An attendee wearing a Make America Great Again hat lowers his head on the inauguration day of Donald Trump's second presidential term in Washington, on Jan. 20.Amanda Perobelli/Reuters
John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
Monday’s sharp selloff on the New York Stock Exchange revealed just what traders think of U.S. President Donald Trump’s plans to impose tariffs on Canada and Mexico. Meanwhile the rally in government bonds suggests investors are rushing for safety in anticipation of a recession. And with good reason. The tariffs make worse an already bad situation.
For all its booming growth, the American economy has a serious weakness: it’s living on credit. Take the postpandemic explosion in government debt out of the picture and it would be as moribund as Canada’s. Even allowing for the fact that as holder of the world’s reserve currency, the U.S. government gets a lot more slack from creditors than any other country, there is only so much debt you can accumulate before problems arise.
When debt dynamics get as bad as they have in the U.S., things get resolved in one of two ways. If debt keeps rising bond investors would be unable to absorb the added supply, which has the effect of driving up interest rates. That started last year, and the consequent rise in credit costs began crimping spending and investment.
To forestall further rate rises, therefore, the government can cut spending, which however depresses economic demand. That’s what Elon Musk’s Department of Government Efficiency is supposedly doing. Although it’s not yet clear just how much money DOGE is actually saving the government, the uncertainty it has injected into the economic picture has already made businesses and investors tighten their purse strings.
So whatever course the government chooses, the U.S. economy is running out of gas. Economic indicators have been softening for months. In addition to recent surveys on consumer and business confidence as well as travel plans, which show an increasing reluctance by Americans to spend, on the very day Mr. Trump announced his tariffs the Institute for Supply Management released its monthly index of manufacturing activity. It found that orders were dropping so sharply the sector will soon be contracting. Worse, managers expect to be paying much higher prices, suggesting that even more inflation is in the pipeline, which could further constrain sales and output.
As if that’s not bad enough, the Atlanta Fed produced its latest “nowcast” on the state of the U.S. economy, a running update using current data. It estimates that at the moment, U.S. manufacturing is shrinking at an annual rate of nearly 3 per cent which could translate into a very serious recession.
That figure has to be taken with a grain of salt. Not only are nowcast snapshots quite volatile, but American GDP has been artificially depressed by a massive wave of imports from firms trying to get ahead of expected tariffs. Nevertheless, the scale of slowdown points to an economy that is weakening quickly. As Mr. Trump delivered his triumphal state of the union address, the economy had begun imploding beneath him.
While some market analysts maintain that deregulation and tax cuts will boost the economy later this year, making any slowdown temporary, what they overlook is that conditions in the labour market will make it difficult for the economy to regain speed. Last year the Biden administration began clamping down on immigration, something the Trump administration has intensified. That has shown up in data on labour supply, whose growth is slowing sharply. At best, an American rebound will be tepid. At worst, it won’t happen at all.
In contrast, other major economies are showing renewed signs of life. For all its current difficulties, China is still growing at around 5 per cent a year, and the government is starting to implement new measures to further stimulate growth. India’s economy has slowed recently but is still expanding at an average annual rate above 6 per cent. But the really big story is Europe. The massive stimulus program agreed by the incoming German coalition and the move by Brussels to increase EU borrowing to fund rearmament has led to a renewed optimism for the European economy.
This means the path forward for this country is clear. Canada can’t get away from having the U.S. as its biggest trading partner, but it could reduce its dependence by pursuing closer ties with these trading partners. It could also take a page from the German handbook. While there is lots one can criticize in the way the federal government spends money, like Germany, it has been more prudent than many other developed countries in the way it manages its finances, which is why bond investors continue to offer it relatively favourable interest rates.
If the U.S. enters recession, it will drag Canada down with it. What better time to not only engage in a major program of infrastructure and defence spending, but to use that to deepen our trade ties with other partners. Canada can make this crisis an opportunity.