Canada’s growing trade deficit; an early warning system?

Is the drop in Canadian export an early sign of a big slowdown in American consumer demand (PCE), and is the U.S. economy slipping back into recession (or very low positive growth) and will set the stage for additional quantitative easing?

Statistics Canada released revised current account data for Q1/2010 and new data for Q2/2010.  The results conform to Canada’s continued economic health (at least in the first half of 2010), and the continued weakness abroad.  The "bright lights" in the numbers revolved around equipment & machinery import – which speaks volume about future potential increase in labor productivity (although since manufacturing is only 25% of GDP…the overall impact on labor productivity will be limited).  

 

Source: StatsCan

It would seem that foreign investors have finally quenched their appetite for Canadian assets.  There appears to be a marked slow down in investment: of course this data predate the offer by BHP to acquire the assets of Potash Corp.  On an amusing note most Canadian newspapers highlighted the fact that Canadian direct investment abroad rose to $9.7 billion in the second quarter.  But didn’t make much hay over the fact that although this is higher than 2009, it is still below the level achieved in 1996 – an indication that Canadian investors still see Canada as their primary target of investment, following a net repatriation of funds in the first quarter.

There is a sense that the international investment community has enough of “All things Canadian” which is a good think, because the inflow was becoming unsustainable, account for nearly 6% of GDP over the past 9 months.

 

Source: StatsCan

Some Canadian economist (BMO I’m looking at you) take the view that Canada has benefited mightily from foreign stimulus:  "The peak impact that the stimulus-fuelled rebound in global growth has had on demand for Canadian products is beginning to fade, leaving in its wake a more subdued, but ultimately more sustainable, growth rate of exports."  Personally, I suspect that the “transfer” from the US to Canada has been minimal (except in the energy area).  More troubling for Canada is if we assume a return to historical norm for U.S. consumption of 64% of GDP (compare to around 53% in Asia) instead of today’s 70%, the U.S. consumption will be much lower going forward.  That could have a tremendous impact on Canada – especially with regards to vehicles.  

 

This is where reality gets interesting:  In Q2/2010, PCE amounted to $9.3 trillion (down by 15% from its 2007 peak) out of a $13.2 trillion economy (70% on the nose).  Should the US return to a 64% level of consumption to GDP either:

(a)        Consumption has to fall a further $802 billion (6% further drop), or

(b)               GDP has to rise by 9%, while consumption remains unchanged – in other words exports need to rise.  

However, exports account for 12% of GDP – or $1.6 trillion, which would mean that US exports would have to rise 48% -- that’s a big hill to climb.  The long term impact on Canada’s must therefore be negative, first as America’s largest trading partner (with an appreciating currency).

In these condition is becomes more difficult to be bullish about Canada’s economic prospect.  In a sense, Canadian industry heavy capital investment may well translate into a productivity increase that will reduce the impact of a strong currency, but there is little doubt that 2011 will be a challenging year for Canada.

We projected 3.2% GDP growth for 2010 – consensus is apparently for 3.5%, but our view of 2011 has worsened from 3.2% to only 2.5%.  Depending on what happens to our American neighbors.

P.S.  Reviewing my post of last week, it seems that I am far more bearish than I was just 5 days ago.  I must note that I made an error in my model (changed a protected cell) making the correction to this error has increased the numbers back to the same levels as last week, but GDP growth may well be at 2.5% in 2011 (new figure) from the 3.2% level (I should have shown before)