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The day after Greek bailout: worry and calculating impact

OTTAWA — Europe’s trillion-dollar debt solution held for a second day Tuesday as global stock markets and currencies headed back nearer to levels they enjoyed prior to last week’s steep sell-off.

OTTAWA — Europe’s trillion-dollar debt solution held for a second day Tuesday as global stock markets and currencies headed back nearer to levels they enjoyed prior to last week’s steep sell-off.

The Toronto market was up and New York down marginally, after big rebounds on both Monday.

Meanwhile, the Canadian dollar rose past 98 cents US, a signal that markets judged that global risk was diminishing.

But it appeared that investors as well as governments were keeping their fingers crossed, given the growing realization that the eurozone rescue package hammered out on the weekend may only delay the day of financial reckoning.

Gold, a traditional safe haven destination for nervous money, rose $19.50 to a record high close of US$1,220.30 an ounce.

The New York Times quoted a prominent equity analyst as describing the mood on Wall Street as a “wall of worry” over sovereign debt, China and other uncertainties.

The market monitoring group of the Institute of International Finance, co-chaired by former Bank of Canada governor David Dodge, warned that the crisis should be considered a “wake-up call” to other countries, including the United States and the United Kingdom, to get their fiscal houses in order.

In the short term, the backstop agreement did appear to assure holders of Greek treasury bonds they will get their money on maturity next week, and gave the country a window to make some additional borrowings at non-crippling rates.

But what happens next? And what might happen to the $1-trillion in pledged support if the rest of the so-called PIIGS (Portugal, Italy, Ireland, Spain and Greece) need help to finance their debt.

“We fear that as the market gives this announcement ... more than a few hours of scrutiny and assessment, the day after the day after may not play out as nicely as the day before it,” said Carl Weinberg of U.S.-based High Frequency Economics.

Although North America’s exposure is indirect, even Canada stands to lose from the fallout.

The TD Bank’s deputy chief economist, Craig Alexander, says Canada’s economy would take a significant hit — just like it did in 2008 — if government debt worries lead to a second financial market crisis. Even if the problem is somewhat contained, Canadian economic growth will be slowed by Europe’s debt problems, he said.

A slowdown in the European economy — the world’s biggest — would cut demand for Canadian exports to Europe of everything from machinery and manufactured goods to food products, grain, fertilizers and chemicals. But Europe represents only about 10 per cent of Canadian exports, so the impact would be relatively minor.

A debt default would also cause financial losses to any Canadian bank or companies holding European bonds, but again the exposure appears to be minor.

The real danger, says Alexander, is if a debt default or debt restructuring leads to the failure of one or more major European banks, it could cause a knock-on effect that causes international credit markets to seize up as occurred in the fall of 2008 following the collapse of Lehman Brothers.

“We saw the real impact of that. You saw export financing dry up and exports shipments plunge globally. That’s the worst case scenario for Canada,” he said.

Given that about one third of Canada’s economy is based on exports, the country fell into a recession lasting almost a year with the loss of over 400,000 jobs as a result of the recession after the Lehman collapse.

Even under the best case scenario — that European countries and the United States manage to put in place the austerity measures needed to assure markets their debts can be managed — the result would be slower global growth, which would still affect Canada’s export sector to some degree.

By one calculation, modest austerity measures in Europe would slice about one per cent of gross domestic product from the continent’s already weak growth prospects, with some Mediterranean countries plunged back into recession.

The irony is that Canada would also suffer even though it has done most things right, says David Rosenberg, chief economist with Toronto-based Gluskin Sheff.

“Being a small, open economy sensitive to commodity prices, this is one of the many times when sudden shifts in global economic sentiment can hit us disproportionately,” he said.

Alexander still believes a double-dip recession remains an outside risk, but adds it can no longer be dismissed as easily as it was a few months ago.

Canada’s economy grew by a surprisingly strong five per cent in the last three months of 2009, and judging by the 109,000 new jobs added in April, it is still advancing strongly. But now it is expected to slow considerably in the second half of the year.

“The good news is we got out of the recession; the bad news is we have the legacy of late 2008-2009 to deal with and those legacies are enormous,” Alexander said.

“I’m worried (that) if the U.S. economy slows down and the global economy moderates, once again the export sector is challenged, and we’re going go through this at the same time the dollar is strong. I think the expectations for strong economic growth going forward needs to be tempered.”

For Europe, the repercussions from letting government debt cross over to the unmanageable column could restrain growth for a decade, he said.