May 8 (Bloomberg) -- Financial markets will turn on the U.S. as they have on European governments if the U.S. fiscal situation doesn’t improve, said Martin Barnes, chief economist at BCA Research in Montreal.
The risks posed by the U.S. budget deficit are important for the Canadian economy, economists said at the Bloomberg Canada Economic Summit in Toronto today. While rapid moves to reduce the U.S. deficit could slow the Canadian economy, investors could also sell U.S. bonds if the government doesn’t do enough.
“I’m very worried,” Barnes said at the Bloomberg Summit in Toronto today. “It’s only a matter of time. It’s a question of when, not if, the markets do to America what they did to Europe. The markets will turn to the U.S. like a pack of wild dogs once they finish chewing Europe out.”
U.S. House Republicans have proposed a budget that would lead to a $3.1 trillion deficit over the next decade, a little less than half as much as President Barack Obama’s budget plan. The battle between Republicans and Democrats over reducing budget deficits is set to intensify toward year-end, when the administration and Congress must decide whether to extend income-tax cuts, raise the debt ceiling and allow automatic budget cuts to be enacted.
A U.S. slowdown caused by fiscal tightening constitutes a “bigger threat” for Canada than a financial crisis in Europe, said Avery Shenfeld, chief economist at Toronto-based CIBC World Markets. Canada ships about three-quarter of its exports to its southern neighbor.
“When you make the move to address budget deficits, if you do it too abruptly, you are left with the mess that we have in Europe,” Shenfeld said. “Recession is pretty much across the board in all the countries that have been forced or chose to adopt this austerity plan. And the U.S. has its own potential austerity coming in 2013 if they don’t change their policy trajectory.”
Fiscal tightening in the U.S. will probably be limited as lawmakers vote against scrapping tax cuts, Barnes said.
“They will extend most of the tax cuts,” he said. “They won’t let the defense spending cuts go through. There will be fiscal tightening but it won’t be anything near like the fiscal cliff that some people see.”
While progress has been slow, improvements in the U.S. housing and job markets point to a strengthening economy, said Eric Lascelles, chief economist at RBC Asset Management.
U.S. economic growth is poised to outpace that of Canada this year and next, according to economists surveyed by Bloomberg. U.S. gross domestic product will climb 2.3 percent this year and 2.5 percent next year. That compares with 2.1 percent in 2012 and 2.3 percent next year for Canada, a separate survey shows.
“We’ve seen I think a bottoming in U.S. housing markets,” Lascelles said. “I don’t expect much of a run forward, but I think we’ve probably seen a bottom. The job market has made an important turn. We’re seeing job creation. Important things are beginning to heal.”
Growth in the U.S. is strong enough that the Federal Reserve won’t need to undertake more asset purchases, known as quantitative easing, to spur growth, Shenfeld said.
Still, when compared with previous recoveries, expansion in the world’s largest economy remains “lousy,” Barnes at BCA Research said.
“It’s a very disappointing recovery,” he said. “We’ve lowered the bar on what is considered an acceptable outcome. I like to remind people that coming out of the 1981-82 recession, the economy grew 7.7 percent on average for six quarters. That was a recovery. At 3 percent growth it will take years to get the unemployment rate down.”
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