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Opinion: Gathering European economic storm clouds

A setback in the European economy must be expected to have large spillover effects for the rest of the global economy that would all too likely reach our shores.

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Anyone who thinks we are not on our way to another round of the European sovereign debt crisis has not been paying attention to the economic and political troubles currently besetting that continent. As Shakespeare might have put it, those troubles are coming to Europe not as single spies but as battalions.

Those combined troubles hardly bode well for the European and global economic outlook. This is especially the case considering that a number of Eurozone member countries, and most notably Italy, did not take advantage of the good economic times to reduce their very high public debt levels. This makes those countries particularly vulnerable to another European economic recession or to any loss of risk appetite in the global financial markets.

A disturbing feature of the current European economic landscape is that all of its major economies are being challenged simultaneously by a variety of meaningful economic and political challenges.

For a start, Germany, Europe’s largest and most dynamic economy, is now on the cusp of a recession as its highly export dependent economy is being hard hit by the marked Chinese slowdown. Further weighing on the German economy has been the U.S. Commerce Department’s recent classification of European automobiles as a national security threat and the Trump administration’s indication that it is considering imposing punitive tariffs on European automobile imports.

At a time that the German economy is stuttering, political problems are clouding economic prospects in the United Kingdom and France, Europe’s second and third largest economies, respectively.

Heightened investor uncertainty about the UK’s post-Brexit relationship with Europe has already moved the UK economy from being the G-7’s fastest growing economy to its slowest. Sadly, that uncertainty is likely to persist even should Theresa May succeed in preventing the UK from crashing out of Europe without a deal at the end of this month. Even were May somehow to get parliamentary approval for her Brexit deal, that would only be the prelude to protracted negotiations over the UK’s future economic relationship with Europe.

Meanwhile, in France, social unrest associated with the Yellow Jacket movement is seriously denting investor confidence in that country’s economy.

More troubling yet for the global economic outlook are the serious economic and political troubles besetting Italy, Europe’s fourth-largest economy and its second most highly indebted economy. Being around 10 times the size of the Greek economy and with a public debt totaling more than $2.5 trillion, an Italian debt crisis would have the real potential to roil the global financial system. All too likely it would do so in a very much more serious manner than did the earlier Greek debt crisis.

During the second half of last year, the Italian economy succumbed yet again to an economic recession. The last thing that it now needs is the simultaneous economic slowing of the German, United Kingdom and French economies. Stuck within a Euro straitjacket and saddled with a market-unfriendly populist government, it is difficult to see how Italy could grow its way out of its debt problem in those circumstances. This makes the Italian economy particularly vulnerable to any further loss of risk appetite in the global financial market.

As if troubles in its major economies were not sufficient cause for concern, economic reform and austerity fatigue seems to be on the rise in the Eurozone’s peripheral countries ahead of their elections scheduled later this year. A most recent example of this fatigue has been the decision by both the Greek and the Spanish governments to raise the minimum wage to levels that those countries can ill-afford.

Fortunately this time around, as the European economy shows clear signs of slowing, the European Central Bank (ECB) does not appear to be asleep at the wheel. Instead, last week in addition to slashing its European economic forecast, the ECB announced an abrupt policy U-turn. It did so by taking any interest rate increase off the table for next year as well as by indicating that it stood ready to revisit its decision to reduce the size of its balance sheet.

Welcome as the ECB policy U-turn might be, it would not appear nearly sufficient to right the ailing European economy. Rather, for that to occur, one must hope that those countries in Europe, most notably Germany, with the fiscal space to do so, will use that fiscal space to provide the European economy with a much needed  budget stimulus. It would also help matters if the Trump administration were to back off any notion of imposing automobile import tariffs on an already troubled European economy.

In framing economic policy, global and U.S. policymakers would do well to recall that the European economy is larger than that of China. As such, a setback in that economy must be expected to have large spillover effects for the rest of the global economy that would all too likely reach our shores.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney. He wrote this for InsideSources.com.

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