In global financial circles, there’s an old saying: “When America sneezes, the world gets a cold.” But in the age of globalization, that quaint expression looks increasingly like a relic of a bygone era.
These days, “every consumer in the U.S., Europe, Asia, and elsewhere is connected to a global economy,” says Bruce Yandle, distinguished adjunct professor of economics at the Mercatus Center at George Mason University’s Washington, D.C., campus. “When the great wealth-creating machine slows down — whether in Europe, the U.S. or China, consumers worldwide face dimmer prospects.”
Put simply, the sovereign debt crisis that began in Greece has spread throughout much of the eurozone. The eurozone crisis already has had a direct impact on consumers in Europe. But in an interconnected world, experts agree any fallout won’t be limited to Europe. Read on to find out how the eurozone crisis could affect your pocket book.
Trade and the economy
While it may not feel like it to most American consumers, the U.S. economy is mending. But the modest growth may fizzle if the eurozone crisis deepens, says Werner Bonadurer, clinical professor of finance at Arizona State University.
“Recent U.S. economic growth has been fueled by government spending and exports,” Bonadurer says, pointing out that exports to Europe account for about 20 percent of U.S. gross domestic product. “A reduction in exports will reduce GDP because Europe is one of the largest export markets for the U.S. That will dilute the U.S. recovery.”
But if there’s an immediate silver lining to Europe’s woes, it’s that many financial analysts predict that a “flight to quality” may encourage investors to park their money in U.S. Treasury bills because of their perceived relative safety as an investment. According to Bonadurer, that should keep interest rates low in the U.S., but he warns that too much liquidity in the U.S. economy could “lead to a higher domestic inflation risk.” That could be exacerbated if European central banks keep their rates low for an extended period of time.
Recently, American investors have seen bad news from Europe on one day drive U.S. stocks down the next. But that pattern doesn’t just affect the Wall Street crowd. According to Terry Connelly, dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco, widespread bank failures in Europe or downgrades in European sovereign debt could spell disaster for the average American.
“A run on the euro banks, a France downgrade or both could well provoke an equity market crash of 1,500 points or more very quickly,” Connelly says. “(Those scenarios) would kill off the U.S. recovery, blow out 401(k)s and IRAs just getting back on track, and create a consumer-driven recessionary fall in spending (that may trigger) the prospect of deflation in the U.S.”
So which U.S. stocks are most likely to tumble on bad news from Europe? According to Bonadurer, 20 percent of the Standard & Poor’s 500 index earnings come directly or indirectly from Europe. And while the damage is likely to be widespread, Bonadurer believes sectors such as aircraft, machinery, and professional and financial services are likely to be hit hardest. But he says equity markets across the globe also are likely to suffer, making it difficult to predict which types of businesses will feel the most pain.
We think of money market funds as safe investments. But as some consumers learned in 2008, money market funds that are heavily exposed to assets falling in price may see their own net asset value drop below $1 per share, what is called “breaking the buck.”
“If a money market fund has exposure to the sovereign debt (of some eurozone countries) or a bank in one of those countries, there’s a risk that it could break the buck,” says Scott Cramer, president of Cramer & Rauchegger Inc., an investment firm in Maitland, Fla. “In 2008, people in those funds got their money back, eventually. But it’s not an experience you want to go through.”
Few funds currently have exposure to the most troubled countries but, “if the crisis spreads to Germany, France or Great Britain, the risk that some funds may break the buck increases significantly,” Cramer says.
For now, it’s something Cramer says he’s continuing to monitor. If consumers invested in a money market account through their bank, there’s a good chance it’s insured by the Federal Deposit Insurance Corp., but they should check. If their money market fund is through a brokerage house, it’s not likely insured, but consumers can ask about the fund company’s exposure.
While there’s a lot of data out there about the adverse effects of a eurozone crisis, the bad news also tends to erode consumer confidence and that could be most damaging of all, says Jamie Cox, managing partner of Harris Financial Group in Colonial Heights, Va.
“If enough people believe that something is true, then it becomes reality,” Cox says. “Consumer sentiment is driven largely by employment. If consumers believe that their employment status is compromised, then they will spend less because they are afraid. The more pronounced the negative headlines, the more consumers believe that their employment may be at risk.”
So far, those negative headlines in Europe haven’t impacted consumer sentiment in the U.S. “But that can change quickly,” Cox says.
In 2008, few people would have predicted the collapse of Lehman Brothers, and fewer still would have pegged that event to a widespread panic that struck at the core of consumer confidence. It is hoped that Europe won’t see any Lehman-like collapses, but if it does, Cox expects real trouble on the consumer spending front.
“Consumer spending doesn’t stop in a recession, it slows down,” Cox says. “In a financial crisis, it grinds to a halt.”
With the Euro under pressure and falling in value, you might guess the dollar stands to gain, making American currency that much stronger for tourists traveling to France, Germany or any of the 17 countries that use the euro. But while it’s hard to predict moves in the currency market, travelers betting that the euro’s loss will be the dollar’s gain are probably right, says Christopher Vecchio, junior currency analyst at the foreign exchange trading firm DailyFX in New York.
“If the market unfolds as expected, the U.S. dollar stands to strengthen significantly against the euro,” Vecchio says. “Traveling to Europe during the crisis would be the ideal time. The U.S. dollar would be stronger, which would reduce costs abroad.”
Vecchio says that by next fall the euro and dollar may evenly trade at or near a 1-to-1 ratio. The dollar has traded from $1.32 to $1.42 against the euro over the last year.
But before you pack your bags, you might want to check your own finances, Connelly says.
“The euro will lose relative value against the U.S. dollar, which makes trips to Europe more affordable for the U.S.’ now famous top 1 percent,” Connelly says, “But the 99 percent will suffer the effects of a profound European recession.”