July 28, 2011

US debt crisis poses 'contagion threat' to eurozone

As the US battles the threat of a debt default, concerns for the impact on the eurozone have risen. Fabian Zuleeg, economist at the European Policy Centre, warns that the US crisis could have a serious knock-on effect.

http://www.dw-world.de/dw/article/0,,15270738,00.html

The deadline for the United States to raise the debt ceiling above $14.3 trillion (9.9 trillion euro) is just a week away. Republican and Democratic leaders are caught in a standoff with little hope of a compromise. Worst case scenario, the US government could be unable to pay its bills come August 2.

The stalemate is rattling investor's worldwide, sending stocks and the dollar down, while pushing gold prices to a record high. Deutsche Welle asked Fabian Zuleeg, economist at the European Policy Centre in Brussels, how serious the crisis could be for the eurozone.

DW: What impact has the dispute had on the European single currency?

Fabian Zuleeg: There is of course an immediate impact on the exchange rate between the euro and the dollar in the sense that given the uncertainly in the US at the moment, the dollar is weakening. But I think what is far more important is what longer-term impact this might have. Certainly it's drawing some of the attention away from the euro, but I don't think it helps the world economy to have even more uncertainty in the system.

Analysts are saying that if the worst comes to the worst and the US government can't pay its bills on August 2 then there will be a severe shock to the global economy. President Obama has been referring to Armageddon. What's your view?

I think that's slightly overstating the case, but certainly it would be a shock to the global economy. The US government is a major spender in the world system, so if it really comes to a complete freeze of the US budget, then that could well have an impact beyond US borders. But I think talking about Armageddon is overstating it a little bit.

What would the impact be on the eurozone?

Well I think the impact would possibly be through a knock-on effect. If we have a situation where American banks are starting to feel that activity is slowing down in the US and they react to that, then that could well have an impact on the European banking system and that European banking system is still fragile given the euro crisis.

What are the differences and the similarities between the debt crises in the US and the eurozone?

IMF chief, Christine Lagarde IMF chief Christine Lagarde has also warned of the threat a US default poses in EuropeI think there are major differences. What we are seeing in the US is pretty much an entirely a political crisis. It's about the republicans and the democrats locking horns over what the priorities are in terms of fiscal policy. What we have in the EU is far more about structural factors. It's about the long-term reasons why economies such as the Greek economy and the Portuguese economy are struggling to have healthy growth rates and are continuing to run up big deficits and big debt.

As the two blocks struggle with their respective crises, what can they learn from one another?

I think the key thing which should be on the minds of decision makers on both sides of the Atlantic is that you don't get driven by the markets. Instead, you make decisions which pre-empt what happens in the markets. Once you are in a situation where the markets are speculating, where the markets are driving the situation it becomes very difficult to get out of it and very often it becomes more costly.

And the markets are driving this crisis on both sides of the Atlantic? Have I understood you correctly?

The markets are a big factor in continuing to drive the crisis. Of course the underlying reasons are in the political decisions which are taken, but the markets are certainly not helping to calm the situation.

Is the future of the United States dollar remaining the world's reserve currency in doubt?

I don't think it is in doubt because of this immediate crisis, but it just adds to a long list of doubts over why the dollar might loose its status as a reserve currency. But this is a long-term development and to some extent we had the competition from the euro. But I don't think that many people see the euro as the next reserve currency given the crisis we have just had.

So it would be simplistic to suggest that the euro could benefit in any way from the dollars weakness?

I think it might benefit in the short-term, but I think the long-term situation is far more worrying. What we should be worried about is the global economy and the health of the global economy. If anything takes more of the recovery out of the system, if the US slows down, then I don't think that will help the eurozone.

Interview: Mark Caldwell / ccp
Editor: Rob Turner

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