After a short hiatus, the trade war between Canada and the United States has resumed with vigor, as has Donald Trump’s taunting of Canada. But just as many do not remember that the market volatility we are currently experiencing mirrors Trump’s first term, many have forgotten that Canada did well during the first trade war, pulling more than its weight during the NAFTA renegotiations.
“Canada nevertheless appears poised to lose this round overall.”
Unfortunately for Canada’s leaders, circumstances have greatly shifted in the years since. The fiscal and monetary response so far suggests they are preoccupied with protecting the sovereign debt, one of the highest against GDP among developed nations. While Canada will not literally become the 51st US state, the trade war could lead to Canada’s markets losing a fair amount of independence from the United States in its cherished domestic sectors.
During Trump’s first term, Canada’s economy was booming, and the country—then led by a fresh and popular Prime Minister Justin Trudeau—retaliated against the US president’s protectionist policies with reciprocal tariffs on more than $11 billion in American goods. After a few months of negotiations, Canada modestly increased access to its dairy markets in exchange for several important concessions from the United States. These included avoiding auto tariffs and preserving most of its dairy supply management system. It was an impressive showing for Canada.
This time, Canadian negotiators are in a far weaker position. Shortly after the signing of the US-Mexico-Canada Agreement, Covid hit. The policy response to the pandemic caused both household and federal debt levels to soar to historical highs, enabled by the actions of the Bank of Canada and all levels of government. The resulting monetary easing led to inflation, which the Bank of Canada has since been attempting to control through quantitative tightening and rate hikes. The Bank of Canada even resumed quantitative easing as it restarted rate cuts in June 2024 in response to economic weakness. Despite these efforts, the Canadian dollar has continued to decline against the US dollar, hitting some of its lowest levels in decades.
With the onset of the trade war, the Bank of Canada announced further rate cuts to “protect the economy,” while the Canadian federal government responded with aggressive counter-tariffs and financial support for companies and individuals affected by the fallout. Mark Carney, the new prime minister of Canada, has vowed to maintain these counter-tariffs until the United States “commits to free trade,” clearly seeking to replicate Trudeau’s initial success using this tactic.
The combination of rate cuts and another fiscal injection into the economy protects debt at the cost of rising inflation and further weakening of the currency. Ultimately, the long-suffering Canadian consumer will face ever higher living costs as a result. The resulting political pressure on the government may push it to accept a bad deal with Trump. Trump seems to be cognizant of Canada’s greater weakness and has been aggressively ramping up tariffs lately, though in his typically chaotic one-step-forward, two-steps-back fashion.
That said, Canada still enjoys a few advantages. For one, the two economies have highly intertwined sectors. For instance, tariffs on Canada’s auto exports—currently paused by the Trump administration—would also rebound on American auto manufacturers, as each vehicle exported from Canada contains 45.5 percent American parts.
A second advantage is elite cohesion. The US political system is more centralized at the federal level than the Canadian one, but the political tension between Democrats and Republicans is far greater than that between political parties in Canada. When it comes to defending energy and resource exports, Canadian political leaders and provinces tend to consolidate quickly, despite otherwise having little in common. Individual Canadian provinces have built close economic relationships with several Democrat-leaning US states. This dynamic weakens unity behind Trump’s trade war efforts and creates pressure to negotiate. Perhaps this is why Trump initially framed his tariffs as a response to illegal flows of drugs and people across the Canadian border rather than an effort to reconfigure trade.
Canada nevertheless appears poised to lose this round. Chrystia Freeland, Canada’s former finance minister who was a contender for the Liberal Party leadership, recently suggested that Canada should align itself with nuclear-armed NATO members as protection against the United States. While this may be mere rhetoric, it reflects a growing sentiment among traditional US allies. European leaders, along with Canada, are receiving a clear signal that the United States is withdrawing from its partnerships, prompting efforts to adapt to a new geopolitical paradigm. Already, Canadian provinces have pledged to reduce internal trade barriers between provinces. In the long term, the best-case scenario is that Canada finally develops its transatlantic and Pacific trade routes and domestic transportation infrastructure. But such a transition will not come without a painful adjustment period.