Three layers of the European debt crisis.

For those of you who are a bit confused about what exactly is happening, or not happening, in Europe.

This post is for Americans who know nothing about the debt crisis in Europe.  I am going to try to provide a big picture framework and draw attention to what I think should matter most to Americans.  If you have expertise in this topic I hope you’ll help me improve my analysis.  This topic is somewhat new for me.

I think of the European debt crisis in three layers:

  1. national debt crises in several European countries;

  2. a structural crisis of the Eurozone; and

  3. potential banking crises in Europe and the U.S.

Most current press coverage is about the middle layer: can European leaders prevent the Eurozone from dissolving? The top and bottom layers deserve more attention than they are receiving. American policymakers need to think hard about and plan for the possibility that a really bad outcome in Europe leads to another American banking crisis.

Why ultimately should the US care? (As a background, the author of this post, Keith Hennessey, is the former Assistant to the U.S. President for Economic Policy and Director of the U.S. National Economic Council under ‘W.’ Hardly a liberal.)

The bottom layer, the interaction between European sovereign governments and banks in Europe and the U.S., is not getting nearly enough policy or press attention, and it worries me a lot. From an American self-interest perspective, the direct economic effects of a Eurozone collapse on U.S. exports would be very bad and could easily tip the U.S. into recession. But the effects of a collapsed Eurozone or an Italian default on European banks, and the indirect effects that are passed through to American banks, could be far, far, worse. Think 2008 financial crisis worse.  The worst case scenarios for Europe appear to pose a low probability, high consequence threat of another horrific U.S. banking crisis.  This is why American policymakers should care deeply about Europe — because if the Europeans screw it up badly, it could do serious damage to the American economy, transmitted through still flawed and vulnerable banking systems.

Read the full post here.

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Filed under Economics, Europe

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