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Originally published December 10, 2011 at 10:02 PM | Page modified December 10, 2011 at 10:10 PM

Jon Talton

Time to confront the repercussions of the European crisis

The core eurozone accounted for $5.1 billion in merchandise trade for Washington companies in 2010, up 9.5 percent from the pervious year. The state also receives foreign direct investment from Europe.

Special to The Seattle Times

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Among the events that turned the severe contraction of 1930-31 into the Great Depression was a series of defaults in Europe that essentially destroyed the world financial system.

That couldn't happen again, could it?

"If Spain and Italy were to exit (the eurozone), there would be a collapse of systemically important financial institutions throughout the European Union and North America and years of global depression." So wrote William Buiter, Citi chief economist, in the Financial Times last week.

Even as European leaders gathered late last week for an emergency summit, news reports emerged of some EU nations making contingency plans to print their own currencies again if the euro goes away or the number of nations using it shrinks.

The European Central Bank cut its interest rate, claiming to be acting to head off a recession. But the recession has already arrived. The central bank also had to radically expand lending to banks on the brink.

It has come to this.

More than two months ago, I wrote that our Asia-facing region is vulnerable to Europe's troubles. That hasn't changed.

"Europe's slow burn continues to cast a pall of uncertainty over the global economic outlook," state economist Arun Raha told me recently. "The critical question is whether the European sovereign debt crisis will turn into a European banking crisis. If it does, it will drag both the U.S. and the state back into recession."

Eric Schinfeld, president of the Washington Council on International Trade, said, "Clearly our state and regional economy is strongly tied to the EU."

The core eurozone accounted for $5.1 billion in merchandise trade for Washington companies in 2010, up 9.5 percent from the previous year. The state also receives foreign direct investment from Europe. Two examples are Philips in Bothell and Norway's Renewable Energy Corp. in Moses Lake.

International tourism is important, with international flights between Seattle and London, Paris and Frankfurt. France and Germany alone have accounted for more than 28,000 visitors to Seattle so far this year.

The consequences of a European slowdown for agriculture are less. About 3 percent of the cherry crop and 1 percent of apples and pears are shipped to the EU. It's a different story for a European meltdown.

"I do not hear much worry about direct business risk to the EU as a result of the financial troubles," said Mark Powers of the Northwest Horticultural Council. "I think of most concern is if the troubles in the EU spread to the U.S. banking system or lead to a significant appreciation of the dollar against other currencies around the world." Export sales have benefited from a drop in the dollar's value.

Unfortunately, after a series of encouraging business developments locally, especially the Boeing contract, we must confront the repercussions of the European crisis.

The roots of the trouble seem to bear some resemblance of what happened here. Ireland, Spain and some other nations experienced real-estate bubbles that collapsed. Poorly regulated mega-banks made highly profitable bets that went bad, then held the gun of financial collapse at the heads of governments and central banks to get bailouts.

Beyond that, the similarities end.

The euro was an experiment created in good times, when it seemed strong growth would never end, when a United States of Europe appeared in the making. It lowered costs of cross-border trade and especially enriched Germany, which benefited as the continent's export powerhouse. To investors and lenders, it seemed virtually risk free.

But the euro is flawed by the individual fiscal policies set by 17 different nations using the common currency, as well as the 27 nations that make up the European Union. Some are strong and well-run, such as Germany. Others, even in good times, suffered from limited economies and poor governance (e.g., Greece).

It took the Great Recession to reveal these weaknesses as clear and present dangers. Another two years of Euro-paralysis have exposed another flaw: The continent may not be capable of righting itself.

The European Central Bank is not a true lender of last resort, as is the case of the U.S. Federal Reserve. It has been unable to bolster confidence in the continent's banks, which profited handsomely from buying sovereign debt before 2008 and now face existential losses. It has failed to stop the contagion, as loss of confidence has even begun to impair Germany's ability to borrow.

Many EU nations are unlikely to surrender to the tight centralized restrictions demanded by German Chancellor Angela Merkel in return for a rescue. Merkel's voters, meanwhile, are terrified of hyperinflation, an unlikely but not impossible outcome of printing trillions of euros to buy up sovereign debt and restructure it. Even with an unlikely rescue, much of Europe faces years of hard times.

Beyond this, things get complicated, ugly and terrifying.

"The path of the eurozone is becoming clear," MIT economist Simon Johnson and Peter Boone, a senior fellow at the Peterson Institute for International Economics, wrote on Bloomberg News recently. "As conditions in Europe worsen, there will be fewer euro-denominated assets that investors can safely buy. Bank runs and large-scale capital flight out of Europe are likely."

The Israeli diplomat Abba Eban famously said, "When all else fails, men turn to reason."

Perhaps. Reason still hasn't taken hold in Eban's Middle East. As for Europe, the time for such aspirations is rapidly running out. It probably has already done so. Now, the deluge.

You may reach Jon Talton at jtalton@seattletimes.com. On Twitter @jontalton.

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About Jon Talton

Jon Talton comments on economic trends and turning points, putting them into context with people, place and the environment in the Pacific Northwest
jtalton@seattletimes.com

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