In a global economy, there are two economic truths: Financial markets don’t like uncertainty, and everything is connected.
Both are good reasons that Americans should be worried about the European debt crisis.
With Greece’s recent failure to form a new government that can rally around the measures imposed upon it by its European bailout partners, there’s a growing likelihood that the country may be forced out of the eurozone — a 17-nation group that uses the euro as the basis for its currency — and into bankruptcy.
Uncertainty has spiked across the continent, where more than 330 million people use the common currency.
Uncertainty restrains lending, and European banks are already struggling to cut their debt-to-capital ratios. Less lending causes economies to contract, possibly into recession. And a deepening European recession is bad news for U.S. exports — 20 percent of which go to Europe.
Also at risk: U.S. firms’ $1 trillion direct investment in countries in the European Union (EU).
Everything is Connected
Combined, the eurozone has a $12 trillion economy. If Greece defaults, there is expected to be a chain-reaction. Portugal, Italy, Ireland and Spain — all with severe debt problems of their own — could be the next dominoes to fall.
That series of defaults could easily wallop German and French banks that carry large shares of their brethren’s debt.
U.S. investors will be plenty worried by that point, should it com. Wall Street banks have more than $1.3 trillion invested in German and French banks.
Then there’s the $80 billion that five large American banks — including JPMorgan Chase and Goldman Sachs —lent to the wobbly group known as the PIIGS (Portugal, Italy, Ireland, Greece and Spain). If Peter cannot repay Paul, then Paul can’t repay Uncle Sam.
Meanwhile, there continue to be issues here at home. The U.S. economy is on a slow, fragile path to recovery.
If the European financial system implodes, there is little chance that America will be unaffected, and the progress the U.S. has made could be erased. If American banks are forced to write down debts, they will have less to lend back home, at a time when the U.S. economy needs more, not less, activity. Government defaults, bank failures, mass unemployment, social unrest and a severe decline in Europe’s GDP simply will not be restricted to Europe’s shores.
Yet it seems the only thing American policy makers, corporations and investors can do is watch, wait and worry.