How Europe will feel the pinch if the US defaults | Business| Economy and finance news from a German perspective | DW | 29.07.2011
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How Europe will feel the pinch if the US defaults

The world markets are still hoping for a last-minute deal to save the day, but the fronts on the US Capitol seem entrenched. So what happens now? Will the world economy collapse if the US defaults on August 2?

US dollar bill

European economists still trust in US lawmakers

Republicans and Democrats in the United States are stuck in bitter negotiations over raising the US debt above its current $14.3-trillion (10-trillion-euro) ceiling. At the moment, the two sides are simply muddling through from one day to the next. As soon as a deal seems to be within reach, it retreats to the horizon. Votes on possible solutions in the House of Representatives constantly get postponed.

If there is no deal by next Tuesday, August 2, the US may no longer be able to pay its bills - no salaries for public sector workers, no pensions, and no servicing of debts. It's a disaster that no-one can bear thinking about.

"It would certainly be political and economic suicide," says Ulrich Kater, chief economist at the German DekaBank. He believes President Barack Obama would struggle to get a second term in office in next year's election, even though polls suggest more of the electorate blame the Republicans for the impasse.

President Barack Obama

The crisis doesn't help Obama's re-election chances

Politics aside, the economic consequences of the row could be catastrophic. If the US were to be downgraded by the credit ratings agencies, the shock would go well beyond the US borders and affect the entire world financial system.

Don't panic, just worry

That's why no-one truly believes it will come to that, which explains the reserved reaction in the financial markets so far. Apparently, the international financial community still believes that the Democrats and the Republicans will put bury the hatchet in the nick of time - and simultaneously raise the debt ceiling and lower the state deficit.

But there is still perceptible anxiety on the world markets. Stock values are down in Europe, Asia and the US, and the US dollar is losing value against the yen, the renminbi, and the Swiss franc, and even against the euro, which has enough problems of its own.

Not only that, gold prices are soaring, a sure sign that investors are getting increasingly nervous about the worldwide debt crisis. On Wednesday, the price of gold reached a record high, with the troy ounce (around 31 grams) costing up to $1,650.

Export consequences for Europe

So how worried should Europe be about a US default? "I think we should be worried. The deadline is approaching," Zsolt Darvas, research fellow at the Brussels-based economics research institute Bruegel, told Deutsche Welle. "It's difficult to foresee, but if the US defaults, it would quite seriously disrupt the functioning of US financial markets."

Darvas emphasizes the potential implications for Europe. "Europe has many many ties to the US," he said. "The confidence of the dollar would vanish, and so there would be a flight from the dollar. The money can fly to a few places, including Europe, which would push up the European exchange rate."

That could seriously affect exports, particularly for Germany - Europe's biggest exporter. "If the euro goes up against the dollar, that can especially hurt European industrial production," says Darvas. "And that will certainly affect Germany."

And it's not as if Germany can simply tout its products elsewhere. "The Chinese currency is largely backed to the dollar, so if the euro appreciates against the dollar, it also appreciates against the Chinese currency," says Darvas. "And not just the Chinese currency - many, many currencies are backed to the dollar. So that means the euro will appreciate all around the world."

German cars in a port

German exports could be a casualty of the US default

It's happening anyway

Ferdinand Fichtner, macroeconomic expert at the German Institute for Economic Research (DIW), agrees that the US debt crisis could damage Europe's export industry, but he thinks that will happen anyway, whether or not the Republicans and Democrats resolve their differences this weekend.

"First of all, I'm still optimistic that they will find a deal. Not quite as optimistic as I was four weeks ago, but still optimistic," he told Deutsche Welle. "But I don't think it will come to a new financial market crisis either way."

For one thing, Fichtner says even if the US reaches its debt ceiling, the government will still find the money, just because it has to. "It's not as if the payments will just stop - that's not really realistic," he pointed out. "A lot of the payments are automated in such a way that they will go out anyway. The computer doesn't know about the debt limit."

Wall Street trading floor

Wall Street thinks there is enough money for another couple of weeks

On top of that, it's not even clear when exactly the US will run out of money, should no deal be reached. On Wall Street, the assumption is that there will be enough money for at least two more weeks. "The risk of an actual insolvency is from August 15," says Ward McCarthy, chief economist at investment bank Jeffries & Co. "The debt ceiling won't be an immediate problem."

Europe has it's own problems

As for Europe, Fichtner believes the current crisis over the debt ceiling in the US is largely irrelevant compared to the wider crisis of the eurozone.

"I think what will happen - even if they don't come to a deal - is that the US will lose its reputation as a safe haven a little," he said. "And that will become a problem for Europe and especially Germany, because the value of the euro will increase."

"That's probably how it will reach us - not necessarily through an acute financial market crisis. It will be more of a long-term process," he added.

But in any case, Darvas, the Bruegel economist, is still confident that wiser heads will prevail in the Capitol. "They are clever guys across the Atlantic, and they must understand that not having a deal could have a disastrous impact in the world."

Author: Bettina Seidel, Ben Knight
Editor: Gerhard Schneibel

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