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How might a euro collapse affect Canada?

KINGSTON, Ont -- The demise of the euro would deliver a significant blow to the Canadian economy, leading to less trade, higher unemployment and a possible recession, financial experts say.

"The situation in Europe would create a tsunami that would reach our shores very very quickly," Louis Gagnon, finance professor at Queen’s University School of Business told CBC News on Dec 2. "We would be collateral damage and this collateral damage would be very, very significant."

With some European countries seemingly unable to control their spiralling debt crises, and with uncertainty over the type of financial relief the European Central Bank may contribute, there are fears the end of the euro is near.

Gagnon explained that if the euro dissolved as a currency, a number of countries with their debt denominated in euros would immediately have to default since they would adapt their own domestic currencies and those would be devalued from anywhere between 50 to 70 per cent.

As the marketplace establishes the exchange rates, Gagnon said, you would see a "fire sale" on the exchange rates because investors would have very little confidence in these new currencies.

"These countries would be forced to pay back debt holders in euros which they don't have. As well, financial institutions, all the banks have euro obligations," he said.

As some European governments would default, banks holding those bonds would not have money to lend, drying up liquidity, sparking a severe global economic contraction and causing a major economic crisis.

"It's one banking system, when we look at it. If it fails in Europe, the rest of the world would be affected," Gagnon said.

But what does that mean for the average Canadian?

"This would cause panic, fear, remove all the confidence in the financial system," Gagnon said. "The global financial system would become paralyzed … in this way Canadians would be affected."

Canadians would stop spending, which could lead to a possible recession in Canada.

Walid Hejazi, associate professor of international business at the University of Toronto's Rotman School of Management, said that being part of an integrated global economy means what happens elsewhere could affect us.

"Much of our prosperity is driven by our linkages into the global economy and much of the risks are driven by our linkages to the global economy, so you have to deal with both."

Hejazi said employment numbers, income growth, value of our assets, our homes and the assets of financial markets would all be put at risk.

"So it can actually impact the average Canadian quite significantly. So we do have to worry. It's not something the average Canadian can say, 'It's over there in Europe, who cares? There was tremendous goodwill about the benefits that come between Canada and the EU. I found that people really wanted to deepen the relationship because of the economic opportunity, but also because of the history. On the business side, we want the Europeans to get out of this. We want them to do well. One thing that's really clear is when they do well, we do well. When they're worse off, we're worse off."

Matthias Kipping, professor of policy and chair in business history at Schulich School of Business, said the euro collapse would mean countries would become more protectionist, which would have a major effect on a country like Canada that relies on exports.

While Canada’s direct share of global trade with Europe is relatively small, it would be indirectly affected by those countries, in particular the United States, which are heavily exposed to the European market and which Canada trades with.

But Kipping said the crisis would take a little while for it to work its way through Canada.

"People won't get fired immediately tomorrow, but it will work its way through."

The "doomsday scenario," he said, is the credit flows stop, meaning economic activity and trade stop or get severely curtailed.

"The next thing is if trade stops, who are you going to sell to? People who make things, they eventually have nothing to do, and they'll be out of a job. It may not happen next week, but could happen next year."

While Canadian banks don't have much direct exposure to Europe, they would be affected by the "calamity raging in the credit marketplace," Gagnon said, meaning they would have to stop lending to other banks.

But Gagnon said Canada, with its relatively healthier banks and deficit containment, is in a better position than other countries to deal with the crisis.

"Things aren’t looking all that great, but I think we would weather the storm to a better degree than our trading partners and especially Europe."