Like a stack of debt-laden dominoes in a Rube Goldberg machine, European countries have been failing in the wake of the late 2000s economic recession. Recently, Italy and Spain announced their dirty debt woes to the global economy, and it could affect the U.S. markets.
At the end of the last decade, the global economy saw a massive hit to output — a recession for which we were largely unprepared. Europe in particular saw a nasty sovereign debt crisis that, for many countries like Ireland and Portugal, crescendoed in intensity until early 2010. Spain, Portugal and Greece saw their debt downgraded, Italy came dangerously close to a failed debt auction, European stock markets sank and the Euro tumbled against the U.S. dollar.
In other words, Europe has seen better days.
More recently, Greece has found itself drowning in debt. After arduous negotiations, it now looks like the best decision for Greece is to default on some of its debt in order to rein in the debt level for an already exhausted Greek economy.
As unfortunate as the Greek situation may be — and it is concerning for Europe — Italian debt trouble represents an entirely new level of danger for the global economy altogether. According to the World Bank, Greece produced a $329 billion GDP in 2009, while Italy’s GDP was $2.11 trillion — over six and a half times higher. So, when a country that size expresses concerns or has trepidation over its ability to pay back debt, the markets listen.
And oh, have they listened. In general, the markets don’t like surprises. If you want a nasty economic downturn, just wait until the last minute to let global investors know about some bad news.
So it was almost as unsurprising as it was depressing yesterday when, upon more talks about Eurozone trouble, the DOW, NASDAQ and S&P 500 all slumped between one and two percent, in the worst single-day decline in more than a month.
Like a nasty cold in a day care center, the European flu infects its neighbors, includingU.S. markets.
So shocks in the European system, even just concerns about financial trouble, can affect the U.S. in a strong way. The concern in general is not that a Greek or Italian collapse will destroy the U.S. — far from it. But if Greece defaults on its debt, this will put further pressure on Italy, Spain, Portugal and other already-struggling European economies, possibly pushing them over the edge into pecuniary failure, leading to further crisis.
But, other than deficit issues and a stubbornly-high unemployment rate, the U.S. has largely been sheltered from the pre-2008 bubble.
Paul Krugman, columnist for the New York Times, explains in a March 2011 blog post: “To regain competitiveness, [European countries] need massive deflation; but that deflation, in addition to involving an extended period of very high unemployment, worsens the real burden of their outstanding debt. Countries that still have their own currencies don’t face the same problems.”
That is to say, the U.S. can shelter itself against changes in the markets and debt by shifting the money supply. Countries in Europe, because they share a currency and are run by an independent bank, cannot print money — sometimes haphazardly — like the U.S. The trade-off has some amazing benefits for European countries but turns out to be lousy when faced with a situation like we see now.
If you’re interested, take a look at the web of debt holdings globally and you’ll begin to see better how defaults push the global economy toward more defaults. Because we have control of our currency — which holds a privileged position in the global markets — we are largely sheltered from many of the problems facing Europe, but as our slumped economy and unemployment rate show, we are clearly not immune.
All Americans could potentially be affected by debt problems in Europe, not just investors.
Devin Graham is a 22-year-old economics senior from Prairieville. Follow him on Twitter @TDR_Dgraham.
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Contact Devin Graham at [email protected]