Hey guys, its me Europe!
After a short break I have decided to start writing again. Thanks for the notes of encouragement.
Europe has finally decided to join the ‘economic meltdown party’ the US threw almost 3 years ago. Wow, did she make an entrance. The Euro is at a fourteen month low against the dollar primarily due to the uncertainty regarding sovereign debt in Europe. (Sovereign debt is a debt instrument guaranteed by the government). What started with Greece being unable to honour its sovereign debt soon morphed into, Italy, Spain and now Portugal being, or in the process of being downgraded by the rating agencies. Though the analysts seem to be spilt on the problem of financial contagion (as defined by Investopedia to be the likelihood of significant economic changes in one country spreading to other countries, in this case referring to economic crises). It is still an issue to be very worried about. The last time we saw severe financial contagion was in 1997 when the Asian economic crisis, started in Thailand and eventually spread to South East Asia and Latin America. In the case of the EU what is even more worrying is that the Euro-Zone is connected not only through geography and low trade barriers but a common currency as well.
Affect on the EU economies:
If the suffering of Greece and Portugal was not bad enough, the Wall Street Journal Blog has an interesting post discussing how Spanish spreads are widening as we speak. This is a serious issue considering that Spain is the 4th largest economy in the EU. Though Spain’s debt problem is not as bad as the one in Greece, it does have problems of its own regarding unemployment. Affected European countries are cutting spending to tackle the crisis which in turn is going to have a negative impact on future growth rates of these countries. The current rioting opposing the austerity measures taken by the governments is not making the situation any better.
Though the UK is not having problems with its sovereign debt, it is still in the news with the looming elections. It will be interesting to see how the UK election will pan out. I am curious to see what kind of government the people want — one that is big on bailouts and intervention or one that takes a more conservative, survival of the fittest approach. Needless to say the election will have a significant impact on how the crisis unfolds.
Affect on the Euro:
The current crisis can have an effect on the future of the Euro as well. Stuart Burns makes a great case for how Greece, (along with most of the Mediterranean countries) have enjoyed the fixed borrowing rates by being a member of the European Union. Greece with little or no organic growth and double digit unemployment and inflation was allowed to borrow money at the same rate as France or Germany. As a result the Greek economy grew rapidly (mostly through financing by the public sector) but did not have the means to support herself. With the current bailout and fear of contagion, responsible countries like Germany or France are being tested, and are not taking kindly to the increase in the borrowing costs and taxes in order to bail out other EU member countries.
Affect on US Markets
The dow lost around 200 points yesterday and 95% of S&P stocks were down while the Vix was moving up. Though these movements could be attributed to the Oil spill on the Gulf of Mexico and the foiled terrorist plot in NYC, it would be naive to think that the state of Europe is not causing a significant burden on the US or even global markets. The unemployment numbers to be released in the next few days will have a significant impact on how the US economy will react to the current declines.
If the US should learn any lesson from this European crisis, it should be that the inability to repay sovereign debt is a real concern, especially after accumulating a large deficit. Is it time for the US to start taking care of its own debt? Jim Owens, CEO of Caterpillar Inc. writes a phenomenal article in which he goes over major areas of the economy that the government should be focusing on in order to tackle the current deficit problem in order to heal the ailing economy.
Note- The ECB (European Central Bank) general meeting tomorrow morning is going to have a significant impact on the direction of the Euro. Hopefully, the ECB will restructure the debt of the struggling countries and cut interest rates. Such cuts will devalue the Euro, but it is a necessary step at this point.
