What happens if the U.S. defaults on its debt for the first time, and how will that affect Canada and Oil-rich Alberta?

The U.S. debt limit was reached in January 2021, but the Treasury Department used extraordinary measures to avoid a default until early June 2021. Then, however, Congress raised the debt limit by $2.5 trillion and extended it into 2023, averting a potential crisis. As a result, the debt limit could have been reached on December 15, 2021, but the government avoided default until early 2023.

Canada’s economy grew by 5.0% in 2021 after contracting by 5.1% in 2020 due to the COVID-19 pandemic. The recovery was driven by domestic demand, especially private consumption and fixed investment, as well as exports of goods and services. As a result, inflation dropped to 4.3% in March 2021 from 5.2% in February 2021 but remained above the Central Bank’s target range of 1.0–3.0%. In addition, Canada had a trade surplus of CAD 1.04 billion in March 2021, the highest since July 2014, as exports rose 6.6% month-on-month and imports increased by 4.3%.

Crude oil prices have been on a downtrend since October 2021, mainly due to the emergence of the Omicron variant of COVID-19, which raised concerns about global demand and travel restrictions. However, gasoline prices in the U.S. and Canada have risen to record highs due to the closures of six refineries in the U.S. The refining process comes at a cost. However, the operating oil refineries added 30% to 40% spread per gasoline barrel, the highest in 45 years. The spread currently sits at a record high as current north american demand stayed the same into a weakened refining capacity.

Based on this information, one possible scenario is that if the U.S. defaulted on its debt on June 1, 2023, it would hurt both the U.S. and Canadian economies and global financial markets and confidence. The U.S. dollar could depreciate against other currencies, making imports more expensive and exports more competitive. As a result, the U.S. government could face higher borrowing costs and reduced access to credit markets. However, I expect the Federal Reserve to start cutting interest rates by the end of 2023. As a result, U.S. consumers and businesses could face lower interest rates and spending power, which we call Deflation, like back in 1928. The U.S. trade deficit could widen as imports become more expensive and exports less attractive.

The Canadian economy could also suffer from the spillover effects of a U.S. default, as the US is Canada’s largest trading partner and source of foreign investment. The Canadian dollar could appreciate against the U.S. dollar, making exports less competitive and imports cheaper. The Canadian government could face lower borrowing costs and increased demand for its bonds as a haven asset. Canadian consumers and businesses could face lower interest rates and higher purchasing power. The Canadian trade surplus could narrow as exports become less attractive and imports more affordable.

A US default could also affect the oil and gas sector, depending on how it affects the global supply and demand for crude oil and gas. For example, if a U.S. default triggers a worldwide recession and reduces oil and gas consumption, prices could fall further, hurting producers’ revenues and profits. On the other hand, if a U.S. default disrupts the global supply chain and reduces oil and gas production or refining capacity, then prices could rise and benefit producers’ revenues and profits.

The oil and gas jobs could also be affected by a U.S. default, depending on how it affects oil and gas companies’ profitability and investment decisions. For example, if a U.S. default lowers oil and gas prices and reduces producers’ profits, they could minimize exploration, development, production, or refining activities, leading to job losses between 20% to 30%, especially in Alberta, Canada or possibly wage cuts 20% to 40% in exchange for keeping the job losses below 20%-15%. Conversely, if a U.S. default raises oil and gas prices and increases producers’ profits, they could expand their exploration, development, production, or refining activities, leading to job creation or wage increases, which will less likely happen, as history speaks for itself, whenever market correction happens like in 1928, 1987 and 2008 investors and consumers would panic which leads to less consumption and jobs losses.

Many other factors could also influence the outcome of a U.S. default on its debt on June 1, 2023, such as the duration and severity of the default, the policy responses of governments and central banks, the reactions of investors and consumers, and the geopolitical implications of a U.S. default.

Even if the U.S. didn’t default on June 1 and passed this time, there would be a market correction with a magnitude of  1987 and 2008 combined and up to 12 Million job losses in the U.S.

Moustafa Maher – Economist