Is the European crisis good for America?

May 18, 2010
Tim Duy has a provocative thesis: that the Europe crisis is good for the US economy, at least for the next few quarters.

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Tim Duy has a provocative thesis: the Europe crisis is good for the US economy, at least for the next few quarters.

Bottom Line: The European crisis, by keeping US interest rates in check and oil prices low, may do more to help the US recovery than hurt it. In the process, however, we would expect the flip side of the resulting capital inflows into the US to emerge – namely, a rising external imbalance. Arguably, this simply shifts the ultimate adjustment to sometime in the future. Again.

Is this really true? Interest rates can hardly be any lower than they are, so for the time being they’re exactly where they would be even if there wasn’t a European crisis. The situation in Europe might at the margin make the Fed slightly more reluctant to start tightening, but it’s not going to make any real-world difference for a while yet, if ever.

As for the price of oil, again I think the influence of European news is marginal, and only secondarily due to fundamentally lower demand from Europe. Mostly, I think that the option value embedded in the oil price — the idea that you might be able to buy now and then sell in the future at a profit — has fallen, as the prospects for serious oil-price appreciation have eroded. In other words, the fall in oil is financial, rather than fundamental. Which still helps US growth: the price of oil is the price of oil either way. But I think the connection with Europe is a second-order effect.

More to the point, if the European crisis really does end up delaying and therefore exacerbating the way that the US is going to have to deal with its twin deficits, that bodes ill for future interest rates, and is likely to keep the yield curve steep for the foreseeable future. If global liquidity embarks on another flight-to-quality trip to the US, that’s a nice short term boost on this side of the pond. But it’s not at all sustainable, and I’m not even sure it can reasonably be considered a “net positive” if it only increases the likelihood of a W-shaped recovery.


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