Europe about to experience American-style credit crunch

McClatchy NewspapersMay 17, 2010 

WASHINGTON — The rapid slide in value of the common European currency known as the euro continues to rattle global investors amid signs that problems on the other side of the Atlantic could spread and infect other economies, even slowing growth in the United States.

The problems in Europe stem from having a single currency in 16 nations with widely varying levels of economic health and debt. Not even last week's trillion-dollar bailout stemmed concerns, which range from slower growth to fears of an outright crumble of the European Union.

Like the United States just a few years ago, Europe now faces a financial crisis of the proportions not seen since the aftermath of World War II.

Here are some answers to questions about why problems in Europe offer Americans both risks and opportunities.

Q: Doesn't the euro's drop against the dollar make it cheaper to travel there?

A: Yes, for ordinary Americans with the financial means to travel abroad, Europe looks like it will be on sale this summer.

"We're getting quite a few reservation requests for Europe, so we anticipate it will be a good year for Europe" as a destination, said Cindy Evans, a European vacation expert in Bend, Ore., for Journeys, an international travel consultancy.

On Monday, the euro was worth $1.23, well below a peak of $1.60 in late 2007. The euro has lost 8 percent against the dollar this month alone, and analysts are now talking about the real chance of equal value between the euro and the dollar.

Q: What about neighboring countries?

A: England, a popular tourist destination that doesn't use the euro, also has seen a steep drop in the value of its currency, the pound, vs. the U.S. dollar. The British pound now trades at $1.44, well off the high of $2 in July 2008. The pound has been hit by concerns that England has too much debt and too slow growth to raise enough revenue to put a dent in its debt load.

Q: Any other benefits for ordinary Americans?

A: Oil prices are falling sharply, and that should be felt at the pump later this week. For the better part of four years, when the dollar rose against the euro and other currencies, oil prices moved up in tandem. The theory was that oil producers wanted prices linked to the dollar since oil contracts are generally traded in U.S. dollars. But Europe's problems signal slower global growth, and that means less demand for oil. On Monday the price of a barrel of oil settled at its lowest price of the year at $69.78 on the New York Mercantile Exchange. Just a few months ago it was in the mid-$80s, and talk had been of a return to oil at $100 a barrel.

Q: Aren't cheap European travel and cheaper gas good for the United States?

A: It's good for those who travel there, but the slide in the euro and pound make U.S. exports more expensive in the global marketplace relative to products from England and the European Union. More troubling is the reason why these currencies are dropping — too much debt and too little economic growth. There's bad news sinking in with investors that European economies have generous social safety nets that are proving very costly to maintain. Citizens there don't want to pay even more in taxes, but they don't want to lose government benefits to which they've grown accustomed.

Q: Are all European economies overly indebted?

A: No. And not all indebted countries are alike. Problems in Greece, which triggered the crisis, are very different than, say, Portugal, which has taken many tough steps in recent years to raise the retirement age, raise taxes, cut spending and even buy back its outstanding debt. The focus initially was on the so-called PIIGS_ Portugal, Italy, Ireland, Greece and Spain. Today, however, the concern has migrated to who loaned to or invested in these nations and companies based in these nations.

"For companies, it appears that nationality is increasingly having an impact on borrowing costs, raising all sorts of questions about company valuations," Stephen King, global chief economist for the international bank HSBC, wrote in a note to investors Monday.

In other words, a panic is gripping financial markets in Europe as investors everywhere are afraid and fleeing to safer investments such as gold or U.S. treasuries. European companies and countries will face higher borrowing costs for the foreseeable future.

Q: Why should that hurt stocks in the United States and Asia?

A: Because the problem in Europe isn't just one of government debt, but corporate debt, too. And in an interconnected world, it's not entirely clear which investment firm or bank owns government or corporate bonds, nor is it fully clear where the international links to this government and corporate debt might be. For example, German and French banks loaned quite a bit to Greece and Greek companies. U.S. banks were quite active in Spain, which had an unsustainable housing boom and many of the same excesses witnessed prior to the near meltdown of U.S. financial markets in September 2008. At the end of 2009, U.S. banks loaned almost $200 billion tied up in Spanish loans and more than $3.8 trillion in loans to European banks, according to the Bank of International Settlements.

Q: Isn't this reminiscent of the turbulent fall of 2008?

A: Yes. The fear gripping Europe is leading to a rise in short-term lending rates, and that raises the cost of borrowing, both for consumers and between banks. That was the U.S. experience. In Europe now, it's getting hard to get a loan, and what loans are made are more expensive. This slows growth, which increases the chances of default. Ratings agencies downgrade European bonds, and the fear of default soars. You get the picture, a rolling snowball gathers speed. In another similarity to Wall Street in 2008, European corporations are now having trouble getting the low-cost, short-term financing from money market funds, which are the lifeblood of how companies finance their day-to-day operations.

"It's just a general heightened caution in extending short-term credit," said Lou Crandall, chief economist for money market researcher Wrightson ICAP, pointing to similarities with fall 2008 on Wall Street. "One of the problems that you have (is that) financial markets rest heavily on trust. And one of the problems you have after any financial crisis is the market's immune system has been weakened because people are reminded of what can happen."

Q: Why are problems in Europe our problem?

A: The days of isolationism are long over, and in an interconnected global economy, problems in one major driver of global growth, Europe, are felt everywhere, especially today in the United States as it limps back into an expansion mode. To head off its widening financial crisis, the European Central Bank has pledged up to $1 trillion in lending, and governments could be borrowing to get out of their problems caused by borrowing. Additionally, European countries are under pressure to impose bitter medicine on their economies: tax hikes and spending cuts on social welfare programs.

"This will result in accelerated — and painful — simultaneous fiscal tightening across Europe," according to Monday's weekly credit outlook report by Moody's Investors Services.

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