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 deadlinefor approving the U.S. debt ceiling.

"If it's short and sweet, it's not going to have much impact on Canada," saidAvery Shenfeld, chief economist at CIBC Capital Markets. "A week or two ofoperatingthe government at slightlyreducedlevelofactivitydoesn'thavealotofspilloverto Canadabecausebigcapitalprojectsthat were contractedearlier will still continue.

"This is mostly about governmentoperatingspending, whichwouldn'thave a lot of Canadian contentin 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'dbe knocking a decimal place off the Canadian growth rate for the fourth quarter," he said. "So,if youwere projecting growth of 2.2 per cent, it might be 2.1. Theimpactof two-week shutdownwouldbe lost in the decimal places of measuring CanadianGDP."

RBC has estimated that a month-long shutdown would reduce Canada's GDP in thefourth quarter by 0.25percent.

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 theNasdaq 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 guessthey had their little fit ahead of the shutdown," said BenjaminReitzes, senior economist atBMOCapital Markets, in an interview with CBCNews.ca.

"Equities are higher, gold islower,oil is lower. Peoplejustaren'tall thatconcernedabout theshutdownhaving asignificant negativeimpacton the economy at thispoint."

The Canadian dollar was at0.9681 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 hadexpanded at the fastest pace since April 2011, whichstrengthened the U.S. dollar.

That, says Reitzes, shows thatthe 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 willcause the U.S. Federal Reserve to delay its phasingout of economic stimulus measures.

The debt ceiling requiresthe U.S. government to essentially slash $600 billion US of its annual spending if theycan'tapprove an increase.That's four per cent of U.S.GDP, which is enough to throw the U.S.economy intorecession. Avery Shenfeld, chief economist atCIBC

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

"The debt ceiling requiresthe U.S. government to essentially slash $600 billion US of its annual spending if theycan'tapprove an increase," Shenfeld said. "That's four per cent of U.S.GDP, which is enough to throw the U.S.economy intorecession."

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. Itmight have to missinterest 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 essentiallybe in default.

"The ramifications from a global perspective are unknown; it's not a road anyonewants to go down," Reitzessaid.

Default unlikely

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

"In Canada, there is noequivalent," said Shenfeld. "When we passa budgetthat hasspending and tax rates in it, the approval for theborrowingthat'srequired goes along with it.

"The U.S.political systemlikes to have the opportunity to vote toapprovespending but then vote toopposetheincrease inborrowing that that spending necessitates, sothere'sno logic to thiswhatsoever."

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 andmove money to "safe" securities such as Canadian debt, for example.

"At thispoint, since no oneactuallybelievesthe U.S. governmentisgoingtodefault on itsdebt,thereisn't a madrushto the exits from U.S.assetsto a safe havenlike Canada," Shenfeld said. "And even if wecross thatbridge into adebt ceilingissue, therewouldalso be worriesabout how the Canadian economywouldbe impacted. It's notclearwe'd be the preferred safe haven."

Some businesses already worried

Ultimately, saidReitzes, the way to gauge theeffect 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., thegreater will be the spillover effect in Canada.

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

"That just leaves the domesticeconomyon itsown, andhousehold debt levels are at a record high, housing islikely flat to slowing andgovernmentsareconsolidating, so thatsuggeststhat growth will remain middling, aswe'veseen for the past year or so."

Many Canadian businesses are acutely aware of Canada's reliance on the U.S. and are alreadyworried 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 BobDolyniuk, executive director of theManitoba Trucking Association, in an interview with CBC's Karen Pauls. "Trade between Canada and the U.S. is in the billions of dollarsa 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 ."