Why Europe Matters: A Stark Warning for the United States

Dec 01 2011

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The United States’ and European economies are closely linked and the potential for negative spillover from the European sovereign debt crisis to the United States is of significant concern.

U.S. exports of goods and services to the Eurozone (countries using the euro as their currency) was $285 billion in 2010, while imports from Eurozone countries amounted to $331 billion.  U.S. foreign direct investment in Eurozone countries was $1.37 trillion and Eurozone foreign direct investment in the U.S. amounted to $937 billion.

Additionally, while U.S. banks and money market mutual funds have reduced their exposure to European banks, significant exposure and concern over the impact of major European bank failures on the U.S. financial system remains.

At the heart of the crisis in Europe is the unsustainable levels of debt and deficits in many Eurozone countries.  Initially, concern focused on Greece, but recently greater concern has centered around Italy and Spain.  Accompanying this growing concern has been a significant increase in the borrowing costs of those nations.   Spreads between the borrowing costs of countries like Italy and Spain with Germany have widened significantly over the past year.

Debt and deficits that appear sustainable when borrowing costs are low become quickly unsustainable in the face of rising borrowing costs.   This should serve as a stark warning to the United States that it needs to act sooner rather than later to bring government spending down to sustainable levels relative to the size of the U.S. economy.

Rising Yield Spreads over German Bonds

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