We've been hearing a lot about the troubles that European governments have faced in dealing with crippling amounts of debt. But even though this particular debt crisis originated in Europe, it has negative implications on the world, and especially in the United States. Every time bad news comes out of Greece, Italy or any other European Union country, U.S. investors are hit hard with huge losses in the Dow. This is because American banks have over $800 billion worth of exposure to Europe's ailing financial system.
This should cause great concern to the average American because if Europe defaults and collapses on its debt, it will take the U.S. economy down with it. And what's most worrisome about the situation is that the U.S. and the Federal Reserve are bystanders who cannot step in to solve the problem.
The EU has only been dealing with the symptoms of this financial crisis and not the underlying causes. One of the causes is that the EU does not have a lender of last resort, such as the Federal Reserve, that can immediately recapitalize weak banks. In addition, the EU continually insists that countries that receive bailouts should have strong austerity measures placed on them, which do more harm than good. For example, a country like Greece needs to liberalize its markets and spread tax burdens more evenly to raise revenues. But the austerity measures place harsh taxes on Greece which will stunt its growth and make it harder for it to pay back its debt.
We don't even know who will fund this debt with German taxpayers vehemently resisting German financing of the debt deal, and foreign governments like China being weary of investing in European debt. Any hope of actually increasing the bailout amount was shot down when Europe refused to put up more of its own money. Instead, European bankers tried to use leveraging tricks that involved taking out insurance policies on sovereign debt to artificially inflate the total amount of the debt deal. These are the same kind of financial tricks that brought upon the 2008 financial crisis.
The crisis in Europe might seem daunting and irreversible, but there is still hope for Europe if the European states take a legitimate step in the right direction. The solution to this problem is that first the European Union should allow the European Central Bank to backstop sovereign debt and act as a lender to any sovereign nation that cannot fund its own debt. Second, Europe needs to move away from setting harsh austerity measures on countries that are bailed out. This will lead to economic growth instead of contraction and put the Europeans on a road to paying off their debt. If Europe does not initiate these actions, its debt will continue to spiral out of control and this will bring down the American and world economy. For Europe to get its act together there needs to be political and financial will to change the methods that European bankers have endorsed for decades. Only then will the world be safe from sovereign debt in Europe.
