Sunday Times (London)
May 23, 2010
by Irwin Stelzer
President Barack Obama is a busy man. What with having to persuade the UN Security Council to pass the latest and toothless sanctions on Iran, excoriating oil companies for the Gulf oil spill, pushing a financial reform bill through Congress, and attacking the state of Arizona for enacting a law to stem the tide of illegal immigrants, something his administration refuses to do, you would think he has no time to take on the troubles of euroland.
But he found time to call Spain’s president, Jose Luis Rodriguez Zapatero, to urge him to get his financial house in order. There is no indication Zapatero told the president to do the same — one doesn’t bite the hand of someone about to feed him. Spain’s president and his EU colleagues needed at least two favours from the American leader.
The first was for Obama to resist congressional demands that he prevent the International Monetary Fund from contributing US dollars to the EU bailout of Greece and other members of Club Med: a measure moving in that direction passed the Senate on a 94-0 vote. Obama has obliged — so far.
The second favour was to get Obama to go along with the Federal Reserve Board’s decision to make dollars available to the European Central Bank for use by European banks. He did. The eurozone has one more request to make, but not just yet: that America intervene in currency markets to stabilise the euro.
Obama acquiesced because he fears the trouble on euroland’s periphery will nip America’s recovery in the bud or, in the now-common usage, that the contagion will spread across the Atlantic. Indeed, investors here are already showing signs of contracting the disease, to which no American firm or bank is thought to be immune. Roberto Pedone of Thestreet.com points out that even Apple has a 27.5% exposure to the eurozone. It may seem far-fetched to think that a few tiny eurozone countries can bring down the mighty American economy, but Obama has reason to worry.
Let’s start with his biggest political problem — the so-called jobless recovery. Despite what is clearly a faster, better-than-expected recovery, the jobless rate remains too high to create a feel-good factor among most voters, especially the lower-income groups on which Democratic politicians depend. Note that while many retailers are seeing their customers return, Wal-Mart has recorded its fourth consecutive quarter of declining sales, which says something about the plight and gloomy outlook of a good part of the Democratic base.
Obama has been banking on a doubling of American exports in five years to create millions of jobs. Forget whether that goal is realistic. If it was before the euro crisis, it no longer is.
The decline in the euro from about $1.50 to $1.26 has made European goods more competitive in America, and made-in-the-USA goods and services dearer in euroland. Worse still, since the Chinese peg the yuan to the dollar, the euro’s fall and the yuan’s associated rise have also made Chinese goods less competitive in the 16-nation euro bloc. This is no small matter to the Chinese, desperate to create enough jobs to avoid social unrest: the eurozone absorbs 14.6% of China’s exports, making it second in importance only to America’s 20%.
That has had two effects that Obama would like to see reversed. The first is that it has made the Chinese less inclined than ever to do what America has long sought: allow the yuan to rise by loosening its peg to the dollar. The second is that it diverts Chinese exports from Europe, where Chinese products are now more costly, to America, where the yuan-dollar peg prevents any loss of Chinese competitiveness. Obama’s trade union supporters are not pleased. As if the situation were not already bad enough, most experts are predicting that the euro will hit $1.10 before stabilising. That might make Americans dust off their travel brochures, but it won’t do much for job creation in the US.
The president has other reasons to worry about contagion. The problem in Greece has focused attention on all sovereign balance sheets, at a time when rating agencies are under pressure to be more niggardly with triple-A ratings. Given the Grecian-level of the American fiscal deficit, it is no surprise the rating agencies have warned America that it no longer can take its high rating for granted, and must rein in spending, which the Republicans are calling for, and/or raise taxes, which the Democrats are demanding. Result: stalemate, and a debt-to-GDP ratio heading towards somewhere between 90% and 100% in the absence of big policy changes.
Then there is the non-trivial matter of America’s banks, which have important relationships with their European counterparts, and an even greater exposure to European bank debt than to the IOUs of Greece and other troubled countries.
The Wall Street Journal estimates that the exposure to French and German banks and those in smaller euroland countries comes to more than 80% of the funds set aside to absorb losses by our five big banks — JP Morgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley. Count only troubled Ireland, Spain and Italy and the figure is still a hefty 25% of the rainy-day funds.
American banks worry that a series of defaults in Europe will hit the balance sheets of European banks, making them unreliable counterparties. That would make interbank lending more costly and perhaps even bring it to a halt. You don’t have to have a deep understanding of bank finance to understand what would happen, only a memory of what occurred during the last bout of interbank nervousness after the collapse of Lehman Brothers in September 2008.
There is some good news for the president — and for America — in all this. In crises, there is a flight to safety, which means the dollar. For the first time since September, the Chinese have stopped selling and are once again net buyers of US Treasuries. Other investors are giving up Europe for America. That means low interest rates here, which just might offset the negative impact of a devalued euro and a pegged yuan.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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