Problems in Europe could end up dragging growth in China, hit commodity prices and derail the nascent American recovery, according to Satyajit Das, the author of "Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives".
“North America and Asia have been bystanders as the European crisis developed. Increasing concerns are evident, as European problems now threaten global recovery,” Das said.
As China’s biggest trade partner, the European Union economy is crucial to Beijing’s hopes of maintain double-digit growth.
“Any slowdown in Europe would affect Chinese growth. China is also a major holder of euro sovereign bonds, standing to lose significantly if problems continue,” Das said.
Chinese officials have been in Europe promising to stand by euro zone governments needing to raise money on international markets. It is in Beijing’s interest, and in the interest of the commodity producers who fuel its growth, for Europe to stay out of trouble, Das said.
“A slowdown in China would affect commodity markets, both volumes and prices, and commodity exporters such as Australia and South Africa. Minutes of a 7 December 2010 from the central bank of Australia, one of the world’s best performing economies, indicated increasing concerns about developments in Europe,” Das said.
You Pay Either Way
Without a fiscal union or the launch of a so-called E-bond, both of which Das sees as very unlikely, the chances of a default by one or more euro zone countries is very high, he said.
“If the EU does not agree to fiscal union or continuing support, then pressure on Portugal, Spain, Italy and Belgium may reach a tipping point, making default or restructuring the likely end game,” according to Das.
“Presumably, existing programs, such as those for Greece and Ireland, would be suspended. Governments would announce debt moratoriums, defaulting on at least some debts and forcing writedowns. This would be followed by a domino effect of defaulting countries within Europe,” he said.
If this where the case, Germany, France and even the UK would end up injecting capital and liquidity into their banks to ensure solvency, Das continued. “The richer nations would still have to pay, but for the recapitalization of their banks rather than foreign countries.”
Weak Euro Hits US Growth?
“A continuation of the European debt problems, especially restructuring or default of sovereign debt, would severely disrupt financial markets. Losses would create concerns about the solvency of banks, in particular European banks,” Das said.
“In a repeat of the events of September 2008 and April/ May 2010, money markets could seize up, as trust about the ability of parties to perform contracts evaporated. In turn, this volatility would feed through into the real economy, undermining the weak recovery,” he explained.
“Any breakdown in the euro , such as the withdrawal of defaulting countries or change in the mechanism, would result in a sharp fall in the new currencies. In turn, this would, in the first instance, result in large losses to holders of debt of those countries from the devaluation.”
Money would then jump to the safety of the dollar, hitting the nascent American recovery, Das said.
“This may compound existing global imbalances and trigger further American action to weaken the dollar. Further rounds of quantitative easing are possible, setting off inflation and destabilizing, large scale capital flows into emerging markets.”
“In turn, the risk of protectionism, full-scale currency and trade wars would increase. A breakup of the euro would adversely affect Germany, which has been growing strongly. A return to the Deutschmark or, more realistically, a euro without the peripheral countries, may result in a sharp appreciation of the currency, reducing German export competitiveness,” Das concluded.