By Bill Watkins, Ph.D.
The United States is the world’s economic powerhouse. Our markets, productive capacity and workforce are the envy of every other country. Still, with over $4.5 trillion in trade, our economy is not immune from imported distress. Today, the risk that some overseas event will seriously damage our economy is as high as it has been in decades. This is not because of the large volume in trade, which is generally good. Instead, today’s risks arise from geopolitical sources and we are still weak from our recession.
Before discussing those risks, though, we should dismiss risks that tend to be exaggerated. China’s newfound economic strength leads this category, with talk-show hosts lamenting the forecast that China’s economy will exceed that of the United States in relatively short order.
We hope China’s economy exceeds that of the United States, and the sooner the better. China’s per capita output is currently at most $7,180, depending on the conversion method. This is dismal compared to the United States’ per capita output of $48,190. If China’s economy were the same size as that of the United States, its per capita income would still be only $11,181. Their economy will exceed ours only because of their population. It is no indication of American weakness. We should be pleased that billions of people are finally enjoying the benefits of the industrial revolution.
The economic impacts of Japan’s recent disaster are also overhyped. While this was and still is a terrible tragedy on a human scale, its economic impacts will be so small as to be unidentifiable in U.S. economic data. The economic impacts are measured in billions. The U.S. economy is measured in trillions. The sheer size of the American economy and world trade just swamp the size of the disaster.
By contrast, the risks in Europe are underappreciated. Europe’s banking system is under extreme stress, a result of the financial crisis that initiated our most recent recession and continuing sovereign debt issues. Given the weakness of our own economy and financial sector, we are poorly prepared to suffer another financial shock.
We hope China’s economy exceeds that of the United States, and the sooner the better.
Unfortunately, European risks are not limited to its banking sector. The Eurozone is too big for a common currency. A functional currency zone requires both capital and labor mobility. So, a large place like the United States can prosper under a single currency because labor and capital are very mobile here. Europe has too many language and cultural differences to be an effective currency zone because those differences limit labor mobility.
We see the impacts of a too-large currency zone in huge variances in unemployment rates. Germany’s is less than 10 percent, while Spain’s exceeds 20 percent. Worse, Spain has no monetary and few fiscal policy options. It gave those up when it joined the European Union.
Those differences in unemployment are unsustainable, and lead to social unrest. We’ve seen this in Greece, Spain, Portugal and Ireland. Eventually, some countries must leave the EU. How and when that’s done could have serious economic impact here. If countries plan ahead for an orderly exit, the economic impact to other economies such as ours will be minimized. However, we would still likely see somewhat higher risk premiums tightening credit markets.
What happens, though, if countries postpone the inevitable and wait for a crisis before exiting the EU? We would expect a worldwide financial crisis on the order of what we saw in September 2008.
The dramatic changes sweeping the Middle East pose the most immediate threat to our economy. Uncertainty necessarily accompanies wholesale change, but except for the possibility of oil supply interruptions, most of the uncertainty has the potential for only small impacts to our economy. Who governs and how may have huge impacts on the local economy and its people, but if the oil flows, we will be mostly insulated.
Of course, the risk of oil supply interruptions is high, and supply interruptions would generate sharp price increases, which would have very serious impacts. Oil price changes have been a recurring source of American economic distress. There is even good evidence that oil prices contributed far more to the recent recession than is generally recognized. A sudden spike in oil prices would surely initiate a sharp new recession.
Unfortunately, European and Middle East risks come at a very bad time. Our financial institutions are still weak. Our real estate markets appear to still be in decline. Millions of Americans are unemployed or underemployed. Worse, we can only minimally influence the policies that may have such impact on us. In large part, we’re reduced to hope.
Bill Watkins is Executive Director of the CLU Center for Economic Research and Forecasting, which provides local, state and national forecasts for government, business and nonprofit leaders throughout North America. He and other members of the CERF team have been quoted by many news organizations including the Wall Street Journal, CNN and Forbes.