"When the U.S. sneezes, Canada catches cold." I don't know who came up with that expression, but it's been used pretty much every time that someone tries to connect bad U.S. economic news to Canada. A case in point is last Friday's U.S. labour market release.
The links between the U.S. and Canadian economies are certainly strong enough, but they are also widely misunderstood. For example, the notion that a U.S. recession is passed on to Canada by means of a reduction in our net exports is simply wrong.
About 30 per cent of Canadian output is exported, and roughly 75 per cent of exports go to the U.S., which means that some 20-25 per cent of Canadian GDP is exported to the United States. If U.S. demand for Canadian exports were proportional to U.S. income, a 1 per cent decline in U.S. GDP would show up as a 0.2-0.25 per cent decline in Canadian output. (See also here, where I estimate that everything else held constant, a 1 per cent decline in U.S. GDP produces a 0.3 per cent decline in Canadian GDP).
But of course, everything else isn't held constant when the U.S. goes into recession. For reasons that are not immediately obvious to me, the forex market's response to a U.S. recession is to produce an appreciation in the U.S. dollar against ours. The resulting depreciation in the Canadian dollar has the effect of increasing net exports. In each of the last three recessions, net exports have provided a positive contribution to Canadian GDP growth.
Canada's problem in the most recent recession wasn't a fall in net export volumes; it was a fall in the prices we received for our exports, especially in the prices of oil and other commodities. The driving force behind our recessions is the decline in expenditures of investment and -- to a lesser extent -- a fall in consumer spending.
Last Friday's disappointing U.S. jobs report is by no means good news for Canada. But the downside risk takes the form of lower prices for oil and other commodities, not a reduction in net export volumes.
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