumable depreciation in the U.S. dollar and a
proportionate appreciation in the Canadian dollar.
But beyond the reliably myopic Canadian landscape, both British and American economists are raising serious questions about the ability of any country to decouple from the US. Why?
Well, all decoupling theories are based on the idea that strong exports from Europe, Canada, and other Western nations will flow unimpeded to China, whose appetite for raw materials is insatiable.
However, that appetite is fuelled by factories producing goods to export to, you guessed it, the United States.
Melvyn Krauss of the Hoover Institution wrote a piece on decoupling for the Japan Times. Replace “euro” with “loonie”, and he could be writing about Canada:
As a consequence, the euro is rising not only against the dollar, but also against Asian currencies, whose central banks intervene in foreign exchange markets to fix their currencies’ value against the dollar.
This damages European exports to both the U.S. and Asia.
Reduced European dependence on the U.S. export market can hardly protect Europe from the effects of the U.S. economic slowdown if the euro appreciates as much against the key Asian currencies as it has against the dollar.
The decoupling argument also assumes that recession in America has no effect on Asia. This is nonsense. Asian income certainly will decline if Asians export less to the U.S. — and this, in turn, will reduce Asian imports from Europe.
And before you get excited about the emerging Chinese middle class and domestic demand, bearish economist Nouriel Roubini dampens those hopes:
Some argue that, while a US hard landing may hurt China and Asian economies, there is wide room for domestic demand and non-US demand to maintain the growth of Asia. But this is another myth that has little basis. The role of domestic demand in China’s growth is very modest. You have an economy where exports are 40% of GDP; where investment is 50% of GDP and, leaving aside housing investment, most of such investment is directed towards the productions of more exportable goods; where the current account surplus has gone from $20b in 2002 (2% of GDP) to an expected $300 billion plus this year (12% of GDP). China and Asia strongly depend on trade and on trade to the US.
The strongest argument against decoupling, however, comes from the Chinese government itself:
A global economic slowdown stemming from problems in the US subprime mortgage market and the resulting credit squeeze “will be the biggest challenge to China’s economy next year”, a report from the ministry’s policy research department said.
I’m starting to feel a cold coming on.