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Why America should care about Europe’s economy

In the globally connected economy, financial pain in either Europe or the US has worldwide ripples.

By Correspondent / July 13, 2011

Traders are pictured at their desks at the Frankfurt stock exchange on July 13.

Amanda Andersen/Remote/Reuters

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As European economic woes worsen, should Americans worry about the eurozone? After all, the US has plenty of its own economic troubles to contend with.

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But in this globally connected world, there's plenty of concern to go around. American jobs and economic growth are directly tied to how and when Europe addresses its fiscal and debt problems, as well as to Chinese inflation and exports. In turn, China depends on the US and European ability to return to robust growth. And the entire global economy rides on Congress approving higher US debt levels.

In short, economic fumbles in Europe will be felt in America, and vice versa. After a couple of years of mostly uncoordinated global recovery strategies and trillions of dollars in bailouts and stimulus funds that have had mixed results, weakened world economies have less room to maneuver and are thus more exposed to what happens elsewhere.

“Even if it looks far away, there is no way for the US to be immune to significant issues in Europe,” says Gilles Moec, a London-based Deutsche Bank senior economist. “We’re talking about a really large amount of national debts which are at risk which could bend global wealth.”

One may ask how the probable default of a tiny economy like the Greek one can wreak more havoc in world markets than Argentina’s 2002 default. The difference is that markets are on edge, increasingly irrational, and reacting more to speculative scenarios than to real numbers. That’s the nature of the beast.

The EU has dragged its feet on how it will deal with the unavoidable Greek default and second bailout, which in turn raises the question of how it would address an increasingly likely new rescue of Ireland and Portugal. And if there is no clarity on what happens with the small, more manageable peripheral countries, then it’s all together uncertain what would happen if Spain or Italy needs funds eventually.

It’s not a question of solvency per se, that is, about European countries being able to pay back their debts, but of liquidity. Market concern is that Europe will not be able to agree on a timely strategy to make sure all the contingencies are in place. And if there is no liquidity, then the solvency issue becomes real, not psychological.

Many investors can’t take that chance and thus are rebalancing their exposure just in case, moving their money to safer assets, which explains why markets plummeted globally in the past few days.

“It’s quite hard to disentangle anymore. In general it’s risk aversion,” says Luigi Speranza, a London-based economist with BNP Paribas. And even if there is little new evidence to justify a run on Italy or Spain, “the market is on high alert. And you can’t underestimate market reaction because it can be self-fulfilling."

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