Canada’s real Brexit worry should be the surging U.S. dollar

Canada’s direct trade with the United Kingdom is relatively small—but the real risk for exporters is further damage to the U.S. economy

stock market trader at Bloomberg terminal

Traders reacted swiftly to a Brexit “Leave” vote. (Thomas Samson/AFP/Getty)

I keep reading that Canada needn’t worry too much about Brexit because we do so little trade with the United Kingdom—only about 3% of merchandise exports are purchased by our Motherland. In other words, as long as the United States keeps motoring along, we will be fine.

But the implications of Brexit in the U.S. is precisely the point. America’s economy is doing OK—but it is fragile. (There is a reason the Federal Reserve keeps balking at raising interest rates.) A fresh bout of market volatility could hurt business and consumer confidence. That could crimp household demand and business investment, the two things that drive imports.

More important is what Brexit is likely to do to the U.S. dollar.

The International Monetary Fund said this week that the American currency could be overvalued by as much as 20%. Such assessments lack precision, but the point is straightforward: the dollar’s strength is impeding the ability of U.S. companies to compete for international sales. The IMF listed the greenback’s current value as a risk to growth. The Fed also has expressed concern about the dollar this year. American companies used to do most of their business at home. But they became bigger exporters after the Great Recession because domestic demand had shrunk. The days when a stronger dollar was unambiguously good for America’s consumption-led economy are over. It is at best a mixed blessing now.

If the U.S. dollar was a drag on the world’s biggest economy earlier this week, it is even more so now. When the world’s traders get nervous, they buy Treasuries and other U.S.-dollar assets. It was up more than 2% against a basket of other major currencies. That is a big move in one day. (Not as big as the pound’s record plunge, to be sure; investors also took refuge in the Yen and the Swiss franc.) Most analysts assume Brexit will keep the Fed from raising interest rates, in part because that would put more upward pressure on the currency.

The most optimistic economists assume the turbulence in global financial markets will recede once the initial shock of Brexit passes. The pound could rally a little. But it is hard to imagine a scenario in which everything reverts to the way it was on the morning of June 23. There is simply too much uncertainty about what is in store for the U.K. A recession is entirely possible. Investors will be less than keen on holding British assets. The U.S. dollar quite likely has entered a new phase of excessive strength.

That won’t be good for the U.S. economy and, therefore, a threat to Canada’s export prospects. Bank of Canada Governor Stephen Poloz likes to say a higher dollar is a natural way of sharing U.S. demand with the rest of the world. Brexit will test the limits of America’s benevolence.