How the Euro Virus Travels

Although exports aren’t the problem, much can still go wrong | “A lack of confidence can be very contagious”

Matthew Philips, with Tim Higgins and Kate Andersen Brower


On Friday evening, June 1, about 350 people gathered in a high-ceilinged room at the Chicago Cultural Center, sipping wine as songs by Sister Sledge and Kool & The Gang played in the background. The $2,500-a-ticket-and-up fundraiser was one of six President Barack Obama held across the Midwest that day. That morning the Department of Labor had released the worst employment report of the year, showing the economy added just 69,000 new jobs in May. The culprit, in the president’s eyes, was Europe. “A lot of that’s attributable to Europe and the cloud that’s coming over from the Atlantic,” he told the crowd. “The whole world economy has been weakened by it, and it’s having an impact on us.”

Parsing out the exact impact of the European crisis on the U.S. economy can be difficult. There’s a strong chance that Europe can wound the U.S., and the cumulative effect could be drastic. The danger doesn’t come from where you would expect — exports from the U.S. to Europe. Though turmoil in the region certainly poses a risk to U.S. exporters, for the first quarter U.S. exports to Europe were up more than 8 percent, to $86 billion. Total exports account for only about 14 percent of U.S. gross domestic product, a small fraction of which go to Europe.

Yet as the economy has recovered over the last three years, increased exports have accounted for about 45 percent of GDP growth, says RBC Capital Markets chief U.S. economist Tom Porcelli. “That’s an enormous number for something that accounts for such a small part of overall activity,” says Porcelli.

Porcelli believes Europe’s troubles may hit U.S. exports in a more roundabout way. Emerging markets such as Brazil, Mexico, and China have accounted for the bulk of U.S. export growth over the last few years. Since the recession began in 2007, exports to Brazil have increased by more than 70 percent. Emerging market countries get the majority of their lending from European banks. So if Europe continues to deteriorate and its financial system tightens, some emerging markets could lose a key source of financing, which in turn could squeeze their ability to keep buying U.S. goods. “That’s a very important aspect that can’t be overlooked,” says Porcelli.

Europe’s mess also poses significant supply-chain risk to U.S. manufacturers. According to Kris Bledowski, a senior economist at the Manufacturers Alliance for Productivity and Innovation, even if American companies are not shipping a lot of goods to Europe, it’s an important source of components, such as car engines and plastic parts, to many U.S. manufacturers. “The feedback I’m getting is a concern over the logistical issues that may arise in Europe due to labor issues or economic paralysis there,” says Bledowski. Of special concern, he says, is European suppliers losing access to credit from local banks.

Another potential point of contagion is the U.S. financial system’s exposure to Europe’s souring debt, particularly that of Spain and Greece. According to the Bank for International Settlements, which promotes cooperation between central banks, U.S. banks held $952 billion in euro area debt in the third quarter of 2009. By the fourth quarter of 2011, the latest data available, that exposure was down to $656 billion. That’s a comfort, but still a large risk.

While the region’s turmoil has helped lower the borrowing costs of the U.S. government as investors seeking safety buy Treasuries, a new study from the Federal Reserve Bank of San Francisco found that Europe’s woes have increased the borrowing costs for U.S. corporations through a phenomenon known as the contagion coefficient, essentially a measure of correlation. From 2009 to 2011, every percentage point increase in the amount that European corporations were charged to borrow money translated into a 0.68 percentage point rise in the rate U.S. corporations paid, meaning that about two-thirds of the rise in European corporate borrowing costs were passed on to U.S. companies.

Other psychological factors are far more difficult to quantify. Paul Ashworth, chief economist at Capital Economics, says the turmoil in Europe is “responsible for quite a lot” of the recent U.S. economic slowdown, not so much from a direct sales or trade perspective but in the dampening effect it’s had on animal spirits in the U.S.

The European crisis has been like a big yellow caution flag waved in front of many U.S. businesses, Ashworth says, giving many managers reason to act conservatively. “A lack of confidence can be very contagious,” says Shawn DuBravac, chief economist of the Consumer Electronics Association, a trade group that represents 2,300 companies. As businesses hold off from hiring and investing in reaction to a crisis, economic activity decreases even more. “The crisis of 2008 is still very fresh in the minds of a lot of U.S. businesses,” says DuBravac. “Any time you see something that seems similar, you’re going to revert to those bad memories.”

For some large U.S. multinationals, Europe’s plight is already producing losses. General Motors’ European vehicle sales fell 12 percent during the first quarter of this year compared with the same period in 2011. The carmaker’s first-quarter European operating loss totaled $256 million, which doesn’t include $590 million in writedowns. Analysts expect it will have to spend at least $1 billion shutting some of its 11 European factories and laying off some of its 39,000 workers there. GM Chief Executive Officer Dan Akerson signaled the difficulties back in February: “The situation in Europe today is not a whole lot different than it was in the United States or North America generally three-plus years ago.”

The bottom line Although exports to Europe were only $86 billion in the first quarter, overall U.S. exports account for 45 percent of GDP growth.


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