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Eurozone debt: Grave threat to US economy or imaginary boogeyman?

Under grimmest scenario, debt-burdened Greece, Ireland, Italy, and Spain can't pay what they owe to Eurozone banks, which then stumble, causing US banks to falter, too. But US banking system is stronger now, and regulators are more vigilant, say optimists.

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However, overnight interest rates in Europe (as measured by the London Interbank Offered Rate) are up slightly, notes Jay Bryson, an international economist with Wells Fargo Securities . “It’s not huge – it is not like the time when Lehman [Bros.] went under – but it’s moving in the wrong direction,” he says. “If LIBOR rates spiral out of control, that is how it affects the US economy.”

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The spillover to the US would come because almost every business loan is tied to the LIBOR rate, says Mr. Bryson. “That is why we care; we live in an interconnected financial system.” The LIBOR rate, published daily in London, is the interest rate at which banks around the world lend money to other banks.

A major problem, says Bryson, is that many European banks have loans out to other European banks and institutions. French banks have loans to Greece, Ireland, Portugal, Spain, and Italy that are equal in value to 30 percent of France's gross domestic product, he estimates.

“If Spain and Italy need bailouts, like Greece, the European Central Bank might be able to do Spain, but they [the Europeans] will exhaust their rescue fund and may go over it with Italy,” Bryson says. “You could be looking at a rescue package of close to $1.42 trillion. No one has that kind of cash around.”

In a worst-case scenario, the European banks would have to take hundreds of billions of euros in writedowns. US banks would likely stop making loans to European institutions. “There could potentially be another credit crunch,” says Bryson.

European bankers are continuing to extend credit to the troubled nations, so long as they cut government spending. But this is only a short-term fix, some economists say.

“The regulatory authorities have kicked the can down the road,” says Kurt Rankin, an economist at PNC Financial Services in Pittsburgh.

How far have they kicked it? Possibly, not very far.

A European credit crisis “could explode at any moment, or nothing might happen,” says Mr. Gault of IHS Global Insight.

The key thing to watch, says Gault, is the economic statistics coming out of Europe. If they are poor in the months ahead, he says, doubts will creep in that European nations will have enough revenue to make payments on their debt.

At the moment, that’s not an immediate worry because Germany – the economic locomotive of Europe – is still growing, especially because of buoyant consumer buying and strong business spending, says Bryson. However, France’s economy is now flat. And some other nations, such as Greece, have probably entered a recession as the public austerity budgets reduce their output.

The other area to watch is global interest rates, says Bryson. If short-term interest rates start to rise, he warns, there could be a big crisis in confidence.

“I would say we’re not out of the woods yet,” he says.

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