Current European Crisis and Its Impact on US Economy

January, 2012

Hiwhoa Moon, Ph.D. Graduate School of International

StudiesKorea University, Seoul, KoreaEmail: hmoon21@korea.ac.kr;

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Order of Presentation

I. Recent European Turbulence and

Its Impact

II. Outlook of The US Economy

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Recent European Turbulence and Its Impact

• Economic turbulence in Southern Europe represented by PIGS (Portugal, Italy, Greece, and Spain ) has been casting a dark shadow over the prospect of the early financial market stabilization and recoveries in the European and other global economies.

• The excessive government debts, poor recovery performance, and lack of much needed structural reforms have been the prime causes of the troubles in these and other European countries

European Turbulence 2

• The impact of the turbulence has been of a global scale, plunging the index of stock prices by as much as 30 percent within two weeks’ time in all major capital trading centers since the break of the Greek crisis in early May 2010.

• The value of euro also was also experiencing free falls throughout the global financial markets for quite some time.

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European Turbulence 3

• The turbulence in these European countries plus the prospect of excessive government debts in almost all major European countries have been persistent in causing a serious loss of market confidence on European economy, and subsequently the global economy as a whole, even to date.

• The serious impact appears even more compounded due to the fragile structure of the euro monetary system

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European Turbulence 4

• The euro monetary system joined by 17 EU members revealed serious structural weakness during the current European crisis

• Due to the common money used by these countries, the monetary policy of a member’s central bank or the European Central Bank is bound to have limited impact only

• The current European monetary system appears to have two critical structural problems.

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European Turbulence 5

• First problem is that, for instance, when an additional money supply was injected into a member’s economy for stimulation, that economy is likely to have little impact only, due to the easy leakages into neighboring economies.

• The second is that the adjustment in the balance of payments resulting from the automatic exchange rate adjustment between a chronic trade surplus economy and its corresponding trading partner which experiences persistent deficit in trade against the other partner, cannot be expected since the two groups are using the same currency.

European Turbulence 6

• Therefore, for the Southern PIGS countries, despite their huge trade deficits against the Northern European states, stimulation of exports and the subsequent additional increase in economic growth is hardly expected.

• If this were not the case, i.e. they were using different currencies with their Northern trade partners, the current problems, including the low growth, low employment, and large fiscal deficits, could have been significantly relieved.

European Turbulence 7• The impact of the current European crisis

appears a lot more serious than originally thought since the efforts to reduce debts in these countries, which appear essential to contain the current crisis, is certain to delay the global recovery or even may invite a double-dip

• The May 2010 agreement to bailout Greece with 110billion euro and to establish a European common fund for emergency bailout worth 700 billion euro, appeared initially helping stabilize the European and global markets, albeit moderately.

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European Turbulence 8

• However, the structural adjustments of those European economies appear hard to achieve due to strong resistance by diverse interest parties in each of those economies as witnessed in Greece and elsewhere, plus the extremely difficult task of reversing government balances from chronic deficits into sizable surpluses

• Therefore, the current European financial difficulty are likely to cast a prolonged dark shadow over the entire global economy.

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European Turbulence 9• Due to the disappointing result in the efforts

of Greek economy to reduce fiscal deficits/debt following the bailout package of 110 billion euro in May 2010, plus the bad signs in other PIGS economies since then, there has been a serious fear of total meltdown of European economy and the global economy.

• However, in October 2011, European governments, IMF, and private holders of Greek government bonds agreed to write off half the currently outstanding Greek sovereign debt, to extend new additional credit of 100 billion euro to Greece by 2014, and to utilize the existing European Financial Stability Facility (EFSF - 440 billion euro) to guarantee loans up to1 trillion euro.

European Turbulence 10

• New fiscal package has been agreed on among 26 EU members (excluding UK) toward end 2011. This package includes provisions that penalize members automatically that fail to contain annual fiscal deficits within 3% of GDP.

• In January this year, heads of France and Germany agreed, for the first time since the break of Greek crisis in May 2010, to place more weight on stimulating economic growth than the fiscal resiliency, which has been exclusively focused to date.

European Turbulence 11

• Another emergency fund, the European Stability Mechanism (ESM) has been agreed on among EU members. This is scheduled to be launched with 500 billion euro in June 2012.

• These series of measures significantly helped weaken the fear of the melting down of the European and global economies.

Europe: Medium-Term Prospect 1

• As to the medium-term prospect of the European economy, there are favorable and unfavorable elements simultaneously.

• The favorable elements include: decision to write off half the Greek sovereign debt; to increase EFSF and to triple IMF capital for timely and effective bailouts; to create another emergency fund, the ESM; ECB’s willingness to release almost unlimited liquidity to buy up bonds issued by Greek and other troubled European economies.

Europe: Medium-Term Prospect 2

• The most serious unfavorable factor is that the fundamental causes of the current European crisis have not been addressed: substantive reductions of fiscal deficits and the sovereign debt are difficult to achieve; the structural reform in corporate, government, and financial sectors are not showing any sign of meaningful progress due mainly to the strong resistance by interest parties;

Europe: Medium-Term Prospect 3• Growing domestic political

liabilities on the Northern European governments resulting from the continued assistance to Southern countries cause fear of a sudden sharp cut-back of their assistance to Southern counterparts;

• Continuous downgrading of credit ratings for almost all economic entities in Europe, including France, seriously undermines the already fragile market confidence in Europe and other part of the world;

Europe: Medium-Term Prospect 4

• No signs of visible macroeconomic gains including GDP growth, employment, government revenue, etc. in most part of the Europe.

• A crucial yet paradoxical point is that the austerity program that has been called for to the troubled economies in Southern Europe is likely to lead to low growth and low government revenue in the short-term, which in turn lead to further increases in fiscal deficit and sovereign debt.

Concluding Observation on Europe 1

• The current status of the European economy, without noticeable improvement nor sudden serious deterioration, is likely to hangover there over a long-term, at least several more years to come.

• However, the direction to which the European economy is currently heading appears toward the deterioration, although gradual.

• The fatal structural weakness of the current euro monetary system plus lack of political will to take decisive actions and moral hazard in most Southern European countries, outbalance those favorable factors identified above.

Concluding Observation on Europe 2

• Therefore, European governments should unite to take a bold policy and paradigm switch from the current bearish protective policies favoring fiscal contraction, which is certain to lead to less growth and less government revenue, to an aggressive policy seeking more government spending on justifiable stimulation for additional growth.

• However, they should be also aggressive in pursuing sweeping institutional reforms to remove the fundamental causes that invited the current crisis.

Current Trend of US Economy 1

• Since latter half of 2009, confidence on the market has been recovered and appreciable improvements in macro economic indicators have been recorded, thanks largely to the unprecedented sizes of the bailout and stimulus packages.

• After 2.5 percent GDP growth in 2010, a slightly less growth is projected for 2011.

• Job market also has been showing steady improvement: unemployment rate fell from close to 10 percent in 2009 to current 9.1 percent.

Current Trend of US Economy 2

• Major contribution to better performance in growth and employment came from exports and fixed investment.

• Another favorable trend is that the US balance of payments has been improving steadily thanks to export increases to mainly emerging economies such as China.

• US industrial competitiveness in general has improved appreciably through the painful restructuring and the weakened US dollar.

Current Trend of US Economy 3

• However, persistent challenges undermine the potentials of the US economy.

• The housing market is still under deep trouble continuing to generate huge foreclosures and homeless households.

• Although open unemployment rate is slowly falling and stands currently at 9 percent, real unemployment rate is estimated to be around 16 percent and about 25 million people are out of job if those part-time workers and those who gave up seeking jobs are accounted.

Current Trend of US Economy 4

• Another serious challenge is that the political populism has been emerging strongly in the recent past, undermining the effectiveness of government policies.

• The long-lasted confrontation in the US congress over the government debt-ceiling appears seriously affecting market confidence as well.

• Economy of a nation can achieve its maximum when the signal given by the government is coherent and consistent regardless of whether it is from the executive branch or congress.

Concluding Observation on US Economy

• The US economy is heading to improvement obviously, unlike the European economy.

• However, the current challenges, most of which are legacies of the crisis started in 2008, will continue to inhibit maximizing the potentials of the US economy.

• A prolonged low growth is projected for a few years at least unless the current challenges including the housing market and polarization of politics can be redressed.

• In addition, the bleak outlook of the European economy will undoubtedly increase the uncertainty over the US economy for some time.

Thank You for Your

Attention!!!