Thesis on "Financial Crisis on Canada"

Thesis 15 pages (4978 words) Sources: 11 Style: MLA

[EXCERPT] . . . .

Financial Crisis in Canada

Canada is the world's 9th largest economy according to the World Bank

The economy is diverse, encompassing a highly-developed service sector, strong technology, abundant natural resources and a well-developed manufacturing sector. Due to the importance of energy exports to the economy, the Canadian dollar is sometimes considered to be a petrocurrency and trade in the C$ is highly correlated with the price of crude oil and natural gas

Canada went into the financial crisis with an eleven-year string of balanced budgets to its credit. However, at the outset of the financial crisis the economy began to weaken

That said, the impacts of the crisis have been different for Canada than for the United States, in part due to its position as an energy exporter. The responses to the crisis have been different, too, a combination of the different impacts, different ideologies and a different governmental structure. This paper will examine the impacts of the global financial crisis on Canada, and outline the Canadian government's response to the crisis.

Affects of the Global Financial Crisis

In general, the financial crisis has not had as significant an impact on Canada as it has on most other industrialized nations. To illustrate, one needs only to look at the country's financial sector. The Canadian banking business has traditionally been structured quite differently from that of the United States. While the American banking system was deliberately set up to be decentralized, while Canada's highly-centralized banking system has traditionally worked in partnership with the federal government to stimulate economic growth. The protected market has allowed Canada's banks to grow -- they now occupy four of the top ten spots on the list of largest North American banks

As American and European banks were collapsing and/or receiving bailouts last fall, Canada's banking system was ranked as the most sound in the world, completely solvent with health balance sheets

. The Canadian banking systems received government not because they needed it to maintain liquidity, but to level the playing field against foreign banks that were essentially backed by the fiscal strength of their governments

Canadian banks were well-insulated from the credit crunch for a number of reasons. For one, they are better capitalized. Canada's banks have an average capitalization ratio of 9.8% (much higher than the 7% mandated by law). This compares with 4% for American investment banks and 3.3% for European commercial banks

. As a result, Canadian banks have been able to withstand losses on mortgage-backed securities without compromising their solvency. The structure of the industry has protected investment banks as well. Whereas U.S. investment banks operate with little supervision, many of Canada's investment banks are owned by the big commercial banks, meaning that they come under the tight regulatory control of the Bank Act.

These regulations include a variety of provisions that have resulted in a stable financial system. Regulations have not been loosened in Canada to the same degree that they have been in the U.S. And Europe. As a result, Canadian banks are not as highly leveraged as banks elsewhere. Other regulations limit unbridled expansion as well. In the U.S., mortgage interest is tax deductible, which encourages overconsumption of housing stock

. In Canada, mortgage interest is not tax deductible, thus the housing bubble was not as severe.

The strength of the financial sector should not be taken as a rousing applause of Canada's ability to weather the economic storm. It does, however, provide a measure of stability in the economy. This is essential, because Canada's economy has always been heavily dependent on exports. Today, the majority of these exports go to the United States. In 2008, Canada sent $335 billion worth of goods and services to the U.S.

Major exports include energy (oil, natural gas, hydroelectric power) and manufactured goods. Ontario, for example, is the largest producer of automobiles in North America, with most of that production heading back south of the border.

Therefore, any downturn in the United States economy will inevitably have an impact on the Canadian economy. In the past year, the Canadian GDP has dropped 2.4%

. The American GDP actually improved 1.1% for 2008

. Exports in the previous year for Canada dropped 16.8%. This drop in exports relates directly to the weakness in the U.S. economy. This has led to a significant downturn in Canada's manufacturing sector, which dropped 14.5% in the last year. Unfilled orders increased 14.2%, indicating that customers were not following through on the purchases they had tentatively made. This drives up inventory levels, and spurs a reduction in production.

As a result of loss of production, the manufacturing sector has seen significant job loss. In January of 2009, the sector lost 101,000 jobs, out of a total of 129,000 lost in the Canadian economy overall. This monthly total was larger than any monthly total in the previous two recessions

. The national unemployment rate has thus increased to 7.2%, compared with 7.6% in the United States at the time. The deterioration of jobs in manufacturing was not offset by increases in other parts of the economy. Including the January figures, the Canadian economy had lost 213,000 jobs since October. Note that the Canadian economy gained 107,000 jobs in September

Canada's housing sector was one of the main economic drivers during the 2000s, much as it was in the United States. The perception is that some parts of the country experienced a housing bubble, particularly British Columbia and Alberta, and to a lesser extent Toronto. Housing and other construction spurred economic growth but the bubble was not believed to be as substantial in Canada for a couple of reasons. One is that because mortgage interest is not deductible, demand for housing was limited, particularly speculative demand. Another reason is that Canada's mortgage market remains backed by the major banks, and they did not increase subprime lending to the extent that U.S. lenders did. Moreover, Canada does not have the same type of strong, liquid secondary market for mortgages as was facilitated in the U.S. By Fannie Mae and Freddie Mac.

House prices in the U.S. have declined on average 25% during the financial crisis. In Canada, they have only declined 12.5%

. In part, this is because prices had not become so inflated in the first place. Another contributing factor is that because Canadian banks are much more solvent than U.S. banks, the credit crunch does not exist in Canada to the same degree as it does in the United States. A final factor is that consumer confidence in Canada is higher. The latest consumer confidence figures in Canada are 67.0

, versus 26.0 in the United States.

Another economic impact of the financial crisis is with respect to the currency exchange. As a net exporter, Canada relies on a low currency exchange rate as a source of competitive advantage for its exports, in particular with respect to the U.S. dollar. At the outset of the financial crisis in early 2008, the Canadian dollar was trading at or above the U.S. dollar as a result of it being a petrocurrency. However, as the global financial crisis began to weaken the world's economies, crude prices dropped, taking the Canadian dollar with them. The result of this is that the global financial crisis has restored Canada's competitive advantage in terms of currency exchange. However, this has not stunted the damage to the manufacturing base. It will set the country up well, though, for a recovery once the U.S. economy begins to pick up.

In terms of politics, the economic crisis has been less a political issue than it was in the United States. Canada held a federal election last fall, with the Conservative Party returning to a minority government. The election was significant because Canada was the first major country to hold an election since the global financial crisis broke open

. While the economy was an important issue, it did not dominate the campaign the way that it did during the U.S. election campaign. Instead, issues such as the war in Afghanistan were at the top of the agenda.

The formation of a minority government put the Harper government in an awkward position with regards to the financial crisis. The United States and other nations began passing stimulus packages and bailouts in the fall of 2008, but the Harper government deferred on the issue until the new year. The government needed help from another party to gain a majority of votes in Parliament, and therefore wanted to couple a stimulus package with its budget. The budget eventually passed with the help of the Liberal Party. There was nothing unusual in the political machinations required to pass the stimulus package -- the Harper minority has been forced to take such measures for the past several years.

In that way, the political situation has not changed much in Canada as a result of the financial crisis. The economy is increasing in importance as an issue. Rather than divide the nation, however, it… READ MORE

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