Trending in DC: International Problems Impact US Markets

It seems like every day we hear more about the ongoing financial turmoil in Greece.  

This issue has dragged on for years, and every time it appears there might be a resolution to the problem we hear about more setbacks.  Is this just a problem for Greece, or just Europe’s concern?  Unfortunately, in an increasingly connected world economy, problems in far off places can have significant impacts here at home.  

Countries In Turmoil

“The problem with socialism is eventually you run out of other people’s money.” – Margaret Thatcher

The Greek economy has never been the model of efficiency and security.  While this country provides historic influences throughout the world in the areas of art and culture, it has long struggled to remain self-sufficient in modern times.  Although it continues to be a beautiful country, with stunning beaches and resorts, its economy has struggled under the weight of corruption and cronyism.

Today, Greece finds itself on the verge of total financial collapse.  The country owes €340 billion ($375 billion) to its creditors.  This is from a country whose annual GDP is roughly $242 billion.  The European Central Bank (ECB) does not want Greece to fail.  Everyone from Angela Merkel, the German chancellor to Mario Draghi, the president of the ECB, have tried to come up with ways to help Greece control costs and become more financially responsible.  However, Greek leaders and the people of Greece remain unwilling to make the sacrifices necessary to achieve true austerity and economic security.

If Greece ultimately is unable to satisfy its financial obligations it may be forced out of the European Union and it may have to drop the Euro as its currency and return to the drachma.  This “Grexit” will increase instability in the entire European economy.

Similar countries, such as Portugal, Italy, and Spain could quickly follow suit and leave the European Union.  The promise of increased peace through stronger economic ties could be challenged if the EU begins to fall apart.  Also, if Greece does ultimately leave the EU, there is no way to recover any part of the money lent to it by others in the ECB.  This will further drag down an already suffering European economy.  

While much attention has been on the problems of Greece and the European Union, in China, an overheated market has begun to boil over.  The Chinese social experiment of the past 30 years has been whether a country with virtually no political or social freedom could achieve economic success.  In other words, can an economy that is controlled, subsidized, and promoted by a central government compete with free markets in other parts of the world?

For the past few years, the answer was yes.  China’s annual GDP growth has been in the double digits for several years and while it has slowed in recent history, it still far surpasses the economic growth of developed countries like the United States.  However, the more the Chinese economy grows the more difficult it becomes to maintain that growth, especially with a population of 1.3 billion people to support.  

The Chinese investment markets have become increasingly volatile and speculative.  Stories abound of “ghost cities” that were built to help prop up infrastructure spending to maintain the illusion of economic strength.  You can even see a video of a 57 story Chinese skyscraper that was built in 19 working days: https://www.youtube.com/watch?v=PyxwgLYbAk0.  

However, the Chinese economic expansion is now beginning to sputter.  Chinese stock markets are down over 30 percent in the past month.  Leaders throughout the country are doing all they can to stop the drop and restore confidence.  Authorities have loosened restrictions on borrowing to fund stock purchases and last weekend, China’s 21 top brokerages and fund managers pledged to purchase large amounts of stock and will not sell until market levels have recovered.

These measures have shown some stabilizing impact on the Chinese economy, but overall, this has illustrated how fragile the Chinese economy is and how insecure leaders are about markets overall.

What Does This Mean for Us?

With all the turmoil around the world, what does this mean for American markets?  

The first impacts are those seen by investors in foreign markets and those who trade directly in foreign currency.  The uncertainty tied to Greece will also slow down economic growth throughout Europe.  However, Greece is a very small part of the Euro Zone, which is just a fraction of the world economy.  

China, on the other hand, is a much larger part of the worldwide economy, and weakness in China will have much larger impacts throughout Asia and around the world.  China’s economy has been decelerating for many years, but the current turmoil could cause leaders in the country to curtail reforms or pull back on investments.  A direct impact to those of us in the Western US could be a reduction in Chinese tourists who have been coming in droves to visit the natural wonders of Utah, Idaho, and Wyoming (not to mention the not-so-natural wonders of Las Vegas).  

While the direct impacts of slowing economies in other parts of the world may not be large, indirect impacts could be much more dangerous and potentially more severe.  Financial insecurity in one continent can create a virus in all parts of the world.  This is what happened during the Great Depression.  Markets tend to be driven by two intrinsic emotions: greed and fear.  As fear in one part of the world grows it feeds fear in other parts of the world.  This can spread quickly and is hard to combat.

What Can We Do?

The question, therefore, is what can we in America do to prepare for global risk and economic turmoil.  

A top priority of the Federal Reserve is to be in a position to increase interest rates.  The Federal Funds Rate, the main monetary tool of the Fed, has effectively been at zero since 2009.  This largely eliminates interest rates as a tool to help strengthen the economy.  Federal Reserve Chair Janet Yellen has stated that she would like to begin raising interest rates as soon as possible this year.

A second tool being considered is fiscal policy.  Strategic tax reductions can help boost an economy, especially if increased revenues are reinvested into the economy.  

A third tool is direct government spending.  This can be in the form of infrastructure spending or even in the form of direct spending to encourage consumer spending.  The “cash for clunkers” program was an example of using this tool to encourage spending on automobiles.  

Unfortunately, there is little Washington can do now to address the potential weaknesses of tomorrow.  We will have to continue to remain vigilant and be prepared if our economy starts to suffer from the struggles existing on the international stage.