14 May 2010

Euro-Zone Crisis No Threat to U.S. Recovery

But United States may not take comfort much longer

 

Greece’s government faces mass protests as it tries to implement austerity measures required by the international rescue program.

Greece’s government faces mass protests as it tries to implement austerity measures required by the international rescue program.

By Andrzej Zwaniecki
Staff Writer

Washington — The debt crisis in Greece and uncertainty about other distressed European economies are unlikely to undermine a U.S. economic recovery, according to economists.

Greece’s economy is just too tiny to affect U.S. economic activities significantly, said Ian Shepherdson of High Frequency Economics, a research company in Valhalla, New York.

So far, the strengthening of the U.S. dollar against the euro has been the only significant effect of the crisis. A stronger dollar makes U.S. exports to Europe and markets where they compete with European goods more expensive and thus less competitive. In addition, because of slower-than-expected economic growth in Europe, European consumers will buy fewer imported goods.

Nevertheless, “you put it all together, and it still makes a small impact on the U.S. economy,” said Nariman Behravesh, chief economist at IHS Global Insight, a worldwide company that provides financial analysis and forecasting.

A bailout of more than $140 billion, supported by the European Union and International Monetary Fund, has helped Greece avert an immediate risk of default on its sovereign debt. An even larger stabilization plan announced May 10 by the two groups to back other indebted European economies has calmed jittery bond and stock markets around the world, at least in the short term.

Economists view the agreement about the rescue among the governments of the 16-member European Monetary Union, or euro-zone, as well as the amount of the funds made available, as a watershed development in dealing with euro-zone indebtedness.

“If you do enough and impress on the market that you mean business, that resolves the crisis for the moment,” said Patrick Crowley, a professor of economics at Texas A&M University in Corpus Christi.

The recent actions make the spread of the crisis to other European countries less likely.

 

U.S. exports may suffer if the euro continues to fall, but the U.S. economy not as much.

U.S. exports may suffer if the euro continues to fall, but the U.S. economy not as much.

But this may not be “the end of the story,” Shepherdson said, as Greece and some other European economies continue to pile up new debt to serve old debts. This buys their governments more time without addressing the underlying problem — an unsustainable fiscal path, he said.

Deep cuts in government spending and new taxes, which are supposed to put economies on such a path, will lead to recession or weaker growth and higher unemployment, Shepherdson said. Unless the governments can carefully navigate a course between the risk of social unrest related to economic gloom and the risk of default, a similar crisis will materialize in the future, according to economists.

Crowley believes the euro-zone countries cannot effectively address fiscal issues without reform of their Stability and Growth Pact, a set of rules on fiscal discipline. He said weaknesses of the monetary union, which lacks monitoring and enforcement mechanisms, have contributed to the current fiscal woes. Faced with a difficult path ahead, the euro-zone countries need either a supranational fiscal authority or reform that would make members more accountable, Crowley said.

The European Commission has called for more centralized budget controls for European Union members. In a broad outline of a new budget peer-review process published May 12, it also recommended punitive measures for countries that break existing EU budget rules.

WHAT’S ON THE HORIZON?

However distant at the moment, the return of the banking crisis could be a serious threat to the global recovery, Shepherdson said. Huge losses on European sovereign debt held by German and French banks could cause a panic that spreads across the Atlantic and discourages lending, he said, in the same way that problems in the U.S. financial sector in 2007–2008 quickly spread to banks in Europe. To avert a repeat, the European Central Bank on its own, and with help from its U.S. counterpart, is pumping short-term credit into the European banking system.

A worry for U.S. exporters is the potential for a continued slide of the euro. Were it to drop to parity, or close to it, with the U.S. dollar, U.S. exports would be hurt “quite dramatically,” Behravesh said. However, he views such a scenario as fairly unlikely and adds that its overall effect on U.S. output would be cut in half by two factors: a fall in oil prices and in the interest rates on U.S. Treasury bonds, both related to investors’ search for a safe haven.

Shepherdson believes that because exports make up only 12 percent of U.S. gross domestic product, their decline in European and other markets wouldn’t be “catastrophic,” even if the U.S. dollar nears parity with the euro.

But taking a longer view, Niall Ferguson, a professor of history at Harvard University, said the United States should not find comfort in this as its debt-to-gross-domestic-product ratio is projected to rise at a faster rate over the next three decades than those of Portugal, Ireland, Greece or Spain, according to a 2010 report by the Bank of International Settlements.

The crisis in the euro-zone should be a wake-up call for the U.S. government to act on its own fiscal problems, Ferguson said May 13 at the Peterson Institute for International Economics in Washington.

(This is a product of the Bureau of International Information Programs, U.S. Department of State. Web site: http://www.america.gov)