Warning signs global economic chaos could spread to Canada: Don Pittis

Canada's latest job creation numbers out at the end of last weekwere astounding. The most recentfigures for the country's economic growth, at an annual rate of 2.6 per cent, were better than almost anyone expected.

But while both U.S. and Canadian economic indicatorsclimbto new heights, there are growing warning signsthat neither will be able to escape a gathering stormthat is affecting so many other parts of the world.

Just as Canada's stunning employmentfigures were being released Friday, the latest victim of political and economic chaos, Turkey, was suffering a new economic disaster.

Contagion-triggered

In Canada, the unemployment ratefell back to its recent low of 5.8 per cent. Measured as a percentage of the population, Canada's employment rate and participation rate exceeds that of the U.S.

In normal times you would expectsuch an economic signal would drivethe loonie higher. Instead, a few hours after the jobs results the Canadian dollar was down nearly halfa cent.

"The loonie failed to gain momentum from that economic indicator release given the current geopolitical climate,"Alfonso Esparza, an analyst at the currency-trading company OANDA, said in an email.

And Canada wasn't the only country affected by the turmoil in the world.

"The Turkish lira has been in free fall and has triggered contagion fears as Spain, Italy and France have high exposures," wrote Esparza.

Before the Asian crisis of 1997, many analysts talked about "divergence" shorthand for the idea that the developed world, especially the U.S., would remainunaffected by contagion from the less-developed south.

In fact, as the Asian currency meltdown of the time unfolded, there was early evidence that the supporters of divergence had been right.

Flight to safety

While many warned then that a collapse of exportswould hurt the U.S. economy, a flood of money, sometimes referred to as the "flight to safety," poured into the country, pushing U.S. interest rates down.

"While the reallocation of capitaltowardsthe United States generated the above-mentioned negative trade effects on U.S. GDP, the capital inflows also generated a positive effect on U.S. GDP by financing an increase in U.S. spending, both directly and indirectly, by generating a drop in interest rates," said a paperpublished bythe New York Federal Reserveshortly afterthoseevents.

But in an interconnected world contagion can be subtle and delayed. Some say low interest rates contributed to the collapse of Long-Term Capital Management, a hedge fund that bet on foreign bond spreads with borrowed money.

Following a series of awful bets, the company was bailed out by the U.S. central bank in 1998 on the grounds that it could havecaused a widespreadnational,and perhaps global, economic crash.

Interest rates cuts by then-Fed chair Alan Greenspan to help markets cope had a twofold effect that helped bring on thefinancial crisis of 2008.Not only didcheap money encourage investors to bid up the price of real estate, the Fed's action assured investors that the bank would always step in to rescue them shouldthey getinto trouble.

The sanctions fad

Perhaps it isbecause some parts of the globaleconomy have returned to economic health that so many world leaders have been willing to put politics before economics. Led by U.S. President Donald Trump, hurtingyour former friends has become afad.

The U.S. has ordered sanctions not just on Turkeybut also on Russia, Iran and North Korea. It has put trade tariffs on nearly all of its trade partners, with an especially tough regimen against China, one of the world's two biggest trading nations.Saudi Arabia seems to have caught the bug with its decision to sacrifice its economy to fend off criticism on human rights.

And while Canada has so far not retaliated against the Saudis, that's unusual. Normally everysanction results in a counter-sanction.

While in the days of the Asian crisis twodecades ago, it was easier to think of countries such as Thailand and Indonesia, two nations at the centre of the currency and economic meltdown, as small and distant. But this time things are different.

As the share of the world's GDP controlled by the most developed countries has declined, China has grown so that, measured by the purchasing power of its people, it is now bigger than the U.S.

As China begins to weaken due to trade wardisruptions, countries that sell to it, including Australia, are beginning to feel the pinch. There are signs that foreign investment, including in Canadian housing, has stopped growing. This week's real estate numbers on Wednesday will offer more evidence.

In the case of Turkey, only months ago it was one of the world's fastest growing economies. Its location on the edge of the European continent makes contagion even more likely. High levels of education, advanced banking, industry and trade mean it is highly integrated into the European Union economy.

Spreading disease

On Friday, shares in Europeanbanks with Turkish exposure tumbled. So did the currencies of other developing countries including South Africa and Argentina.

Once again the flight to safety has begun to push the U.S. currencyup as global investors sell developing country assets and buy those denominated in U.S. dollars. That rising U.S. dollar islikely the main thingkeeping the loonie down.

But even more than in 1998, such a rushof money into the U.S. currency may be too much of a good thing. Already overheated by low interest rates, tax cuts and fiscal spending, the economy of our southern neighbour is unsustainablyhot.

And althoughit is something the leaders of the U.S. government seem to have trouble understanding, a flood of money into the economy inevitably results in a flood of money out, in the purchase of cheaper foreign goods,driving away the jobsthat Trump is using misguided means to try to protect.

Until he gets that straight, expect more rounds of protectionist attacks on Canada and many others, leading to another round of contagious economic chaos.

Follow Don on Twitter @don_pittis