Free Markets, Free People


Europe’s debt crisis and the US

James Pethokoukis reminds us that if we’re not watching the European debt crisis, we should.  The one thing Tim Geithner apparently got right was how it could effect the US negatively.  Geithner said:

Europe is so large and so closely integrated with the U.S. and world economies that a severe crisis in Europe could cause significant damage by undermining confidence and weakening demand.

And that’s the obvious truth.  If you need to catch up, here’s an article in the Financial Times to bring you up to date (you may need to sign up or register to read it).

Pethokoukis then points to a report from Barclays Capital that details what Geithner was talking about:

Our baseline forecast assumes that policymakers will prevent the turmoil in Europe from leading to a full-blown financial crisis similar to 2008 and that US policymakers will not impose excessive fiscal tightening starting in 2012. If, by contrast, either of these risks is realized, the potential for another recession will increase substantially. We use the Fed’s stress scenario under the Comprehensive Capital Analysis and Review (CCAR) as an alternative scenario to our baseline, but ratchet up the intensity modestly and analyze its effect on the outlook for house prices.

1) Our modeling suggests that in a recession scenario, house prices, as measured by the CoreLogic headline index, could decline another 7% in 2012 . … The scenario posits declining real GDP for four consecutive quarters, with Q2 12 having the deepest decline at 6% (q/q saar).

2) Real disposable personal income also declines for four consecutive quarters, albeit with a one-quarter lag relative to the decline in GDP, and the unemployment rate moves  persistently higher, peaking at 12.1% by the end of our forecast horizon.  …

3) Furthermore, the rising unemployment rate suggests that delinquencies would push shadow inventory higher, putting downward pressure on distressed home prices. Together, the two effects send home prices significantly lower in 2012.

Or in simple terms, if Europe goes, so does the US.  Housing down another 7% and unemployment up into the 12% area.

Obviously this is all based on modeling and plugging in various numbers.  So just as obviously those numbers could be off a bit.  However, the basic premise is correct.  If Europe can’t solve its debt crisis, the US will also suffer and, as you can see, suffer mightily (check out the chart at the link). 

I think the political implications are clear even for the most partisan among us.

~McQ

Twitter: @McQandO

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13 Responses to Europe’s debt crisis and the US

  • The rumored solution to the European debt crisis is to leverage the EFSF (have it sell bonds backed by France and Germany and use the proceeds to bailout whichever country needs bailing out).  The problem with this is that it just puts in place another layer of debt without addressing the real problem of the PIIGS running unsustainable debt.  Leveraging the EFSF to bailout Greece will probably work in the short term as they only need $400 billion or so.  The problem is that if the EFSF has to bailout Italy and/or Spain it will have to leverage into the trillions.  In such a case the solution is the new problem.  Also, if anyone defaults on the bonds sold to the EFSF then France and Germany get to pick up the tab.  Germany can probably do so if it is not too big of a default.  France can’t.
    This is not a solution.  This is kicking the can down the road in hopes that better times ahead will solve the debt crisis.

  • Europe has to show a willingness (not just put on a show) of cutting entitlements and cutting spending.  The same thing the US needs to do.  We cant afford our own bills much less picking up the tab for Europe as well.

    • If you want to see Europe’s willingness to accept austerity then take a look at the headlines coming out of Greece.
      Namely strikes and riots.
      Here is a good read on the subject:
      http://www.zerohedge.com/news/david-rosenberg-insanity-fixing-excess-leverage-more-leverage-and-relentless-euro-rumormill
      The money quote:

      Why are we so skeptical? Well, when you go back to the opening months of 2010, it was all about Greece and the prime goal was to prevent contagion to Portugal and Ireland. We know how that went. Then that fall, the risk was Greece, Ireland and Portugal and this was when the term PIG was coined. At that time, the goal was to protect Spain and Italy. And we know how that went. Then just this past July, the crisis moved beyond just Greece, Ireland and Portugal to include Italy and Spain (and this is where PUGS was coined). At this point it was about preventing contagion to the banks, but nothing has worked. The contagion has merely spread, and this is not the first time a late-day press release or policy announcement was leaked to juice the market.
      The Europeans are living in a world of denial that they can continue to give funding to Greece as it continuously refuses to meet its fiscal targets. Ditto for Portugal. How will France be able to avoid a downgrade? And how do the banks not take a big haircut in all this?

      • The western Europeans have had “Cradle-to-Grave” welfare states for a couple generations now.
        Unfortunately, THIS generation isn’t going to make it to the grave before it all implodes. As they were born and bred to that welfare state and its nebulous/empty promises, they are utterly clueless of what would happen and how to deal with it.
        Probably the US has to learn the same lesson the way Europe is learning theirs: the HARD WAY. By that I mean you can only kick the can down the road so long before you hit the INEVITABLE dead-end.
        It ain’t rocket science.

      • In most European countries, there are no private pension plans … no safety net for the safety net.

      • The Europeans are living in a world of denial

        This is the contagion that continues .. “denial”
        Exactly when does anbody expect Obama to look into the TOTUS and tell the American people that the housing bubble has exposed a huge gap in our future budgets to the point that the government and future “entitlees” are going to have to take a “haircut”.
        I watched a decade ago when Lucent Technologies did virtually the same thing in the private sector.  The difference was that instead of kicking debt down the road, it sucked in it’s future market till there was a huge vacuum in demand.  We know where Lucent is today.

  • The obvious next question … is this the same model that had unemployment topping at 8% with the “stimulus” ?

  • The Europeans are going to do whatever is necessary to prevent a full blown financial crisis. Can they prevent one? I don’t know. I’m almost convinced they are trying to square a circle.
    What’s left unsaid above is the exposure US banks have to European government debt and credit default swaps. Remember the billions of swaps AIG sold? Well our really smart bankers have been doing the same thing with European government debt.

  • “If Europe can’t solve its debt crisis,…”
    Define ‘solve’.

  • The problems that the financial crisis has brought about are more and more reflected in the policies of many governments in Europe. One of the recent cases is the fall of the Slovak government because of the disagreement over the EFSF which should be the last resort if one of the biggest European countries such as Spain or <a href=”http://calgaryrealestate.ca/news/2011/09/housing-market-piigs-italy/”>Italy</a> suddenly defaulted. Only the future will reveal whether the EFSF will respond adequately to the negative economic development in those countries but when compared to Greece their default would really be detrimental for the world economy.

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