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Report on Business Just in time for NAFTA talks, trade deficit figure shows how entwined Canadian, U.S. economies are

At a moment when Canadians are at peak-worry about the future of Canada-U.S. trade, the present has turned remarkably rosy.

Just hours before the top trade negotiators of Canada and the United States were due to sit down in a crucial round of negotiations on the North American free-trade agreement, Statistics Canada reported that Canada’s merchandise trade deficit in July shrank to a slim $114-million, the smallest in 19 months. Exports hit another record – their third in four months.

And who can Canada thank for its greatly improved trade balance? Why, the United States – whose leadership is pushing hard to extract a more favourable deal from Canada on trade. Canada’s merchandise trade surplus with its biggest trading partner hit $5.3-billion in July, the biggest in nearly a decade. Exports to the United States rose 3.3 per cent month over month, to a record $38.4-billion; on a year-over-year basis, exports were up nearly 16 per cent.

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Related: Trudeau accuses Trump of flouting trade rules

Canada’s trade balance with most of its other major trading partners deteriorated in the month. Exports to non-U.S. markets fell 6 per cent; Canada’s non-U.S. trade deficit widened to $5.5-billion from $4.8-billion. The near-elimination of Canada’s trade deficit in July was, then, almost entirely thanks to cross-border business with the United States.

Given that they are dealing with a U.S. administration that has long pointed to trade deficits as evidence of unfair trade relationships, this was probably not an ideal day for Canada’s trade team to show up for talks with these numbers hanging over the table. Still, the negotiators on both sides are well aware of what they truly indicate: How intrinsically tied the two economies are to one another.

The booming U.S. economy – second-quarter growth of 4.2 per cent annualized, the unquestioned growth engine among advanced economies – is the crucial fuel for Canada’s trade revival. If President Donald Trump deserves credit for the former – and he insists he does – then he has only himself to blame for the latter.

And despite Canada’s efforts to diversify its trade, its export success still largely hinges on the appetite of the U.S. economy for Canadian goods. Canada’s exporters, and its economy more broadly, have always thrived best in periods of strong U.S. growth. The current cycle is proving no exception.

Apparently, Canada's export fortunes also still depend heavily on oil prices – to the chagrin of anyone who had imagined Canada’s economy had put the driver of its previous cycle behind it. The value of Canada’s energy exports to the United States is up nearly 50 per cent from a year ago – accounting for a swing of about $3-billion in the monthly bilateral trade balance all by itself. In July, Canada’s overall energy exports hit their highest level in nearly four years, even though volumes declined, as crude flirted with its highest prices since the late-2014 oil crash. Excluding the energy segment, Canada’s exports were actually down for the month.

Statscan’s trade report also shed more light on the damage inflicted by the U.S.-imposed tariffs of 25 per cent on Canadian steel and 10 per cent on aluminum that began in June, as well as Canada’s subsequent retaliatory tariffs against a diverse basket of U.S. goods. Canadian steel shipments to the United States actually rebounded 16 per cent in July, but that recouped only part of their 36-per-cent plunge in June. Aluminum exports, which are subject to a smaller tariff than steel, slipped 2 per cent in the month, after dropping nearly 5 per cent in June. Meanwhile, U.S. steel imports into Canada, which were hit by a matching 25-per-cent retaliatory tariff, slumped nearly 40 per cent in their first month under the Canadian levies. Imports to Canada of a wide range of U.S. goods hit by a 10-per-cent Canadian retaliation fell by 23 per cent.

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These numbers highlight why the threat of an escalation in protectionist measures, especially if the NAFTA talks fail, continue to cast a conspicuous cloud over the Canada-U.S. two-way trade outlook from here. The damage from tariff wars can be swift and severe. But for now, the continued strong U.S. economy, and the resultant demand for Canadian goods, is the much stronger prevailing force influencing the Canadian economy.

Notably, the Bank of Canada said in its interest-rate decision on Wednesday that despite the continuing uncertainty surrounding trade policy, “the rotation of demand towards business investment and exports is proceeding.” Business investment has been growing along with trade, it noted, as the strong order flows from export customers have compelled companies to expand to meet the demand. If there’s a wall of worry for Canada’s goods producers, they’re getting over it – and it looks like they’ve been climbing on the shoulders of exports to do so.

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