A strong currency and global slowdown are choking Canada's trade-dependent economy.
The merchandise trade deficit swelled in July to $2.3-billion, the largest since Statistics Canada began tracking the data in 1971, driven wider by sharp declines in virtually all of the country's major exports.
"This is about as bad as it gets for Canadian exporters," Bank of Nova Scotia economist Derek Holt warned.
Exports are a key driver of Canada's economy. In an annual report Tuesday, the Department of Foreign Affairs and International Trade portrayed trade as the lifeblood of the economy, accounting for one in five jobs and 63 per cent of gross domestic product. Last year, exports of goods and services climbed 11.8 per cent to a record, helping to narrow Canada's current account deficit, the broadest measure of trade and investment flows.
But in recent months, exporters have been slammed by the powerful combination of the strong dollar – now above par with the U.S. currency – and weaker prices for some commodities.
Particularly worrying is the fact that both the value and volume of exports and imports are falling simultaneously, suggesting global economic weakness is now seeping deep into the Canadian economy.
"It's never encouraging to see a deteriorating trade balance, but it's really bad news when the weakening is sparked by falling two-way trade," said economist Emanuella Enenajor of CIBC World Markets.
The weak trade performance could knock as much as a full percentage point off economic growth in the third quarter, BMO Nesbitt Burns chief economist Douglas Porter said.
"This is not a flash in the pan," he said. "We're going to be saddled with weak trade for a while."
Exports of energy, autos, agricultural products, forest products and machinery and equipment all declined in July, compared with June. The overall drop was 3.4 per cent, paced by an even larger 5-per-cent decline in exports to the United States, Canada's largest customer.
And despite the strong dollar, which has risen even higher since July, Canadian shoppers and businesses are consuming and importing less. Imports fell 2.2 per cent in July.
The high dollar allows Canadian businesses to buy foreign-made equipment more cheaply. But with the global economy slowing, businesses are increasingly leery of investing. And heavily indebted consumers are increasingly tapped out.
CIBC's Ms. Enenajor worries that Canadian businesses aren't taking advantage of the high dollar to invest in productivity-enhancing equipment and machinery.
She said there's no guarantee the dollar will stay this high for long. She pointed out that foreign capital has been flooding into the Canadian dollar in the face of uncertainty in much of the rest of the world. With Canada running a large current account deficit, foreigners could quickly repatriate those funds in the face of a sudden shock, such as a sharp drop in the price of oil.
"That's a fickle flow, a risky flow, that might at any moment reverse itself if foreign investors take that capital back home," she said.
At $2.3-billion, the trade deficit narrowly eclipsed the old mark, set in September of 2010. The gap has grown steadily in each of the last four months. Until the 2008 recession, Canada had generally been running large surpluses. Since then, it has been running more monthly deficits than surpluses.
The largest contributor to the drop in July exports was energy, where exports fell 8.5 per cent, in part due to several refinery shutdowns and other production disruptions. On the import side, crude oil imports were roughly unchanged, but coal and refined products fell sharply.
Nonetheless, economists expect energy and auto exports to fare better in future months, but not likely enough to erase the trade gap. In spite of a 5.3 per cent drop in auto exports from June to July, the industry continues to do relatively well over the longer haul. Auto exports are up more than 21 per cent since July of last year.