Global Debt Crisis, Eurozone and the US Economy

Edon Shaqiri

President

Axel Weber, the visiting professor of economics at Chicago Booth and the former President of Deutsche Bundesbank was the latest guest speaker to be featured at the Myron Scholes Global Markets Forum.The forum was held May 25th, 2011 at the University of Chicago, Gleacher Center, Chicago, Illinois. Weber’s presentation was appropriately titled, The Future of Economic Governance in the Euro Area: Quo Vadis. FREE officers: Myself, Timothy Plett and our advisor Frank Wyrostek were in attendance. In response to the financial crisis, the EU in particular has proposed a series of new regulations and a long lasting framework which will undoubtedly affect the broader capital markets in the coming years. Weber was an excellent choice given his background and reputation in central banking and his involvement in the Eurosystem.

The Eurozone Mess

Immediately into his presentation, Weber was quick to differentiate between a currency and sovereign-debt crisis. An argument supporting the former claim, according to Weber is often a misplaced notion given that much of the issues in Europe stem from problems that the US is currently facing. Simply put, the crisis felt in Europe are a microcosm of the global debt crisis and as investors, we have to realize that we are dealing with a sovereign debt crisis and not a monetary one.

Now, as far as the Eurozone is concerned, the main causes of the sovereign debt crisis point to excessive public spending which has led to large budget deficits that are too big to manage. The main countries hit by these problems are Portugal, Ireland, Italy, Greece and Spain (PIIGS). Eurozone regulations prohibit running deficits in excess of 3% of GDP however, by the year 2009, Greece’s deficit for example was above 15% of their GDP. In turn, these deficits have forced Greece and Ireland to seek and receive funding from the International Monetary Fund and implement austerity measures which will cripple Eurozone economies in the short-run. That is why the regulatory framework which the EU has drafted focuses on looking further ahead and addressing structural issues in the long run.

In his address, Weber pointed at some key areas where weaknesses prior to the crisis could be identified. The gaps in the regulatory framework tagged with distorted incentives inside the financial system were obvious reasons why the EU crisis spread so quickly. Regulation by design is quite static. Making the system resilient in this case is key. So how do you find the right balance and implement a resilient framework which will not stifle economic growth? The EU seems to feel they have the right formulas in place to remedy the lethargic state of crises.

The Political Ramification

Weber also made sure to address the intertwined political ramifications which in my opinion are most troubling for the continent. There is consensus amongst EU members that any kind of war or violent implosion would not be tolerated, however the bold experiment in unity has exposed and has not held up to the economic stress that sovereign states are currently facing. The question EU politicians were faced with at the beginning of this experiment dealt with whether or not unity amongst sovereign nations would be political or fiscal/monetary by design. With the crisis at hand, that question is back on the table. The political risks facing the continent are deeply rooted and have been accentuated by sporadic labor unrest and public protests in most major capital in Europe.

The burning question though, whether or not the EU is a fiscal/monetary union or a political one must be answered more succinctly this time around, for European consumers will only grow more restless as the crisis worsens.

Overall Impact on the US Economy

To illustrate how intertwined the US economy is with the Eurozone, consider this: the cumulative sovereign debt levels in Europe are at 14% of the GDP. The majority of this debt is held by countries like Germany, Great Britain and France. In turn, the holdings of these countries are directly enmeshed with US banks. If these loans were to be charged-off by 30 cents on the dollar, the EU banking system would implode even more and suffer the fate of the US system back in 2008 with Lehman Brother’s collapse.

With unemployment still relatively high at 8.7% and unpredictable real estate prices tracked by the S&P Case-Shiller Home Price Index, the US economy runs the risk of faltering to a double-dip recession, especially if the European debt crises are not confined.

The US dollar has made great strides against the Euro however a stronger dollar during a recovery stifles short run international competition, given that it keeps industries from exporting.

As you see the problems which face many Europeans today are a lot similar in nature to the issues the US economy has to confront. In the long run, I am confident that both economies will overcome the economic obstacles which they are faced with now, however the policies and the regulatory framework which we implement will reflect that growth and central bankers such as Axel Weber are quite aware of this point.