Thursday, May 13, 2010

How Could the Greek Debt Turmoil Affect Us?

Greece has a tiny economy compared to the U.S., and is not a major trading partner. Nonetheless, there are reasons for concern for a backlash on the U.S. economy, despite concerted efforts by the European Union, Federal Reserve, and other major central banks to stabilize the situation.

In the short run, a global “flight to safety” is driving down interest rates on U.S. Treasury securities and raising the value of the dollar. A stronger dollar makes American goods more expensive abroad and hurts our exports. Moreover, the turmoil and necessary fiscal restraint in Greece and other over-stretched European nations will likely slow European economic growth, further reducing purchases from the States. The Euro area in total accounts for over 15% of American exports. The turmoil could lead to a measureable reduction in American exports, and thus slow economic growth here.

While rates on U.S. Treasuries decline, the European financial distress is driving LIBOR higher. With much short-term borrowing in the U.S. indexed to LIBOR, the resulting uptick in interest rates will hurt American businesses.

In the long run, the potential default of Greek debt has raised interest in the global financial markets for fiscal discipline in other nations, including the U.S. So far, Treasury rates have not responded, but the risk is there. The result in the U.S. could be either a tighter federal budget or higher interest rates, either of which would be a drag on our economy.

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