U.S. debt ceiling, not shutdown, a bigger worry for Canada

The U.S. government shutdown dominated headlines on both sides of the border Tuesday, but economists say there is little chance of the shutdown harming the Canadian economy unless it drags on past the October deadline for approving the U.S. debt ceiling.

"If it's short and sweet, it's not going to have much impact on Canada," said Avery Shenfeld, chief economist at CIBC Capital Markets. "A week or two of operating the government at slightly reduced level of activity doesn't have a lot of spillover to Canada because big capital projects that were contracted earlier will still continue.

"This is mostly about government operating spending, which wouldn't have a lot of Canadian content in it."

Some businesses that supply items to U.S. government departments or rely on the civil service to have permits or visa applications approved might be slightly affected, but generally, the effect of even two weeks of a government shutdown would barely show up in Canada's economic indicators, Shenfeld said.

"Roughly speaking, you'd be knocking a decimal place off the Canadian growth rate for the fourth quarter," he said. "So, if you were projecting growth of 2.2 per cent, it might be 2.1. The impact of two-week shutdown would be lost in the decimal places of measuring Canadian GDP."

RBC has estimated that a month-long shutdown would reduce Canada's GDP in the fourth quarter by 0.25 per cent.

Markets not panicking

The movement of stock markets on both sides of the border on Tuesday backed up the sense that the shutdown is nothing to worry about — for now.

The Toronto Stock Exchange composite index, the Dow Jones industrial index, the S&P 500 and the Nasdaq were all up slightly, as were the European markets, and there was little sign of panic or flight to safe investments such as gold and oil.

"The markets are calm today. I guess they had their little fit ahead of the shutdown," said Benjamin Reitzes, senior economist at BMO Capital Markets, in an interview with CBCNews.ca.

"Equities are higher, gold is lower, oil is lower. People just aren't all that concerned about the shutdown having a significant negative impact on the economy at this point."

The Canadian dollar was at 0.9681 cents US by late afternoon, down 0.18 per cent, mainly in reaction to positive news out of the U.S. that showed that in September, manufacturing had expanded at the fastest pace since April 2011, which strengthened the U.S. dollar.

That, says Reitzes, shows that the government shutdown is not yet enough of a disruptive force to weaken the U.S. dollar in the face of more positive economic indicators.

Could delay stimulus rollback

The outlook could change if the shutdown continues and investors begin to suspect that it will cause the U.S. Federal Reserve to delay its phasing out of economic stimulus measures.

The debt ceiling requires the U.S. government to essentially slash $600 billion US of its annual spending if they can't approve an increase. That's four per cent of U.S. GDP, which is enough to throw the U.S. economy into recession.— Avery Shenfeld, chief economist at CIBC

The real economic impact, however, will start to be felt only if the shutdown continues past the Oct. 17 deadline for the U.S. Congress to approve a higher limit on the amount of national debt that can be issued by the U.S. Treasury so that the government can meet its financial obligations.

"The debt ceiling requires the U.S. government to essentially slash $600 billion US of its annual spending if they can't approve an increase," Shenfeld said. "That's four per cent of U.S. GDP, which is enough to throw the U.S. economy into recession."

The U.S. has some large payments to make in November, Shenfeld said, and if the new debt limit is not approved, no one knows which of those payments it would default on first. It might have to miss interest payments on loans, or fail to pay social security or default on U.S. Treasury securities, which, in Reitzes' words, are the "gold standard collateral for banks" and would mean that a large part of banks' assets would also essentially be in default.

"The ramifications from a global perspective are unknown; it's not a road anyone wants to go down," Reitzes said.

Default unlikely

The debt ceiling battle is a uniquely American tradition that in recent years has become increasingly politicized.

"In Canada, there is no equivalent," said Shenfeld. "When we pass a budget that has spending and tax rates in it, the approval for the borrowing that's required goes along with it.

"The U.S. political system likes to have the opportunity to vote to approve spending but then vote to oppose the increase in borrowing that that spending necessitates, so there's no logic to this whatsoever."

Fortunately, most economists agree that it is highly unlikely that the U.S. Congress won't approve the debt ceiling, which is why there is no urgency to flee the U.S. market — and move money to "safe" securities such as Canadian debt, for example.

"At this point, since no one actually believes the U.S. government is going to default on its debt, there isn't a mad rush to the exits from U.S. assets to a safe haven like Canada," Shenfeld said. "And even if we cross that bridge into a debt ceiling issue, there would also be worries about how the Canadian economy would be impacted. It's not clear we'd be the preferred safe haven."

Some businesses already worried

Ultimately, said Reitzes, the way to gauge the effect of the shutdown here is to remember that Canada's economic fortunes are tied to those of the U.S.: the greater the impact the shutdown has in the U.S., the greater will be the spillover effect in Canada.

"Our Canadian forecast for next year and the latter part of this year is driven in part by a firming U.S. economy, and if we don't get that, then you'll see exports won't be as strong as we have in our forecast, and investment likely won't be as strong either," he said.

"That just leaves the domestic economy on its own, and household debt levels are at a record high, housing is likely flat to slowing and governments are consolidating, so that suggests that growth will remain middling, as we've seen for the past year or so."

Many Canadian businesses are acutely aware of Canada's reliance on the U.S. and are already worried about the potential effect on their industries. Truck drivers who transport goods across the border expressed some concern Tuesday that even though border staff are not among the government workers who are off the job, there may be a reluctance to pay overtime during the shutdown, which could clog up border crossings.

"Our concerns would be getting our freight across the border," said Bob Dolyniuk, executive director of the Manitoba Trucking Association, in an interview with CBC's Karen Pauls. "Trade between Canada and the U.S. is in the billions of dollars a year, and stopping the trade between the two countries would have a huge impact not only on Canada's GDP but the U.S. GDP.

"If they are creating backlog because of lack of overtime for the officers, that backlog will continue to increase to a point where you will have gridlock at the border. We've seen it in the past when we have had slowdown ."