As Secretary Geithner travels to Europe again this week to express America’s “deep concern” about the escalating euro crisis, his counterparts will listen politely—but here is what they will really be thinking: “We know we have a big crisis on our hands and that we have to act decisively, thank you—but what can you do to help? Yes, we appreciate the Fed’s participation in enhanced swap lines, but we all know this is just a palliative.”
His fellow finance ministers will grow impatient. “We understand that you have a fiscal mess, but we don’t have a lot of time right now. We really need to prepare for the meetings with the Chinese, Brazilian and Mexican delegations. After all, as you and your president keep repeating, this is Europe’s crisis to deal with.”
This is more than ironic. It is unreal, tragic in fact, because everyone around the conference table will know that a collapse of the euro would not only be a calamity for Europe but also a disaster for the United States.
The form, reach and severity of the looming crisis are massively uncertain. Assessments of the likely impact of a euro zone breakup on the United States range widely. The IMF found that a 2.5 percent reduction in European GDP would result in an 0.7 percent fall in U.S. GDP, while the OECD calculated that disorderly sovereign defaults in some euro countries could reduce U.S. GDP by more than 2 percent. In a systemic crisis, don’t trust official projections—international organizations are politically influenced and are congenitally incapable of giving you the full picture when the news is really bad. In any event, their models cannot capture the main features of a major crisis, namely “animal spirits” and the undecipherable interconnections of the global financial system.
Private analysts are no smarter, but at least they are not politically influenced. A UBS analysis suggests that a weak country leaving the euro zone could lose half its GDP in the first year, while Germany’s exit would reduce its GDP by 20 to 25 percent, implying a much larger shock for the United States and the global economy than anybody is prepared for.
U.S. banks have claims on vulnerable euro zone countries equal to 22 percent of Tier 1 core capital; adding in derivative transactions, including gross credit default swap (CDS) exposure, brings the total to 80 percent. Total assets at risk, including U.S. bank holdings in the troubled countries, CDS exposure and vulnerability to European banks affected by the crisis, could exceed $4 trillion. These risks are reduced by hedges against losses (including CDS purchases), while some forms of “voluntary” default may not trigger CDS payments. On the other hand, if counterparties are unable to meet their obligations, then hedges and offsetting transactions may be worthless. Estimates of conditional probabilities of distress (a measure of the likelihood of default by U.S. banks given a major credit event in European banks) indicate that a failure of banks in the core European countries could have similar implications for U.S. banks as the failure of Lehman Brothers in 2008.
Other U.S. financial institutions also would be hit. Money-market funds, insurance companies, pension companies, investment houses and hedge funds have an undetermined exposure to European countries in the form of bonds, CDS transactions, swaps and other derivatives transactions. U.S. money-market funds hold European paper totaling $384 billion in September 2011. (This is a 30 percent decline since June, according to Institute of International Finance data). Lack of knowledge over the actual exposure of U.S. pension and insurance companies to Europe is very likely to magnify the indirect impact of a crisis by boosting precautionary withdrawals, forcing institutional investors to liquidate their assets.
A crisis that called into question the existence of the euro will generate the mother of all flights to the dollar. At first glance this would not seem like a bad outcome. U.S. banks might enjoy a much-needed rise in liquidity, and in a “normal” period of excess capacity, increased foreign inflows would drive down interest rates and stoke domestic demand. But in a severe crisis with attendant bank failures, the asset of choice is likely to be Treasury bills, not bank deposits. And given near-zero short-term interest rates and an atmosphere of heightened uncertainty, increased inflows would be unlikely to boost demand.
With dollar appreciation, global demand for U.S. goods would plummet and reinforce the recession in Europe, which purchases 19 percent of U.S. exports. Europe’s troubles would in turn hit emerging markets by limiting their exports (Europe accounts for a third of global imports), impairing their access to loans (European banks account for 70 percent of foreign claims on emerging markets), and triggering capital flight on a much larger scale than seen so far. A downturn in the most dynamic global economies would further reduce demand for American goods, while the ensuing global recession and declines in equity prices would shrink overseas profits of U.S. firms and household wealth.
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Just my opinion, and maybe I'm wrong, but I think it would instead be an immense credit to our intelligence. This debt situation is like a cancer, and when it started threatening here our answer was essentially to feed ourselves titanic amounts of the kind of ice cream that caused the problem in the first place in the form of deficit-financed bailouts and etc., promising that while the ice-cream was anesthetizing things we'd find and agree to some tough cures. Both for the banks and etc. and for our government.And yet we have so far it appears that we have agreed to absolutely nothing really meaningful, with just about everyone agreeing the cancer, predictably enough, has gotten worse. Now the metastasized body called Europe is throbbing, and here once again we hear calls to feed Europe (yet more) ice-cream. (More because our Fed has already pumped a helluva lot into Euro banks). And we are told we can do this safely because we would please pretty-please insist they promise to take cures far far worse than the kind we won't even take, and indeed the kind of cures that would likely inspire actual revolutions in some of their members. Cures that such revolutions would, as their first official act on their first day, vehemently renounce. Just how, exactly, are we going to guarantee that Italy, say, is really really really going to start (and keep) doing what it's never done before and actually enforce its tax code? Or that Greece is going to permanently cut some staggering percentage of its incredibly bloated government "work" force without undergoing a revolution? Or that Spain, Portugal and God-knows who else are all going to do ... what?I have no doubt that the default of a Citibank or Goldman Sachs or Italy or a crash of the Euro would indeed cause big chaos in the world that the authors of this piece live in. Everything in their universe would change as many of the formers powers they are so accustomed to would get blown away and new powers started springing up. But my sense is that the world for the average person wouldn't change nearly so much, so that all these calls for never-ending bailouts aren't really about preserving the situation of that average person, but instead about preserving the sand-box these authors play in. A sand-box full of stupid-at-best-and-corrupt-more-likely old powers they just can't imagine ever changing.But change is inevitable, with the question thus being whether you're going to husband your resources and weather it, or commit suicide by trying to prevent it. Again, just my opinion, but while everyone seems to agree that the problem has been too much debt ice-cream, I never seem to see any explanation of just how exactly force-feeding ever more is going to ultimately solve it. And the authors of this piece have certainly never even addressed this issue either.
What kind if scam are these politicians trying to run now. The FED has given many billions is secret loans already. These bailouts will end very badly for everyone, that is how WARs are started. You can not solve a debt crisis with more debt. The worse is yet to come for the Euro zone. What happens when Italy and Spain find them selves in the same position as Greece. It will be sovereign pandemonium across the European continent. What we saw in 2008 is gonna look like a walk in the park. The euro currency is finished. Once the markets figure this out watch the dow jones index and the sp500 and all indecies around the world crash in a spectacular fashion.
Euro zone crisis is proceeding and Europe needs more money to fix their financial problems. Everybidy thought that Europe and euro are strong, but as we can see euro slowly falls down today. On one hand it's not bad for the US, it makes the dollar stronger,but on other hand, euzone crisis can become a disaster for the US. I agree, crisis is like a cancer, Europe is an important economical part of the world, they had a stable economy, rich countries and strong currency, today European countries borrowing money to stay afloat and I am sure, in one or another way this crisis will affect the world, not only US.