(By Mani) So far, the fallout from the European financial crisis has had a limited impact on the U.S. economy. However, the reverberations from Europe's troubles are certain to wash up on U.S. shores, as the economic and financial ties between the U.S. and Europe are deep and long running.
There are three key avenues for Europe's troubles to transit to America: trade and investment flows, the capital markets and the banking system. International trade accounts for less than 15 percent of the U.S. and around one-fifth of the exports go to Europe.
"The long underlying financial crisis and weak growth of the region has slowed exports to Europe over the past few years and, with economies weakening further there, will likely slow them even more during the second half of this year," Wells Fargo economist Mark Vitner said in a client note.
In addition, weaker economic conditions in Europe have contributed to slower growth in China and Latin America, slowing demand for U.S. products in these countries. Moreover, U.S. companies with operations in Europe have likely become more cautious about expanding operations and hiring new staff in the United States.
Conversely, a few European companies have closed or consolidated their U.S. operations as they tighten their belts.
Europe's linkages to the United States via the financial markets are also relatively direct. As uncertainty rises and contagion increases, investors tend to pull away from riskier assets leading to increased stock market volatility and lower share prices.
Pressures have also increased in the corporate bond market. Corporate bond spreads in the euro zone have historically been closely correlated with bond spreads in the United States," Vitner noted.
A recent study published by the Federal Reserve Bank of San Francisco shows that a one percentage point increase in the European corporate bond spread historically corresponds to between a 0.44 and 0.85 percentage point increase in the U.S. bond spread, with the variation being a function of the type of corporate bond being measured.
The study further says that the contagion coefficient from Europe is relatively large when compared to previous crises in Russia during 1997 and 1998, when the contagion spread was around 0.20 and Mexico's 1994-1995 crisis, when the contagion ranged from 0.20 to 0.60.
There have also been a few notable dustups in the banking sector, but from an overall perspective, U.S. financial institutions are believed to have manageable direct and indirect exposure to Europe's most stressed economies.