“Canada’s economic fundamentals are strong.”This simple sentence is often used by Prime Minister Stephen Harper when questioned about the economy and he has to date, been quite correct in this statement.However there is a sinister side to this and it is often being ignored by economists; particularly those in banks and government.That hidden beast is the American economy and it is not strong by any measure of definition.History has taught us that what happens to the US usually has Canada in pursuit about 6 months later.
So the people of Canada are reassured by this statement but don’t understand what is being said.What are these economic fundamentals, what do the mean, and how do they affect us?
There are a number of measures used by economists to measure the health of an economy but primarily it is about a half dozen that are used as the base indicators.It is equally important not to just look at the current numbers, but more important perhaps to look at the historical trends.The other often made mistake, primarily by journalists is to focus on only one or two instead of the major indicators.To focus on only a narrow number is to skew the interpretation.
To begin, the economy is not just money in, money out and money left over either as a surplus or deficit.It is multiple factors combined that in the end lead our country’s financial health to either a surplus or deficit.It is critical to understand that overall the figures may be acceptable or good, they could be skewed again by regional performance instead of national.For decades, the strength of the Ontario economy overshadowed the desperation of other regions such as some of the Atlantic provinces or Saskatchewan.The same is true today as Alberta’s good fortune is overshadowing the poor performance of Ontario and Quebec.
One of the most often quoted statistics is that of unemployment.Obviously as unemployment increases it is indicative of a shrinking workforce.This in turn can affect others through a ripple effect as those affected no longer have the income to spend.Additionally, federal coffers shrink and so, federal spending should follow suit in order to avoid a deficit.Businesses begin to restrict operations and banks tighten up credit.It is a formula for an economic slowdown.
Inflation is often the predecessor to a rise in unemployment as an economy heats up until it must be addressed by the central bank; The Bank of Canada.Typically their response is to raise interest rates forcing a slowdown in the financial sector.But what is inflation?Inflation occurs when an economy grows at a rate faster than actual output.In other words it is like buying the same goods time and again, and each time the price goes up as does the supply.By raising interest rates and tightening credit, the bank is making it harder to borrow and so forcing business to slow down its growth.This has the effect of withdrawing supply of money and consequently goods.This is a double edged sword because increasing rates too much can force a recession and increased unemployment.
Interest rates are also carefully watched although from a much broader point of view than what you or I would seek at the bank.The central bank prime rate is the one that determines the “overnight” lending rates for the bank.This is short term borrowing by the charter banks from The Bank of Canada.It is the rate offered to the banks very best customers and foreign investors.Obviously increased rates can be inflationary as every sector of the economy is affected.However these rates can also be used to attract foreign investment in Canada’s currency.So raising them will bolster investment but also can have a negative effect on the consumer.
Gross Domestic Product is the output of goods exported from Canada after domestic consumption.A surplus means that Canadian production is being exported to other countries.In other words it is foreign trade.A surplus means we are exporting more than we import.Canada has traditionally enjoyed a surplus with its biggest trading partner, the United States.Much of this surplus has been directly traceable to the production output of the automotive sector that has fueled the economy of Ontario.Other significant areas of activity are food exports, lumber, natural resources and fisheries.The recent decline in Ontario has been compensated for by increases in natural resources, most notably energy from Alberta and Saskatchewan.
Productivity has recently been added to this list and is significant in that it ties the value of goods produced to each of the major indicators.As productivity increases or falls, GDP, unemployment, interest rates, value of the Canadian dollar, tax rates, and inflation all factor in to determine whether the goods being produced are being done so in an efficient manner.Let’s assume that 10 years ago a widget was made and sold for 10 dollars.Today, that same widget might be worth 20 dollars to produce because of increased unemployment, interest rates etc.In this light it is a very important indicator of overall economic health, and it is one economists do not like to quote because it shows the trend of economic rise and fall without addressing specific areas.It can be very misleading but to ignore it is to ignore economic growth on a larger, global scale.
In the end, all of these factors affect the consumer from the standpoint of purchasing power when government acts to address economic imbalances.The danger of course is a government manipulating an economy without considering the effects elsewhere in that economy.This is where people begin to lose confidence in the economy itself and withdraw money from circulation by increasing savings.This can have a negative effect since the car you don’t buy could put your neighbour out of work who can't buy the life insurance you sell.
It is all intertwined like a spider web and at the center of it all is the Governor of The Bank of Canada who acts in accordance with the policies of the government of the day.Cut one of the main lines of the web and it is weakened, cut two, three, four and eventually it will fall.
This is the problem facing the American government.Canadians need to understand that we are not immune since several of our web supports are south of our borders.