Why a Euro-Zone Crisis Can’t Be Avoided Very Much Longer

Each postponement of financial disaster in the euro zone seems likely to last for a shorter time, and the U.S. won't be able to escape the fallout indefinitely

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Stocks rallied powerfully late last week after European Central Bank President Mario Draghi declared that the ECB stands ready to do whatever it takes to preserve the euro. That was mighty tough talk, but analysts remain skeptical about the outlook for the common European currency. No one doubts that the ECB can provide short-term support for euro-zone economies. But even so, most forecasters believe that the euro zone is heading for a crisis. And whatever form that crisis takes, the impact on the U.S. would be negative.

So why did the Dow gain more than 400 points in two days, rocketing through the 13,000 mark to a three-month high, after Draghi’s speech on Thursday? The answer is that the euro’s eventual failure has been predicted for so long that it has become conventional wisdom. Each postponement creates a burst of optimism — not that the crisis has been solved but simply that it has been delayed.

(MORE: Spain on Edge as Focus Shifts from Banks to State’s Finances)

But each respite is likely to last for a shorter period of time. And what has finally happened, in my view, is that the euro has passed the tipping point. From where things stand now, it seems as though the situation will only get worse — and the deterioration will probably accelerate.

There are three seemingly unavoidable problems:

The next round of losses in Greece cannot be charged mostly to private-sector lenders. When Greece was bailed out in March, banks and other private investors took most of the losses, which they were willing to do because they also stood to lose a lot if Greece defaulted. But now that the share of Greek sovereign debt held by commercial banks, insurance companies and investment funds has been greatly reduced, future bailouts will necessarily diminish the value of debt owned by government banks and international financial institutions. In some cases, those lenders may be restrained by law from cooperating with any such devaluation, and at the very least the costs that result will ultimately fall on taxpayers.

Austerity and ECB lending have not been able to hold down interest rates. Bailouts and budget cuts have been enough to persuade investors to keep lending to overindebted countries. As a result, bond yields were reduced for a time in key countries, such as Spain and Italy. Within the past month, however, yields on 10-year Spanish bonds climbed back up to 7.6%, well above the 7% that is generally considered to be the danger mark. Yields on Italian bonds also rose, reaching 6.6%. Since Draghi’s speech, yields in both countries have come down a bit. But it is notable that recent euro-zone rescue policies have been unable to hold Spanish and Italian bond yields anywhere close to a safe 5% level, where they were in March.

(MORE: The Real Problem with Offshore Tax Havens)

The growing magnitude of the problem will run up against political constraints. There is a limit to the amount of money the ECB, the International Monetary Fund and other such lenders have available for bailouts. As those institutions use up their reserves, they will need large amounts of new money if they hope to keep postponing a euro crisis. But where will that money come from? The number of countries in trouble keeps growing. Both France and the Netherlands, which supported and helped pay for previous bailouts, now have financial problems of their own. And resistance is growing in Germany against taking on further liabilities (not to mention the fact that contributing to larger bailouts may raise constitutional problems).

Of course, there is no way to know precisely when the scale of euro-zone financial problems will exceed the resources available to keep postponing them. But it is clear where the process is heading. And as soon as investors begin to think that endgame has started, interest rates will probably shoot up in Spain and Italy and accelerate the process.

Moreover, in any likely scenario, troubles in the euro zone could have a substantial negative impact on the U.S. before the November elections. Economies have been slowing in much of the euro zone — indeed, the private sector has actually been shrinking for six months. Outside the euro zone itself, the U.K. economy has been in recession for three quarters. In addition, China’s growth has dropped from double digits to 7.6%, the lowest level in three years.

Exports account for less than 14% of the U.S. economy, compared with more than 30% for the U.K. and almost 50% for Germany. Nonetheless, foreign business is extremely important for many of America’s largest multinationals and technology companies. Apple, Coca-Cola, Intel and McDonalds all get more than 60% of their sales overseas. As a result, any slowdown in foreign economies is a major drag on important parts of the U.S. economy. That’s one of the reasons that tech stocks have underperformed the broad market since April. And further weakness overseas would likely affect even more of the U.S. economy.

None of the possible outcomes for the euro zone augur particularly well. If some of the financially weak countries are forced to abandon the euro or the euro zone breaks apart, there will be shocks to the international banking system that would slow most major economies. And if international bureaucrats are able to sustain the euro for more than a few months through brilliant management, the austerity policies needed to do so would only push economies closer to a global recession. Either way, it’s hard to see how the U.S. can escape the fallout from a European financial crisis for very much longer.

MORE: Has the European Slowdown Finally Hit the U.S.?

12 comments
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Michael Bochenski
Michael Bochenski

Fiat US Currency holding up Fiat Euro Currency = double inflation. It is time to end this awful experiment and go to a gold and silver standards even other commodities do better. Fiat dollar trades in labor for labor that is slavery. The gold standard allows you to trade labor for real property. In 1780 $100 of labor  rose to $437.00 by 1913 an increase of 4.37 times . End of gold standard $100 dollars of labor in 1913 cost $30,800.00 TODAY! It is not even hard math its more like simple logic.

Epiminondas
Epiminondas

Dang persnickity socialists!  You think they're crazy enough to bring the house down on their own heads rather than admit the error of their ways?  You're durn tootin' they are. Or maybe they're just ignorant fools.  Persnickity any way you look at it.

Axilleus
Axilleus

They want to the ECB print their way out of this mess. I think that everybody has come around to the conclusion that either the ECB starts printing money and buying government bonds on a massive scale in Spain, Italy, and whatever other country starts having problems or the game is up and the whole thing goes byebye.  Not just the euro currency, but the EU on the whole would not survive its breakup.

rene591
rene591

Debt and Empire-gets you every time-overstretch resouces and profiligate politians and citizens- both Europe and US has to get its house in order-debt will have to be liquidated- not sustainable. we are all austrians now-

Dean Schechinger
Dean Schechinger

Europe's austerity  isn't working because they raised taxes and cut very little spending. In effecct they took the money from consumers that they should have let them keep and spend.Hey isn't that what our  president wants to do? Any chance we can change his mind?....Never mind.

Mark Urbo
Mark Urbo

Why would the markets fall for this obvious trick to calm the euro crisis waters for the time being ?

How many times have the euro zone financial leaders said they have a deal or a way to resolve the crisis - about eight times by my account - and yet the crisis continues...

romano71
romano71

I hope Europe is not expecting the US to dole out cash to solve their problems....

stephen weber
stephen weber

You know.... It is mostly a fact that the financial crisis of 2008 was American Companies. It is fairly obvious that the world is interconnected. And the truth is as clear as honesty. American business practice (since technically we are top dog) is the cause of the current European Crisis.

Here is the logic.

what happens tomorrow does depend on what the players do today. 

You are saying,

What is happening today doesn't depend on what the players did yesterday.

Can you attempt to see what you are saying? Or are you and anyone else that agrees with you like that lady in history that said, "Let them eat Cake..."

zza371creek
zza371creek

I would not think of the EU as a Crisis because of how long it has been going on. I think of the EU like the African failed states it is just going to be a on going problem.

A crisis is something that happens suddenly and people don't have time to adapt too. If people have not adapted to a world with the EU breaking up or playing a smaller role in economic growth they have been living under a rock.

romano71
romano71

Your comment is absurd. The richest customers for US goods are in Europe. So basically what you are saying is that we had 2 years to find new customers? What do you think, they grow on trees?

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Although the prevailing view on the Euro is that it's unsustainable, and

that its demise is a foregone conclusion, it has, at least up until

this point in time, managed to weather the storm relatively intact

metropika
metropika

Although the prevailing view on the Euro is that it's unsustainable, and that its demise is a foregone conclusion, it has, at least up until this point in time, managed to weather the storm relatively intact.