By MATTHEW YGLESIAS [Slate] – A massive and sudden contraction of the European banking system would have the effect of automatically contracting credit conditions in the United States. If European credit markets tightened, the dollars held by European banks would suddenly become much less available as the basis for lending to American financial intermediaries and, ultimately, firms and households.
As George Mason University economist Tyler Cowen put it “if true, we are doomed.”
It sounds counterintuitive to believe that less lending and less debt could be a problem when we’re currently suffering from the excessive borrowing of the past. But this hangover theory is mistaken. Less credit and less borrowing now will only make our problems worse. Some currently solvent enterprises and households will be pushed into bankruptcy by difficultly rolling over their current debt. Others will curtail purchases and investments. Both factors will reduce incomes and drive overall spending down, further adding to America’s already large stock of idle facilities and unemployed workers. The punch will come, in other words, not because the collapse of the European banking system will cripple the European economy and thus indirectly hurt our ability to sell things to Europeans. Instead the collapse of the European banking system will directly cripple an American economy that depends on European banks to provide a fair share of our credit. The middling growth of the past year has been powerfully driven by an incredible boom in equipment and software investment by American firms that could dry up overnight and deal a devastating blow to an already fragile economy.
Conventional thinking about Europe’s difficulties does not yet appear to take the effect on American credit markets into account.
Continued at Slate | More Chronicle & Notices.
