July 18, 2011
During my time as a Commerce student, I never really thought it was possible that the US would default on its debt. After all, US T-Bills usually set the benchmark for interest rates worldwide and carry less risk than any other security in existence. And one of the Finance professors claimed that if the US ever defaulted on its debt it would mean “The end of capitalism as we know it.”
While this phrase sounds slightly hyperbolic — it isn’t by much. And when I first heard that the US was struggling to agree on the terms of raising the debt ceiling, I thought it would be resolved in more than enough time to have it passed before the deadline. It’s looking a bit grim at this point, though.
I’m still holding out hope that Congress will come to an agreement before the early August deadline because crashing markets still scare the *#%$ out of Americans, but Tea Party Republicans are definitely holding up the process of negotiations.
Obama and the Democrats wanted to reform the budget to include both tax hikes and reducing spending, but the Republicans are having none of it. Essentially, as a friend put it over brunch on the weekend, “It’s one of the most important game of chicken ever played.”
So what does it matter to Canadians if the US defaults on its debt? Well, in short, it matters a lot. If the US defaulted, then their debt would no longer be an attractive investment and money would flood out of the country and send the US dollar plunging. This would take the US economy with it. Since the US is our single-largest importer, representing about 70% of our export market, that would mean pretty bad things for Canada too. Our goods would also be relatively more expensive as their dollar would be a lot lower which would further discourage them from purchasing Canadian goods. This could, in turn, mean bad things for the housing market as Canadians have less to spend on homes.
In other parts of the world, the European debt crisis isn’t looking good either. Canadian banks could suffer immensely from any falter in the traditionally un-risky countries (i.e. Britain, France, and Germany). But we could still be impacted by their less-than-stable brethren.
According to the Globe and Mail:
…[I]f countries such as Greece or Portugal default, the euro area might start to come apart. That could trigger a broad credit freeze up, well beyond Europe, as countries sort out who owes what and in which currency. There would be panic as investors flee to safe havens and safer currencies.
Mark Carney has an opportunity to raise interest rates tomorrow. But the general consensus is that there’s no way that he will — too much uncertainty. That’s the nature of a truly interconnected, worldwide economy. The entire world is subjected to the fiscal mismanagement of other countries. Ahh well, hopefully the game of chicken will end soon enough and Canada will get through the crisis unscathed, but it’s definitely something to check out over your morning coffee.