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The European Debt Crisis In America

Daniel Rothberg |
June 26, 2012 | 7:33 p.m. PDT

Staff Reporter

(Creative Commons).
(Creative Commons).
In what is shaping up to be a make-or-break week in the 2012 election, all eyes have turned to a slew of domestic issues before Congress and the Supreme Court. With the health care law on the chopping block, student loan legislation expiring June 30 and continued discussion of “Fast and Furious,” it is bound to be a wild week in American politics. As if that wasn’t enough, another complex issue is festering across the pond: the European debt crisis. 

Last Wednesday, President Obama acknowledged the impact that the crisis might have on his re-election campaign. And to make matters worse, Wall Street took a hit Monday on skepticism about a European Union summit that begins Thursday. Some have even started suggesting that the European debacle mirrors the 2008 global financial crisis. 

As the United States enters another month of slow recovery, here’s a rundown on some ways the crisis abroad might affect the economic and political landscape here at home.

Exports

On June 20, Federal Reserve Chairman Ben Bernanke announced action to provide additional support to the American economy. In a press conference, Bernanke listed three "head winds" facing the U.S. economy and first on the list was that the recession in Europe was hurting American exports.

In April, American exports to the European Union dropped by 11.1 percent. Europe is responsible for nearly one-fifth of U.S. exports. What's more, Bloomberg News reported earlier this month that companies ranging from "American exporters from Dow Chemical to Hewlett-Packard are bracing for a decline in demand from Europe as the region's deepening debt crisis threatens to derail a source of strength for the U.S. economy."

Still, there is some hope. Despite the fact that the recovery has slowed down, Dean Baker, co-founder of the Center for Economic and Policy Research told Talking Points Memo on June 19 that he believes it can still withstand the Euro crisis, as Reuters reported late last year.

“[E]xports to the region are only about 2 percent of U.S. GDP,” Baker said. “If exports are down by 10 percent because of the crisis (a huge falloff), this only knocks around 0.2-0.3 [percentage points] from U.S. GDP.”

U.S. banks

For many months, media outlets have covered the exposure of American banks to European debt. In late January, The New York Times reported that banks are attempting to mitigate potential losses (in the billions) through credit-default swaps, which essentially serves to insure a debt instrument (a bond, mortgage, etc…) against a default.

But these hedges might not be as effective as banks hope. With $602 billion of swaps having been written on Italian, Spanish, Portuguese, Irish and Greek debt as of January, some question whether companies will be able to pay the swaps in the case of a financial meltdown. In 2008, A.I.G. was unable to make payments on its credit-default swaps, nearly taking down the firm.

There’s another looming threat that could worsen the effect of a European crisis on U.S. banks. What if there is a dissolution of the euro? For starters, payouts for many credit-default swaps are in euros. Dissolution, as The New York Times reported, would place the value of these contracts in question.

But dissolution would affect banks in other ways. Earlier this year, 15 of 19 large banks passed the Fed’s stress test, which looked at how banks would perform under certain variables, one of which was an economic downturn in Europe and Asia.

Some experts, however, believe the test was weak. Simon Johnson, an MIT professor and former chief economist at the International Monetary Fund, wrote an article for Bloomberg arguing that U.S. banks are not prepared for the full-blown crisis in Europe. Johnson wrote the test omitted certain risks including “serious euro dissolution” and that the Federal Reserve should apply pressure on banks to increase capital.

“If the world’s largest bank can lose $2 billion to $3 billion in a relatively calm quarter through incompetence and neglect on the fringes of its operations, how much does it stand to lose when markets really turn nasty across a much broader range of its activities,” Johnson wrote. “And how might that harm the U.S. economic recovery?”  

Election 2012

In addition to economists, politicos have been keeping a close eye on events in Europe because, as mentioned before, a European crisis could have significant consequences to electoral outcomes in November.

Both President Obama and Republican presidential nominee Mitt Romney acknowledged this last week.

"I think it's fair to say that any - all - of these issues, economic issues, will potentially have some impact on the election," Obama said at the G-20 summit in Mexico last week, according to USA Today.

But there is little that the administration can do about it, even though they may be blamed for the effects of events in Europe. At least, that's what Sabina Dewan, director of globalization and international employment at the Center for American Progress, a liberal organization, said to USA Today.

That doesn't mean references to the European debt crisis won't crop up in election rhetoric. Last week, Romney attempted to use Greece as an example of where America is headed without cuts to spending.

"One of the things I think about is whether America's going to hit a Greece-style wall," Romney said at a rally in Wisconsin June 18, reported the Associated Press. "Spending a trillion a year more than [the United States take] in is leading us to Greece."

 

Reach Staff Reporter Daniel Rothberg here; follow him on Twitter here.




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