European debt affects you

Radhakrishnan Gopalan

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Radhakrishnan Gopalan

Assistant Professor in the Olin School of Business, Washington University in St. Louis

Many Americans wonder: If the European debt crisis is happening on the other side of the Atlantic, does it even matter to consumers here? It does, according to Washington University’s Radhakrishnan Gopalan, Ph.D. In this interview, the impact of Europe’s debt crisis on the U.S. economy is discussed with Gopalan, assistant professor of finance at the Washington University Olin School of Business.

What is the significance of European debt issues on American consumers?

There are at least three important implications of the European debt crisis for the American economy. The most direct effect is that some of the banks that lend in the U.S., not necessarily U.S. banks, have significant exposure to sovereign debt of the countries that are in difficulty: Greece, Italy, Spain and Portugal. If any of these countries were to go into default, then that is likely to affect the banks and their ability to lend in the U.S.

Second, Europeans buy a lot of American goods. One of the bright spots in the U.S. economy currently is the exports. If Europe were to go into recession, then that is likely to affect demand for American goods and services.

Third, the problems of countries like Italy show what can happen if a country does not get a grip on its debt. Germany is a prime example of how prudent financial management can stand you in good stead in times of difficulty. As a percentage of the economy, the U.S. government has more debt than the whole of Europe put together, I believe. Thus far, the U.S. has been fortunate in that investors still consider the dollar as a safe haven and rush to the dollar when things get bad elsewhere. But it may not take much for investor perceptions to change, and that would put the U.S. in a very bad situation. So while it is great that the borrowing rate for the U.S. government has gone down due to the European crisis, because of money flooding into the dollar, the U.S. should consider this as a wake-up call to do something.

What are the odds of a global credit event, such as what was seen in 2008 following the failure of Lehman Brothers, resulting from Europe’s debt crisis?

Relatively small. I think governments have (learned) from the Lehman crisis. Everyone in Europe knows that Italy is too big to fail, and its default would lead to a cascade. Germany is too intertwined with the rest of the Europe to let it happen. Germany’s exports to the rest of Europe are almost a quarter of its (gross domestic product). Furthermore as I mentioned earlier, there is enough money in Europe for the debt crisis to be solved. What is currently happening is Germany using the crisis to make the other countries swallow a bitter fiscal austerity pill. Once that is done, then I believe they will all get together to prevent a full-fledged conflagration.

What one significant aspect of Europe’s debt situation to U.S. consumers isn’t getting enough attention?

The fact that it is a wake-up call for the U.S. Italy is a prime example of a country that was running high deficits, had a noncompetitive economy and is paying the price. Germany is a prime example of a country that got its government deficit down, made the economy competitive and is reaping the rewards. The failure of the supercommittee in the middle of the European crisis clearly shows at least the politicians have not (learned) any lesson from the crisis.

Special thanks to Radhakrishnan Gopalan, Ph.D., from Washington University’s Olin School of Business, for participating in this interview.