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RR RUEHGA RUEHHA RUEHMT RUEHQU RUEHVC
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R 281415Z OCT 08
FM AMEMBASSY OTTAWA
TO RUEHC/SECSTATE WASHDC 8642
INFO RUCNCAN/ALL CANADIAN POSTS COLLECTIVE
RUEHRL/AMEMBASSY BERLIN 1123
RUEHLO/AMEMBASSY LONDON 0968
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RUEATRS/DEPT OF TREASURY WASH DC
RHEHNSC/WHITE HOUSE NSC WASHINGTON DC
RUEHBS/USEU BRUSSELS 0647

UNCLAS SECTION 01 OF 04 OTTAWA 001372 
 
SENSITIVE 
SIPDIS 
 
STATE FOR WHA, WHA/CAN, E, EEB, EEB/IFD 
TREASURY FOR ERIN NEPHEW 
 
E.O. 12958: N/A 
TAGS: CA ECON EFIN ENRG EPET ETRD
SUBJECT: PSYCHOLOGY, REALITY AND INTEGRATION: CANADA'S 
ECONOMIC HEALTH WILL NOT PROTECT IT FROM THE GLOBAL DOWNTURN 
 
REF: A. TORONTO 322 
     ¶B. TORONTO 327 
     ¶C. OTTAWA 1362 
 
SENSITIVE BUT UNCLASSIFIED -- PLEASE PROTECT ACCORDINGLY. NOT 
FOR INTERNET DISTRIBUTION. 
 
¶1. (SBU) Summary:  How Canada fares in the global economic 
crisis will be measured as much by its integration with the 
U.S. economy as by Canada's own domestic economic policies. 
The bottom line is:  Canada's solid economic policy 
management will only serve to mitigate the impact of the 
global financial crisis and the United States, economic 
difficulties.  Canada,s deep economic integration with the 
United States will cause Canada to suffer as much or 
potentially more than many of our other large trading 
partners, if the U.S. economy enters a prolonged recession. 
Of course it could conceivably be hurt less if the United 
States in turn suffers less economic hardship than other 
countries or pulls out of its economic downturn. End summary. 
 
¶2. (SBU) Canada's macroeconomic indicators are largely 
healthy (the global financial crisis aside) and this 
country's history of cautious, highly-regulated financial 
operations, now looks "prescient" rather than "outmoded." 
Canada,s October year-on-year inflation rate is 2.2 percent; 
its 6.1 percent unemployment rate is at historically low 
levels (with every province suffering from skilled labor 
shortages); and the federal government has enjoyed a budget 
surplus each year since 1998.  The relative drop in the 
Canadian dollar (down 25 percent against the USD since the 
beginning of the year) should boost Canada's manufactured 
exports, though revenues from priced-in-USD energy have 
dropped significantly and Canada,s balanced budget also 
provides a macroeconomic cushion.  Nevertheless, Canada's 
deep integration with the United States leaves Canada 
vulnerable to our economic and financial downturn. These 
facts are not the only negatives spilling across this long 
border; the drop in confidence among Americans is leading a 
gloomy cold front that is seriously dampening consumer 
confidence and thus markets in Canada.  One example:  the 
drop in the Toronto Stock Exchange aggregate since January 2 
and again since September 15, which parallels the fall in the 
Dow Jones over the same period.  The bottom line is: Canada's 
solid economic policy management will at best only serve to 
mitigate the impact of the financial crisis, and its 
proximity to and interrelationships with the U.S. will cause 
it to suffer as much or potentially more than many of our 
large trading partners. 
 
¶3. (SBU) In recent days, we have been talking with a number 
of well-placed economic actors ranging from the Deputy 
Minster of Finance to Canada's G-8 sous-sherpa to the chief 
economist of the Royal Bank of Canada (RBC), and their 
staffs, for a picture of what the Canadian economy is facing. 
 We've been helped by excellent formal and informal reporting 
from our Consulates. What follows is a summary of the 
consolidated picture of the Canadian macroeconomic situation 
and its vulnerabilities. 
 
Canadian banking system healthy but still worried -- housing 
market cooling 
============================================= =============== 
 
¶4. (SBU) Canada's banks and investment brokerages have been 
Q4. (SBU) Canada's banks and investment brokerages have been 
operating for years in a much more conservative regulatory 
environment than their U.S. counterparts. Among a host of 
different reserve and capital base requirements, Canada never 
separated investment banks from retail banking operations in 
Canada and thus all brokerages are part of the financial 
empires controlled by Canada's five major retail banks.  This 
means that even investment/brokerage operations must meet the 
regulatory requirements pertaining to retail banking 
operations.  The aggregate leverage of Canadian banks is 
markedly smaller than the levels now extant in the United 
States and there is only a small sub-prime mortgage 
component.  Additionally, the collapse of the asset-backed 
commercial paper market last year forced Canadian banks to 
recognize and deal with certain problematic asset categories. 
 
OTTAWA 00001372  002 OF 004 
 
 
 The World Economic Forum recently ranked Canada's banking 
sector as the world's healthiest.  Yet this will only 
insulate Canada up to a point.  Given the interrelationship 
of financial markets across the border, the tightness of 
credit flows in the United States is having a measurable 
impact on Canadian lending, especially within the tighter 
capital adequacy ratio requirements that Canadian 
institutions must meet.  In terms of housing market lending, 
Canada is not facing a homegrown mortgage crisis -- the 
consumer housing market remains relatively strong compared to 
the United States, but consumer confidence is causing a dip 
in purchases and housing starts.  There are local housing 
bubbles (in Vancouver, parts of Ottawa, and Montreal), but 
very little of this effect is related to sub-prime mortgages, 
rather to rapidly escalating property values.  In addition, 
the mortgages at risk are a very small percentage of the 
loans held by the big five national banks. As the RBC chief 
economist noted, "we are facing a cooling rather than a 
collapse of our housing sector." 
 
Canadians will maintain their balanced-budget religion; see 
their credit actions as "maintaining a level playing field" 
============================================= =============== 
 
¶5. (SBU) It has been a shibboleth of Canadian pol-econ policy 
since the mid-1990s (when Canadian Federal deficits 
ballooned) that Canada must maintain balanced Federal 
budgets.  This is a political red-line that will only be 
crossed in extremis, and no one here thinks that type of 
crisis is near.  In Keynesian terms, this limits the ability 
of Ottawa to prime the pump during economic downturns.  Some 
economists have explained to us, however, that they have 
enough positive headroom within their budget and off-budget 
accounts to try and jumpstart and/or mitigate any approaching 
downturn in the economy by increasing spending without 
actually going into deficit.  At the same time, the Federal 
and some Provincial governments are taking measures to ease 
the credit crunch here.  Finance Minister Flaherty announced 
on October 23 a range of actions, including purchases of up 
to C$25 billion of insured mortgages and expanding insurance 
coverage by the Canadian Lenders Assurance Facility.  In 
addition, the British Columbia provincial government on 
October 24 outlined a 10-point program of tax cuts, budget 
cuts and capital outlays to help insulate the province, and 
the BC Premier is recalling the provincial Parliament to vote 
on this legislation.  In Ontario, Canada,s manufacturing 
heartland and economic center of gravity, a province that has 
been hit hard by the high Canadian dollar over the past year 
and declining consumer demand in the U.S., the Premier 
recently announced a deficit provincial budget (see ref B), 
the first since 2005. 
 
Volatility and regional differences in growth complicate 
Federal economic and energy policy 
============================================= =============== 
 
¶6. (SBU) As a corporate chief economist told us this week, 
"it is the volatility of both exchange rates and energy 
prices that is killing us, not the actual levels of either." 
Several of our contacts have opined that an exchange rate of 
QSeveral of our contacts have opined that an exchange rate of 
US 80-85 cents to C$ 1 is probably the long-term 
purchasing-power parity level and the level that balances 
Canada's export engine with its import needs.  Yet the 
movements from US 95 cents to US 80 cents to the C$ during 
the last two months (and from US 1.10 a year ago) are making 
decisions, predictions, and hedging very difficult.  The rise 
of the US$ is also introducing a sardonic factor -- a senior 
bank economist told EMIN that "you guys have the best of both 
worlds; you can tank the world economy and then increase your 
currency's strength as it serves as a store of value when 
problems become global." 
 
¶7. (SBU) Another area of uncertainty for policymakers is the 
large differences in economic performance across the 
provinces.  Many of the western provinces (BC, Alberta and 
Saskatchewan) with a largely resource extraction economic 
base call themselves the "have" provinces with high 
employment rates and healthy bottom lines, while Ontario, 
Quebec and Atlantic Canada are suffering from the demise of 
 
OTTAWA 00001372  003 OF 004 
 
 
the manufacturing sector.  In fact, the huge demand for labor 
in the energy bubbles of Alberta and Saskatchewan have eased 
unemployment in Canada,s eastern provinces. 
 
¶8. (SBU) Canada faces a complicated nexus between exchange 
rates, trade, and energy prices at the best of times.  A 
major contributor to the value of the Canadian dollar is the 
price of oil, as Canada is a major oil exporter, supplying 
the United States with 17 percent of our oil needs.  In 
particular, the capital and labor-intensive oil sands sector 
in Alberta is watching oil prices and exchange rates closely; 
there is a fair amount of disagreement here about the 
"break-even level" below which continued extraction would be 
unprofitable.  Yet trade for Canada is a major national 
engine of growth and the lower exchange rate will have a 
positive effect (as long as domestic and U.S. demand keep up) 
on manufacturers, who have taken a hammering over the last 
five years due in part to the rising C$. 
 
¶9. (SBU) We defer to CG Calgary, but pass on that the 
emerging consensus position in Ottawa is that technology 
developments and growing productivity levels are lowering the 
oil market break-even point to somewhere in the US$ 50 per 
barrel range.  Yet while Ottawa policy makers may be talking 
about the break-even point for oil sands production, that 
figure is actually less relevant, since producers must only 
cover their variable costs to make continued production 
worthwhile.  A number of factors suggest they will continue 
to do so.  The general slowdown in the U.S. and Canadian 
economies may work to lower some costs, especially labor, and 
the flip in exchange rates may support continued production 
and export.  In-country costs are in C$, while export 
revenues are in US$, making it that much cheaper to meet 
those costs.  While Canada does import energy from the United 
States, imports are much smaller than exports.  On the whole, 
Canada,s energy sector is probably benefiting from the 
reversal of exchange rates. 
 
¶10. (SBU) The situation with capital investment is different, 
however.  Imported material costs are higher in C$ terms, and 
financing decisions may be different (balance sheet vs. 
credit).  Even though oil companies are normally very 
conservative on price forecasts made in support of investment 
decisions, we are seeing companies slow down major projects, 
which also eases pressure on material and labor markets. 
 
Consumer and corporate psychology a key factor 
============================================= = 
 
¶11. (SBU) One of the main factors that will determine how 
Canada rides out the United States, perfect economic and 
financial storm is psychological.  The interrelationship 
between our two real economies is so massive as to tie Canada 
largely to developments in the United States no matter what 
their policy choices; but industrial and consumer gloom could 
lead to a self-fulfilling prophecy in both countries.  There 
has been over the last decade "less excess" in consumer 
spending and indebtedness in Canada than in the United 
States, and thus less vulnerability.  But Canadians have long 
experience with having the U.S. economic dog wagging their 
Qexperience with having the U.S. economic dog wagging their 
northern tail, and they are already slowing down their 
purchasing and borrowing levels in a manner which will, like 
a vicious circle, contribute to their own national slowdown. 
Businesses will focus on cutting costs and jobs in 
preparation for what they fear will be a deflationary spiral. 
 Credit is not as tight here as in the States, and the 
housing markets are healthier, but the exposure of Canadian 
citizens, firms, and banks to the U.S. markets writ large 
(and not to mention to American media and to our overall 
economic zeitgeist) will have a major impact both on reality 
and in psychological terms. 
 
¶12. (SBU) For those reasons, it is perhaps not a surprise 
that the Canadian Government is very supportive of the 
Administration's coordination over recent weeks with the G-7 
and now with the G-20 on a global approach to the global 
crisis.  Senior Canadians are participating actively in these 
discussions and have praised the speed and "multilateral 
nature" of the USG response so far. 
 
OTTAWA 00001372  004 OF 004 
 
 
 
Visit Canada,s Economy and Environment Forum at 
http://www.intelink.gov/communities/state/can ada 
 
BREESE