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Wednesday, October 26, 2016

Euro Crisis Worsens, With Huge Risks For U.S.

The situation in Europe is looking increasingly dire, posing a grave risk to the global economy.

In the past day alone, the Greek government shut down because civil servants are protesting austerity measures, Moody’s has downgraded Italy’s debt, and France and Belgium had to act to save European lender Dexia. Even those without a good grasp of the intricacies of the European Union and its financial institutions — a category that admittedly includes most people both within and outside Europe — realize that the euro crisis bears a disastrous potential for economies throughout the world.

The impact of the worsening situation in Europe is already being felt in the stock market, but it could have more lasting effect on U.S. economic recovery. Ezra Klein writes in The Washington Post:

[Recent events in Europe] point to two things that could happen over the next year that would crack the American recovery and reshape the 2012 election: Some European countries could default on their debt and the European debt crisis could undermine the continent’s financial system and lock credit, much as happened here after the fall of Lehman.

On Monday night, Goldman Sachs sent out a research note that sounded less like an analysis and more like a warning. Their European arm, they said, “now expect the Euro area to fall into recession beginning in the fourth quarter, with full-year 2012 growth at only 0.1%.” Ouch. But they tried to be as clear as possible: this is our problem, too. “The European crisis threatens US economic growth via tighter financial conditions, reduced credit availability, and weaker growth of US exports to the region. This impact is likely to slow the US economy to the edge of recession by early 2012,” they continued.

The fact that it’s our problem doesn’t mean we have much say in the solution. Talk to government officials and they’ll tell you that the United States has three points of leverage over the Europeans: 1) They care what we think. 2) They need the International Monetary Fund’s assistance, and we have a major voice in that organization. 3) They want the Federal Reserve to continue providing liquidity and support to the global financial system in ways that work with their rescue plans. Put together, that’s more than enough to make us heard. It’s not nearly enough to make us decisive.

The IMF is trying to re-work its strategy to prevent a total EU collapse, but the crisis continues to worsen and cause market turbulence. The United States might not be able to directly intervene and prevent a disaster in the EU; it can, however, create a plan to help Americans if our economy is significantly damaged by the situation. Meanwhile, GOP presidential hopefuls in the United States seem to be avoiding the European issue entirely. Given the severity of the associated risks, the euro crisis warrants closer attention from the American public — and especially from American politicians.

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  • kurt.lorentzen

    One of the biggest things Ezra Klein fails to mention is the meltdown of “global confidence” if countries default on debt. The IMF can only go so far in supplying debt as payment for more debt. That practice has the benefit of lowering payments because even though the debt is not erased, it has lower interest so provides some relief by lowering the payment (like refinancing a mortgage). If that’s not enough, and countries do default, the money supply that feeds the deficit spending here at home is likely to significantly dry up, and most certainly will become more expensive. This is why the best hedge against all of this is a balanced budget (actually, a surplus budget with debt repayment factored in). That could serve to make US funds a safe harbor (or at least US taxes the lesser evil as compared to the European losses) for US businesses. If we play our cards right, we could yet come out of this in pretty good shape. But it will require leadership that’s willing to make the hard choices, pick up a gigantic eraser, and start erasing the red ink.