WHY IT MATTERS: Europe's Economic Crisis

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Associated Press

Posted on October 10, 2012 at 12:35 AM

Updated Wednesday, Oct 10 at 1:05 PM

The issue:

Europe is struggling to control a debt crisis, save the euro currency and stop a repeat of the 2008 financial crisis that sent the world spinning into recession. The continent's troubles are the No. 1 threat to the fragile U.S. economy. If the crisis spreads to the U.S., Americans could find it harder to get loans and the country could slip back into recession.

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Where they stand:

Neither President Barack Obama nor Republican presidential candidate Mitt Romney has offered plans for Europe. The U.S. government lacks the cash and the will to rescue European countries struggling with huge debts. Obama has urged Europe to act more decisively. Romney has used the crisis to warn that the United States will face its own day of reckoning if it doesn't reduce the federal debt.

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Why it matters:

Europe buys 22 percent of the goods America exports. U.S. companies have invested heavily in Europe. So any economic slowdown in Europe dents U.S. exports and corporate profits. But the biggest fear is that a European financial crisis will flare up and move west across the Atlantic — the way Wall Street's 2008 crisis moved east to Europe — with dire consequences for the U.S. economy.

Europeans are struggling to repair a system that was flawed from the start. The euro, introduced in 1999, makes it easier to do business across Europe; no more changing francs to deutschemarks when French and German companies do business. But the common currency joined countries with vastly different economies and political cultures — and each got to keep running its own budget. During the 2000s, banks were willing to overlook the differences and lend at low rates to countries like Greece with dubious records of fiscal discipline. Lenders knew they'd be repaid in euros, not local currencies that could be devalued by inflation. Greece and other countries took advantage of the easy money. Their debts proved crushing after the recession hit.

To fix their finances, European countries have cut government spending and raised taxes. Greece, Portugal and Ireland had to tighten their belts to qualify for bailouts. But the austerity has taken a toll. Europe is sliding into recession. The pressure might force Greece to abandon the euro and revive its old currency, the drachma. Other countries — notably Italy and Spain — might follow Greece out of the eurozone.

Abandoning the euro would free countries from an economic straitjacket. When they joined the eurozone, they surrendered control of interest rates to the European Central Bank, so they cannot cut their own rates to boost their economies. Nor can they push down their currencies to give their exporters a price advantage and trade their way out of trouble.

But breaking up the eurozone would be dangerous. Borrowers in countries that left the eurozone would struggle to produce enough money in their weak local currencies to repay old debts denominated in much stronger euros. As debts soured, Europe's banking system would freeze. Its economy would follow. The pain would spread. Worried about a crackup, investors are demanding higher rates on Italian and Spanish debt, driving those countries' borrowing costs to unsustainable levels.

Is there any way out? European Central Bank President Mario Draghi has promised to "do whatever it takes" to save the euro by buying government bonds, pushing down interest rates and providing relief to Italy and Spain. Some economists call for eurozone countries to assume joint responsibility for the weakest countries' debts. Germans oppose so-called eurobonds, arguing they would give strapped countries less incentive to put their finances in order and would raise Germany's own borrowing costs.

EDITOR'S NOTE _ One in a weekday series examining issues at stake in the election and their impact on people

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