Friday, May 14, 2010

How does the Europe sovereign debt crisis affect the US? Part I

It seems that the market was not convinced that the sovereign debt crisis in Europe is over even after a $1 trillion backstop program for Euro Union (EU) and over $100 billion rescue package to Greece. The Dow had another triple-digit down day when there was no single sector that closed in green. The euro tumbled as far as $1.2358, its lowest level since the fall of 2008 as investors fled to safety such as gold, USD and yen. Since the beginning of 2010, the euro has lost about 13.5% of its value against the dollar.

Some argued that the EU problem is far from over while some argued that the $1 trillion program was more than enough to put an end to the panic. Some others argued that the spillover effect of the crisis on the US was exaggerated. After all, Germany was the only country that is among the top 5 trade partners in 2009 [Click on the following diagram to enlarge it.]

However, together EU countries carry about 20% of the US foreign trade. Exports to EU countries were $221 billion and imports from those countries were $281 billion. As a result, the trade impact is not completely dismissable. Precipitous fall of Euro against US dollar may hurt American exporters. In additions, multinational companies who derive revenues from overseas will suffer from unfavorable translations of their overseas revenues into US dollar. Among American companies with large exposure to Europe are Exxon Mobil (XOM) 38%, General Electric (GE) 24%, Ford Motor (F) 21%, Johnson & Johnson (JNJ) 26% and Dow Chemical (DOW) 13%. This effect has not taken into consideration cross-country spillover effects. For example, if Chinese economy slows as demand from Europe weakens, Chinese demand for American goods may weaken too.


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