Canada should take no solace from America’s woes

America is heading “back to the Stone Age.” In some places, quite literally.

As “Third World America” by Luiza Ch. Savage details, “stone age” refers specifically to the practice of breaking up stretches of paved road and replacing them with gravel as a cost-saving measure, as some American towns have recently done. And yet the phrase also seems broadly symbolic of a larger process at work in the U.S. as it attempts to unwind a massive level of household and public debt. Throughout it all, Canadians should resist any urge to gloat. This is equally bad news for us.

The disappearance of government revenues in the U.S., primarily at the municipal level and driven largely by the collapse in the housing market, is having a significant impact on life in middle America. Savage, Maclean’s U.S. correspondent, provides numerous shocking examples of counties without police cars, parks without maintenance and classrooms without supplies.

The U.S. appears on its way to becoming a country without hope. Reinforcing the rocky theme, popular U.S. commentator Arianna Huffington says her country is moving “from the Jetsons to the Flintstones.”

And the news continues to worsen. In June, the most recent figure available, the U.S. trade deficit widened to nearly US$50 billion. The greenback is slipping. And the federal debt, already a mind-numbing US$13 trillion, continues to grow. The deficit for July alone was US$165 billion.

(Although this was a slight improvement from a year ago, when it was US$180 billion.) Fears of deflation continue to haunt what was once the world’s most vibrant economy. All this has economists lowering their already slight forecasts for growth in 2010. “The pace of economic recovery is likely to be more modest . . . than had been anticipated,” according to the U.S. Federal Reserve Bank. The U.S. economy is going sideways, not up.

Some Canadians may take a certain amount of satisfaction in the economic hardships faced south of the border. Our more heavily regulated banking system has proven to be more robust than that in the U.S. Canadian government deficits, while still large by historical standards, appear manageable over a period of a few years. Municipalities in this country are not going broke. And Canadian homebuyers have generally avoided the excesses of the American mortgage market. Our more cautious approach to government and markets appears to have paid off.

And yet Canadians should be careful not to give in to the delights of schadenfreude. A darker and more stony scenario may be lurking around the corner for us as well.

Paul Krugman, the Nobel Prize-winning economist and well-known New York Times columnist, has been effusive in his praise of the Canadian experience throughout the Great Recession. And yet he recently pointed to some danger signs that could spell greater economic hardship for Canada as well. “Canadians borrow and spend like, well, Americans,” he wrote on his blog recently. “And while they managed to avoid getting caught up in the big synchronized North Atlantic housing bubble, trends since are not completely reassuring.” He pointed to the frothy Canadian real estate market as a large risk. “Things up north bear watching,” he concluded.

Responding directly to Krugman’s warning, Canadian economists Derek Holt and Gorica Djeric of Scotia Capital recently observed that “he’s mostly right.” The economists fret that most commentators are “overly sanguine with respect to the state of Canadian household finances.”

Debt as a share of personal disposable income for Canadian households is at record levels, they note. While the U.S. reduces its household debt load through forced austerity measures, Canada’s number keeps getting bigger. And by some measures, the trajectory of house prices in Canada appears strikingly similar to that in the U.S. prior to the bust. “The Canada advantage isn’t immutable,” they conclude.

The fact Canada’s GDP slowed sharply in the second quarter of this year, dropping from an annualized 5.8 per cent rate in the first quarter to two per cent, further suggests caution over optimism.

Finally, it bears mentioning that, regardless of our relatively advantageous situation, the Canadian economy remains tightly and intricately wound with that in the U.S. Seventy-five per cent of our exports and over 50 per cent of our imports are attributable to the U.S. Expectations for economic growth in Canada still depend largely on what happens south of the border. We’re in this together.

With this in mind, the most optimistic scenario for Canada is a prompt and robust recovery in the U.S., plus a renewed commitment to austerity and debt reduction among Canadian households and governments. This is no time to rest on our laurels.