U.S. and EU: Facing Common Challenges

Deborah A. McCarthy
Principal Deputy Assistant Secretary, Bureau of Economic, Energy and Business Affairs
Spain-U.S. Chamber of Commerce Luncheon
Miami, FL
October 27, 2011

As prepared for delivery

The U.S. and the EU face common challenges emerging from Europe’s debt crisis. We must continue to develop our partnership in order to forge mutually prosperous futures, and private sector organizations like the Spain-U.S. Chamber of Commerce are key players in this agenda.

Welcome & Roadmap

Thank you, Emilio, for that kind introduction, and thank you to everyone for the opportunity to speak with you today. Emilio and I have known each other for a number of years, and I was delighted to accept his invitation to speak at today’s luncheon. The past 24 hours have been a defining time for the future of Europe, and I am very pleased to have the opportunity to engage with you on the important topic of Europe’s ongoing financial crisis.

I have been involved with this issue for some time. Prior to my current position, I served at the U.S. Embassy in Athens as Deputy Chief of Mission. During my tenure there, severe problems with the Greek economy and irregularities in reporting key economic statistics came to light. These resulted in substantial revisions to government deficit figures, the proximate trigger for the current crisis. Since that time, governments seem to be stuck in a constant cycle of acting and re-acting to financial developments. Yesterday’s announcements take a significant step forward toward emerging from this trap.

I would like to begin by defining the Eurozone crisis in terms that everyone here understands intimately—by the numbers—as well as by demonstrating the link between the U.S. and the EU economies. I will then discuss the implications for the United States before examining steps we can take to move forward. I need not underline the importance of these issues to this group, except to note that our government is addressing them at the highest possible levels. This priority is reflected at the State Department as well. We are acutely aware of the increasing importance of economics in the U.S. foreign policy agenda, as Secretary Clinton discussed in her October 14 speech on economic statecraft.

Defining the Eurozone Financial Crisis and EU-U.S. Partnership

Last night, European leaders announced additional measures to address the financial crisis plaguing the region. Although details of the agreement are still emerging, we believe the steps to increase capital ratios at European banks, to help Greece achieve debt sustainability in the long-term, and to establish a convincing firewall limiting contagion effects are positive developments for the global economy.

While we commend the progress made by our European colleagues, we (like the markets) eagerly await the decision on how best to leverage the EFSF and agree that careful consideration of options is better than a hasty decision. As European Commission Jose Manuel Barroso has said “this is not a sprint but a marathon.”

Markets also seem pleased with the outcomes of yesterday’s summit although much work remains to finalize details of the plan.

Sending a credible message to the market is essential, and timing matters. We see today as a first step in re-establishing the momentum of economic recovery to be followed by next week’s G20 Summit in Cannes. The provision of a comprehensive roadmap to address Europe’s financial turmoil will allow G20 leaders to reiterate a global commitment to growth-enhancing economic policies, helping to further renew investor and market confidence.

Europe faces difficult challenges in the days ahead. The cocktail of low growth, aging populations, structural inefficiencies, and high government debt load is profoundly challenging. And the latest numbers are not pointing toward an improving situation.

Last week, Eurostat said that eurozone countries started this year with combined government debt of 85% of GDP, a figure which exceeds the eurozone’s own limits (under the Stability and Growth Pact) and constrains their ability to respond in a crisis. Of course, we have our own work to do in the United States.

The importance of the EU as an economic partner and strategic ally on many issues makes the eurozone crisis that much more profound. Let me highlight a few statistics that underscore the importance of this partnership.

  • The economic relationship between the United States and the EU is unique as it is based on investment rather than on trade. By the end of 2010, U.S. firms had invested nearly $1.5 trillion in the EU, while European firms had invested an equivalent amount into the United States. These investments have combined annual sales exceeding $4 trillion, a number which dwarves both their bilateral trade and their trade/investment relationships with any other country, including China.
  • This is not to say that trade is insignificant. The U.S. economic relationship generates trade flows of about $3.6 billion per day. Transatlantic investment is directly responsible for roughly 7.1 million jobs.
  • Europe accounts for over 20 percent of U.S. goods exports and over 35 percent of U.S. service exports. U.S. commercial relations with Europe are three times that of China – a fact often overlooked in the media.
  • Despite these challenges, EU27 trade with all its major partners grew in the first six months of 2011 compared to the same period in 2010, despite questions regarding Europe’s financial crisis. The EU27 trade surplus with the United States increased by €3 billion for the same six-month period comparison.
  • Germany enjoyed the largest surplus, while Spain, Greece, Italy and Portugal were among the countries with the largest deficits. This statistic helps to underscore the underlying competitiveness challenges facing Europe and explain why fiscal austerity must be accompanied by structural changes in EU periphery countries.
  • Europe is the most significant “foreign source” of investment and jobs in America – the total stock of European FDI tallies $1.6 trillion and accounts for 70 percent of all FDI in the United States. Following the 2008-09 economic crisis, EU27 FDI in the United States (outflows) declined significantly in 2010, falling by 85 percent, from €79 billion in 2009 to €12 billion in 2010. This was not a trend unique to the United States; total FDI outflows from Europe fell by 62 percent in 2010.

The interdependence of these two economies means that we are all in this together. EU countries’ FDI in the United States primarily has targeted the manufacturing, finance, wholesale trade and banking sectors. Unfortunately, two of these areas, finance and banking, currently face some level of distress in European counterparts.

However, the current economic crisis and uncertainty in Europe has taken its toll on investment. FDI into the EU - which includes investment in foreign businesses but not purchases of sovereign debt - fell from €216 billion in 2009 to €54 billion in 2010. One can assume that questions about Greece’s debt sustainability and Europe’s response mechanism led potential investors to be more cautious about inward capital flows to the region.

The steepest fall in FDI came from offshore financial centers, which injected €46 billion into the EU economy in 2009 and just €4 billion the year in 2010. The biggest overall drop came from the U.S., with a fall from €97 billion to €28 billion.

On the European finance side, I note with concern that European stock prices have lost nearly a quarter of their value in the last six months, and major stock indices have declined about 10 percent. As you well know, this volatility in financial markets has reduced risk appetite, undermined business and consumer confidence, and reduced household wealth.

Implications for the U.S. & G20 Agenda

As you can see—and as you knew well before coming to today’s luncheon—Europe faces serious problems. What implications do these developments have for the United States? They have been a factor moderating U.S. exports and job growth, and clearly pose continuing serious downside risks. For decades, the United States and Europe have served as global engines for growth. While we are confident in our current path toward recovery, we recognize emerging markets, including Latin America and China, have an increasingly central role to play in global economic prosperity.

The road to recovery has been bumpy in recent months, and we hope that yesterday’s announcements in Brussels will put financial markets on a more solid footing and whet risk appetites again.

We believe in active dialogue to remove remaining barriers to trade and investment across the Atlantic, and our principal forum remains the Transatlantic Economic Council (TEC) meeting.

U.S. economic growth will increasingly rely on our ability to compete and win overseas. For that reason, we are looking to partner more aggressively with organizations such as the American Chambers of Commerce and Business Councils, such as the ones present here today, to effectively collaborate on achieving our economic growth agenda.

In terms of the U.S. financial system, direct exposure to the most vulnerable Eurozone countries is moderate, but we are concerned about risks from broader financial inter-connectedness with Europe.

It is difficult to quantify precisely all possible exposures, but recent estimates indicate direct U.S. exposure to Europe, as a whole, approaches $1 trillion. Other potential exposures - such as derivatives contracts, guarantees, and credit commitments – present much greater challenges in assigning a dollar value. Recent Bank of International Settlements data from the end of June 2011 suggests these indirect U.S. exposures to European banks top $2 trillion; but these are only estimates.

Reports indicate U.S. money market funds have reduced short-term lending to European banks by up to 42 percent of total assets, its lowest relative exposure since 2006. Bank of America and Citigroup recently announced reductions in their respective European portfolios. Fortunately, many U.S. banks have stronger capital positions than in 2008 and have a heightened ability to handle any financial shocks.

These changes underscore the importance of our broader goals of rebalancing the global economic system. This has been a key element of our G20 discussions, and we expect it to continue in next week’s G20 Summit in France.

While the eurozone will undoubtedly be a topic of the G20 summit, the United States expects that the G20 will focus on its core areas, particularly ensuring sustainable and balanced growth; addressing global imbalances; establishing stronger norms for exchange rate policies that will help accommodate the challenges for the global economy; and building a more stable international monetary system with strong oversight of the major financial institutions and markets.

Latin America as Example of Emerging Market Responsibility

With demand weak in the advanced economies, it is essential for emerging markets to make progress in shifting domestic demand to support global growth. While the obvious target for the domestic consumption adjustment is China, there are numerous other emerging economies where these growth-enhancing measures can be employed. Let’s look at Latin America as one instance.

The economies of Latin America weathered the shocks of the 2008-09 financial crisis relatively well. Many believe they have been insulated from the fallout of the ongoing European crisis (or at least, more so than the United States). We are beginning to see indications, however, that this insulation will not be able to withstand a prolonged and deepened European crisis.

A recent report by the Institute of International Finance suggests banks in emerging economies are tightening credit standards and facing increased problems with non-performing loans. Given the large overlap between banking systems, in particular between Spanish banks and Latin America, the tightening of credit standards may not be surprising. However, the implications for business operations in Latin America may not yet be readily apparent.

The interconnectedness of the global economy serves as a strong motivator for all countries to urge for timely and decisive action to curb the contagion effects of the European financial crisis.

Economic Statecraft: Updating Our Foreign Policy Priorities

Within the State Department, we are working to redefine our foreign policy priorities to focus more on “economic statecraft:” the intersection of economics and foreign policy. Secretary Clinton has noted that America’s global leadership and economic strength are a package deal.

Our success in responding to the crisis unfolding in the Eurozone; to the dramatic changes sweeping through the Middle East; and to our own critical priority of restoring jobs back home all demand a sustained commitment to putting economic issues at the forefront of our foreign policy agenda.

During much of the past decade, American foreign policy was intensely focused on places where our security threats were the greatest. Today, we must focus equally on the places where our growth prospects are the greatest.

Much attention has been given to the rise of Asia and the importance of emerging markets globally. Indeed, we must do more to develop the world's economic operating system in the Asia-Pacific region, and we should seek opportunities to work with our allies in Europe on issues of shared concern. Therefore, we must capitalize on these economic relationships and prioritize those sectors – such as services, technology, and high-value added manufacturing – where our comparable strength can help set global standards.

We are intensifying efforts with the EU to move toward a more systematic approach to regulatory cooperation in an effort to avoid creating further barriers for our traders and investors. We are also cooperating transatlantically to anchor a system of fair and open competition in the face of an increased role of state-owned enterprises in the global economy, particularly with the rise of emerging economies.

Increased engagement in fora such as the G20, UNCTAD, and OECD, and in bilateral arrangements such as the Strategic and Economic Dialogue with China, will be important in establishing a more solid framework for our relationships, and will serve to strengthen the global economy.

We also believe that events, such as this one today, that gather members of the business community are critical in forwarding our economic policy agenda. You are the ones making the investment and trade decisions for your businesses. Effective communication with the private sector will only enhance our commercial efforts, and we firmly support working together. A strong and thriving global economy provides mutual benefits for all of us.

Despite the work to be done, our economies and societies remain flexible, resilient, and innovative. While we will, at times, take different approaches to economic policy, consistent with our own domestic needs and interests, Europe and America are standing together to rebuild our economies.

For more than 60 years, the European-United States relationship has been a win-win partnership for us and for the world. It is a cornerstone of our joint prosperity, not to mention an engine of global growth throughout this time period.

And when considering the economic challenges we have overcome together in that time, including the re-building of Europe in the post-War years and its reintegration after the fall of the Berlin Wall, there is little doubt that together we can continue to meet the challenges of the future.