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Morningstar markets editor Jeremy Glaser sizes up the situation today and the best and worst scenarios.
Tags:The Impact of the European Credit Problems,business tips,europe credit downgrades effect investors,europe sovereign credit downgrades,european credit problems,european credit problems effect us investors,morningstar
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The Impact of the European Credit Problems
Jason Stipp: I'm Jason Stipp for Morningstar. Continued trouble in Greece and the Eurozone rocked the markets on Tuesday on the heels of some sovereign credit downgrades. Here with me to talk about the situation and what it means for investors, is Morningstar Markets Editor, Jeremy Glaser. Jeremy, thanks for joining me.
Jeremy Glaser: You're welcome.
Jason Stipp: So, the situation seems like day after day you read that the situation has been improving and then you read it's had a step back and now, it seems like it's had a major step back. What exactly is going on with the Greece crisis and the other countries that are in trouble over there?
Jeremy Glaser: You're right, Jason. There's been a lot of fits and starts into solving the Greek debt crisis. In the last couple of days, it seems to have gotten a lot worse. First, we found out that the budget deficit that the Greek government had estimated is actually going to be much worse than they first thought; that the austerity measures that they put into place haven't really made a big impact in the amount of debt that the government has. Investors have gotten really scared that the spread between a Greek bond and say, a safer German bond have continued to widen and widen and widen and people aren't convinced that the Eurozone and IMF joint bailout is going to make a big difference. No one knows exactly when that money's going to hit. There are some political problems of exactly how the European Union can actually do this bailout.
So, I think until people see that money, they're going to be scared of Greek debt. So, we saw S&P downgrade Greek debt to junk status but also, they downgraded Portugal's debt a notch which shows that there's a lot of fear that this contagion, that this idea that we're going to have problems with Greek debt is starting to spread to other countries that have high debt levels. Portugal, Spain, are some that are mentioned the most frequently and it's starting to spread very slowly across the continent. I think a lot of investors just don't know when it's going to stop.
Jason Stipp: Well here in the U.S., during the trading day today, the market really took a dive. So obviously, U.S. investors, you can never know for sure what's causing it but it seems like they're worried about this too. Is there a direct effect for U.S. investors in what's going on over in Europe?
Jeremy Glaser: Very narrowly. I don't think there's a huge direct effect with Greece in itself defaulting. I don't think a lot of U.S. investors have much exposure to Greece and it's a pretty small market. So, there are not a lot of companies that are selling a ton of goods into Greece or getting a lot of exports from the country. But I think the biggest problem is what it says about the state of the European economy which is incredibly important to a lot of American companies.
Jason Stipp: So, if you were going to say then that there's possibly an indirect effect, I mean, what things should be on our radars as potential risks here?
Jeremy Glaser: Yeah, there are a lot of big ones. I think the first one is just in general, the European economy seems to be recovering at a much slower rate than that of Asia and other developing markets and even that of North America. We've seen pretty good growth in other regions but Europe still seems to lag behind.
GDP growth seems to be lagging a lot of other regions and it seems to be kind of a big problem. If you see countries, they are having trouble with keeping the currency stable and defaulting on sovereign debt, you're not sure that they're going to be there to continue to stabilize the banking system in Europe which is much weaker than it is throughout the rest of the world at the moment.
It makes it unclear that they're going to get that growth, they're going to be able to purchase these products and there are a lot of American companies that have a lot of interest in selling goods to Europeans. So, that could be a big problem. But I think there are a lot of other areas of instability that we could see in Europe. The UK elections that are coming up have a very indeterminate effect. It looks like the Liberal Democrats who are coming on very strong could end up in a coalition government with the Tories. Something we haven't seen here since the '70s in UK politics. Who knows what the impact of that could be on monetary and fiscal policy? Who knows what the impact of further defaults if it spreads from Greece, if it really hits Portugal, if it really hits Ireland, if it really hits Spain?
Those are much bigger economies that could have a much bigger direct effect on the United States. There are just a lot of question marks right now. Investors don't like uncertainly and I think that has a lot to do with why the sell-off is happening.
Jason Stipp: The market seems to be contemplating a lot of those potential things that could go wrong. So, I guess if I had to ask you then, what you think the worst case and the best case scenario to come out of this, what should we be thinking as far as the outliers of worst and best?
Jeremy Glaser: Yeah, I think it's impossible to know exactly what the worst or the best could be. But I think in general, the worst-case scenario is that this is going to be the death knell for the Euro and that we're going to see that people decide that this is not a good monetary union and Germany is going to get fed up bailing out some of these other countries. And Greece will leave and maybe some of the other countries will. Who knows exactly how that would go? There are a lot of logistical problems with actually getting rid of a currency union. It's something that hasn't happened a lot in the past and there are just a lot of uncertainties surrounding that. But if that were to happen, it could reduce European trade. We could see Europe falling further behind the rest of the world and that could be a really big problem. That's something that people have been talking off and on, not necessarily seriously but if these problems keep going, I think you're going to hear a lot more about the Euro itself being under siege.
On the best-case scenario, this could be a point where Europe kind of galvanizes behind the Euro and really strengthens it. One of the things that are unusual about the Euro versus, say the U.S. dollar is that monetary policy and fiscal policy aren't being done in a coordinated fashion. So, the United States, you have the Federal government dictates fiscal policy and the Federal Reserve does monetary policy. In Europe, the European Central Bank does monetary policy but each individual country is responsible for their own fiscal situation.
So, if a crisis like this gets Europe to come closer together and bring a lot of those fiscal policies in line with each other, it could actually strengthen the Euro and help trade and help avoid a lot of those things that would happen if we would get into that worst- case scenario.
So, if the bailout is successful and they are able to get Greece out of this crisis and stem the crisis that’s happening in other countries, I think we could see Europe actually emerge stronger in a best-case scenario but I'm not sure that that's terribly likely.
Jason Stipp: Well, we'll have to keep our fingers crossed in any case. Thanks for the contexts and the insights.
Jeremy Glaser: You're welcome.
Jason Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.