Economic analysis

Why Canada’s sluggish economy spells trouble for the U.S.

Canada’s poor performance is hitting where it hurts, below the border
A "Made In The USA" sticker is seen on a box containing Hammer Strength weightlifting equipment at the Life Fitness manufacturing facility in Falmouth, Kentucky, U.S., on Thursday, April 9, 2015. The U.S. Census Bureau is scheduled to release durable goods figures on April 24. (Luke Sharrett/Bloomberg/Getty Images)
A "Made In The USA" sticker is seen on a box containing Hammer Strength weightlifting equipment at the Life Fitness manufacturing facility in Falmouth, Kentucky, U.S., on Thursday, April 9, 2015. The U.S. Census Bureau is scheduled to release durable goods figures on April 24. (Luke Sharrett/Bloomberg/Getty Images)
A “Made In The USA” sticker is seen on a box containing Hammer Strength weightlifting equipment at the Life Fitness manufacturing facility in Falmouth, Kentucky, U.S.(Luke Sharrett/Bloomberg/Getty Images)

Selling snowmobiles to Canadians should be a can’t-miss business proposition. But in recent months, Minnesota-based Arctic Cat has warned shareholders that its reliance on toque-wearing Canucks, who have reliably accounted for nearly one-third of its sales, could result in a $US15-million drop in annual sales.

Once buoyed by flush rig workers in the hinterlands of Alberta, Arctic Cat has seen previously rising Canadian demand for its neon-coloured sleds plateau over the past few months as the plunge in oil prices exacted a steep economic toll in Western Canada. Worse, the Canadian dollar has fallen dramatically against the U.S. greenback—the loonie’s now worth just 75 cents U.S.—which takes a big bite out of Arctic Cat’s U.S.-dollar earnings. “That’s the tough part for anyone doing business in the Canadian market,” CFO Christopher Eperjesy says. “It’s boom or bust.”

Arctic Cat is far from the only U.S. company that’s hurting because of Canada’s oil-induced funk. Retailers in U.S. border states report fewer Canadian shoppers, hoteliers are seeing fewer Canadian tourists and real estate agents say snowbirds’ demand for U.S. real estate has all but dried up. More important, the value of U.S. manufactured goods sold in Canada—everything from computers to construction equipment—has taken a major hit, as U.S. exporters are forced to sell their wares in much cheaper Canadian dollars.

Though we rarely stop to think about it, our economy’s performance has a big impact south of the border. Canada, which is expected to post GDP growth of just 1.1 per cent this year, accounts for about 20 per cent of America’s US$2.3-trillion export sector, making it the single biggest destination for Made in America products in the world. Equally important, Canada has emerged as one of the chief ways the U.S. is exposed to China’s debt-fuelled troubles. Explaining why she opted not to raise interest rates at its September meeting, U.S. Federal Reserve Chair Janet Yellen cited the “significant impact” of China’s rapid slowdown on emerging markets “as well as more advanced countries, including Canada, which is an important trading partner of ours that’s been negatively affected by declining commodities prices, declining energy prices.”

Canada, in other words, is now counted among the headwinds buffeting the all-important U.S. economy. And while that’s bad news for Washington, it’s becoming an even thornier problem for Ottawa. By all accounts, the federal government’s strategy to rekindle GDP growth consists of waiting for Canadian exporters, armed with a cheap loonie, to cash in on surging U.S. demand—a coattail-riding strategy that will be enormously difficult to execute, as long we’re standing on Uncle Sam’s feet.

The disappearance of deal-hungry crossborder shoppers is probably the most visible example of how Canada’s economic woes are affecting our southern neighbour. In July, for example, the number of cars, passenger trucks and SUVs crossing from B.C. into Washington state at the Blaine Sumas and Lynden crossings fell nearly 16 per cent, according to the Western Washington University’s Border Policy Research Institute. “Unlike the large border crossings around Ontario, ours is heavily comprised of travellers engaged in discretionary trips like shopping, so I think it’s safe to say the exchange rate is a significant factor for us,” says Laurie Trautman, the institute’s associate director. Another study, by the Business Council of British Columbia, found cross-border shopping trips made by B.C. residents had fallen 28 per cent since 2013, the last time the loonie was near parity with the U.S. dollar.

The trend has had a direct impact on U.S. store owners. At one Costco in Kalispell, Mont., warehouse manager Greg Gillingham told the Associated Press that sales to Canadian customers have fallen by about 30 per cent since the beginning of the year. Meanwhile, a recent report in the Buffalo News noted that fewer crossings at the Peace Bridge between Buffalo, N.Y., and Fort Erie, Ont., had local gas stations and grocery stores concerned, but were being offset, for now at least, by U.S. shoppers in neighbouring areas.

Tourism, however, is a different story. Back in 2013, when the dollar was near parity, Canadian visitors spent US$23.4 million in the U.S., according to the U.S. Department of Commerce. But spending was down two per cent last year and expectations are that the trend will continue in 2015. A recent report by the Conference Board of Canada estimates as many as half the five million Canadians who were crossing the border each year to take advantage of cheaper flights at U.S. airports may now decide to stay home because of the unfavourable exchange rate. In picturesque Maine, meanwhile, only about a million tourists were expected to visit this past summer, compared to about 4.2 million last year and 5.5 million in 2013, with the decline being blamed mostly on Canadians staying home. “We have also heard that, for those who are visiting, spending and length of stay have fluctuated from prior years,” says Jennifer Geiger, with the Maine Office of Tourism.

Canadian purchases of real estate in U.S. communities—typically warm, sunny ones—are also on the decline. A recent study by Irvine, Calif.-based business analytics firm CoreLogic showed a 34 per cent drop in U.S. home purchases by Canadian buyers during the first four months of this year, compared to the same period in 2014. Frank Nothaft, the chief economist at the firm, wrote in a blog post that Canadians mostly buy homes in the popular Miami, Fort Lauderdale and Palm Beach areas, where home prices rose by as much as eight per cent year-over-year. “Couple that with the effect of a stronger U.S. currency, and the average Canadian considering a home purchase in south Florida saw a jump in purchase cost of 20 to 25 per cent in the past year,” he wrote.

Yet, while missing Canadian tourists and slowing real estate sales tend to grab people’s attention, it’s not necessarily where the Canadian slump threatens to have its biggest impact. There are also signs that several blue-chip American companies are similarly beginning to feel the effect of Canada’s slowdown. Heavy-equipment-maker Caterpillar said earlier this month it may cut as many as 10,000 jobs through 2018, as it grapples with a severe downturn in the mining and energy sectors, including in Canada. While Caterpillar didn’t break out specific Canadian numbers, data from the U.S. Association for Equipment Manufacturers showed exports of construction equipment here fell by 12 per cent during the first half of the year. Companies such as U.S. Steel are also facing tough times, as Canadian purchases of the metal plunged 25 per cent year-over-year in July, according to industry figures. Other big U.S. exporters that have been hurt by the rising value of the U.S. dollar relative to the loonie and other global currencies include Tiffany & Co., Wal-Mart, Johnson & Johnson and Procter & Gamble.

Although we’re used to being chided by Americans for our global wallflower status—on a 2008 episode of 30 Rock, Steve Martin’s character memorably refers to Toronto as being “just like New York, but without all the stuff”—those who follow U.S. industry closely say the weak Canadian economy is no laughing matter for companies and their shareholders. “Our manufactured goods are down four per cent this year, and it doesn’t help that exports to Canada, our largest trading partner, are down 6.6 per cent,” says Chad Moutray, the chief economist for the U.S. National Association of Manufacturers. “That hurts.”

Indeed, what many Canadians probably don’t realize is that a big chunk of U.S. GDP growth over the past five years—as much as 30 per cent—was directly tied to its resurgent export sector, where Canada looms large. Part of that was the result of the lower U.S. dollar, which, until it rebounded sharply last year, made American-made goods cheaper abroad. In the year after the recession ended, U.S. President Barack Obama also revealed his government’s national export trade initiative, which was designed to boost the economy and create jobs—a strategy that includes pushing for trade deals such as the Trans-Pacific Partnership, which Canada signed earlier this week. “Manufacturing has a huge impact on the U.S. economy,” says Moutray. “It has a huge multiplier [effect] and is a nice pathway to the middle class. I think you see politicians on both sides of the aisle talk up manufacturing as the perfect sector to devote resources to.”

At the same, there’s also evidence that American policy-makers are getting fed up with countries that are trying to give their weakened economies an edge by devaluing their currencies against the U.S. dollar. China surprised many by taking steps to devalue the yuan in August. It was followed by Vietnam and Korea—moves that prompted a group of U.S. senators to urge Obama to take a hard line on currency issues in the Trans-Pacific Partnership talks to prevent U.S. companies from being harmed. While Canada was not singled out, despite negotiating its entrance in the 12-country trade deal, some have questioned whether Bank of Canada governor Stephen Poloz was trying to “talk down” the loonie last year in a bid to make Canadian manufacturers more globally competitive—a charge he has publicly denied. Nevertheless, what’s not in dispute is that Poloz cut rates twice this year in an unsuccessful bid to stave off a recession, which forced the loonie down even further and created more headaches for the U.S. Federal Reserve. From his seat in Arctic Cat’s offices in Plymouth, Minn., Eperjesy doesn’t believe the sharp currency movements he’s witnessed in recent years—both in Canada and Europe—can be explained entirely by economic fundamentals. Not that there’s much he can do about it. “Unfortunately, when you do business in global markets, you have to live with that,” he says.

What may be more difficult to live with is the possibility that a flagging global economy, and the rapidly depreciating currencies that have followed, will stop the U.S. recovery in its tracks. The U.S. Fed has been eyeing an interest-rate hike for months, but has so far been unwilling to make a move, as long as the U.S. economy is at risk of being toppled by weak growth elsewhere in the world, including in Canada. That, in turn, raises the prospect that America could slip into another recession—which occurs every three to 10 years, on average—with no more bullets left in its monetary clip.

In the meantime, Arctic Cat will look inward for growth. Eperjesy says the company is planning to ramp up its focus on selling ATVs and dune buggies to sun-drenched Americans in the U.S. south and west. As for Canada, Arctic Cat has two options to offset the damage being done by the weak loonie: Raise prices and risk ceding market share to Arctic Cat’s Canadian competition, or cut costs by undertaking a massive project to relocate part of the company’s supply chain north of the border. “It’s a pretty simple equation,” Eperjesy says. “The solution is the hard part.”