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Sat, 05 Jan 2013 18:15:00 GMT | By Deirdre McMurdy, MSN Money

Why America’s fiscal pain is our pain too

Canada’s leverage to the American economy – and politics – casts a shadow over the next year.

Deirdre McMurdy

As any close neighbour would, Canada has been watching events unfold next door with especially rapt attention in recent weeks. After all, you need to know if it’s still going to be possible to borrow a cup of sugar in a pinch – or if your neighbour is about to go hurtling over a fiscal cliff.

At the last minute, the U.S. did manage to avert immediate ruin, but it only deferred a big part of the pain. Income taxes have been frozen for 98 per cent of the U.S. population – and they’ve increased for the so-called one per cent.

But spending cuts, not so much. The tough decisions on $110 billion worth of cuts have only been pushed off, forcing Congress to somehow agree on a new debt ceiling in the future.

Based on the last minute grappling over the same issue in August 2011, when lifting the debt ceiling became a political bargaining tool – and created the fiscal cliff scenario – it’s not terribly reassuring.

As it now stands, in about two months, the U.S. Treasury will have to suspend new bond issues and stop paying some bills.

For businesses – and capital markets – that means more prolonged uncertainty. And for America’s business partners and neighbours, it means certainty of the worst possible sort: there’s more political brinksmanship and recriminations ahead.

For Canada, which does $1.6 billion a day in cross-border trade with the U.S. and has a complex agenda of shared issues, the impact on economic growth is a concern.

Specifically, the failure to extend the payroll tax holiday – and its consequent rise from 4.2 per cent to 6.2 per cent – adds about $1,000 a year to the financial burden of average American families – which has an immediate impact on the consumer spending required to propel the economy forward. That alone is expected to shave as much as 0.6 per cent off the U.S. GDP in 2013.

Given Canada’s ongoing leverage to U.S. demand, it’s not a terribly promising scenario. Already, a softer economy there has taken a toll on commodity exports.

But even more worrisome for Canada is the political disarray. It’s going to be tougher than ever to deal with a continental partner that is so deeply fractured along partisan lines. That’ll have a bearing on everything from trade policy to environmental standards.

Without question, what divides Americans has become more important than what unites them. Within the Republican party, for example, there is a fissure between the pragmatic northeastern conservatives, like New Jersey governor Chris Christie, and the hardcore right-wing Tea Party members who are based further south.

Given that the Republicans control the House of Representatives, politics is impeding progress. And that’s a problem – to say the least.

Certainly for Canada, the fact that the U.S. is turned so resolutely inward means any issues on our agenda will get short shrift – and it’s typically a pretty significant agenda.

(It’s worth noting that another issue that is turning the U.S. inward is the looming debate over another long-deferred political issue: gun control.)

Right now, for example, the issue of market access for oil and gas exports is a huge issue. And there’s not much chance that the proposed $7.6 billion Keystone XL pipeline from Canada to the U.S. will even get considered at this point.

Another cross-border concern is that the hard-fought Softwood Lumber Agreement expires in 2015. Given the history and the complexity of this long-standing trade issue, it needs plenty of advance work on both sides. And two years passes quickly when two bureaucracies are involved.

The creping protectionism of Buy America clauses is another flashpoint. If the U.S. economy remains soft and jobs continue to erode, it’s a mindset that gains grassroots popularity. And punishes trade partners like Canada.

Although Canada and the U.S. signed a new perimeter security and trade agreement a year ago, it needs further work to achieve its full impact.

Canada’s burgeoning trade relationship with China is another potentially contentious issue that requires good will and proactive engagement between Ottawa and Washington. The Northern Gateway pipeline, for example, is specifically engineered to bring Canadian energy to Asian (and more particularly Chinese) markets. Relations between China and the U.S., meanwhile, are anything but warm these days.

It may take another two months for the full extent of the problem to be delineated – something that stock markets have chosen to downplay in recent, boisterous trading sessions. But without question, the challenges facing Americans will be Canada’s challenges as well.

After all, you can change your friends, but you can’t change your neighbours. Or avoid their politics.

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