The Keystone Connection

The European Sovereign Debt Crisis and the Effects on the U.S. Economy

Wednesday, March 07, 2012 By Sarah V.

More than ever before, the U.S. economy is connected with other nations around the world. America imports and exports significant amounts of goods and services annually. One of our largest trading partners is the European Union (EU), which consists of 27 regional member nations. Within the European Union is the euro zone, consisting of 17 countries which use a common currency called the Euro. This is where the center of the European sovereign debt crisis originated. Generally speaking, the European sovereign debt crisis resulted from the pressure on the relationships between governments’ debts, the banks, investors, and citizens. For example, when a country such as Greece borrows an excessive amount of money (in the form of government bonds) and later is unable to repay these loans, a local insolvency crisis results. Since Greece is “attached” to euro zone countries via its common currency and banking relationships, these other euro zone countries will also be affected. This degree of “contagion” depends on the other nations’ economic health and extent of financial involvement in Greece ’s economy. While it is currently contained, there are still effects to the American economy, due to our close connections with the European Union. Therefore, the problems in the European Union are directly affecting the everyday lives of people in the U.S. One of the most important financial systems in the world is the global banking system. It provides credit and services for many institutions around the world. Businesses and governments are especially dependent on the banks, since credit is often the lifeblood of these organizations. If a government like Greece cannot afford to repay their debt, the European Commission may inform the banks that they may not receive all of the funds they invested. Therefore, to preserve funds, the banks would begin to sell some of their assets and tighten credit. What does this mean for America ? Since we are closely connected to the European Union, the effects of the debt crisis can have a significant influence on our economy. When the global banks begin to tighten credit, it becomes more difficult for companies to contract loans to maintain or expand their businesses. Therefore, limited availability can reduce supply, and increase prices for existing goods and services. Also, slowed business growth can limit job opportunities and slow economic growth. This affects both European and American banks and companies. Since many of the banks in America diversify their assets by investing in the European Union, the ripple affect of tightening credit would come to U.S. companies, and the chain reaction would continue here. So, not only would imported products be affected, but also US-made goods. In addition, many investor portfolios in America contain European sovereign debt bonds, since they were, and in some cases still are, considered safe investments. If a country defaults either voluntarily or involuntarily, they could not pay the value of the bonds, and the investors could take a loss. This could have a direct impact on the financial markets in America . Due to these, as well as other factors, the problems in the European Union significantly affect people in the U.S. In response, our government is closely monitoring the situation, and is taking steps to limit the influence of the European sovereign debt crisis in America . By regularly staying on top of the current events, Americans can better prepare, both personally and nationally, against the possible effects of this sovereign debt crisis.