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Loonie's plunge signals long-term risk for Canadian and global economies

OTTAWA - The Canadian dollar plunged to its lowest level in eight months before recovering Tuesday, sending a clear signal that Europe's debt crisis has the potential to reach across the Atlantic and impact Canada's mending economy.

The loonie has lost about eight per cent of its value over the last month in reaction to fears in global equity and financial markets about the lasting imprint of government debt, and now a new risk — the threat of war on the Korean peninsula.
 
Over the weekend, the Bank of Spain had to bail out Cajasur — the second savings bank in that country to receive public money since March 2009. On Monday, four other Spanish savings banks announced plans to merge amid concerns over solvency in the sector.
 
Tension in Asia has also risen since last week after North Korea was accused of the sinking in March of a South Korean warship. Seoul has called for sanctions against the North.
 
The Canadian dollar closed down 0.94 of a cent at 93.46 cents US on Tuesday after bouncing off a low of 92.18 cents US earlier in the day.
 
The loonie is not alone in seeing its value eroded. Other commodity currencies have also taken a hit in the flight to dependable and liquid U.S. Treasury bills.
 
The short-term impact on the Canadian economy of frightened financial markets and a loonie closer to 90 cents than parity, ironically, may be mostly positive.
 
A weaker dollar will give a much-needed boost to manufacturers and exporters who prosper whenever they can sell their products abroad with a currency discount.
 
And the unsettling of financial markets has caused real interest rates to soften for mortgages and other loans. Many Canadian banks have dropped posted rates on five-year mortgages to below six per cent.
 
As a result, prospects that Bank of Canada governor Mark Carney will start hiking rates next Tuesday have gone from a virtual sure thing a month ago to a coin-flip today.
 
Export Development Canada's chief economist, Peter Hall, welcomed the fact that the loonie's wings have been clipped, saying that a dollar at par had the potential to take two or three points off economic growth next year — the equivalent of about $30 billion to $45 billion in output.
 
But the longer term implications may be that Canada's recovery won't go as smoothly as many had hoped. The loonie is acting as a proxy for the global economy: when the Canadian dollar is down, it means so are prospects for global expansion, say economists.
 
"Everything and anything that happens in the world affects Canada," said TD Bank chief economist Don Drummond, noting Canada's dependence on trade and on the prices of commodities it sells to the rest of the world.
 
The longer term outlook is that many governments, not just the poor cousins of Europe, will soon need to deal with debt burdens that cannot be sustained, and the ensuing clampdown on spending will stall the recovery.
 
Several economists, including David Rosenberg of Gluskin and Sheff, said the risk of a second downturn in key economies, including the United States as Washington withdraws stimulus spending, has become very real. Much like in 2008-09, Canada would become collateral damage, they said.
 
"For a small, open (and) commodity-sensitive economy whose entire recession in 2009 was imported from abroad and south of the border, the answer is yes," Rosenberg said when asked whether a second dip is possible.
 
That still remains a minority view, although the TD's Drummond puts the risk at about 20 per cent.
The key question is whether the European crisis is an overblown temporary crisis, or the precursor of government debt woes in the United Kingdom, the United States and other larger economies.
 
Scotiabank portfolio manager Andrew Pyle said he believes the fears over Europe will blow over in a matter of weeks, which will cause both oil prices and the loonie to recover to previous levels.
 
"I think people will be surprised to see how quickly that will happen. I wouldn't be surprised to see us back to parity in July," he said.
 
But it's the longer-term prospects that most worries Drummond. He says the perception that the situation will stabilize if the bailout of Greece and other countries works, or that things will implode if the bailout doesn't work, is simplistic.
 
"Those countries (with large debts) aren't getting out of this any time soon . . . easy bailout or not," he said.
 
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