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The elephant in the room

Credit unions, especially those invested in auto, steel, softwood lumber and dairy exports, are keeping a close eye on the flip flops, uncertainty and bluster being trumpeted in Washington, DC over NAFTA.

Sharing a continent with a bigger, richer, more aggressive neighbour has always been a challenge for Canadians, but never more so than during the past 18 months since our neighbour’s brash, braggart cousin from New York became head of the family.

The headlines are chilling if you’re an Ontario autoworker, “Trump vows to end NAFTA,” or a steelworker, “Trump imposes tariffs on steel and aluminum imports,” or a British Columbia lumber worker, “Trump imposes 20 per cent tariff on softwood lumber,” or an Ontario or Quebec dairy farmer, “Trump wants to end supply management.” (NAFTA is the North American Free Trade Agreement between Canada, the US and Mexico.)

With his focus on returning America to some long-lost time when everything was great, all cars were built in Detroit, all steel was forged in Pittsburgh and all immigrants came from Europe, President Donald Trump is trying to impose his vision of Trumponomics on North America and the world.

It’s impossible to follow the never-ending twists and turns as Trump tweets one policy at 5 am, more at 6:30 am, only to head in a different direction by noon. But let’s look at the most important fallout from Trumponomics and what it means to Canadian credit unions and their members.

The two main elements of Trumponomics are its domestic actions: tax cuts, increased infrastructure spending and a rising deficit in addition to the international trade and tariff moves mentioned above. In an interview with The Economist a year ago, Trump said his economic policy “really has to do with self-respect as a nation. It has to do with trade deals that have to be fair.”

The main aim of Trumponomics is to boost economic growth. To that end his tax-cut induced deficit will pour more money into an economy that is already growing close to capacity with high employment. An economist will tell you that’s a recipe for inflation. “Trump’s tax cut and job act plan comes at a time when the economy in the United States is operating pretty close to full capacity,” says Helmut Pastrick, chief economist at Central 1 Credit Union. “You add new fiscal stimulus and tax cuts and that adds fuel to the inflation fire,” Pastrick says.

“We are seeing some increase in investment even though the uncertainty is quite high.” – Benoit Durocher

Pastrick expects US interest rates will continue to rise and spill over into Canada. The Bank of Canada probably won’t follow the Federal Reserve (the US central bank) in lockstep, although the trend should
be higher, Pastrick says. “But long-term bond yields very much do follow US bond yields.” Assuming economic growth remains at about three percent, “then those higher bond yields are going to
spill over into Canada and that will mean higher cost of funds and higher mortgage rates, even if the Bank of Canada were to remain on hold.”

Pastrick says the good news is that credit unions and banks benefit with rising rates so the net interest margin is beginning to improve.

Frank Kennes, vice-president of Agricultural and Commercial Lending at Libro Credit Union (104,000 members, $3.5 billion in assets) says rising rates are positively impacting its bottom line. “The two small increases in prime have already started decompressing things and there is more money to be made for us when prime goes up but there isn’t a corresponding increase in savings rates. It’s positive for us at this point,” says Kennes.

Impact on credit union members

So, how are credit union members responding to Trumponomics so far? “People have heard a lot of bluster but they haven’t really seen any negative impact on our economy at this point,” Kennes says. He compares it to the response by farmers who over the past 20 years have heard many threats that supply management will be dismantled. But there’s never been any action, so now they just shrug off the worry and carry on. “There’s a threat but nothing happens,” says Kennes. “Trump blows a lot of air but nothing has happened at this point. That’s not to say that it won’t but I think a lot of people in a lot of businesses are saying we have to see it to believe it.”

In Windsor, Ont., the heart of Canada’s automotive industry, Charles Janisse, CEO of Motor City Community Credit Union (12,250 members, $350 million in assets) is seeing a similar reaction. His credit union has several business members in the auto parts and tools sector. “They have so much business today that their primary concern is meeting the needs of the business that they have,” Janisse says. “They are worried about the future, they are worried about what NAFTA is going to do but until they have to deal with it they have to deal with the issues they have today, such as a shortage of skilled trades.”

But the trade threats are lurking at the back of their minds. “All of the automotive people that we deal with are saying, ‘Come see me in 18 months because we expect there to be a slowdown.’ They want to make sure they don’t over extend and they want to make sure they have adequate capital to survive a slowdown, because they’ve seen these slowdowns before. Any changes in NAFTA are something that will potentially impact that slowdown.”

Janisse says that in the short term, with factories running full steam, they can pass on any cost increase that might be caused by tariff turmoil “but as soon as there’s a slowdown that’s where you really see it.” On the other hand, he says Motor City has business members that have unique skill sets in the automotive field and they will be able to carry on, no matter what happens.

Pastrick notes that NAFTA does need to be updated, since it was drafted 25 years ago. “The whole notion behind these negotiations was to modernize the agreement. This agreement came into effect in 1994. In many significant respects the world has changed, particularly on the digital front.” He says all the countries have concerns about the need for updated rules on intellectual property, in part due to advances in technology and software and regions like pharmaceuticals.

What if the US walks?

Trump has threatened, repeatedly, to walk away from the agreement if he doesn’t get a deal he likes. This has led to an unprecedented US lobbying program by Canadian politicians and business leaders in Washington and key states. Realizing the importance of trade for their regions, many governors have joined in the effort.

“Trump’s tax cut and job act plan comes at a time when the economy in the United States is operating pretty close to full capacity.” – Helmut Pastrick 

What if there is no agreement and the US walks away?

Then, trade between the countries would fall under World Trade Organization (WTO) rules. That means Canadian companies would face duties of about five percent on shipments to American customers and closer to three percent on many auto parts.

How would that translate in dollars and cents?

“If NAFTA is withdrawn, there will be a negative impact on the North American economy, for all participants,” Pastrick says. “Mexico has the most to lose, followed by Canada. Then the US Equity markets would go down, the Canadian dollar would probably drop but when it comes to the real economy the impact would continue to play out over time.”

Without NAFTA the GDP of the Canadian economy would be about one percent lower over the next five years,
a cut that could cost 90,000 jobs, the Conference Board of Canada projects. While that number is not insignificant, especially to the individuals affected and the communities where they live, it would not be a disaster. “The worst scenario is the end of NAFTA and a return to the WTO rules, which would not be catastrophic for the Canadian economy,” says Benoit Durocher, senior economist at Desjardins Group (seven million members, $258.4 billion in assets). “Many businesses are starting to invest again just to be able to keep up with the increase in external demand and also the domestic demand,” Durocher says. “We are seeing some increase in investment even though the uncertainty is quite high.” That’s unlikely to stop even without NAFTA, Durocher adds.

Despite his government’s huge efforts to preserve NAFTA, Prime Minister Justin Trudeau says its loss would not be a catastrophe. “We will not be pushed into accepting any old deal and no deal might very well be better for Canada than a bad deal,” he said during a trip to Chicago earlier this year.

Tariffs on BC softwood lumber

A look at BC’s softwood lumber industry gives a glimpse of what happens when tariffs are imposed. This past January, Canadian exports of lumber and sawmill products dropped 14 percent after the US imposed duties late last December, Statistics Canada reported. But the softwood lumber industry has been the centre of trade friction for years and BC has dealt with it by finding new customers.

BC once sent nearly all of its softwood lumber exports to the US. Now, America accounts for about half the industry’s $5 billion export business, with 26 percent of sales going to China and 16 percent to Japan. The flipside is the impact the tariffs are having in the US. It’s estimated the softwood lumber duties cost American companies about $1,500 more to build a single-family home and, in some hotly competitive markets, they are looking at price increases to pass that cost on to purchasers.

Pastrick says that China is Trump’s real target on the trade front “and indeed there are some legitimate reasons. China has not been a fair trader in its history and it does have issues with intellectual property and technology transfer.”

Will the turmoil ever end?

One top American analyst, Terry Haines, managing director of research company Evercore ISI, told The New York Times he sees “no trade war, but also no trade peace.” Haines says that the US could launch a steady stream of actions against trading partners, especially China, and some of them may even prove costly. But Haines argues it is unlikely that Trump will escalate things in ways that will launch a 1930s-style cycle of rising tariffs and all-out economic warfare.

Let’s hope he’s right. ◊