Who Will Win the Tariff War? Canada or the US?

After the American Century

Donald Trump has tried to bully Canada since the very beginning of his second term. So far he has failed, and it appears quite likely that he cannot win this confrontation of his own making. There are many reasons why he will likely fail.

1. Prime Minister Carney has strong popular support and few Canadians like Trump. Even before the failure to agree on tariffs last week, millions of Canadians have stopped traveling to the US, and they are boycotting many US goods. From the Canadian perspective, Trump's recent suggestion that Lake Ontario ought to be renamed Lake America is a gratuitous insult which worsens the possibility of a resolution to the conflict.  VP Vance's recent reference to Canada as a state, rather than a nation, was also an insult to Canadians. And in the trade negotiations, before they broke down, the US atacked the use of the French language in Canada, which is not negotiable nor is it a matter of trade. As a result, Trump has alienated a large majority of the Canadian public. Inside the US, the many insults may play well with the Republican base, but to the rest of the world they appear arrogant, undignified, and puerile.

2. Trump is also unpopular in the US, and he has begun this conflict with little support. Only one third of US voters approve of his presidency, and the attacks on Canada are among the least popular Trump policies. The Republicans may lose seats in the November elections if this trade war gets more serious and the already high inflation rises further due to the tariffs.

3. Canada's overall trade balance is better than that of the US, which has a long-term problem, as can be seen in the following graph from the Federal Reserve Bank in St. Louis. It tracks the trade balance each month from 1995. There is not even one month in the last 30 years when the US had a positive balance of trade. 

Indeed, there was a huge decline in January, February and March of 2025, as a direct result of Trump's sudden violation of treaty agreements, in a one-sided attempt to coerce other nations. These initial tariffs were later judged to be illegal by the US Supreme Court. 

How does Canada compare on overall balance of trade? The Canadians had a trade surplus every year from 1995 until 2008. Since then, it has had deficits in many years. However, since 2016 it has often been in the black. In the chart below the heavy black line shows the overall balance.  The light green above that line shows the trade surplus Canada has long had with the US; the dark green below that line shows the deficit with the rest of the world.

The reason Canada has a trade surplus with the US is largely due to three kinds of exports: crude oil via pipelines into the upper Midwest, electrical energy from Quebec to New England, and gold sold worldwide, but particularly to Britain. It also sells a lot of aluminum, automobile parts, and forest products.

    Note the overall result. Canada has had periods of surplus in its balance of trade, including $3.9 billion Canadian dollars in June. In short, despite Trump's attacks, its economy is weathering the storm nicely. Indeed, its trade balance is far better than the US's.

4. Canada is shifting its trade away from the US to more stable partners, notably in Europe and Asia. This takes time, but the tariff war will accelerate the process. Prime Minister Carney, who previously ran the Bank of England, is developing closer ties with China, Britain, the EU, and many of the Commonwealth nations. Canada is building a pipeline from its oil and gas fields to the Pacific coast, which will make it easier to sell to Asia. It is negotiating with the EU, with whom it already has a free trade pact. Moreover, the things that drive Canadian exports are all in high demand, and prices are rising, for gold, oil, and electricity. Ironically, Trump is helping Canada's balance of trade, because his policies and actions have driven up the cost of oil and electricity in North America, and his unpredictability has helped push up the cost of gold.

5. Canada  has more intelligent leadership that the US. Trump is an expert at alienating allies and truly masterful at creating uncertainty. No ally knows if the US will support them in a crisis. In recent weeks, he has needlessly angered South Korea. He has weakened the US standing in the Middle East with his ill-conceived war against Iran. He has infuriated Europe by backing away from Ukraine and coddling up to Russia instead. He has particularly alienated Denmark and the other Nordic nations by demanding Greenland. But there is no need to extend the list. Trump has made the US unpopular around the world, as detailed in a previous posting on this blog. In contrast, Carney has excellent relations with the EU and the Commonwealth nations, and Canada deservedly enjoys a good international reputation. In a tariff war, a nation needs friends. Right now, Canada has them; the US not so much.

In conclusion. Canada is in a good position to export is oil elsewhere, to sell its gold everywhere, and to demand higher prices for its electricity, aluminum and forest products sold to the United States. However, do not focus overmuch on the specific items subjected to tariffs in this battle. Focus instead on how successfully Canada reorients its trade toward new partners. While specific Canadian industries will be harmed in the short run, in the longer perspective the nation will gain by diversification. Trump wants to force Canada to become part of the US, but this is unlikely. Rather, like his hostile behavior toward NATO, which led Finland and Sweden to join, making NATO stronger, Trump's bullying is pushing Canada away toward more reliable partners. 

Of course, it does not have to end badly. Mr. Trump often reverses himself. He has created this crisis, and he can undo it. But the anger in Canada will not suddenly disappear should he seek reconciliation. Even if the tariff war ends well, the Canadians will likely push to diversify their trade relations and become less closely tied to the United States.

Back to Banking Basics: Learning from Canada

After the American Century

Once upon a time, mortgages were simple. The home buyer went to a bank, which (1) decided whether the house was worth its price, (2) whether the purchaser looked like a good risk, (3) what rate of interest to offer, and (4) how big a down payment was needed to seal the deal. Furthermore, (5) banks kept on hand a decent reserve of capital, in case some buyers defaulted on their loans. In those simpler days, all the risk was divided between just two parties: the customer and the bank. But all five of these elements of the simple mortgage have changed over time, and the disastrous results emerged in the present crisis.

(1) Houses were bought and sold for irrationally high prices. There were years when home prices rose by 20% or more. But salaries were not shooting up that fast, and banks should have considered the potential resale price to be less than the irrationally soaring market price. In Britain, for example, by 2005 people were buying houses for as much as five times their annual salary, but a good rule of thumb in the industry has long been that people cannot afford a house that is more than c. three times their salary. To find a way for ordinary people to pay extraordinary prices, banks invented all sorts of new kinds of loans, including some where the buyer only paid off on interest, without making any attempt to pay down on the loan itself. And so the bubble grew.

(2) Banks failed to make hard-nosed evaluations of whether customers were good risks. In fact, as has been documented again and again, lenders encouraged people to purchase homes that they really could not afford, secure in the knowledge that they would repackage and sell these dodgy mortgages to others. In many cases, banks divided up mortgages, repackaged them, and spread the (as it turns out toxic) risk, and so distributed these risky loans all over the world. By 2008 millions of people were defaulting on their loans, the rate of foreclosures shot up, house prices began to fall, the whole house of cards came tumbling down. In the United States, in January of 2009 alone the number of foreclosures was 274,399. Assuming an average of four occupants per home, that means more than 1 million people lost their house and all they had invested in it, in just one month.

(3) During the years of bad practices, banks also played games with interest rates. In Britain, for example, many banks offered quite low rates for the first years of a mortgage, whose cost then increased dramatically. Borrowers would then go out and pay some high fees to refinance the house and start the process over again, without ever managing to pay off much on the house itself. As a result of such practices and many other manipulation of interest rates, it became quite difficult for consumers to understand what they were really paying for a mortgage. so that "supply and demand" were not as important as (mis)perceptions of capital supply that stimulated irrational demand.

(4) Down payments have fallen over the last century. Back in c. 1920 it was not unusual to demand one third to one half of the total value of a house as a down payment. I am not suggesting that one should return to that standard, but it does put in perspective the developments since that time. After World War II, in the US, veterans could buy a house with a down payment of only $1, as the federal government insured the contract, making it risk free for the banks. Veterans did prove to be good credit risks during the expansive 1950s and 1960s. But the great success of such programs suggested that enormous economic growth could be achieved by extending more credit to more people, notably by asking for smaller down payments. Today, few people put up more than 20% as a down payment, the amount necessary to obtain the best interest rates. In some cases, cash payments were not made, as many people used their pension plans as collateral, putting their old age at risk. Thus there are people in the present crisis who are losing not only their homes but their pensions as well. Others paid higher interest rates but put up as little as a 5% down payment or in some cases even 0%.

(5) As the number of loan defaults snowballed, it quickly became apparent that banks were not prepared. They had not kept decent sized reserves on hand. In many cases, they had purchased mortgage insurance, from companies such as AIG, that is now the dead weight threatening to drown the whole banking system. For AIG became a global player in the mortgage business, giving the appearance of safety and solvency to all sorts of schemes, each of which helped banks to escape from the irritating demand that they actually have some money in their vaults. US banks on average have only about 4% of their capital value on hand in the form of actual money.

President Obama is trying to clean up this enormous mess, but it will not be easy, because the simple borrower-lender relationship has become so complex, with so much division and sale of risk, insurance schemes, and arbitrage that only accountants who specialize in this field can understand the billion dollar details. In the short term, it seems impossible to avoid pumping billions more into the under-regulated industry, to rescue the economic system as a whole. Meanwhile, the public is understandably furious that bankers should continue to be well paid.

Fortunately, there is a model for a better banking system: Canada. There, banks were kept under tighter control, and as a result the Canadians have weathered the world financial storm without much damage. Theie banks did not have so many dodgy mortgages and they had an average of 9.8% capital on hand, more than twice the US average. Canadians did not forget the five essential features to mortgage lending discussed above. In 2008 the Geneva-based World Economic Forum rated Canada's banking system as world's best. Not incidentally, the Canadian dollar today is far stronger against the American dollar than it has been historically.