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We Are All Europeans Now

Irwin M. Stelzer

We are all Europeans now. Doubt that—and just try to get news about the American economy on the financial news networks on any morning. No luck. Lots of talk about German chancellor Angela Merkel’s balancing act—trying to keep from being turfed out of office, while still sending Germans’ hard-earned money south to rescue Greece. More talk about the perilous condition of the European financial system, with under capitalized banks struggling to survive as the value of the sovereign debt on their balance sheets heads south. CNBC reporters bundled onto planes for quick overnight trips to Athens to interview everyone from politicians providing assurances that Greece, with its debt-to-GDP ratio a staggering 165 percent, really means it this time when it promises to lay off public sector workers and collect taxes, and the man on the street who vows to shut the country down if there are layoffs, and not to pay any taxes, much less the draconian new levies on property. If there is time to spare, they take a quick hop to Madrid to hear why it is not feasible for the government to privatize the lottery system, as it had promised to do. And with luck, some partying in Rome with Silvio Berlusconi—not really, but I am sure financial reporters would find that a relief from the mostly dull people they interview as a regular matter.

All of this has consequences here in America. In part because news watchers tend to give great weight to bits that confirm their already held views, and bad news is absorbed almost immediately. Most Americans already think we are on the wrong track, as they witness the spectacle of a president who has decided to campaign rather than govern for the next 14 months, and a leading Republican candidate calling Federal Reserve Board chairman Ben Bernanke “almost treasonous.”

No surprise that when Europe’s politicians can’t agree to head off what looks like another Lehman Brothers moment, already nervous Americans start dumping shares and fleeing to U.S. treasuries that yield negative inflation-adjusted interest rates. Then, reports that the Bundestag has backed Merkel’s bailout plans, and U.S. markets jump a few hundred points, with banks leading the way. Never mind that the exposure of U.S. banks to their European counterparts is limited more or less to the large, core country banks, rather than to banks in Greece and the periphery countries. Dino Kos, a former executive at the Federal Reserve Bank of New York and now managing director of Hamiltonian Associates Ltd., says the risk of transatlantic contagion is low, since governments in France, Germany, and other core countries will in the end support their banks. Besides, U.S. financial institutions have had ample time to reduce their exposure to Europe: money market funds reduced their short-term lending to European banks to $214 billion from $391 billion between the start of the year and the end of August, according to JP Morgan Chase.

But attempts to immunize the American financial system from European contagion can only be partially successful. European banks depend on the Fed to provide dollars to make up for the retreat of money market funds from the lending market. That has U.S. politicians on edge. Many have been looking for a stick with which to beat Bernanke, with Republicans who have recently sent him a letter urging him not to launch QE3 leading the charge. “Increasing [the Fed’s] exposure and that of the U.S. government to foreign banks is a moral-hazard problem,” says Edward Royce, the California Republican who sits on the House Financial Services Committee. The Fed “does need to be concerned about how a liquidity run on the European banks will impact us—our financial markets, our financial institutions, the economy as a whole,” says Texas Republican representative Kevin Brady, vice chairman of the congressional Joint Economic Committee, reports Bloomberg News. And William Dudley, president of the Federal Reserve Bank of New York, adds that regulators lack enough data on foreign institutions operating in America to “make informed judgments about the adequacy of such firms’ capital and liquidity buffers.” And since experience suggests that we do not fully understand the extent of the inter-relatedness of the world’s financial institutions, Americans have good reason to watch developments in Europe.

Of course, there is plenty of bad news right here in America. Orders of durable goods declined as the summer ended. New home sales continue to drop, falling in August by 2.3 percent, the fourth consecutive month in which buyers found record low interest rates of about 4 percent on 30 year mortgages an insufficient incentive to take on those mortgages, and banks found many of those willing to do so to be insufficiently credit worthy to warrant a mortgage. House prices seem to have stabilized, but nevertheless were 4.1 percent in July, below levels from a year earlier, the last month for which we have data from the Case-Shiller 20 city house price index.

Even the good news is bad: the government revised its estimate of second quarter GDP to account for higher personal consumption expenditures and exports, and lower imports. The result was to raise the growth estimate by 0.3 percent—but only to a meager 1.3 percent, not enough to put a dent in the 9.1 percent unemployment rate. Optimists say the economy is stalled, pessimists contend that it is already in recession.

Most important, businesses continue to sit on their cash. A survey of 140 CEOs by the Business Roundtable, an organization of the largest American firms that together account for $6 trillion in sales and employ 14 million workers, found that most have downgraded the forecasts of sales and capital spending that they made in the second quarter. “The findings of this survey show declines in every category of economic measurement [and] increased uncertainty among CEOs concerning the economic climate and business environment,” commented Jim McNerney, chairman of the Business Roundtable. Since McNerney is also CEO of Boeing, which this week watched its first Dreamliner fly off to Tokyo after a three year delay, we must assume that he is privately more optimistic than his colleagues.

And certainly more cheerful than the CEO of Coca-Cola, Muhtar Kent, who says that the business environment in the U.S. is less friendly “in many respects” than in China, and that Brazil is more attractive to investment than America. “They’re learning very fast, these countries. In the West we’re forgetting what really worked 20 years ago.” That’s what commentators have in mind when they say that until confidence in the American political system returns, the economy will hover between stagnation and recession.

One recipient of these weekly effusions says that reading them has become an exercise in masochism. Sorry about that: I’m just the messenger.

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