How Will a Recession or Poor Economic Growth in Europe Impact the United States?

Much of the volatile behavior of the stock and bond markets over the past few days has been attributed to fears that Europe is heading into a recession and that this will drag down the U.S. economy. Today’s post covers the age old adage “perception versus reality” and looks at how European growth could impact U.S. growth.

First, let us walk through a quick explanation of how international trade feeds into U.S. GDP growth. One component that makes up total GDP growth is a category called net exports. This measures the change in net exports from one quarter to the next. Net exports has two components:
1) Exports

2) Imports.

Exports are sales of U.S. made goods to the international markets (including Europe). An increase in exports from the previous quarter adds to GDP growth while a decline in sales from the previous quarter reduces GDP. Imports are purchases of foreign goods. Imports subtract from GDP growth because the money is not spent in the U.S.  A rise in imports from the previous quarter subtracts from GDP growth while a reduction in imports from the previous quarter adds to GDP growth.

Data from the Bureau of Economic Analysis shows that since the 3rd quarter of 2010, net exports have contributed .02% to U.S. GDP growth.

With that primer covered, let us look at perception versus reality.

Perception:

1) Europe is sliding into a recession

2) Since Europe is the largest trading partner with the U.S., a recession in Europe will have a major impact on the U.S. and might even drag us into recession.

Reality:

1) Europe does appear to be sliding into recession. In fact, some of the European countries in the Eurozone are already in recession. The Eurozone’s GDP growth for the 2nd quarter of 2014 was zero and Germany’s GDP growth contracted (.2%).

2) Research by a Canadian economist (David Rosenberg) shows that exports to the Eurozone could fall by 50% and the total impact to U.S. GDP growth would be .6%. If U.S. GDP maintains its 2% level of GDP growth then, all else being equal, that would reduce growth to 1.4%.

The problem is that all else is not equal because there is another dynamic going on with international trade that positively impacts the import side of the equation. That dynamic is the energy complex. With U.S. oil production booming, the U.S. is now importing less oil than in the past. This has led to the trade deficit narrowing from over 5% of GDP in 2005 to less than 3% now. Falling imports are a positive for U.S. GDP growth that potentially offsets the negative impact from falling exports. Oil prices are another component of the energy complex. With oil prices falling, then the value of imported oil drops which is a reduction in value of imports. Once again, lower imports adds to GDP growth and is another potential offset to falling exports.

So, the perception that a recession in Europe will drag down the U.S. economy is not necessarily a reality, especially with the positive dynamics happening on the import side of the equation.

The reason for the high volality in the stock markets has more to do with the concerns over the exposure of U.S. companies to Europe, because of their foreign sales, rather than the concerns about the impact to U.S. GDP growth. Companies in the S&P 500 have approximately 40% of their revenue derived from international sales. So, a recession in Europe holds the real risk that U.S. companies that have heavy European sales exposure could see their stock prices impacted. The reality is that you could see high volatility  in the stock market that would be independent of the economy.

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