The Optimists' Turn: EU's Crisis May Not Be So Bad
Originally published on Tue January 10, 2012 4:25 pm
Europe's debt crisis is a huge threat to the U.S. economy. Or is it?
For many months, economists have been warning that Europe's debt troubles could spiral into a massive recession that drags down U.S. growth.
But some analysts say those fears may be wildly exaggerated. The U.S. economy has been "decoupling" from Europe for some time, and wouldn't be significantly harmed by any recession taking shape over there, they argue.
In fact, the decoupling already is a fait accompli because U.S. financial institutions and corporations have responded to warnings about Europe by taking defensive steps, such as stockpiling cash and avoiding European bonds, according to Vincent Truglia, director of global economic research at Granite Springs Asset Management.
"If it was a year ago, we'd be more susceptible" to financial turbulence triggered by any European government defaults, Truglia said. "At this point, if you haven't gotten prepared for it, you should not be working for a major financial institution."
Why Europe Won't Hurt The U.S.
For those who agree with Truglia, the evidence of U.S.-EU decoupling is all around. Here are some factors that suggest Americans will not be dragged down by Europeans' trouble:
Interest Rates: The interest rates that many European governments must pay to attract bond buyers are high. For example, Italian bond yields are exceeding 7 percent. But the U.S. Treasury can offer yields of less than 2 percent on 10-year notes and still attract buyers. Since Treasury bonds serve as a benchmark for all sorts of lending rates, state governments, companies and individuals in this country can borrow money more cheaply than their EU counterparts.
Currency Values: Over recent months, the euro, a 17-nation common currency, has lost value while the dollar has advanced. That suggests global investors have been losing confidence in Europe while gaining an appreciation for U.S. safety and strength.
Stock Prices: In 2011, publicly traded shares in the eurozone dropped more than 11 percent while U.S. stocks were down only about 2 percent. This year, U.S. stock prices are rising, while European stocks are mostly flat at depressed levels.
U.S. Growth: As 2012 begins, the U.S. annual growth rate appears poised to run at nearly 3 percent, and job creation is accelerating. Meanwhile, with the exception of Germany, most eurozone economies are barely growing, and some already are contracting.
Japan's Example: Japan experienced a "lost decade" from 1991 through 2000 — a period with very little growth. Now it appears Europe may be heading into a similarly long downturn. But Japan's weak economy did not tank U.S. growth in the 1990s. Likewise, optimists say, Europe's long recession won't have a major impact on U.S. growth.
Momentum: In 2008, the United States and Europe experienced recessions triggered by the U.S.-based mortgage securities meltdown. But BRIC nations — Brazil, Russia, India and China — had enough economic momentum that year to quickly shake off the troubles and keep powering through. Likewise, in 2012, the U.S. and the BRICs will keep growth rolling even as Europe slides.
Indeed, the BRICS and other emerging markets with young and fast-growing populations, such as Indonesia and Turkey, will hold the keys to U.S. economic health, not Europe, according to the man who coined the acronym BRICs. Jim O'Neill, the chairman of Goldman Sachs Asset Management, has released a new book: The Growth Map: Economic Opportunity in the BRICs and Beyond.
In the book, O'Neill says emerging economies will make Europe relatively less important to Americans.
"The world economy has doubled in size since 2001, and a third of that growth has come from the BRICs," O'Neill wrote. "Their combined GDP increase was more than twice that of the United States, and it was equivalent to the creation of another new Japan plus one Germany, or five United Kingdoms, in the space of a single decade."
Optimists say the United States may not only escape Europe's troubles, but actually could be helped by the turmoil. Investors are pulling money out of Europe to seek shelter in U.S. stocks and bonds. "There's a flight to quality," Truglia says.
This influx of capital can help U.S. businesses expand while keeping interest rates low.
Risks From Europe Remain
But even optimists admit the course of events will be very difficult to predict this year because of several major unknowns. For one, China's economy could be in for a "hard landing," if its growth stalls. If China, Japan and Europe all are in recession in 2012, then it would be very difficult for the United States to shake off that much bad news.
And, of course, the idea that U.S. financial institutions could really build a fireproof wall around themselves to protect against a European market meltdown could be wishful thinking. Many analysts say financial institutions are so globalized that a series of European government and bank defaults would necessarily lead to trouble for U.S. financial institutions.
"In the near term, the eurozone sovereign-debt crisis is the biggest threat to the U.S. economy," IHS Global Insight chief economist Nariman Behravesh wrote in his 2012 assessment.
One pessimist goes further. David Levy, an economist with the Jerome Levy Forecasting Center LLC, said in his 2012 outlook that U.S. companies couldn't absorb a major financial shock from Europe because "private balance sheets, in the aggregate, remain oversized, fragile, and sufficiently troubled to keep contracting."
Despite some evidence of decoupling, Levy believes that "any major jolt to ... markets will aggravate this unstable financial situation and risk triggering a new vicious cycle of financial and economic decline."