Will Europe trump retail sales?
U.S. retail sales rose a greater than expected 0.5 percent in October, as beaten down consumers opened their wallets to buy cars, electronics and a variety of items on the Internet.
On the heels of an improving GDP (up 2.5 percent in the third quarter) and rising consumer confidence, does this mean that the U.S. economy is (gasp!) better than expected?
I hate to burst your pre-holiday euphoria, but while the U.S. economy is muddling along and growing at a improving, albeit slow rate, it faces a stiff headwind blowing across the Atlantic.
Yes, it's Europe again. The drama has moved from Greece to Italy, Europe's third largest economy. Italy has $2.6 trillion in outstanding debt, which it could probably manage to service, except for one problem: interest on the debt is rising. A year ago, things seemed under control, as investors were willing to lend Italy money at less than 4 percent. Just yesterday, Italy sold $4 billion worth of five year bonds at 6.2 percent.
Think of this like your credit card company jacking the rate on your Visa--things were honky-dory when the interest rate was 9.99 percent, but when you have to pay twice that amount, it's tough to meet your new, increased monthly nut.
I know what you're thinking: why do we have to care about what's happening in Italy? Here's why.
If Italy (or Greece) can't repay all of its obligations, bondholders are going to take a hit. The big lenders to both Italy and Greece are European Banks, which are going to come under pressure if these countries can't repay their loans.
Why should we care about European banks? Because U.S. banks hold lots of European bank debt. The Congressional Research Service report to Congress noted: "Given that U.S. banks have an estimated loan exposure to German and French banks in excess of $1.2 trillion and direct exposure to the PIIGS valued at $641 billion, a collapse of a major European bank could produce similar problems in U.S. institutions." In other words, our two financial systems are interconnected.
But wait, there's more. If the European economy tanks as a result of these sovereign debt crises, the US economy could follow suit. According to the BEA, Europe buys 22 percent of all U.S. exports and so a recession there, would hurt our exporters. Not only that, but a Euro crisis would cause the U.S. dollar to gain value, which would make exports more expensive everywhere in the world.
In fact, the threat of a European recession has prompted the San Francisco Federal Reserve Bank to peg the odds of a U.S. recession in 2012 at over 50 percent. At the end of the day, I actually do not think that the U.S. will tip back into a recession, but for everyone who wonders why they need to pay attention to events in Europe, 50 percent odds might grab your attention.
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