How will the U.S. fiscal cliff affect Canada's economy?The 57th election for the President of the United States has come and gone with Barack Obama maintaining his POTUS status. Whether your political nature runs red or blue, on either side of the American border, one thing’s for certain – the leader of the world’s largest economy has decisions to make that will affect us all.

While some news outlets are musing that Democratic leadership poses less of an economic threat to Canada, this doesn’t detract from the looming “fiscal cliff”. Far from being the U.S.’ problem, the strategy employed by Obama and his still-split Senate will resound globally. Let’s break down exactly what’s at stake, both for our neighbours to the south, at home, and on the international scale.

What is the Fiscal Cliff?

Simply put, the fiscal cliff is the culmination of several economic and stimulus measures put in place as a result of the 2008 economic crisis and debt. At the stroke of midnight on December 31, 2012, some of these measures will become active, while others will expire.

Here’s what’s up for grabs as part of the Budget Control Act:

  • The expiry of Bush-administered tax breaks
  • The end of Obama-administered payroll tax breaks
  • Cut off of emergency unemployment benefits that went into play post-crisis
  • Spending cuts will go into effect as part of the 2011 Debt Ceiling deal – as many as 1,000 government programs could be affected.
  • Obamacare-related taxes will activate

The Impact of Tax Hikes and Spending Cuts

While many of these changes are generally necessary and symptomatic of recession recovery efforts (stimulus can’t last forever), combined they pose quite the shock to the U.S. economy. If everything moves forward on the 31, it could push the U.S. into another recession (and guess who’s going down with them).

Here are a few alternative scenarios on the Senate’s table:

Option 1: Slash the Deficit, and Burn

The good news – all proposed measures would result in cutting the U.S. deficit by HALF – a whole $560 Billion! The bad – GDP would also be cut by four points, enough to prompt the loss of 2 million jobs and an instant recession.

Option 2: Raise the Debt Ceiling

Another possibility is to avoid these measures altogether for the sake of jobs and growth – but it’ll plunge the U.S. into deeper debt. A higher debt ceiling will send international markets into a calamity. It will also shove the global economy into a new era of instability as Europe and any other faltering economy will be left to their own monetary devices. The cost of borrowing would skyrocket and, as experienced in the 2008 crisis, credit would crunch.

Option 3: Find Middle Ground

Why can’t we just all compromise and get along? Well, this is the generally desired outcome. But, as with all issues pitted against Senate, this is far easier said than done. Stance-wise, Republicans want to cut spending and avoid raising taxes altogether (and they’re harping on Obamacare to prove their point). Democrats are looking to balance things out with a bit of both. Either way, it’s a race against time to pick a strategy before the deadline and still manage to accomplish the resulting fiscal consolidation (worth $4 TRILLION over 10 years)!

The Canadian Impact

Our connection to our American neighbours goes far beyond the border crossing. They’re our largest trading partner and everything – from the state of their housing market, to their interest rates on borrowing – affects us.  One potential side effect of extending the debt ceiling could be a credit ratings downgrade courtesy of Moody’s Investor Services. Such action would further strengthen Canada’s dollar, and put our trade industry – which already hit a record high deficit this year – in further dire straits. It would also raise costs for Canadian companies borrowing from American banks.

Taking a credit hit would also leave the States unable to contribute to monetary bailouts for flailing international economies – meaning Europe and the IMF would be on their own.  Ever more dire are the resulting conditions should a U.S. debt payment be defaulted upon, plunging Canada and many other nations into recession. Seeing as our own Canadian household debt levels are in a precarious place at record highs, it leaves us exceedingly vulnerable.

So, keep an eye on those U.S. finance headlines in the months to come – the actions decided upon this winter will affect us all.