Debt woes in Europe could infect U.S. recovery

[February 11, 2010]  WASHINGTON (AP) -- The United States, which led the world into recession, may now see its fragile recovery stifled by events across the globe.

Dangerously high debt levels in Greece and some other European countries could trigger a wave of national defaults, undermining revival in Europe and probably in the U.S. as well.

And China's recent steps to cool its economy also complicate President Barack Obama's plan to attack high unemployment here by increasing U.S. exports. Financial markets have been whipsawed over concerns that debt problems in Greece -- and perhaps also in high-debt Spain, Portugal, Ireland and even Italy -- might infect stronger European neighbors.

A strike by civil servants to protest wage cuts shut schools and grounded flights across Greece on Wednesday. European Union leaders plan to discuss the crisis -- and the feasibility of rescue attempts -- during a summit Thursday in Brussels, Belgium.

Euro zone countries are key U.S. trading partners, and the United States can't meet Obama's goal of doubling exports in five years -- or reap the benefits in new jobs -- if debt default contagion spreads throughout Europe.

Likewise, China is deemed an important growing export market for American goods. But Beijing's recent steps to curtail bank lending and its economic saber-rattling at the United States have increased trade tensions between the world's largest economy and a country poised to soon surpass Japan for second place.

The U.S. recession began in December 2007 amid a meltdown in housing and credit markets. The crisis spread quickly to Europe and other major economies.

Unlike Western economies, China never dipped into a full-fledged recession. Thanks to enormous government spending and government-orchestrated bank lending, China rebounded quickly to a strong growth path.

Economists believe the U.S. recession ended sometime last summer. But recovery since then has been tentative and spotty, with unemployment still hovering close to 10 percent.

The Obama administration says it wants to move away from an economy fueled by heavy consumer spending and reliance on imports toward what economic adviser Lawrence Summers calls "an economy that's based on investment, that's based on exports, that's based on saving."

Unfortunately, all the other major economies are also counting on digging themselves out, at least in part, through expanded exports. For every nation to be able to meet such a goal, of course, is a mathematical challenge.

Fears of possible sovereign defaults in Europe have also focused new attention on the bloated U.S. budget deficit.

The government deficit in Greece stands at 12.7 percent of the nation's annual economic output as measured by gross domestic product. That's more than four times the limit allowed by the European Union, but it's not that much greater, proportionally, than the 10.6 percent deficit-to-GDP ratio in the United States.

Barack Obama's new budget projects a record deficit for this year of $1.6 trillion, to be followed by $1.3 trillion in 2011. Years of accumulated deficits have resulted in a national debt of $12.3 trillion. Congress recently upped the statutory cap to over $14 trillion to accommodate even more borrowing.

The financial turmoil in Europe does have one possible silver lining for the U.S.: The uncertainty has raised the value of the dollar as measured against the currencies of 15 of the nation's 16 biggest trading partners.

But there's a downside to that, too. A stronger dollar makes made-in-America goods more expensive in overseas markets, dealing yet another blow to struggling U.S. manufacturers and exporters.

Even short of actual sovereign defaults, huge budget deficits in Europe could lead to further cuts in those countries' credit ratings.

And the United States isn't immune -- despite protests by Treasury Secretary Timothy Geithner that the U.S. "will never" lose its sterling credit rating.

Moody's Investors Service recently warned that the U.S. government's credit rating could eventually be in jeopardy if the nation's finances don't improve. The cost of borrowing for the government would soar under a downgrade of the creditworthiness of U.S. Treasury bonds and bills.

Simon Johnson, a former chief economist at the International Monetary Fund and now a management professor at the Massachusetts Institute of Technology, said recent troubles in the euro zone might actually give the U.S. some breathing room -- but only if the U.S. also takes serious steps to get its own financial house in order.

"The euro is seriously under pressure," reinforcing the dollar's role as the world's pre-eminent, or "reserve," currency, he said. Despite lots of fears, he added, there has been little evidence that China or other major holders of U.S. debt are on the verge of fleeing the greenback, especially for the euro.

"It means we will be able to run up more debt, markets will let us do that at lower interest rates, than they would have otherwise," Johnson said. "This buys us time to tackle the medium-term issues -- around health care spending, around Social Security and around a sustainable tax base."

Johnson warned that foreign patience could hinge on creation of a bipartisan U.S. commission that could force Congress to vote on deficit-lowering recommendations, such as higher taxes or cuts in Social Security and Medicare.

The Senate rejected such a commission last month. Obama has said he will create a similar panel, even though his would not have the power to force Congress to either accept or reject its recommendations.

[Associated Press; By TOM RAUM]

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.