How The Euro Collapse Will Affect the U.S.
The Present Euro Status
Great Britain is now planning on the basis that a Euro (€) collapse is just a matter of time.
British diplomats have been told, we learned last Friday, November 25, 2011, to prepare to help tens of thousands of British citizens in EuroZone countries with the consequences of a financial collapse that would leave them unable to access bank accounts or even withdraw cash. Things are changing rapidly in Europe as the EuroZone moves towards partial or complete disintegration. Germany was unable to sell all of its bonds, and most of the rest of the EuroZone could not sell any at all. The European Central Bank (ECB) restated that it would not buy Greek, Portuguese, and other sovereign debt, so those countries will not be able to refinance their existing debt as it comes due. This means the big European banks which booked profits by making high interest Euro loans to Greece and other soon-to-default countries are going to sustain massive losses. The ECB said it will buy assets from EuroZone banks to provide them with liquidity so they can weather the resulting losses from defaults.
Perhaps the largest blunder was to render all credit default swaps (a form of insurance against default) on sovereign debt essentially worthless, or void, by making the Greek default “voluntary.” This has made it impossible to hedge against EuroZone sovereign debt purchases, and thereby destroyed the market, making investors believe that the Euro cannot be trusted, that it’ll repeatedly find ways of reneging on contracts, that’s its at the point of no return, that it is no longer a serious currency.
What Is Currently Being Done
With China refusing to bail out the Euro, I paraphrase DJ Redman’s excellent article about what Federal Reserve chairman Ben Bernanke is currently doing: Bernanke lowered interest rates for dollar swap lines, along with cooperation from four other major central banks (Canada, England, Japan, and Switzerland), to the ECB, thus attaching the European debt crisis exposure to the banking systems of the other four countries mentioned above in a move to obscure the fact that he is lending more money, and collecting lower interest rates, to the European Union (EU). This move does little to solve the underlying problem of mountains of government debt in Europe.
French President Nicolas Sarkozy and German Chancellor Angela Merkel called for changes to the Lisbon Treaty in order to prevent future government debt crises threatening the EuroZone, of which France and Germany are a part. In a joint statement with Chancellor Merkel, President Sarkozy proposed revisions to the EU treaty in order to bring in tough sanctions against countries that threatened the Euro‘s stability by running high levels of government debt, as well as to establish a permanent EU bail-out fund. Any treaty changes are seen as serious setbacks for British Prime Minister David Cameron because he has opposed any EU institutional changes and recently renewed his “referendum lock” pledge to hold a popular vote on any future treaty that passes new powers to Brussels.
Meanwhile, Sarkozy on Thursday, December 1, 2011, announced a meeting with Merkel aimed at guaranteeing “the future of Europe.” The meeting is to take place in Paris, France, on Monday. They will finalize Franco-German plans for tougher EuroZone governance aimed at avoiding economic collapse and the end of the Euro. Sarkozy said it was crucial that more control was given to Brussels (my personal observation: relinquishing sovereignty) over national budgets as countries like France were pushed towards recession.
How The € Collapse Will Affect Us
There are two fundamental differences with the situation in America and Europe, political and economic.
Politically, despite everything that has gone on in America recently, in the US we have a cohesive political system. We are one country that (more or less) speaks the same language. We are, in times of trouble, the United States Of America. Europe is not the United States Of Europe. In Europe, 27 leaders ALL have to come to an agreement on a decision, then go home and sell that to 27 democracies. Europe literally and figuratively does not speak the same language.
Economically, America has a key weapon at its disposal: the Federal Reserve can print as much money as is needed to finance its borrowing. The countries in the EuroZone do not have this power. Countries that have gotten into financial trouble so far, the PIIGS (Portugal, Ireland, Italy, Greece and Spain) do not have their own individual central banks that they can rely on to print money and buy their debts.
We live in a globalized economy, so what happens in Europe will not stay in Europe. The collapse of the Euro means that contagion could trigger a worldwide economic meltdown, and America will inevitably be hurt. The EU is America’s largest trading partner. In 2010 $239.8 billion of US goods went to the EU. If it is in deep recession, American companies will suffer and more American jobs will disappear. Further, it is estimated that American banks and market funds hold more than $2 trillion in European banks. Those European banks hold a lot of European sovereign debt that could go bad. There is a very real possibility of banks going bankrupt. That means that American banks could suffer big losses and stop lending to Americans. The Euro collapse cannot be underestimated. American companies will be less likely to hire, and American consumers will be more unlikely to spend.
A disorderly sovereign debt default, such as the collapse of the Euro, could cause U.S. Gross Domestic Product (GDP) growth lowered by 2.05% in 2012 and by 2.77% in 2013, accompanied by deflation. Unemployment, currently at 9%, would rise by at least 2% in 2013. Developed country GDP would be 5% lower by 2013. If one or more countries were seen at risk of leaving the EuroZone, higher interest rates on debt and bank runs would add to instability, causing political, economic and market upheaval.
Governments sell their debt to other countries to finance government spending. Others buy government bonds because bonds give a secure, low-interest rate return. But when it looks like a country, say Italy, can’t pay back its debt, the investment gets riskier and investors expect a little more money back, for the extra risk. On Oct. 8, 2010, Italy’s 10-year bond yield was 3.744%. The same bond closed Wednesday, November 30, 2011, at 7.021%. In 2010, the U.S. exported around $14.2 billion in goods and services to Italy. A collapse of Italy’s system would ripple through Europe and quickly pass through America as each collapsing country propelled the shut-down faster and faster.
for another perspective listen to Mitchell and Ray talk about the EU crisis on the CDNews Radio network