The Japanese catastrophe will not threaten the economy, Europe will

On Wednesday, Portugal’s parliament rejected government-proposed austerity measures, Prime Minister Jose Socrates resigned, and now Portugal almost certainly will need a bailout.

America’s economy may be dragged into Europe’s approaching cataclysm. Not only will America be called on to bail out Europe’s debts, but Europeans will have to cut back purchases of American exports.

American Enterprise Institute fellow Desmond Lachman told me, “The fall of the Portuguese government could not have occurred at a worse time, coming as it does on the eve of a European summit which was supposed to announce a grand bargain as a solution to Europe’s ills.”

He continued, “The political vacuum in Portugal, which will last through at least June, will only add to the severity of the eurozone crisis, coming as it does on growing evidence of the collapse of the Greek economy and growing restiveness in Ireland about the harsh terms of the IMF-EU agreement.”

Leaders of the 27 European member countries are meeting in Brussels to approve a permanent European Stability Mechanism, a $996 billion fund that would take effect in 2013 in order to provide funding for EU countries in financial difficulties. This will replace the current $622 billion European Financial Stability Fund.

The Portuguese parliament rejected spending cuts that would have trimmed the deficit from 7 percent of gross domestic product in 2010 to 4.6 percent of GDP this year. After Portuguese President Anibal Cavaco Silva accepts Socrates’ resignation, a new government will be sworn in.

Ireland and Greece have already been bailed out by International Monetary Fund (partly funded by the United States) and European Central Bank rescue packages, Portugal is next, and Spain, teetering on the brink, will need its own rescue. This group of countries has earned the regrettable name of PIGS.

Spain, with an unemployment rate of 20 percent and a deficit of 12 percent of GDP, had a housing boom that dwarfed America’s. Before that bubble burst, 18 percent of the Spanish economy was attributable to construction. Its public debt level of 65 percent of GDP is expected to increase as more banks require bailouts due to future defaults.

The simplest solution would be for the PIGS to drop out of the euro or set up a second-tier euro so as to let their currencies depreciate. That would allow wages some flexibility to decline and exports to rise, as Argentina did in the early part of this decade. But within the European Union, the unity of the euro is sacred. In Berlin, it is to preserve the euro, and the European Union itself, that Chancellor Angela Merkel has bucked public opinion in having Germany support bailouts for Ireland and Greece. So the euro is making it harder for Greece, Ireland, Portugal and Spain to recover. They must cut their budgets even as unemployment is high and while the value of housing is still falling.

French banks and financial institutions, with more than $100 billion in loans to the PIGS, according to the Bank for International Settlements, are the worst affected. Then come German banks, with more than $60 billion. America holds about $15 billion in debt to the PIGS, a relatively small amount.

A large European collapse appears to be in store, dwarfing problems in Japan. When it comes, with the interweaving of global financial markets, America will not escape unscathed.

Examiner columnist Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute.

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