Global Economy
Key Player & Background
As the spokesperson for an interest group representing an economic think tank, I am issuing this policy statement to detail the implications for the U.S. economy of a sovereign default in the Eurozone. As Reich notes, the financial crisis in Europe is threatening to spread to the United States. If there is a default in Greece, a panic could start in financial markets, spreading to other Eurozone peripheral debt. Such a scenario would endanger European banks, particularly those of France and Germany. While American banks have limited exposure to Greek debt, or indeed to the debt of other peripheral European countries, they are exposed heavily to French and German banks. Thus, American banks have substantial indirect exposure to the European crisis.
Key players in the United States government need qualified economic advice to help them guide their decision-making processes. Strong, sustainable economic growth requires governance that encourages risk-taking, but it also requires controls that will prevent exposure to catastrophic events. When such events occur, the impacts on the American economy can be catastrophic, as happened in 2008. This policy sheet will outline the situation for the U.S., and what steps Congress and the White House should take in order to minimize the risk to the U.S. economy from such exposure.
Erlanger
notes that financial markets around the world have strong links, and this is especially true among institutions in the world's major financial markets. In the last recession, the contagion began in U.S. housing markets and spread to Europe. This occurred because European banks purchased securities in the U.S. As a means of diversifying and earning higher returns amid sluggish domestic markets. The present situation is essentially the reverse. European banks had a need to finance increasing debt among Eurozone partners as the result of the recession that started in the U.S., and borrowed from American banks to meet this capital need. This creates exposure among U.S. banks to the Eurozone debt crisis.
The Eurozone crisis has its roots in the creation of the euro, a currency serving much of the continental European market, along with Ireland and Cyprus. As with any currency, the euro is backed by the governments who use it, and in this case that is primarily the governments of Germany, France, Italy and Spain. The former two countries are the strongest financially of this group. Those governments have relied on their countries' banks to finance much of the debt that struggling countries like Greece have. Greece is the current trouble country, because it is the closest to default on its sovereign debt. The Economist
notes that the links between national economic activity and the strength of the euro is tight within the Eurozone, so that all countries are mutually responsible for the health of all others within the zone. Germany in particular must spend in order to guard against contagion from countries that need to reduce spending. It is worth considering as well that many prominent American economists had warned from the outset that the euro was a bad idea, since it would create precisely this risk
. Bad ideas, unfortunately, are often perpetuated well beyond their shelf life, and the U.S. must live with the awkward reality this creates for Europe's financial health
. By any reasonable standard, the troubles the euro is facing were entirely predictable, but they came wrapped in a grandiose vision of European harmony
. This vision was always going to fail, with so many different countries and cultures represented
As Reich notes, some of the elements of the Dodd-Frank financial reforms were supposed to address the underlying root causes of the financial crisis this country experienced in 2008. These included a high degree of leverage among U.S. banks, high exposure to risky securities, and difficult on the part of regulators to determine the degree and nature of U.S. exposure to the contagion. These same issues are present in the current problem with the Eurozone. These issues define the current problem. There is uncertainty with respect to the degree of exposure that U.S. banks have to the Eurozone crisis, but it is likely that this exposure level is high enough that if the crisis in Europe becomes worse, the U.S. economy will suffer substantially, and a further bailout of Wall Street will be required.
The region of relevance in this issue consists of several European countries, as well as the transnational bodies of the European Union and the European Central Bank. Greece is a relevant...
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