Geithner Claims U.S. Economy Can Withstand Europe's Woes. Really?

Treasury Secretary Tim Geithner put on a brave face trying to convince the global capital markets that Europe's economic situation will have little impact on America's or the world's recovery from deep recession. His case was thin, and he offered almost no rational support.

Geithner told the Xinhua news agency of China: "You see some of the challenges in Europe now. But I think we're in a much stronger position to manage those challenges." He also said renewed GDP gains in the U.S. and an acceleration of growth in China were essential to the ongoing improvement of the global economic environment.

Many Troubling Issues

Geithner failed to address several issues that could do a great deal of damage to both the U.S. and China. The rise of the U.S. dollar against the euro will raise the price of U.S. exports to Europe. Many financial experts believe the euro's value could fall to parity with the dollar from the current ratio of $1.24 This will make American goods much less attractive than European products, which could cut into the sales of a large number of U.S. companies. China faces the same issue.

Many experts fear that budget cuts and higher taxes in eurozone nations, starting in Greece, Spain, and Portugal, are likely to be regressive. Extremely high taxes tend to slow GDP, especially when they're significant and levied quickly. That means these new taxes could actually slow growth, undermine demand for imports and raise unemployment as businesses send more money to their governments.

The problem of potential sovereign-debt defaults has not been entirely addressed by the nearly $1 trillion aid facility put together by the eurozone nations and the International Monetary Fund. In Greece, the aid it's receiving now still only covers a modest portion of its national debt. The country's race to cut its deficit will almost certainly be undermined by resistance from powerful unions. The same threat exists in Spain and Portugal. Some economist believe that the sovereign-debt issue could spread to Italy and Ireland.

Bank Exposure to Europe's Debt

Chinese and U.S. banks hold European government paper. None of the financial firms have disclosed the size of their holdings and which banks have the greatest exposure. JPMorgan Chase's (JPM) exposure is estimated to be as high as $36 billion. Other large U.S. money-center banks probably have billions if not tens of billions of dollars of European sovereign paper. Any default would damage the balance sheets of large American banks, which are only just now recovering from the credit crisis of 2008.

Geithner is underestimating the extent of the Europe problem -- at least in public.