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Confidence is increasing that the United States could sustain the worst from Europe

By David Francis

August 17, 2012

Earlier this week, German Chancellor Angela Merkel announced that Europehas made dramatic progress in dealing with the continent’s financial crisis. Her comments were meant to build investor confidence and revive hopes that the European Union would act to saveSpain,Italy, andGreece, three countries on the brink of financial ruin.

But in recent months, the chancellor’s comments, as well as statements from other high-ranking officials inEurope, have done little to quell doubt over how the crisis will be resolved.Europe’s problems have been evident for nearly three years, yet no definitive action has satisfied investors that the European Union can be saved.

For years, analysts have cautioned that a turn for the worst in Europe would mean bad news for theUnited States. They warned that the dissolution of the European Union as it is currently constructed has the potential to send theUnited Statesinto a double-dip recession.

Along with political uncertainty in Washington, Europe has served as the economic boogeyman that keepsU.S. investors on edge. However, according to experts, the doomsday scenario inEurope might not have the knockout potential here that many people think.

“I think Europe is more concerned about what happens to theU.S.economy than we are about the European situation,” says Ernest Dawal, chief investment officer of wealth and investment management for SunTrust Banks. “We don’t think [the ongoing European crisis is] going to have a material impact” on theU.S.economy.

Understanding the crisis. Overspending and government deception are at the heart of the European crisis. For years, some European countries were disingenuous about the amount of debt they had, as well as their ability to pay this debt back. They also overspent on maintenance of large bureaucracies and made bad bets on construction and other industries. At the same time, they flaunted EU budget requirements. 

These countries were able to appear healthy because of the strength of the euro. Northern European economies, most notablyGermany, were able to keep the currency strong with consistently positive economic output.

It took the 2008 financial crisis to reveal the extent of Europe’s problems. As the world economy slowed, it became apparent thatGreece and other European countries had unsustainable levels of debt and would need bailouts. Since then, European leaders have taken a number of stopgap measures to reassure markets that the euro zone would survive, but none worked. Wall Street is still not convinced that the euro can survive. 

The European crisis has the potential to affect theU.S.economy in a number of ways. Manufacturing companies that export goods toEuropehave seen orders decrease.U.S.banks also have exposure to European debt, and could face a crisis similar to the downfall of Lehman Brothers if a European country goes bankrupt.

There are also concerns about how a disaster in Europe would affect American consumer confidence, says Andrew Tignanelli, president of The Financial Consulate, an investment advisory firm in Baltimore.

“You can’t in today’s world dissect the major economies of the world and say if one does really poorly, it’s not going to matter to me,” he says. “If the European Union were to have a catastrophe, there’s no way that it’s not going to have a dramatic impact on theUnited States.”

Insulated from the worst? Dawal says a bad turn inEurope would cause a short-term hit to the American economy. But he adds that he believes theU.S. economy is resilient in the long term and would be able to rebound from a European shock.

Dawal says two factors give him confidence: Banks are healthy and manyU.S.manufacturers have shifted their focus on domestic markets. “U.S.banks are better capitalized than their peers inEuropeare. The latest stress tests had some pretty significant circumstance build into them, and our banks help up relatively well,” he says.

“If you look at the percentage ofU.S.exports to [distressed European countries], it’s less than 3 percent. Our direct exposure from an export perspective is nominal,” Dawal adds.

Since the crisis began, experts have advised a wait-and-see approach, urging caution until the European situation is resolved. However, if Dawal is right, now could be a prime opportunity to shift to a more aggressive investment strategy.

And Dawal is not alone in his assessment. Brad Sorensen, director of market and sector analysis at Charles Schwab, says recent statements made by European leaders outlining steps to stem the crisis are encouraging. “We think it’s far too early to sound the all-clear bell … but there’s hope on the horizon,” he says.

Dawal says a far greater threat looms closer to home: The government must come to an agreement that keeps the country from going over the fiscal cliff, he says, referring to the expiration of the Bush-era tax cuts and other spending cuts set to kick in at the end of the year.

“Right now, the biggest threat to theUnited Statesis ourselves,” he says.