In bigger picture, ‘greater concern’ is future of Canada’s relationship with its largest trading partner

Canada’s quick retaliation to U.S. President Donald Trump’s latest volley in his “America First” campaign has raised fears of a trade war between two of the world’s friendliest allies – and thrown doubt on Canada’s long-held status as a favoured partner of the economic superpower.

The consequences of U.S. steel and aluminum tariffs for Canada’s economy are expected to be modest. The greater concern is the future of Canada’s relationship with its largest trading partner, said Benjamin Tal, deputy chief economist of CIBC World Markets.

“I think the more significant issue is that Canada will have to retaliate and start a mini-trade war, which is clearly negative,” Tal said. “That will have a negative impact on the Canadian dollar and the optimism about NAFTA will be replaced with pessimism — which is much more significant than the actual tariff.”

The key now for Canadian negotiators will be to refuse the U.S. administration’s efforts to entangle the issue of steel and aluminum tariffs with the NAFTA negotiations, said Eric Miller, president of the consulting firm Rideau Potomac Strategy Group, which focuses on trade issues.

“The Trump people are deluded if they think Canada will offer additional concessions just because of this,” he said. “There is a process for retaliation which will be executed. Therefore you keep the damage from the steel and aluminum issue contained in its own area. The U.S. may be taking the view that this is related but if we respond to it separately and not give them what they want, then we are in a much stronger position than if we start panicking.”

Nevertheless the U.S. tariffs reflect a significant shift in the way Canada has traditionally been viewed by the U.S., Miller said.

“Donald Trump doesn’t view the relationship with Canada or anybody else as particularly special,” he said, adding that Japan, the U.S.’s strongest ally in Asia during the post-Second World War period has also been hit with tariffs.

“This is not as much about us as many people would like to think,” he said. “They aren’t targeting Canada specifically. We simply haven’t got the recognition of the distinct nature of our economic relations with the U.S. that we usually get.”

U.S. Commerce Secretary Wilbur Ross announced plans Thursday morning to slap tariffs of 25 per cent on steel and 10 per cent on aluminum imported from Canada, Mexico and Europe, on the grounds of national security. The move ended a temporary exemption Canada had been granted pending the outcome of negotiations to revamp the North American Free Trade Agreement.

By afternoon, Canada had hit back, announcing retaliatory tariffs of $16.6 billion. Canada will also challenge the U.S. steel and aluminum tariffs under NAFTA and the World Trade Organization.

Emphasizing Canada’s history as a “secure supplier” of steel and aluminum to the U.S. defence industry, Prime Minister Justin Trudeau described the U.S. tariffs as “an affront to the longstanding security partnership between Canada and the United States.”

“That Canada could be considered a national security threat is inconceivable,” he told reporters during a press conference in Ottawa yesterday.

The impact of U.S. steel and aluminum tariffs on Canada’s economy is expected to be modest. Ontario, home to 70 per cent of Canadian steelmaking, is the most exposed to the tariffs, with steel exports accounting for one per cent of GDP, said Benjamin Reitzes, Canadian rates and macro strategist at the Bank of Montreal. A 10 per cent decline in those exports would cut Ontario GDP by a tenth.

“It’s clearly not a positive for Canada but I wouldn’t be overly negative yet,” he said. “The bigger picture is what comes next and if this is a sign of more tariffs to come.”

Despite invoking justifications of national security, the Trump administration has explicitly tied Canada and Mexico’s exemption from steel and aluminum tariffs to the ongoing talks to overhaul NAFTA. In announcing the tariff decision, Ross said the talks are taking longer than the U.S. had hoped. The parties remain at odds over issues including U.S. demands to limit government contracts awarded to Canadian and Mexican firms and proposals to curtail the power of dispute resolution panels.

During his press conference, Trudeau said a proposed meeting with Trump to seal a NAFTA deal fell through after Vice-President Mike Pence called to say the visit was conditional on adding a sunset clause to the pact. The clause – in which NAFTA would automatically expire after five years unless the three countries agree to extend it – has been a key stumbling block in the talks. Canada and Mexico insist it would hurt investment by depriving businesses of long-term certainty.

With the deadline all but passed for securing a deal in time for approval from the current U.S. Congress, the NAFTA talks are now expected to carry on into 2019. As a result, doubts surrounding Canada’s ongoing access to its largest trading partner will persist, Miller said. That trade issue, combined with concerns about Canada’s competitiveness in light of recent U.S. reductions in business taxes, will all present a risk to the economy.

“NAFTA is one part of this, but combined with other things, it’s a pretty steep hill for Canada to climb to deliver growth over the medium term,” Miller said.

And in the meantime, the Trump administration has, in one sweeping move, gone some distance to alienate key trading partners and allies, said Matthew Kronby of BLG’s International Trade Group.

“The U.S. is demonstrating its fundamental unreliability as a trading partner and its lack of commitment to the rule of law, and that is unfortunate,” Kronby said. “We can hope that in the longer term cooler heads will prevail in the U.S. but the fact that this is happening really will lead to an increased pressure in the U.S. to complete trade agreements with other countries including China.”

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Kevin Carmichael: Amid trade battles, some good news on economy: Canadian companies are expanding

We’re on the brink of a trade war with the United States, so this might cause some cognitive dissonance, but Canadian companies might be getting used to President Donald Trump.

The banner headline from Ottawa on Thursday was Prime Minister Justin Trudeau’s decision to retaliate against the Trump administration’s application of tariffs on imports of Canadian aluminum and steel.

Trudeau and Foreign Affairs Minister Chrystia Freeland held a press conference to announce that Canada will tax American steel and other imports, worth more than $16 billion starting July 1, unless Trump relents. Mexico and the European Union also promised retaliatory duties, portending a global trade fight of a magnitude that hasn’t been seen in decades. Stock markets fell and Canada’s dollar slumped.

All of this was a shame because the day started with some good news.

Statistics Canada reported that the economy grew at an annual rate of 1.3 per cent in the first quarter. Nothing special about that figure, which was in line with the Bank of Canada’s forecast and slower than many on Bay Street had foreseen.

But the significant data was below the surface. Business investment in machinery and equipment rose 4.2 per cent in the first quarter, one of the biggest gains over the past couple of decades. And spending on intellectual property, which contracted in 2016 and had been lacklustre since, surged 3.3 per cent over the first three months of the year, the largest quarterly increase since early 2011. 

These numbers matter because they show that companies are expanding to take advantage of the strongest global economic growth since before the Great Recession. Other data indicate that Canadian industry essentially is running its existing facilities and staffs to their max, which probably is one of the reasons that exports have disappointed: companies simply lacked the capacity to keep up with demand, nevermind increase market share.

Investing to win new business might seem a natural thing for a company to do, but there was lots of worry in Ottawa that Trump had scared Canadian executives stiff.

Anecdotal evidence suggests some companies have put expansions on hold while Canada, the U.S. and Mexico renegotiate the North American Free Trade Agreement. The Bank of Canada worried that sentiment could be widespread. It resisted raising interest rates because its models indicated that investment should be higher, given the strength of global economic growth. The central bank left borrowing costs unchanged for a third consecutive time on May 30, mostly because of uncertainty over trade policy.

Bank of Canada Governor Stephen Poloz and his advisers on the Governing Council made that decision without getting to see the first-quarter GDP numbers. But they have seen the data now, and they appear to like them. 

“We expect business investment to increase, but not by as much as it could without this uncertainty,” Bank of Canada Deputy Governor Sylvain Leduc told an audience in Quebec City on May 31. “That said, business sentiment and investment intentions remain positive, suggesting that firms are getting on with business and adjusting to this more volatile environment.”

Leduc was delivering the Bank of Canada’s second economic “progress report,” a new feature of the institution’s communications strategy that’s meant to ensure every policy decision comes with context and explanation.

Policymakers opted to leave the benchmark interest rate at 1.25 per cent this week, but they wrote the policy statement in a way that made clear they are ready to resume raising interest rate at their next scheduled decision on July 11. The central bank dropped a reference to needing to be cautious and said it would lift borrowing costs gradually, depending on the incoming data. It also said that it already was feeling better about investment, noting that a jump in imports of machinery and equipment signalled buoyant business confidence. 

Leduc spoke before Trudeau and Freeland announced their plans to retaliate. At a press conference, he said it was too soon to predict what the U.S. tariffs would mean for the economy, although he did offer that the effect probably would be negative. “Those measures are not the type of measures that are conducive to a good environment,” Leduc said. “We’ll have to see how it breaks in the data.”

The central bank also will be paying close attention to the housing market for guidance on how the economy is coping with previous interest-rate increases, as well as to hiring data for evidence that wages are rising and marginalized workers are finding jobs.

“Wages are rising somewhat more slowly than we would expect to see in an economy operating at capacity,” Leduc said in his progress report. “This may indicate that some slack remains.”

But it’s noteworthy that business investment no longer features among the central bank’s primary concerns. A protracted trade war could change that, but for now, the data suggest Canadian companies are getting back to business.

 
•Email: kcarmichael@nationalpost.com | Twitter: @CarmichaelKevin

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