U.S. Debt Downgrade Fallout: Toronto, World Markets, Commodities Nosedive, Gold Surges

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Traders work on the floor of the New York Stock Exchange on Monday, Aug. 8, 2011, in New York. (AP Photo/Jin Lee) | AP

OTTAWA - Fear gripped financial markets Monday as the fallout of a downgrade of America's credit worthiness crushed stocks and investors seeking safety sent gold to a record high.

The volatility was reminiscent of the turmoil leading up to the recesssion three years ago, but fears of a sputtering recovery also raised the prospect of stable or even falling interest rates well into 2012.

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Scotiabank economist Derek Holt said the financial turmoil will help prompt the Bank of Canada to keep interest rates on hold until the second quarter of next year at least.

The Canadian central bank had been widely expected to raise rates beginning this fall — making it riskier for consumers to finance high mortgages and other growing debt. But the economic storm clouds have made that unlikely.

"Any talk of the Bank of Canada hiking this year is just foolish in my opinion," Holt said from Toronto.

"The extent of the global shocks that we're going through combined with disappointing domestic growth and a very dovish recent inflation figure gives the bank an awful lot of wiggle room."

The Toronto stock market lost nearly 492 points Monday, leaving it at 11,670.42, down more than 1,100 points or nine per cent since last Wednesday and off about 18 per cent from its high for the year set in April.

Those losses wipe out well above $100 billion in share values — and likely much more — and affected Canadians' investments and pension plans, while undermining the "wealth effect" that drives consumer confidence and spending.

Meanwhile, the Dow Jones industrials average lost just under 635 points to close at 10,809.85, down more than 1,000 points or nine per cent from the middle of last week and about 16 per cent from its high in April.

Prime Minister Stephen Harper urged Canadians not to panic from the latest stocks plunge, and said the market turmoil "doesn't change our overall assessment" of Canada's economic recovery.

"Notwithstanding the fragility of the economy and the headwinds that are there, we believe that a gradual recovery can continue," he said during a trip to Brazil.

The drop in stocks came as gold closed at a record high of more than US$1,700 an ounce higher as investors looked for shelter in the rout that was sparked by Standard & Poor's first ever downgrade of America's credit rating.

The downgrade wasn't unexpected, but investors were already jittery about the weak U.S. economy, European debt problems and Japan's recovery from its March earthquake and tsunami.

G20 finance ministers and central bank governors said Monday they're ready to step in and ensure financial stability as the latest wave of global economic fear gripped investors.

The group issued a statement affirming their commitment "to take all necessary initiatives in a co-ordinated way to support financial stability and to foster stronger economic growth."

"We will remain in close contact throughout the coming weeks and co-operate as appropriate, ready to take action to ensure financial stability and liquidity in financial markets."

"Moreover, we will continue to work intensively to achieve concrete results in support of strong, sustainable and balanced growth in the context of the G20 Framework for Growth."

BMO chief economist Sherry Cooper agreed with Holt that the Bank of Canada would likely not raise rates this fall as some had predicted.

"No one is talking about that any longer," she said. "Right now the markets are building in a cut by the Bank of Canada."

And while Cooper said the U.S. debt downgrade may be dominating the headlines, the main problems are in Europe.

The debt woes in Greece are now also threatening to engulf Italy and Spain and have sharpened fears that a fragile global recovery could easily derail.

Cooper said the commodity-heavy Toronto market has underperformed in recent weeks and the bank stocks were also lower even though the institutions themselves remain strong.

"This is similar to what we saw during the financial crisis in 2008 which is very troubling given that our domestic situation is among the best in the world as we really are truly a triple-A economy," she said.

Cooper said she hoped the decline in gasoline and food prices would spur consumer spending in the U.S.

"If we don't get a rebound in the U.S. economy then we could well see a significant slowdown in Canada," Cooper said.

Gold gained $61.80, or more than three per cent, to close at US$1,713.20, after peaking earlier at a record high of $1,718.20, while the Canadian dollar tumbled nearly a full cent as nervous investors piled into U.S. Treasurys and precious metals. The loonie fell 1.25 cents to 100.92 cents U.S.

On energy markets, fears of an economic slowdown caused by the debt crisis dragged the price of oil down $5.57 to US$81.31 a barrel after falling $8 last week.

The Toronto Stock Exchange experienced wild fluctuations Monday morning, on its first day of trading after S&P downgraded the U.S. debt rating from AAA to AA-plus on Friday afternoon.

The Canadian dollar, now firmly established as a commodities currency, followed the price of oil sharply down, losing nearly a cent in early trading. Oil hit U.S. $83 per barrel, down more than $30 from its recent high in May.

Finance Minister Jim Flaherty noted that Canada is not immune from the economic headwinds buffeting much of the world, but the Tory cabinet minister expressed confidence that the global financial markets won't melt down this week.

The Huffington Post's Daniel Tencer blogged earlier on events as they unfolded:

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"There's real fear that, given the mounting challenges facing the administration and the stand-off in Congress, [the credit downgrade] could really weaken U.S. influence and the U.S. role in the world," Simon Tilford, chief economist at the Centre for European Reform in London, tells NPR's Alan Greenblatt. "For most Europeans, that's not a prospect they welcome."

According to Greenblatt, the downgrade has shaken faith not so much in the U.S.'s ability to pay, as it has in everyone else's ability to pay. He quotes Thomas Kleine-Brockhoff of the German Marshall Fund: "The American downgrade has had an immediate effect on the Europeans."

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"France and Britain are most vulnerable within Europe to a rating review following the U.S. downgrade, with anemic growth and hefty borrowing placing them among the shakiest of the world's triple-A rated lenders," Reuters reports.

Both countries have stable rating outlooks, making a sudden downgrade unlikely and markets have been so impressed by Britain's debt-cutting strategy that they have pushed its bond yields to record lows.

But a surge in the cost of insuring French debt against default on Monday highlighted alarm sparked by Friday's U.S. rating cut as banks and brokerages warned that rating agencies could now have top-rated European lenders in their sights.

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President Obama sought to refocus attention from credit ratings to job creation in the second half of his speech Monday afternoon.

"There will always be economic factors that we can't control -- earthquakes, spikes in oil prices ... but how we respond to those ... that's entirely up to us," the president said, pushing job-creation projects such as infrastructure renewal.

These are ideas Republicans “have agreed to countless times in the past,” the president noted.

The U.S. president sought to lift the nation's spirits a little, declaring at one point that "no matter what some agency may say, we've always been and always will be a triple-A country."

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Speaking at the White House Monday afternoon, President Barack Obama said the U.S. can easily resolve its debt issues, but not in the current, bitterly partisan political environment.

The president said S&P downgraded U.S. credit because "after witnessing a month of wrangling over the debt ceiling they doubted our political system’s ability" to address financial problems. "The markets continue to believe our debt is triple A."

Washington cannot continue along a path "where the threat of default was used as a bargaining chip," the president added. "Our problems are eminently solvable, and we know what we need to do to solve them."

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Prime Minister Stephen Harper evidently agrees with U.S. Treasury Secretary Tim Geithner, Nobel-winning economist Paul Krugman and many others in disagreeing with the S&P's decision to downgrade U.S. credit.

That's according to Brazilian President Dilma Rouseff, who met with Harper in Brasilia today and sealed a number of agreements with Canada. Despite tensions over issues such as currency and the aerospace industry, Canada and Brazil appear to be moving closer to one another economically, with understandings signed today on international aid and Olympic co-operation, among other things, as well as an agreement to create a forum where Brazilian and Canadian economic leaders would meet on the sidelines of international conferences.

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The U.S. has little hope of regaining its AAA credit rating as long as its political environment remains caustic and polarized, Standard & Poor's said in a conference call Monday.

"Given the nature of the debate currently in the country, with the polarization of views across the country right now, we don't see anything immediately on the horizon" that would allow the U.S. to return to AAA standing, David Beers, head of S&P's sovereign ratings, told the media.

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One business day after S&P downgraded the U.S.'s credit rating, the ratings agency has done the same to Fannie Mae and Freddie Mac, the giant U.S. mortgage companies that many economists say played a big role in the U.S. housing collapse.

Fannie and Freddie, which started out as government entities in the 1930s, own or underwrite about half of U.S. mortgages. S&P said it downgraded the lenders' ratings because their credit-worthiness is linked to that of the U.S. government.

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U.S. President Barack Obama is to deliver a statement on the economy at 1 p.m. ET, various media outlets are reporting.

The statement comes as both the TSX and the Dow opened sharply down, mirroring the losses in European and Asian markets.

UPDATE: The televised conference has been delayed to 1:30 pm ET.

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Gold hit an all-time nominal record high Monday morning, as investors continued to flee stocks in favour of safer shores. Gold streaked past the U.S.,700 mark, nearly doubling in price since the start of 2009. But as the Canadian Press notes, gold still hasn't hit its inflation-adjusted all-time high of 0 in 1980, which in today's dollars would amount to ,400.

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Fears of a second-dip recession are driving oil prices down this morning. Oil dropped to around a barrel in early trading, representing a 20-dollar drop since last month, and a 32-dollar drop since it hit a high of 5 in May.

"A drastic weakening of sentiment has brought oil prices down sharply, with sovereign debt fears key in a mounting loss of faith in economic, and hence demand, prospects," Barclays Capital said in a report.

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The Canadian dollar fell nearly one cent U.S. in early trading Monday, following the path of oil prices, which also got crushed in the first full day of trading after the U.S.'s saw its credit rating downgraded. The loonie fell to 101.4 cents U.S. by mid-morning.

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