Thursday, November 10, 2011

Will Europe Drag the U.S. into Recession?

With signs that Europe is likely in the grips of recession due to their inability to adequately address their debt crisis, we’ve been trying to get a handle on how that will impact the U.S. economy. The reality that economies are more globally connected than ever hasn’t prevented some analysts from predicting that the U.S. will be fine, even if growth in Europe is contracting. We weren’t believers in the idea of “decoupling” when it was popular back in 2007-08, and we find ourselves skeptical again today.

A recent research report from Citigroup illustrates how tightly linked economies are these days. The chart below (from the report) shows the correlation in GDP growth rates between major European economies and the U.S. over the past two decades. In the 1990s, the correlation was only 18.5%, and it was much easier to buy into the idea that the U.S. could decouple from Europe (and vice versa). In the past decade, however, the correlation has jumped up to 72%, clearly indicating that the economies move together more often than not.

If the U.S. economy was firing on all cylinders, we might be more open to the idea that a European recession would be a non-event. But with the current recovery lackluster in many respects and with risks still unusually elevated, we're following economic developments in Europe with significant concern.