Sunday, December 2, 2007

US Sneezes; World Gets Sick

. Sunday, December 2, 2007

While the US struggles to manage the sub-prime problem, Europeans are beginning to feel unwell. A story in The Daily Telegraph (UK) nicely spells out the European Central Bank's dilemma--caught between slowing growth and rising inflation and then wonders whether EMU is at risk.

"Interest rate spreads between government bonds in France, Spain, Germany and Italy have lately got wider and wider. In other words, believe it or not, the markets are increasingly betting on the eurozone breaking up – as political tensions rise, and the needs of inflation-averse nations like Germany can’t be reconciled with much weaker debt-driven members like Ireland and Spain. Could it happen? Why not? Every other currency union in the history of man has broken up – unless, like the US and UK, it has been preceded by generations of political union, and held together with a federal tax system. It sounds far-fetched, I know. But the ultimate victim of this sub-prime crisis could be nothing less than the single currency’s existence."

Wishful thinking from a euroskeptic? Perhaps, but this is the first real test of the EU's ability to weather a real economic problem (and an asymmetric shock) with a single monetary policy.

A thousand miles north, a tiny Norwegian town above the Arctic circle struggles to recover from the losses it suffered from investing in assets derived from sub-prime mortgages. The town government invested a quarter of its annual budget of $163 million, and lost a substantial share of the investment (how much is not fully clear).

Residents are unhappy: "As the losses begin to bite, the political finger-pointing has begun. Down the hall from Ms. Kuvaas, the town’s opposition leader, Torgeir Traeldal, is calling for an investigation of how and why Narvik could have made such an ill-advised investment. “Heads are going to roll,” Mr. Traeldal said, repeating the phrase a few times to drive home his point."


US Sneezes; World Gets Sick




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