Several US banks were downgraded this week by Standard & Poor's because of their exposure to the European crisis. In addition, the recent central bank swap agreements have underscored the severity of the crisis facing European banks.
Additional credit downgrades in Europe are being considered, and on December 8-9, 2011 European Union and European Central Bank policymakers will meet to continue to search for solutions to contain the crisis. In this context, AEI economist John Makin explores, in his latest Economic Outlook, why the Eurozone crisis has worsened so quickly in recent weeks and what options this leaves for Europe. Makin explains that:
- The quickly worsening European debt crisis--preordained by a false belief that sovereign governments do not default--constitutes the biggest threat to the US economy and its financial system.
- Europe is caught in a vicious cycle where an intensifying financial crisis slows growth and raises borrowing costs, exacerbating the crisis.
- Europe has three ugly options: (1) borrow more money from outside; (2) have the European Central Bank (ECB) buy more government bonds; (3) allow the European Monetary Union to collapse. In the end, the ECB will probably be forced to triple its balance sheet.
John Makin writes AEI's monthly Economic Outlook. A former consultant to the US Treasury Department, the Congressional Budget Office, and the International Monetary Fund, Makin is available for media inquiries, and can be reached at email@example.com or through his assistant, firstname.lastname@example.org (202.862.5883). For radio or television interviews, please e-mail email@example.com.