Feet to the fire

Maybe divide-and-conquer was the plan all along.  Maybe Donald Trump is trying to exact revenge for Justin Trudeau's perceived slight after the G-7 summit back in June.  Either way, Canada is now in a very tricky place: NAFTA as we have known it for a quarter of a century is on its last legs, and the US and Mexico have agreed on the outlines of a replacement deal that is now being offered to Canada on what amounts to a take-it-or-leave it basis.

The US administration plans to table the deal in Congress this Friday.  With the mid-terms approaching, there is no prospect that the deal will actually get passed by the House and the Senate until next year.  Rather, the short deadline is for Mexican political purposes, allowing incumbent President Pena Nieto to sign off before his sexenio ends in December and his successor takes over.  So by Friday Canada can either sign on to the deal, or reject it and take its chances on negotiating its own bilateral arrangement with the US -- which, lest we forget, accounts for over 70 percent of Canada's exports.

Full details of the accord are not yet available, but there's enough information to suggest that there may be quite a lot in it for Canada. This article lists five key elements of the agreement; we can just consider two items that have loomed large in the negotiations from the outset, but now appear to have been agreed:

• On autos and auto parts, the US and Mexico have agreed to boost the percentage of the value of a vehicle that has to be locally made in order to qualify for tariff-free treatment.  In addition there is a new and separate percentage of the value of the vehicle that has to be manufactured in plants where workers are paid more than US$ 16/hour.  It may seem surprising that Mexico has agreed to this, but early analyses suggest that very few vehicles now made in Mexico would fall foul of the new rules.  Since auto wages in Canada are in line with US levels, there seems to be little reason for Canada to balk at this part of the deal.

• The US originally wanted any NAFTA replacement to have a five-year term, after which any of the parties could walk from the deal.  What has now been agreed is a sixteen-year initial term, with a review after six years leading to a potential extension back to a sixteen-year life.  This appears to represent a major concession by the United States, and should allay Canada's concerns that a short fixed term would make investment decisions impossible.

Canadian negotiators are now back at work and Foreign Affairs Minister Chrystia Freeland has cut short a trip to Europe in order to join the talks in Washington.  Assuming Canada can live with the deal that has been made on autos and the sunset clause, there are two major issues that could stymie attempts to join the deal: dispute resolution and agricultural supply management.

• As regards dispute resolution, the US has always been unhappy about any arrangement that offers recourse to a decision-maker outside the US judicial system, whereas Canada (and Mexico) have preferred not to have to take their chances with US courts.  It is not yet clear how the US-Mexico agreement handles this.

• Supply management may prove the most vexed issue of all. Trump has regularly railed at Canada's tariffs of "300 percent" on dairy products, and he's only exaggerating slightly -- the highest tariff, on butter, is actually 298 percent.  The strongest support for supply management comes from the farming lobby in Quebec; awkwardly enough, there is a provincial election coming there in October.  Still, Canada made some concessions on supply management in order to secure the Trans Pacific Partnership (TPP) deal -- which, of course, Trump walked away from.  This suggests it may be possible to offer some changes that will satisfy the Americans, and as a side benefit provide relief to Canadians stuck paying exorbitant prices for milk, eggs and cheese.

Mexico seems to want a trilateral deal, and despite Trump's tough talk and threats, it seems most of his team wants that too. Whether it can all be squared away by Friday remains to be seen.  And whether Canada joins the deal or not, the domestic political ramifications stand to be severe, because the unctuous Trudeau and the abrasive Freeland have comprehensively botched this file from day one. 

Bank for International Settlements tackles protectionism

This speech by Agustin Carstens, General Manager of the Bank for International Settlements,  is well worth reading.  Speaking at the Kansas City Fed's Jackson Hole conference, Carstens spelled out the reasons why recent trends in international trade alarm him, "as they no doubt alarm many of you":

"Reversing globalisation puts at risk the real economic gains that have come about through closer trade and investment links. This could increase prices, raise unemployment and crimp growth. Retreating into protectionism also risks unravelling the financial interdependencies that enable and encourage trade and investment links. This threatens to unsettle financial markets and put a drag on firms’ capital spending, as investors take fright and financial conditions tighten. Finally, these real and financial risks could amplify each other, creating a perfect storm and exacting an even higher price."

Following Carstens' example, let's take inflation first:

"The globalisation of firms and markets has no doubt contributed to the persistently low level of inflation in recent years. Low inflation has been driven by two long-term forces: trade and technology. Fostered by liberalisation, increased trade openness and, in particular, competition from imports produced in countries with lower wages, drove down prices in advanced economies......"

"...technological advances, especially automation in manufacturing, have brought down global production costs. These two forces go hand in hand. Innovation and more open markets have radically reshaped global production, replacing locally segmented manufacturing with global value chains. These depend on financial openness. They have put downward pressure on firms’ production costs and market power, keeping in check both prices and, ultimately, aggregate inflation....."

".... Seeking to turn back the clock and to retreat to a simpler world of local production may undermine the market discipline that helped curb inflation."

Carstens argues that US tariffs will push inflation higher, forcing the Fed to tighten monetary policy in response.  That in turn would cause the US dollar to strengthen, leaving US manufacturers facing a double whammy in the form of an uncompetitive exchange rate and the retaliatory tariffs imposed by US trading partners. Trump's criticisms of Fed rate hikes may mean that he is dimly aware of this, but rather than admitting the main cause of the problem -- the tariffs -- he seems more likely to attempt to browbeat the Fed.

As regards the impact of tariffs on growth and incomes, Carstens makes reference both to investment and income inequality:

"The uncertainties of turning back the clock imperil investment in advanced economies too, as companies put on hold plans for new or expanded production. Orders for capital goods, although volatile, are showing signs of a distinct deceleration this year from last year’s brisk growth in the United States, Germany and Japan..."

"...Retreating into protectionism, by raising tariffs and ripping up trade agreements, will not fix inequality. For example, as a just-released BIS working paper finds,  revoking the North American Free Trade Agreement (NAFTA) would create only losers, certainly at the national level in Canada, Mexico and the United States, but also generally across North American regions. While higher trade barriers would shield some domestic industries from import competition, the resulting wage gains would be more than offset by the damaging effects of reduced export opportunities and the increased cost of imported inputs for manufacturing firms..." 

A remarkable graph in Carstens' paper shows that of 435 US Congressional districts, only THREE would not see a decline in real wages if NAFTA were revoked.  The graph also shows that Canada and Mexico would, unsurprisingly, suffer somewhat worse than the US in that event. Given Trump's indifference to inequality and to the fate of his neighbours, it is unlikely that this will carry much weight in the White House.

Lastly, the risks to financial markets:

"....Trade in commodities and finished goods requires only simple financial services, such as cross-border payments and foreign exchange. But complex trading relationships....need complex financial services to glue production processes together.  The far-flung operations of multinational firms, which account for an increasing share of trade, require lots of working capital and entail lots of exposure to foreign currency risk.  More complexity is added by the financial transactions needed to manage these positions, including derivatives and hedging strategies to offset currency risk. 

All these links rely on the dollar, which remains dominant in trade transactions or bank loans for working capital, and in international banking or securities markets more generally.  Indeed, in currency markets, the dollar prevails even more in the swap and forward markets than in the spot market." 

Carstens offers examples of financial risks taken directly from recent headlines: the gyrations of the Mexican peso in response to trade developments, and the impact of tariff-induced commodity price rises on the share price of General Motors.

Having laid out these risks, Carstens closes with two short summary sections. The first, titled "A perfect storm?", warns of the risk that trade tensions could trigger all-out currency wars, with "implications for everybody".  And even if the worst case is avoided, Carstens is in no doubt that the net impact of the trade war that the Trump administration seems bent on causing will be negative.  His final section, titled simply "Pain not gain", ends with an unequivocal forecast:

".... in the long term, protectionism will bring not gain, but only pain. Not just for the United States, but for us all."

It's a short paper -- just nine pages, with lots of pretty pictures -- but sadly, that probably won't help it to gain any attention in the Oval Office.

Behind the curve?

Statistics Canada reported this morning that Canada's consumer price index (CPI) jumped 0.5 percent in July, raising the year-over-year rate to 3.0 percent from 2.5 percent in June.  This marked the largest annual increase since 2011 and was way above the consensus expectation, which had seen the year-on-year rate remaining stable. The data promptly boosted the Canadian dollar as traders priced in a higher likelihood of a further rate hike by the Bank of Canada, possibly as soon as September.

All eight major components of the CPI rose in July, which sounds ominous, but in truth, the key culprit for this surge was the transportation index, which rose 8.1 percent in the year to July, compared to 6.6 percent in June.  Within that index, the key component was the price of gasoline, up 25 percent in the year, a development which StatsCan attributes to rising international crude oil prices and supply disruptions. 

Retail fuel prices in Canada are remarkably volatile because retailers are generally competing for supplies with US border states.  In my own region, right against the New York State border, gas prices are now fully 10 percent lower than they were in July.  This may suggest that the upward pressure seen this year is starting to wane, although of course it would only take a supply disruption (such as a hurricane in the Gulf of Mexico) to set prices rising again.

Has the Bank of Canada fallen behind the curve in its efforts to keep inflation at a 2 percent pace?  Looking beyond the headline figures, the answer still appears to be "no".  The average annual increase in the Bank's three favoured core inflation measures was virtually unchanged in July, merely edging up to 2.0 percent from 1.96 percent in June.  That certainly does not suggest that the Bank has much scope for complacency here. but it should give it the luxury of waiting a little longer to determine whether the July blip really is the result of one-off factors.  It remains likely that the next 25 bp rate hike will come in October rather than September. 

The twisted logic of a tariff war

Canadian Finance Minister Bill Morneau has launched a quickfire 15-day consultation on the impact of US tariffs on the Canadian steel industry.  Steelmakers are already feeling the impact as cheaper foreign steel that would previously have gone to the US is diverted to Canada. It seems inevitable that the consultation will produce evidence of mounting damage, in which case the government will move to apply tariffs or quotas of its own.

This was all depressingly predictable as soon as Trump imposed tariffs on steel and aluminum imports, but read the first sentence of the linked report carefully.  It describes Morneau's move as "an olive branch of sorts" to the Trump White House. 

I confess I had to read further into the article to discover the supposed logic here.  Apparently the White House is complaining that Canada represents a back door into the US market for steel from third countries (i.e., primarily, China).  It's not clear how this works: steel trans-shipped from China to the US via Canada is still subject to the US steel tariff, so there seems to be no advantage to be had.  Morneau's concern is surely that steel that was formerly headed to the US is now being rerouted to Canada as its final destination, displacing domestic production.

So it may not be much of an olive branch, though it will probably do no harm if the big thinkers in the White House see it that way.  What we can see, however, is that the precise ripple effects of an individual trade measure, be it tariff or quota, are difficult to foresee in advance.  Moreover, those effects can surface very quickly, forcing other countries (Canada in this particular case) to institute protective measures of their own that will in turn set off other hard-to-predict reactions.

If this is the fallout from tariffs on a relatively commoditized product such as steel, one can scarcely  imagine the impact of tariffs on a much more closely integrated industry such as automobiles.  Better hope we don't have to find out.     

Canadian economy at a turning point?

Almost all of the recent data on the Canadian economy have been strong.  GDP rose much more quickly than expected in May, retail sales are robust, housing prices have started to recover and exports are at record levels despite the Trump trade war. At first glance,  employment data for July, released this morning by Statistics Canada, seem to tell the same story.  The details of the report, however, may be starting to point in a less favourable direction.

In terms of the headlines, the economy added 54,000 new jobs in the month, well above expectations.  This pushed the national unemployment rate down by 0.2 percentage points to 5.8 percent, matching the multi-decade low seen in May.

But let's look at some of those pesky details:

• The net gain in employment for July was more than fully accounted for by part-time jobs, which rose by 82,000 in the month, offset by a loss of 28,000 full-time positions.  This marks the second straight month that part-time positions have accounted for the bulk of the headline gain in employment.  For the past year and more, effectively all of the gains in employment have been of the full time variety, but this now seems to be starting to change.  On a rolling 12-moth basis, full-time jobs are still predominant (211,000 out of 246,000) but the pattern does seem to be shifting in a less-favourable direction.

• For the second month in a row, Ontario led the job gains, posting an increase of 61,000 in July.  There are two important reasons to believe that this cannot continue.  First, Ontario is clearly the Province most exposed to any escalation of the incipient tariff war with the US, especially if the threatened tariffs on automobile exports come to fruition.  Second, it seems certain that the new Ford administration will have to start cutting public sector payrolls if it is to meet its assumed budget targets, even though it pledged not to do so during the election campaign. 

• Virtually all of the new jobs in July -- just below 50,000 -- were in the public sector, with only 5,000 new private sector jobs created in the month.  This seems to suggest that the state of the overall economy may not be as robust as the headline level of job creation seems to suggest.  

None of this implies that the Canadian economy is about to hit a brick wall.  However, some of the near-euphoria that recent economic data have prompted in part of the media is almost certainly overblown. Further monetary tightening by the Bank of Canada still seems likely, most probably early in Q4, but there is little prospect of a return to the above-trend growth rate seen a couple of quarters ago.

Serial screw-ups

The mix of smug self-righteousness and callow inexperience that has characterized Justin Trudeau's government from the outset is starting to cause real problems.  It's unusual in Canadian Federal politics for a government to serve only one term and then get thrown out again, but the way things are going for Justin and his pals right now, you wouldn't bet on them winning next year's election.

We could look at all manner of domestic issues here:  the failure to forge any kind of consensus on energy pipelines;  the insouciant response to the rising number of irregular refugee border crossings, especially in Quebec; Trudeau's backtracking on his loudly-proclaimed zero tolerance policy when he himself suddenly faced a sexual harassment accusation.  But let's confine ourselves to foreign policy,  because that's where the action seems to be right now.

Donald Trump's performance at the G7 summit in Quebec a couple of months ago seems to have been a bravura exhibition of oafishness, but at the end of the day, an agreed statement was crafted.  However, Air Force One was barely wheels-up when Trudeau saw fit to stand up at a press conference and brag about how he had made it clear to Trump that Canada would not back down in the face of tariff threats.  That's a viewpoint that has plenty of support at home, but it was not a smart thing to say right then, particularly given Trump's famously thin skin.

Trump promptly tweeted that Trudeau's backstabbing (as he saw it) would cost Canadians "a lot of money", and developments over the past few weeks have clearly been heading in that direction.  The threat of auto tariffs began to ramp up sharply almost as soon as the summit was over, and may not be averted despite intensive lobbying by US automakers.  More broadly, Canada has found itself excluded from NAFTA renegotiations currently underway between the US and Mexico, with those two countries increasingly confident of a deal by the end of this month.  Canada may well find itself in a "take it or leave it" position if a bilateral deal is reached.

It is reasonable to conclude that Canada's exclusion is a reflection of Trump's anger over the post-G7 debacle, but there may be another factor at play.  Word is that the US NAFTA negotiator, Robert Lighthizer, cordially dislikes his Canadian opposite number, Chrystia Freeland.  Ms Freeland had no diplomatic experience before jumping in at the deep end as Canada's Foreign Affairs Minister, and her ability to offend people does not appear to end with Lighthizer.

Late last week Freeland's Ministry took to Twitter to berate Saudi Arabia over its treatment of dissidents:

Canada is gravely concerned about additional arrests of civil society and women’s rights activists in #SaudiArabia, including Samar Badawi. We urge the Saudi authorities to immediately release them and all other peaceful #humanrights activists. 

The Saudis saw this as an unforgivable interference in their internal affairs and promptly vowed to cut off trade and investment dealings, throwing out the Canadian Ambassador to Riyadh for good measure.  This in turn triggered a remarkable piece of virtue signalling from Ms Freeland's spokesperson:

"Canada will always stand up for the protection of human rights, very much including women's rights, and freedom of expression around the world. Our government will never hesitate to promote these values and believes that this dialogue is critical to international diplomacy."

It's more than forty years since my brief stint in the UK Diplomatic Corps, and of course we didn't have Twitter in those days.  Still, I'm pretty sure that unsolicited and accusatory public statements  can never be considered as either dialogue or diplomacy.  You don't send highly-paid and qualified representatives to each other's capitals and then conduct your diplomacy using the modern day equivalent of a megaphone.

The Saudis are giving as good (or as bad) as they get in terms of rhetoric, per this tweet from the Foreign Ministry:

#SaudiArabia is gravely concerned about the Continues Canadian occupying of the land of Natives who lived and owned their lands hundreds of years. We urge the Canadian authorities to immediately gather its own people and go back to Europe where they belong.

In the meantime, Saudi students are being withdrawn from Canadian universities, the Saudi government is starting to sell its holdings of Canadian assets and so on.  It ought to be a tempest in a teacup, but given the self-righteousness of Ms Freeland (and no doubt also of her boss, the Prime Minister), it's unlikely that Canada will back down from its position, and the Saudis see no reason to do so either.  Trudeau and Freeland may think they are speaking up for "Canadian values" here, but a quick perusal of the reader comments on this article would seem to suggest otherwise.    

Doug Trump and Donald Ford

When Doug Ford was elected Premier of Ontario back in May, it was obvious to everyone that he was riding the same populist, let's-break-things wave that took Donald Trump into the White House.  Similarities between the two men were apparent before Ford's victory, and have only become more striking since Ford took office.  Let's take a quick look.

Both portray themselves as self-made men of the people but this isn't true.  Both have carried on businesses first established and built by their fathers -- real estate in the case of Trump; label-making in the case of Doug Ford.

They have a nil-to-negligible amount of political experience. Absolutely nil in the case of Trump, unless you count his occasional musings about running for office during various talk show appearances; one four-year term on Toronto City Council for Ford, but that hardly counts since his attendance record was abysmal.

Arguably each man only won because of the nature of the opponent he faced. Both Hillary Clinton and Kathleen Wynne were infinitely more experienced and qualified, but each was about as pure a definition of an establishment candidate as you could find. Given the nihilistic mood of much of the electorate, this was fatal.  Any Democrat you can name would have beaten Trump; somewhat less certainly, you can argue that Ford might not have been elected if Wynne had swallowed her pride and quit before the election campaign started.

In both cases it was assumed that once elected, their parties would hold them back from carrying out their more outrageous election promises.  Not so: Trump has moved the US embassy in Israel to Jerusalem, cancelled the Iran nuclear deal, slashed taxes for the wealthy, crippled Obamacare and set off a trade war.  Doug Ford has moved to downsize Toronto City Council, reduce beer and gasoline prices, abolish an updated sex-ed curriculum and start a legal battle with the Federal government over climate change. 

As a corollary of this the "adults in the room" have become irrelevant and powerless.  Trump's cabinet room has had a revolving door since Day One, with no-one seeming able to rein in their boss's worst instincts. Similarly, Ford's cabinet already seems to be something of a sideshow. with the Premier clearly loving and hogging the spotlight in the Provincial legislature. 

How you feel about this, of course,  depends on whether you liked the two men's ideas in the first place.  From my point of view, both Trump and Ford offered up a series of idiotic promises and are now putting them into practice.  But if that's what you wanted, that's what you're getting, and you're getting it hot and fast.  That's why both men are able to count on the support of their so-called "bases" even as the media and much of the electorate looks on aghast, and it's why both seem set to wreak changes that will last well beyond their term in office.

As a footnote, there's one small consolation to be had here in Ontario.  There's almost nothing Ford is doing that I personally support, but it's fun to watch the collective blood pressure at the Toronto Star rise ever higher as one illiberal measure follows another.  Panicked editorials are showing up almost daily.   Get used to it guys -- he's just getting started.