Investors who had hoped for a victory by the Republican Party and Mitt Romney in Tuesday’s election were quick to label the stock market’s plunge in the two days that followed as a logical reaction to President Obama’s win. After all, they argue, a continuation of Obama’s policies mean that the United States is doomed to end up following in the footsteps of Greece.
Let’s dispense with that point first. The United States is in no imminent danger of becoming the next Greece. While the U.S. government budget deficit is unquestionably too high, interest payments on U.S. government debt as a percentage of GDP are well below those that Greece must pay. Similarly, the current account deficit, as a percentage of GDP, is a third of that of Greece's. We’re not about to run full tilt into a crisis, at least not because of the debt.
As things stand today, we can finance that debt far more easily and cheaply than Greece can: Current rates on 10-year Treasury notes are below 2 percent, while comparable Greek government bonds currently yield north of 18 percent. Global investors are still willing to own dollar-denominated assets, recognizing that the U.S. economy is vastly more flexible, more innovative and more productive than most other developed economies. The unemployment rate has been coming down in the U.S. but it’s been skyrocketing in Greece and hit a new high of 25.4 percent, up from 17.5 percent last November.
Yes, legislators in Washington must find a way to avoiding running full-tilt off the “fiscal cliff,” and must do more than simply provide a band-aid solution to the underlying problem of revenues being inadequate to sustain current spending levels. That is common sense, as is the idea that both the Obama administration and the Republican Party must come to the table prepared to compromise on some of their cherished objectives.
But this week’s market selloff has as much or more to do with real fears of what may be brewing in Europe as it has with apprehension of what may happen at home. Practically speaking, the election outcome doesn’t much change the likelihood of avoiding the fiscal cliff: The makeup of Congress, in whose hands a solution lies, hasn’t altered enough for that. It’s hard to see how a Romney victory would have made Congressional Democrats more willing to compromise than Congressional Republicans are – in practice, not just in rhetoric – after Obama’s win. What is new are the renewed uncertainties about what is happening in Europe. As the election campaigns reached their climax in recent weeks, the Eurozone crisis had been consigned to the back burner, thanks in part to Mario Draghi’s pledge to do “whatever it takes” to resolve matters.
Now the limits of his ability to act on that pledge are becoming apparent. True, the Greek parliament did vote in favor of another round of austerity measures, in spite of a general strike and demonstrations outside the legislature in Athens. But almost at the same time, Draghi – whose statements and actions have done so much to shore up investor confidence that the Eurozone crisis can be contained, if not resolved – delivered a blow to markets by declaring yesterday that the European Central Bank is “by and large done” when it comes to helping Greece.
The ECB can’t take a haircut on the Greek bonds it owns as part of a possible bailout; that, Draghi said, would be the equivalent of “monetary financing,” something that is outside the remit of the central bank. Instead, he put the question of resolving Greece’s debt crisis – and the challenge of finding a way to make the country’s debt load sustainable – squarely back in the hands of the Eurozone’s politicians. It’s up to the politicians to repair public finances and remove obstacles to growth, he argued.
And if we are worried about the ability of our own legislators to resolve the U.S. deficit, we can at least take comfort in the fact that all are committed to the concept of the United States and ensuring its future prosperity. In Europe, the idea of “union” is only a few decades old; monetary union is only little more than a decade old and a principle that many of the region’s largest economies, like Britain, don’t subscribe to at all one that many Germans reject if it means they will be footing the bill.
Add to the political hurdles the fact that the Eurozone’s economy clearly seems to have stalled: Austerity programs on the periphery contributed to a 0.3 percent GDP contraction in the second quarter and the EU expects a decline of 0.4 percent in GDP for 2012 as a whole this year, and growth of a mere 0.1 percent next year. Unemployment is at its highest level since the Euro’s debut in 1999, at 11.6 percent across the region.
That is bound to weigh on U.S. financial markets. The country’s largest banks, with a few exceptions, have exposure to the European economy and to the region’s banking sector, however carefully they have managed that exposure. Most of the larger companies in the U.S. are in reality global businesses, deriving a significant portion of revenues and profits by selling goods in Europe and other overseas markets. We may think of McDonald’s (MCD), Gap Stores (GPS) and Colgate Palmolive (CP), to name a few companies at random, as American companies, but they are household names in Paris, Frankfurt, Florence and Seville as well. Other businesses – Netflix (NFLX), for one – are striving to build a presence in Europe at this uncertain point in time.
So it’s hardly surprising that the stock market would react dramatically to an intensification of the Eurozone uncertainty, even as other sectors (energy stocks, coal mining companies, banks) see the last of the gains they had experienced in anticipation of a Romney victory vanish in the wake of the results.
The reality is that we’re about to enter into a period of market uncertainty and volatility fueled by macroeconomic concerns both at home and abroad. Each fresh piece of political rhetoric or news, whether from Berlin, Athens or Washington, is likely to roil markets. That’s particularly likely as the third-quarter earnings season draws to a close, giving us fewer distractions. Absent a miracle in the form of an early (pre-Thanksgiving) resolution to the deficit negotiations at home, or a sudden about face on the part of Germany’s leaders with respect to European bailouts, we’re likely to have to live with nervousness and uncertainty for the rest of the year.
To borrow the famous lines uttered by Bette Davis in “All About Eve”: Fasten your seatbelts. It’s going to be a bumpy month.
