How Europe’s Crisis Can Tip U.S. into Recession
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The Fiscal Times
October 3, 2011

  • More than 40 percent of analysts and investors expect a global recession.
  • Exports to the U.S. and eurozone are 40 percent of emerging-market GDP.
  • Stock market capitalization of eurozone banks has plunged 42 percent.

The eurozone has been heading down a slippery slope ever since its sovereign debt crisis erupted more than a year ago. The crisis so far has been a financial issue complicated by political bickering over a solution. It is entering a more dangerous phase. The debt problems are starting to weigh heavily on Europe’s economy, and the ripple effects are threatening global growth and the fragile U.S. recovery. The eurozone’s crisis is one more headwind that could tip the U.S. economy back into recession in 2012.

Economic forecasts for the 17-member eurozone are being cut sharply for the rest of 2011 and 2012, Ongoing fiscal belt-tightening and new stress on bank funding is tightening credit conditions even in the core German and French economies. Plus, many analysts now believe that Greece cannot escape a second debt restructuring with a much rougher impact on private-sector bond holders.  The jolt would reverberate across Europe’s trade channels and bank balance sheets, increasing chances that financial contagion could engulf even healthy banks and solvent governments, as investors race to safer territory. U.S. financial markets and exports are also vulnerable, and new global uncertainty would weigh further on U.S. business investment and hiring.
Recent gauges of both activity and sentiment in the eurozone have plunged, suggesting the intensifying debt crisis has significantly damaged the economy. Analysts at J.P. Morgan, the latest to slash their eurozone outlook, expect real GDP in the region to slip into negative territory in the fourth quarter. They now forecast a decline of 0.5 percent in 2012, even assuming aggressive action by policymakers to support banks and sovereign obligations. A recession would put additional pressure on government budgets, add to the risk attached to government debts, further erode credit quality on bank balance sheets, and increase the chances of a global recession.

The International Monetary Fund (IMF), which lowered its forecast for 2012 global growth to 4 percent on Sept. 21, defines a global recession as growth below 3 percent. Many private-sector forecasts are already close to that mark.  J.P. Morgan is at 3.1 percent, while Citigroup recently cut its projection to 2.9 percent. Nearly 90 percent of the investors, analysts, and traders surveyed in a Sept. 26 Bloomberg Global Poll say the eurozone economy is getting worse, while about two-thirds say the global economy is weakening. More than 40 percent of those polled expect a global recession in the coming year.

The eurozone slowdown, combined with the falloff in U.S. growth, is being felt around the world, especially in the high-growth emerging-market (EM) economies that led the global recovery from the last recession. Exports from emerging-market economies to the U.S. and eurozone accounted for more than 40 percent of emerging-market GDP last year. In the second quarter, EM export growth slowed to a single-digit annual rate, say J.P. Morgan global analysts, from a double-digit rate in previous quarters. The sharp slowdown in U.S. and eurozone growth suggests further slowing in coming quarters.

James C. Cooper
was BusinessWeek's senior editor, senior economist and author of its influential Business Outlook column. Prior to that, he was an economist at the American Paper Institute, performing economic analysis and forecasting. He holds bachelors and masters degrees in economics.