Implications of An EU Collapse

“What the Fall of the European Union Would Mean for the United States”

The so-called “sovereign debt crisis” has left the European Union reeling since news of Greece’s massive debt was released in late 2009. By mid 2010, three other countries-Portugal, Ireland, and Spain- joined Greece in the list of “highly indebted (European) countries.” The European Union elected to dole out massive bailouts to these nations, with primary focus on Greece. The price of receiving hundreds of billions of euros was a mandatory implementation of austerity measures which have debilitated Greece’s economy. Debt holders- primarily European banks- now grew fearful of the very real possibility that Greece would default on its debt. To make matters worse, debt crises arose in both Spain and Italy, which also required bailouts from the EU in exchange for implementing huge spending cuts and increased tax rates. Fears were so high that Spain and Italy would also be in danger of defaulting that potential debt-buyers demanded all-time high interest rates in order to justify purchasing bonds from those nations. With three nations taking such strong fiscal measures, economic growth within the Eurozone is likely to come to a standstill, making it even harder for highly indebted nations to balance their budgets and temper the cycle of accruing massive amounts of debt. There is a significant possibility now that one or more nations- Greece and Spain most likely- may leave the euro and adopt their former currencies. If not regulated, this could lead to severe depreciation of the returns investors receive on bonds they purchased from the defecting country. This in turn could lead to greater budgetary, and hence, debt, crises within the Eurozone. Some analysts project a steady domino effect, in which one country’s defection could lead to the fracture of the European Union.

Admittedly, this is a very pessimistic view of things. But, if this were to happen, how would it affect the United States? In the event of the collapse of the European Union, there would be drastic effects on the value of the dollar, and economic growth and employment in the United States. These effects would stem predominantly from the fact that upon a hypothetical dissolution of the EU, the euro would be replaced by reincarnations of the previous currencies used by each of the EU’s twenty seven member states.

First and foremost, the most obvious consequence of the fall of the euro would be the relative appreciation of the dollar. The dollar is the predominant reserve currency in the world. That said, in the current international paradigm the euro is widely held by central banks around the world. As important investors, including European ones, fear the devaluation of the euro, demand for dollars has shot up since the onset of the sovereign debt crisis. This demand has been so strong that the Federal Reserve Bank, despite great efforts to lower the value of the dollar, has been thwarted by foreign demand. If the euro were to disappear entirely as a currency, the situation would become even more drastic. At that point, there would be no significant competitors to the dollar as the international reserve currency. Despite a debt situation worse than that of most European countries, the United States would draw a flood in demand for dollar-denominated investments, especially Treasury bonds. This would also correspond with a withdrawal of investment in European assets. As a result of the switch in demand, the dollar would appreciate, especially in relation to the new European currencies.

A strong dollar has several implications for the American economy. On the one hand, this makes imported goods, especially oil, significantly cheaper. So Americans would be paying less at the pump. This would also increase the Purchasing Power Parity of the average American citizen. The trouble with a strong dollar is that American goods will become relatively more expensive elsewhere. Combine that with a European transition to multiple new, national currencies- which will likely lead to consumer fears and tepid consumer demand across Europe- and American exports will be set to tank. Based on the conclusion that imports will become cheaper and exports will become more expensive to foreigners, we can expect a strong dollar to have an adverse effect on net exports in the United States. Such a decrease in net exports would negatively affect the growth rate of the American economy. It is common to associate job growth with general economic growth, and in regards to net exports, this may very well be true. Remember, a strong dollar means that other currencies, especially the hypothesized ones in Europe, would devalue. Which means that foreign workers will become cheaper to employ for American companies whose main source of income is in dollars. While outsourcing has been a problem for American job numbers in recent years, the problem may be exacerbated when a new generation of well-educated Europeans constitutes cheaper labor than their American counterparts. In addition, the devaluation of currencies abroad will make American goods less desirable abroad, resulting in a lower demand for American manufactured goods and hence a lower demand for manufacturing labor within the United States. With an unemployment rate above 8%, the fall of the euro may prove catastrophic for the employment situation in the United States.

These are just a few of the problems that would ensue should the Eurozone cease to exist. There will be other issues, such as a decreased access to foreign credit and a decreased access to credit from those American institutions which hold investments based on the euro and on asset-backed securities from Europe. In an economy which is still recovering from a horrible credit crunch, these scenarios could push back the timetable for American economic recovery.

As you can see, the possibility of the Eurozone breaking up spells bad economic and financial times for America. Although we may not think that the euro crisis affects us, it does; and for that we must hope that the Eurozone can salvage itself. Recently, European Central Bank has pledged to take all necessary measures to ensure the integrity of the European Union. The ECB has even produced two rounds of quantitative easing in hopes of stabilizing the euro, boosting the banking industry, and staving off a credit crunch by injecting hundreds of billions of “easy money” euros into the Eurozone market. We can only hope that this works, or if it doesn’t that the European Central Bank makes good on its promise and stops at nothing to make sure that the Eurozone stays intact.

SOURCES:

Amerman, Daniel: “US Employment May Be Hammered By Euro Plunge.” May 24, 2010

Amerman, Daniel: “The USA after a Euro Collapse.” The Silver Bear Cafe.

3 comments

  • If the demise of The Eurozone were to occur, it would spell disaster for holders of Mutual Funds, particularly the 401k Mutual funds that individuals rely on for their retirement income. As the US Dollar rises in value, there is a corresponding decrease in equity value.

  • If the demise of The Eurozone were to occur, it would spell disaster for holders of Mutual Funds, particularly the 401k Mutual funds that individuals rely on for their retirement income. As the US Dollar rises in value, there is a corresponding decrease in equity value.

  • If the demise of The Eurozone were to occur, it would spell disaster for holders of Mutual Funds, particularly the 401k Mutual funds that individuals rely on for their retirement income. As the US Dollar rises in value, there is a corresponding decrease in equity value.

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