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(No-Data-Available, APR 19/Reuters)
(No-Data-Available, APR 19/Reuters)

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Decoupling, no. Depression, yes Add to ...

The Economist’s Free Exchange blog is turning up the heat on Europe, moving past the recession call and declaring that the region is heading into a full-on depression. And what’s particularly distressing is that it could be avoided – but probably won’t.

“The euro-zone economy is large and overwhelmingly driven by domestic demand,” the blogger said. “That demand has been steadily squeezed by a broad, sustained fiscal tightening. Monetary policy is providing almost no relief. The ECB raised rates last year, and while it has since unwound the 50-basis-point increase from 2011, it shows no interest in cutting rates further below the present 1 per cent level.”

A sharp decline in economic output is bad enough on its own, but will turn far worse if it leads to a messy euro zone breakup, the blogger argued. “We are watching causation this very moment: institutions that know how and why to prevent things from falling apart and which nonetheless sit back and do nothing.”

Meanwhile, Tuesday’s strong report on U.S. manufacturing in April has inspired some observers into taking a more confident tone on the U.S. economy, which of course implies that there is some kind of decoupling going on between Europe and North America.

Brockhouse Cooper shoots down that notion, though: “The U.S. is certainly faring better than the euro zone, and we are more positive on the U.S. than on Europe. However, our view is premised on the idea that the U.S. and euro economies are desynchronized, not decoupled. While we do not expect the full-brunt of the eurozone crisis to spread to the U.S., the view that the two economies have decoupled is flawed.”

They argue that Europe’s mess is still relatively contained within the euro zone. After a lag, the mess will spread – not through trade (given that Europe exports account for just 3 per cent of the U.S. gross domestic product), but through what Brockhouse Cooper calls sizable financial linkages.

“Cross-border U.S. dollar-denominated assets held by euro zone banks are currently over $3-trillion, or roughly 20 per cent of U.S. GDP,” they said in a note. “As European banks pull back from funding U.S. borrowers and refocus on core activities at home, the impact will be felt in the United States.”

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