Many have asked me if the recession in Europe could derail the United States' recovery. That's an important and interesting question, as well as a complex one. While there are some dangers, there are a few positive factors that haven't been considered.
Let's first discuss the possibility of a full blown financial crisis. Yes, a financial panic could definitely cause real problems for our economy. You can see by JPMorgan Chase's (NYSE:JPM) revelation of a $2 billion (now $3 billion) loss on derivatives and bankrupt MF Global's risky sovereign debt gamble that financial institutions can get themselves into a lot of trouble with European debt. All the banks have counter party risk to each other, via not only lending, but more esoteric financial instruments like Credit Default Swaps. Adding to the problem, some of our large banks are still not in the best of shape, especially Bank of America (NYSE:BAC). There is no doubt that another financial crisis here would be devastating for our economy.
However, while this outcome is a possibility, I don't see that as very likely at this point. Greece is already essentially in default, so there's only so much worse its situation can get. Also, I don't believe Europe will allow a banking crisis to happen. Just like America had to accept the unpleasantness of a government funded bank bailout and inject capital during 2008, Europe will likewise have to act in its own best interests if conditions worsen. New leaders like Christine LaGarde have shown much more willingness for united action and monetary easing. And during the ongoing G8 meeting, the members are expressing European unity.
Next, there is the matter of exports to consider. After all, it's a global economy, right? We sell things to Europe too. If they aren't buying, it affects our companies, as in the case of Kellogg's (NYSE:K) last quarter. So couldn't poor sales to Europe drag us into a recession?
Probably not. It's important here to keep Europe in context. Exports to Europe are actually only about 3% of the U.S. economy. Whereas China has to export to other countries, we don't. Americans are quite capable of producing and then consuming much of what it makes. It's one of the biggest reasons why the United States has such a robust economy. Therefore, while I believe Europe's recession will be a drag on specific companies, I don't see exports to Europe creating a recession here by themselves.
Strangely, there are some positives for the U.S. in the European problems. For one thing, look what has happened to gasoline prices. They have dropped over 10% in the last two months. Commodities, such asoil, copper and coal, have fallen as well because with Europe's woes come export-driven China's woes. Since China is one of the biggest consumers of these commodities, traders have them sold off, and that has caused their prices to drop. These reduced commodity prices are a big help to our economy, keeping a lid on inflation, and putting more money back into the American consumer's pockets. Since consumer spending drives 70% of the U.S. economy, that's a big positive.
I'd also like to focus on something less exciting, but probably most relevant; something many haven't considered. That's good old fashioned interest rates.
According to modern economic theory, interest rates are what drives an economy's growth. The lower they are, the faster the economy grows. That's why Ben Bernanke, chairman extraordinaire of the U.S. Federal Reserve, is doing everything he can to keep interest rates ultra low. It's not to punish savers, as some claim, it's to help the entire economy recover more quickly.
If you follow the sovereign bond markets even slightly, you'll see a clear pattern. When investors get scared, they flee to safety. And safety is none other than U.S. Treasury Bonds. Yes, every time the situation in Europe boils over, investors sell European sovereign debt and buy ours, because they know the United States is more than capable of paying its bills.
Investors buying American debt creates more demand, which in turn causes those bonds to rise in price. Higher prices in bonds means lower yields, exactly what Bernanke is trying to accomplish. For example, this latest scare over Europe elections has driven the 10-year treasury bond down to only 1.7%.
Therefore, Europe's pain is our gain; we get lower interest rates which should help the US economy grow. It's almost like a form of quantitative easing. Also, the low bond yields keeps our large amount of government debt that much more affordable.
It's my conclusion that unless the unlikely event of a financial panic occurs in Europe, the U.S. recovery should not be hindered overly by the continental recession. Not only is Europe not that critical to our economy, there also are unusual mitigating factors, such as lower interest rates and commodity prices, occurring where some of its problems are actually spurring growth.
Disclosure: I am long K.