PIIGS’ Impact on Canada

This blog is unashamedly Canadian in content; if it doesn’t relate to Canada I’m not interested, there are so many blogs that have a U.S. or European slant this one is about Canada.  First and foremost, very little of Canada’s trade takes place with Europe, China and the U.K. are more important partners (I know UK is part of Europe…).  What would be the impact of a EMU failure on Canada?

Some of my colleagues tell me I’m a pessimist; I think I’m a realist.  What are the odds that Greece (the "G" in the PIIGS) will be able to reduce government spending in a meaningful way without creating a domestic depression and a change in government?  History shows that when outside forces coerce a government to reduce expenditure -- think of Germany in the 1920 bad things can happen.  According to some analyst it would take 30 years of austerity to reduce government debt to 60% of GDP. 

Two possible outcomes: 

(1) Germany relents and the EU agrees to provide Greece with Euro 45 billion (with IMF).  Rates collapse (currently 2 year Greek debt sells at 13%), and things go back to normal until the next crisis

(2)    Germany because of the regional election on May 9^th cannot reach an agreement to participate in the rescue, and Greece leaves the EMU.  Immediate impact Greek banks face near collapse, bond face value drops from their current 65% -- 75% to 30%.  The Drachma is revived.

What is the impact of this on Canada?  In 2009, merchandise trade with the Eurozone was nearly flat (small deficit for Canada), and services are also near flat, but a dramatic reduction on the value of certain European currencies would have a small impact on the balance of payment for Canada. 

If the PIIGS are forced to leave the EMU the consequences are important for trading nations in general – the impact on China (which exports large amounts to Europe would be important, this would lead to knock on effect on China’s suppliers).  In fact the risk is that the “collapse” of the EMU would be drop which makes the vase overflow.  The Chinese stock market (down 15% this year) is already taking notice of the European crisis.  

The impact on Canada would therefore be a “first derivative” event, we would be affected by changes to other trading nations reduction in merchandise trade with the Eurozone.  It follows that the natural resource ride of the past 2 years would end, prices for oil, gas, copper, aluminum, steel etc would drop.  Canada, as a major exporter of these goods (in total 40% of Canada’s GDP) would feel the impact, the Canadian dollar would drop and imported inflation would rise – the risk therefore for Canada is STAGFLATION!  Where both price rise and economic activity declines -- the worse outcome for Canadian and the Bank of Canada.  Is this the only outcome?  Not really it is possible that emerging market continue to grow but were the "First world" takes a smaller and smaller portion of the cake. OPEC nations may decide to reduce production quotas to maintain their $85 per barrel price target... then the Canadian economy is spared the worse because  Canada is now a Petrol nation.