Thursday, June 10, 2010

European crisis not a major threat to US economy

(WASHINGTON) Anxiety about Europe's debt crisis last month caused US stocks to suffer their worst month in more than a year.

Yet many experts say fears that Europe will deal a sharp setback to the US economy are overblown.

They note that trade between the US and Europe is comparatively small. US banks do lend to their European counterparts and hold billions in investments in those banks and other European firms.

But US banks have enough capital to withstand losses from a European crisis, analysts say.

In addition, the European Union is preparing a US$1 trillion bailout for weak member states. And its central bank has begun buying government debt to protect European banks - and their US counterparts - from the risk of default by EU countries.

The anxieties that have spooked US stock markets could linger a while. The Dow Jones industrial average has fallen more than 12 per cent since late April. But the foundations of the US economy remain secure, experts say.

'The physical linkages with Europe just aren't big enough to undercut the US economy,' said Ethan Harris, head of North American economics at Bank of America Merrill Lynch.

If European countries default on their debt, big US banks with operations in Europe could suffer. US banks don't hold much national debt of Greece, Spain and other countries.

But they do have investments tied up in big European banks - those most at risk in case a European country defaults.

The European Central Bank has warned that European banks might have to reduce the value of assets on their books by US$239 billion over this year and the next. Such losses could prevent the banks from repaying their debts to US financial firms. And if US banks fear such defaults, cross-border lending could dry up.

For all of Europe, US banks have US$1.1 trillion at stake. That's roughly 38 per cent of the US$3.1 trillion in loans and derivatives US banks have with all foreign banks. Derivatives are investments whose value depends on the price of underlying assets, such as stocks or mortgages.

Substantial losses from investments tied to Europe would cause US banks to reduce lending. A deep credit crisis could reduce US growth by 1.5 per cent and possibly cause another recession, Goldman Sachs said in a recent note.

The threat from Greece, Spain, Italy and Portugal - the weakest eurozone countries - itself is small, says Mr Harris of Bank of America Merrill Lynch. US banks' exposure to those countries is US$165.9 billion - just 5.4 per cent of all loans and derivatives US banks have with foreign banks. And US lending to Europe accounts for only about 10 per cent of total US bank assets of nearly US$12 trillion.

Even in case of another credit crisis, few predict anything like the damage caused when banks lost billions on sub-prime loans after homeowners defaulted on their mortgages. Since then, banks have added billions more in capital. They are better able to withstand Europe's problems, Fed governor Daniel Tarullo has said.

Thirty per cent of US exports of goods and services - or US$461 billion - last year went to Europe, according to the Bureau of Economic Analysis. Economic troubles in Europe could sap demand for US exports, slow hiring and drag on the US economy.

Exports could be hurt in two ways: A stronger dollar relative to the euro makes US-made goods and services costlier to foreign buyers. So foreigners buy less. Secondly, budget cuts by European nations further reduce the ability of European customers to afford US products.

'Weaker export growth wouldn't derail the US recovery,' Mr Harris says. Exports account for only about 12 per cent of US economic activity. And US exports to Europe equal only 3 per cent of US gross domestic product - less than the size of the US auto industry.

By contrast, US sales of goods and services to Asia, whose economy is far stronger than Europe's, accounted for 27 per cent of all US exports last year. Exports to Asia would help blunt some of the reduced US export business to Europe. China's currency is pegged to the US dollar, so Chinese customers could still afford US products even if the US dollar kept rising versus the euro.

As the US dollar rises in value compared with the euro, oil prices are falling, too. Lower interest rates and lower oil prices could lead consumers to borrow and spend more and invigorate the economic recovery.

'The U. may actually be an unwitting beneficiary of the crisis in Europe,' James Bullard, president of the Federal Reserve Bank of St Louis, said in a speech last month. -- AP

Source: Business Times, 10 Jun 2010

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