Europe collapse could hurt US Economy

As the European Union braces for the possibility of Greece defaulting on its debt, American Enterprise Institute resident fellow Desmond Lachman writes in his International Economic Outlook (Sep 2010), that the crisis involving Greece, Spain, & other heavily indebted European countries will only intensify in the months ahead.

Lachman asserts that intractable solvency & competitiveness issues confront these European nations as they face a choice between leaving the eurozone or implementing painful austerity measures that will only deepen their economic plight. Either course threatens Europe's already-troubled banking system & the global economic recovery.

Among the key points :

1. A substantial write-down of Greece's debt would have a major impact on Western Europe's already-enfeebled banking system. While the Greek economy accounts for only 2% of Europe's GDP, Greece's sovereign debt amounts to around US$420 billion, and a large portion of this debt sits on the books of French & German banks.
2. The combined sovereign debt of Greece, Spain, Portugal, & Ireland is around US$2 trillion, and a major part of that debt also sits on the European banks' balance sheets. France has lent the equivalent of 37% of its GDP to those countries. As much as 37% of the European Central Bank's loan book is made up of loans to Greece, Spain, Portugal & Ireland.
3. As the recession deepens and unemployment rises with no end in sight in Europe's periphery, Lachman asks whether these countries might be better served by restructuring their debts and exiting the euro.
4. From a US perspective, a deepening in the eurozone sovereign-debt crisis could threaten the feeble US economic recovery now underway. In part, it would do so by weakening the Euro against the Dollar and by clouding European growth, both of which would diminish US export prospects.
5. The more threatening channel through which it could impact the US economy would be by increasing overall financial-market risk aversion and by precipitating another global credit-market crunch akin to what occurred in the aftermath of the Lehman bankruptcy in September 2008. This is possible because global financial institutions are now closely integrated, and US banks have around US$1.5 trillion in loans outstanding to Europe.