Economic jitters hit campaign trail, as Flaherty warns of effects in Canada

Late Wednesday, Finance Minister Jim Flaherty acknowledged that Canada "is being affected" by the volatility in global financial markets, although he said Canada is weathering the storm better than others.

"The Bank of Canada has taken action to ensure the liquidity of the banking system, and indicated that it stands ready to provide further liquidity to Canadian markets as required," he said in a statement.

"I would emphasize that Canada's banking and insurance industries are well capitalized and our financial system is sound."

His words were a departure in tone from Prime Minister Stephen Harper's reassurance Monday that the worst is over for the economy and that if Canada were going to experience a recession, it would have already happened.

Not so fast, say economists. The collapse or bail-out of three Wall Street titans this week and the sharp sell-off in global stock markets - including Canada's - has the potential to make the second half of 2008 even worse than the first.

And the first half was no great shakes, with the economy recording a negative 0.5 per cent gross domestic product growth, the worst six-month performance since 1991.

"Right now what's happening is just outright scary," says Derek Holt, Scotia Capital's vice president of economics.

"It's a completely frozen inter-bank funding market where liquidity has evaporated and ... I don't think it's at all realistic to expect those effects won't hit home in Canada."

The aftershocks could hit Canada with tighter credit conditions, reduced business investment, crashing consumer confidence and finally job losses, he said.

TD Bank chief economist Don Drummond predicts the Canadian economy will remain basically flat for another year. But it could get worse.

"Our forecast is more of the same, but could it get worse, absolutely. You'd be a fool to say there wasn't a substantial probability of downside for that."

This week's financial shocks appear to have elevated the economy into the No. 1 substantive issue of the campaign, and all parties have attempted to score points at the expense of their rivals.

So far, however, polls suggest the Conservatives have not paid a price.

That's because the economy, while weak, isn't bad enough to make people angry, says pollster Nik Nanos of Nanos Research.

In fact, Nanos believes that the "jitters" Canadians have about the economy may be working in Harper's favour, allowing him play on the fear of change rather than have to fend off angry, unemployed voters.

"Right now the economy is in a sweet, political spot for the Conservatives," he said. "If the economy were in a full downturn, it would be a problem."

Harper has been making the exact same argument in the campaign, saying that the worst of the crisis is over, at the same time sounding the alarm about taking a risk on radical new approaches proposed by Liberal Leader Stephane Dion and the NDP and Green party.

The prime minister said this week he needs a strong mandate to ensure his ability to govern effectively at a time of economic uncertainty "sabotaged" by the opposition.

Dion shot back Wednesday that it was the Harper government Canadians have to worry about.

"Who sabotaged the economy over two years and a half? It's (Finance Minister Jim) Flaherty and Mr. Harper," he said.

"They received an economy that had a surplus of $12 billion ... (and) now we have the worst economic growth of the G8. We are close to a deficit, and close to a recession, thanks to Mr. Harper and Mr. Flaherty."

The NDP and the Green party have also taken shots at Harper's economic management, citing thousands of lost jobs in the manufacturing heartland of Ontario.

Nanos says only a real event, such as a report of massive job losses when Statistics Canada next reports in early October or a sharp housing downturn, has the potential to materially change the campaign dynamics on the economic issue.

And while some economists believe that real economic event - capable of affecting Canadians directly - will be coming, likely it will happen after voters have cast their ballots on Oct. 14.

So far, the pain has been borne mostly by market investors, notes Bank of Montreal economist Douglas Porter. The real economy remains relatively solid, with a 6.1 per cent unemployment rate near a 30-year low, and hourly wages rising rather than falling.

But the crisis in confidence has rocked the financial markets around the world. Stock markets in Canada and the U.S. plunged for the second time in the last three days Wednesday, with Toronto shedding more than 300 points after dropping 500 points on Monday. The Dow Jones in New York fell even more sharply.

Holt and Drummond says it is possible for the economy to fall into a recession, although they say it is more probable that it continues to tread water until the latter half of 2009.

The risk, says Holt, is that Canada takes a double-hit from even lower demand for manufactured goods without the cushion of high commodity prices, which have dropped precipitously since July.

But the impact on Canadians won't be felt for months, too late to dramatically effect the election campaign.

Nanos says the simple rule is that when the economy is seen as somebody else's problem, you stick to the status quo - when it becomes your problem, then you vote for change.

At the moment, for most Canadians, it's still somebody else's pain.