Europe is still moving rather slowly towards resolving its financial crisis, as if it has all the time in the world, which is nonsense and maddeningly frustrating to those of us watching from the outside. Europe isn’t likely to melt down, because the consequences would be very painful, especially in Europe, and a meltdown is avoidable. But most anything short of a meltdown would largely impact Europe and have fairly modest implications for our economy and markets. In the meantime, our economy appears to be picking up momentum, once again. U.S. growth forecasts are being revised higher in the face of ever more positive economic data.
Every single component of the solution to Europe’s credit crisis is already agreed upon or quite visible. Greece’s debt will be reduced to more manageable levels as the owners take a “voluntary” 50% loss. The banks will be required to meaningfully raise their capital levels. The governments of Europe will provide support to the sovereign borrowers on the periphery while they work to reduce their budget deficits. The ECB has signaled that monetary policy will become more expansion oriented to offset fiscal drag. Even the IMF stands ready to provide sovereign financing to help the process along. But these agreements or understandings remain mired in political posturing, efforts to pass the costs to others, or to defer the inevitable rather than to get the problems resolved promptly. Still, it is highly unlikely that Europe will permit wholesale defaults to undermine European finance. Sadly, it is only that threat of default that forces them to take the actions that are already agreed upon and they know they must implement.
The economic situation is far better domestically. The passage of several months reveals more clearly that the weakness in the U.S. economy this summer was largely due to temporary events, notably the earthquake in Japan, the ensuing disruption to supply chains, a rise in oil prices and harsh weather. There is evidence for this rebound from the summer slowdown in many economic reports, from retail sales to unemployment claims, to job openings, to capital investment spending. Importantly, there is now also evidence of real recovery in housing, which would be a new source of demand that could help the economy gain some vigor. Home sales have increased, apartment occupancy is rising, rents are rising, new construction is increasing, housing is contributing to GDP growth, and home buying intentions are improving. There are improvements in virtually every housing measure. The risk of recession is quickly disappearing as estimates for GDP growth are being revised upwards as this data comes in. If Europe doesn’t melt down completely, domestic growth should continue to improve, with widespread beneficial effects.