European Economy: Hit Hard by US Financial Crisis

By: KeithTimimi   Date: 8 October 2008

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London, 8 Oct 2008. The European economy has been affected by the financial crisis in the US, with Germany and Iceland being the hardest hit.

This economy produces almost $13 trillion per year, which is about the size as the US economy. Per capita, it is much smaller, as it is made up of 710 million people (in the 48 European states) versus almost exactly half that in the US.

The main currency in Europe is the Euro, although some smaller nations still use their own currencies, such as the UK, Russian, Denmark, Norway, Poland, and others. Some currencies are pegged to the Euro, like those from Estonia, Lithuania, Bulgaria, Cape Verde, and Bosnia and Herzegovina. Therefore, any financial shocks that affect the Euro will have immediate and identical effects on these countries’ currencies.

The Euro has made the collective economies of Europe behave much like one economy, yet most of its countries have their own stock exchanges. There are also two pan-European exchanges, the Euronext and OMX.

The US financial crises hit Germany particularly hard when a proposed bailout there for Hype Real Estate fell through resulting in a colossal bankruptcy (400 billion Euro). This news led to Chancellor Angela Merkel putting a guarantee on all German savings, only one day after criticizing Ireland for enacting similar measures.

The shocks have been felt far and wide in Europe. Greece and Ireland have been forced to nationalize all of their banks, while the Dutch bank Fortis has been nationalized, as has Icelandic bank Landsbanki. In fact, Iceland’s banking industry is on the verge of collapse.

Iceland's Prime Minister Geir Haarde, even went so far as to say that the country’s citizens will experience a decline in their standard of living. He added that the small nation will have to now rely more on its traditional industry of instead of relying too much on financial services.

The remote island nation of about 320,000 currently enjoys the 4th highest per capita GDP in the world. The US and UK are 11th and 12th.

The European Central bank actually raised rates in July. This reduced demand for money, sucking it out of the system – exactly what Europe didn’t need. The European Central Bank could have learned a thing or two from the US Fed’s mistakes in the Great Depression. It did the same thing, thinking that would work, but the then-young Fed was inexperienced and had never faced such a crisis before. And so the Great Depression began.

IMF chief Dominique Strauss-Kahn commented on the situation, “We have to make sure Europe takes its responsibilities, like the US: action must be taken quickly and in a concerted manner.”

At least the UK and Spain have taken proactive measures. $87.8 billion of taxpayer money is expected to be injected into some of Britain’s largest institutions such as Barclays, the Royal Bank of Scotland, and Lloyds TSB.

“There is no such thing as a safe bank now. They are only as safe as the authorities make them,” noted political economist Willem Buiter, from the London School of Economics.

The Spanish housing market has recently tanked, affecting the banking industry – Spain has had its own subprime crisis over the past few years. Prime Minister Jose Luis Rodriguez Zapatero announced the creation of a fund – of anywhere from $30 to 50 billion Euro – to buy back healthy assets from banks. He also plans on increasing deposit insurance to 100,000 Euro.

Russia has undergone huge shocks with its markets falling to long-time lows, and even being closed. Of course closing them cannot avoid all problems, and investors tend to sell once the markets open. The Russian finance minister recently noted the country’s increasingly-lessening reliance on the US dollar. Apparently, that is only wishful thinking.

As EU nations worry about their own economies, they have to keep a close eye on the US. The Fed has yet to release its rescue plan in full, but an interest rate should be in order. Although with rates already so low, the Fed effectively cripples itself once they get down to zero, as it has nowhere else to go. From then on, only monetary expansionist policies will do anything, as it could be stuck in a liquidity trap.

Archibaldo Westenskow, EconomyWatch.com


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