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Will Obama's debt ceiling fall in on Flaherty's deficit-fighting plan?

President Barack Obama updates reporters on negotiations to raise the U.S. debt ceiling during a White House news conference on July 11, 2011.

SAUL LOEB/AFP/Getty Images

Canada could be facing fresh economic headwinds, with rising unemployment and troubled government finances - and there's not a thing political leaders in Ottawa can do about it.

The United States is gripped by a political crisis over raising that country's debt ceiling, with time running out until the Aug. 2 deadline. If that deadline passes without a deal, the world's largest economy risks defaulting on its debt.

The President's grim tone at Monday's press conference suggests both sides are entrenching, with Democrats refusing any deal unless it involves tax increases on the rich and Republicans refusing any deal that contains those tax increases.

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"I do not see a path to a deal if they don't budge, period," Mr. Obama told reporters. If Republican leaders "are sincere - and I believe they are - that they don't want to see the U.S. government default, then they're going to have to compromise."

For his part, House of Representatives Speaker John Boehner, who leads the negotiations for the Republicans, reiterated Monday that GOP lawmakers would not sign on to any deal that included "higher taxes on job creators."

The United States is unlikely to default on its debt immediately after Aug. 2. Even without a deal, Treasury Secretary Timothy Geithner will find a way to pay bond holders. But Craig Alexander, chief economist for TD Bank Financial Group warns the impasse, if unresolved, will send a signal around the world that political gridlock has left Washington incapable of addressing its debt and deficit.

Bond rating agencies will downgrade the quality of American debt and foreign holders of American debt will start to divest, raising interest rates on that debt. The American dollar will be devalued and stock markets will tumble, as investors anticipate the inevitable economic fallout. An already weak economy will grow weaker.

"I don't think it's enough to drive them into recession," Mr. Alexander believes. But an ongoing political crisis over the debt ceiling "could materially slow the rate of growth in the American economy." Annual GDP growth, he fears, could drop well below 2 per cent, which would not be sufficient to keep the unemployment rate from rising.

And where the American economy goes, the Canadian economy is bound to follow. Growth would slow and unemployment rise here as well, throwing federal finances into disarray and disrupting Jim Flaherty's deficit-reduction plans.

The impasse has the Finance Minister worried. "As the largest economy in the world and Canada's largest trading partner, we are closely following the current political impasse in the US," he said in a statement to the Globe and Mail. "Clearly, we believe the situation needs to be addressed in the very near future to ensure continued confidence in the American and global economy."

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NDP finance critic Peggy Nash said the deteriorating situation in Washington only bolstered her party's argument that the Conservatives should slow down their plans to eliminate the deficit, in part by reducing the size of the public service.

"Given this insecurity, this is not the best time to be shedding jobs in the public sector," she said in the interview. But ultimately, "we can only hope that saner minds prevail and they work out an agreement."

In truth, there is little that Mr. Flaherty or anyone else in Canada can do but cross their fingers. Sometime in the next week or so, the Republican and Democratic leadership must find a compromise on raising the debt ceiling that will almost certainly involve both cuts to spending and tax increases.

Then that leadership must convince the Republican-dominated House and the Democrat-controlled Senate to pass legislation bringing that deal into effect, which itself will be a challenge given the influence that the ultra-conservative Tea Party movement has over the Republican caucus.

The obstacles to compromise are enormous. But unless someone pulls back from this game of political chicken the consequences for American workers - and Canadian workers, too - could be dire.

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About the Author

John Ibbitson started at The Globe in 1999 and has been Queen's Park columnist and Ottawa political affairs correspondent.Most recently, he was a correspondent and columnist in Washington, where he wrote Open and Shut: Why America has Barack Obama and Canada has Stephen Harper. He returned to Ottawa as bureau chief in 2009. More

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