Recently, voters in France and Greece threw out their ruling parties as a backlash against austerity measures implemented to solve the eurozone's debt problems. These changes have unsettled global financial markets, but are also paving the way for new conversations about long-term solutions to improving economic growth in the European Union (EU). The continued European debt problem poses both economic and political risks to the United States. Why should Americans care about the European debt crisis? Let's look at some answers.
1. Eurozone debt and deficits are symptoms of more fundamental issues. These fundamental issues include disparate levels of wage growth relative to productivity gains and the enormous range of underlying productive capacity in the European economies. As an example, over the last ten years, Germany has minimized wage growth while wages in Greece exploded. Wage increases in Greece were not offset by corresponding increases in productivity.
2. Reducing debt and deficit levels will help restore investor confidence in the eurozone, which in turn can reduce government borrowing costs. But investor confidence is also strongly influenced by a nation's future growth prospects. The French and Greek elections are a signal that a better balance must be struck among the following priorities: fiscal balance, economic growth and the equalization of competitiveness among European economies.
3. There is some evidence that the Europeans are now moving towards a more balanced approach. Although French and Greek elections have received the most media attention in recent days, an equally if not more important development was the German agreement to a 4.5 percent wage increase for its engineering workforce, which will have constructive inflationary knock-on effects to the rest of the German economy. To the extent that more competitive economies stimulate demand via increasing wages, less competitive economies will enjoy greater export opportunities. In addition, recent reporting suggests that the European Commission, the European Union's executive body, will ease deficit limits for a number of countries this year. More flexibility on debt and deficit levels in the short term should help restore growth, or at least minimize further economic contraction.
4. In addition to a debt crisis, the Europeans are also dealing with a banking crisis. Since the west European banking system is heavily fragmented along national lines, banks are most heavily invested in their own country's debt. As a consequence, the banking system's health is ultimately dependent on sovereigns being able to retain access to affordable credit. Compounding Europe's economic problems are higher capital requirements for banks. While more capital will improve long-term stability, higher capital requirements also limit lending.
5. The European Central Bank (ECB) has assisted banks by alleviating pressure on government borrowing costs, but these measures are only temporary. Unlike the U.S. Federal Reserve, the ECB is not a true "lender of last resort" because of treaty limitations on its power. However, in the context of the crisis, the ECB has both purchased government bonds on the secondary market and has extended credit to banks on very favorable terms, affording both governments and financial institutions time to find more enduring solutions to the crisis.
6. Because the European Union is the United States' biggest single trading partner, an intensification of the European debt crisis could harm the U.S. economic recovery. The eurozone accounts for 13 percent of U.S. exports. Most of those go to Belgium, the Netherlands, France and Germany -- countries that are not currently at the heart of the crisis. Nevertheless, economic contraction and increasing unemployment in one of the world's biggest economic blocs could be a drag on global economic fortunes for years to come.
7. Although the European debt crisis presents economic risks, the political implications should also not be ignored. Most problematic for the United States is the extent to which the European debt crisis diminishes the European Union's stabilizing power in post communist Eastern Europe, including the Balkans. The crisis could also embolden extreme right and left political parties in Western Europe. Countries to watch include France, the Netherlands, Italy, Greece, Finland, Hungary and Romania. The debt crisis also makes a case for some EU nations to cut defense spending, whichundermines the power and credibility of the North Atlantic Treaty Organization (NATO).
8. The European debt crisis could prolong the dollar's dominance in the world, which has some positive effects for the U.S. economy. Despite high U.S. debt and deficit levels, U.S. government borrowing costs and U.S. interest rates generally are exceptionally low. The longer investor confidence in Europe wanes, the more likely it is the U.S. and its currency will continue to enjoy haven status. The strength of the U.S. dollar is in part caused by the fact that central banks around the world have reduced their euro-denominated holdings. On balance, however, U.S. interests would be better served by a swift resolution to the European debt crisis.
Rachel Epstein is an associate professor at the Josef Korbel School of International Studies at the University of Denver