What’s at stake: How vulnerable is the U.S. economy to the turmoil in Europe? How much further would the crisis in Greece have to spread to significantly affect the United States? Have the risks of contagion been exaggerated, or underestimated?
James Bullard, President of the Federal Reserve Bank of St. Louis, argues that European financial troubles are unlikely to send the world back into recession, and the U.S. may actually benefit from unsettled markets over the near term as investors look for a safe place to preserve their wealth. Because the trouble in Europe is rooted in government debt problems, there is good reason to think events will probably fall short of becoming a worldwide recessionary shock. The world has seen these types of events before, and there is nothing intrinsic about such crises that they need to become important shocks to the broader, global macroeconomy.
Fed Governor Daniel Tarullo, on the other hand, thinks that the European sovereign debt problems are a potentially serious setback to a U.S. economic recovery with the potential to strike at both the tender state of the banking sector, and on growth. The official said he worried European financial troubles could weaken U.S. banks, as well as other overseas financial markets, tightening credit availability at a time when the economy would benefit from the opposite action. James Hamilton has the same primary concern about the situation in Europe: that the falling dominos would undermine the net worth of banks that extended the sovereign loans, hindering the banks' access to short-term credit and their ability in turn to fund private-sector loans in a potential replay of the events of 2008. As the probability of default in one country increases, that can increase the risk premium on sovereign debt for other countries as well. Rising interest costs could then force those other countries to restructure their debt.
Tony Barber reports a study by Jacques Cailloux, the RBS’s chief European economist, which says that any assessment of the economic impact of a sovereign default of these economies through trade linkages or through their GDP size misses entirely the point. It is the financial linkages that suggest that these economies are too intertwined with foreign financial institutions to default, a phenomenon largely reminiscent of that of subprime in terms of the potential ramifications that a default would have across the global financial system. The report estimates that the total amount of debt issued by public and private sector institutions in Greece, Portugal and Spain that is held by financial institutions outside these three countries is roughly €2,000bn. This is a staggeringly large figure, equivalent to about 22 per cent of the eurozone’s gross domestic product. It is far higher than previous published estimates. Ted Truman says, in a testimony before the US House Committee International Monetary Policy that it is serious, that at of the end of 2009, US bank exposure to the European Union was $1.5 trillion, half the total foreign exposure of US banks.
Dan Gross says that Greece isn’t as much a threat to the U.S.’s real economy as the financial economy. The threat to America’s real economy posed by Europe’s travails is manageable. It’s the threat to the nation’s financial economy, which can then quickly spill over into the real economy that bears watching. As Reuters reported, Goldman Sachs estimated total U.S. bank exposure to Greek, Portuguese and Spanish debt at $90 billion. That’s not a huge amount for big U.S. financial institutions.
Tim Duy says that the European crisis is a net positive for the US. First, the weaker Euro has taken a bite out of oil prices, which fell back below $70 today. Make no mistake - keeping a lid on oil prices offers continued support for US consumers. And while we can all dream of a more balanced economy less dependent on household spending, for now it remains the best game in town. Likewise, the rush to Treasuries is keeping a lid on US interest rates. Paul Krugman, Ryan Avent, Felix Salmon and Scott Summers react here to such a claim. Stephen Gordon also reacts on this Canadian blog.
Charles Calomiris writes that the turmoil is Europe will have two opposing effects on the U.S., an adverse short-term effect and a positive long-term effect. The adverse short-term effect will be the drag on global aggregate demand coming from the disorderly process of deciding how to resolve the economic problems of southern Europe. In the long-term, however, the European crisis will be a plus for the U.S. It is finally waking up the U.S. electorate to the reality of fiscal arithmetic, and that bodes positively for U.S. economic policy over the crucial decade ahead.
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