Tuesday, 22 January 2008

Will the US recession spread to Europe?

As Wall Street opens after the Martin Luther King weekend, the world is waiting with baited breath to see what happens after the opening bell. The US traders had the day off yesterday, but rather than relaxing they probably spent it in horror as they watched markets across the globe plunge amid fears of a US recession. Markets in Europe suffered their biggest one-day losses since the September 11th attacks. When trading opened this morning in the East the Asian markets took an absolute nose dive. In response the US Federal Reserve made an emergency rate cut early this morning US time, an eye-popping three-quarters of a percent. It helped the European markets bounce back slightly but it was too late for the close of the Asian markets.

So far it doesn’t seem to have done the trick for this morning’s Wall Street trading, probably the most closely watched in years. The Dow fell immediately after the bell, dropping 441.72 points at one point. The Nasdaq and S & P 500 were down more than 3 percent just in the first half hour.

All of this of course is in response to a panic over the fact that the US is either about to enter a recession or it is already in one, sparked by the subprime loan crisis. But aside from the markets, how vulnerable is the rest of the world to this coming economic crisis in the US? The subject has been the topic of much speculation in Europe over the past week.

Insulated Continent

Historically, the way it’s worked in the 20th century is that when the US hits tough economic times, the misery spreads globally. In an economic system with the US at its heart, this was always inevitable. But now the question is, have the major European and Asian economies decoupled enough from the US economy to ride out the upcoming storm?

European regulators have been scrambling to calm the public by asserting that yes, this is indeed the case. Last week Christian Noyer, the governor of the Bank of France, insisted that while there is increasing evidence that the euro-area economy is slowing, most of the factors that are contributing to the bleak outlook in the United States are not present on the continent. In an interview with the International Herald Tribune, Noyer insisted he did not expect any "strong shocks" from French banks as they report their 2007 earnings, despite the constant stream of major losses by banks in the United States, also stressing that consumers and financial institutions in the euro zone will be relatively insulated from the effects of the meltdown of the subprime mortgage market across the Atlantic. "Historically, there was some correlation between the U.S. and the EU economic cycles," he told the paper. "Now it seems there could be at least a partial decoupling. That's not to say that we're immune from a weakening U.S. economy, but there are a series of factors that should dampen the effect."

Yesterday Luxembourg Prime Minister Jean-Claude Juncker, the head of the group of 15 euro finance ministers, insisted there is no immediate need to react to the growing threat of a U.S. slowdown, and that the economic situation in Europe was "clearly different from, better than" that of the U.S. and didn’t require a stimulus package like is being proposed in the US.

Today Dutch Finance Minister Wouter Bos had to make a hasty statement to reporters insisting there is no risk that Europe's economy will experience a recession this year. The EU member states’ finance ministers, known collectively as Ecofin, will be monitoring the situation closely, the ministers insisted today. All of the finance ministers are staying rigidly on message: the European economy is in better shape than that of the US, and it will be only modestly affected by a recession in America.

And just now the EU's economy chief Joaquin Almunia emerged from the emergency meetings to declare that thee United States' overspending is to blame for plunging shares on world stock exchanges, chastising the US for, "Big imbalances...a big current account deficit, a big fiscal deficit, and a lack of savings," and concluding that in contrast, European economies have, "a positive current account position [and] a level of savings in our economies that is the level required to finance our investments."

UK Sneeze

But with stock markets across Europe tumbling over short-term fears about the US economy, many are worried. And many observers have noted that though economies on the continent may be partially decoupled from the US, in the UK it’s a somewhat different story. As has often been noted, when the US sneezes the UK catches a cold. Already there are signs that the UK may be heading down the same path as the US, as it is beset with many of the same problems, although to a lesser degree. The currency is weakening, interest rates and bond yields are falling, property prices are declining and many shares exposed to the housing market are weak.

However on the other side, many are seeking to calm fears by arguing that the UK economy is much more oriented toward Europe now than toward the US. In the event of a US recession exports to the US would be the first thing affected, and today that is a relatively low percentage. Only 16% of UK trade is with the US, its biggest trading partner is now the EU. Also, the weakening pound may be a boon to the UK as its exports will become more competitive against Eurozone countries.

A US recession will likely be a big test for the new collective European economy, and many will be watching to see how Ecofin reacts to the challenge. If Europe were to ride out a US recession in good health, and if the new Asian economies are able to do the same, it could herald the beginning of a new era for the global economy. But a US recession spreading to Europe could be a huge challenge for the still young European common market.

1 comment:

Bank Rates said...

I hope that the time when this post was written then you were not aware of the fact that how bad this recession will affect the world. According to me, America contributes about 25% to world economy so if something happens to US then definitely, it will affect the world. So, there is no point asking this question.