(Updates with market response, Rogoff comment beginning in seventh paragraph. For more on the election: ELECT <GO>.)
Oct. 28 (Bloomberg) -- President Barack Obama’s path to re- election may pass through Berlin and Paris.
The European debt crisis that German Chancellor Angela Merkel and French President Nicolas Sarkozy are struggling to contain looms as the most visible threat to the U.S. economy as Obama heads into his re-election campaign.
European leaders took a critical step toward curbing the crisis yesterday, agreeing to expand their rescue fund. Further details need to be worked out, and the negotiations could still fall prey to political infighting or an investor revolt.
Obama has limited capacity to influence the discussions even with the significance of the outcome for the U.S. economy and the his re-election prospects. He will meet with European leaders at the Group of 20 summit in Cannes, France, on Nov. 3- 4.
Obama’s leverage “is inherently restricted,” said Jacob Kirkegaard, a research fellow at the Peterson Institute of International Economics in Washington. “This is essentially domestic European politics.”
A cascade of defaults that spread from Greece to other nations such as Portugal, Ireland, Spain and Italy would risk a financial panic and freeze in U.S. credit markets, as well as a surge in the dollar’s value that would raise the cost of U.S. exports, said Nariman Behravesh, chief economist for IHS Inc., a forecasting firm. U.S. corporate profits from European operations could face a sharp decline as the continent sank into recession.
Underscoring anxieties over the potential impact of the European financial crunch, U.S. stocks surged yesterday on news of the European agreement then slowed this morning as scrutiny of the deal deepened and the initial euphoria faded.
The benchmark Standard & Poor’s Index rallied 3.4 percent to 1,284.59 in New York yesterday, extending the biggest monthly rally in U.S. equities since 1974. U.S. stocks were little changed this morning, with the S&P 500 down less than 0.1 percent to 1,284.37 at 11:17 a.m., as emerging doubts about the European deal offset a rally in technology companies and commodity producers.
Concern over Europe’s crisis sent the S&P 500 to a one-year low earlier in the month.
The weaknesses of Europe’s common currency area, ranging from its design to a dearth of bank funding and anemic economic growth, weren’t properly addressed in the measures revealed yesterday to stem investor panic, said Harvard University economist Kenneth Rogoff.
“This was absolutely not decisive,” Rogoff, a former International Monetary Fund chief economist, said in a Bloomberg Television interview today. “They’re just trying to keep Greece in the game.”
The risks of Europe’s crisis spreading to hurt the U.S. economy leave an important determinant of Obama’s political future in the hands of a few foreign leaders with whom he has relations that are more “pragmatic” than “close,” said Heather Conley, who was a State Department official handling European affairs for George W. Bush’s administration.
Obama welcomed the deal assembled by European leaders yesterday as an “important first step” to averting a global economic slump.
Obama ‘Very Pleased’
“I was very pleased to see that the leaders of Europe recognize that it is both in Europe’s interest and the world’s interest that the situation is stabilized,” Obama said yesterday before starting a meeting with Czech Prime Minister Petr Necas at the White House.
In an essay published in the Financial Times, Obama also urged the Europeans to resolve the crisis “as quickly as possible” and include “a credible firewall that prevents the crisis from spreading.” European banks must be strengthened and Greece needs “a sustainable path,” he said.
Obama has made his concern over the European crisis clear in public remarks. The crisis is “scaring the world,” he said at a Sept. 26 town hall meeting in Mountain View, California. At an Oct. 6 White House news conference, he urged euro zone leaders toward quicker and more decisive action.
Obama has pressed privately for strong action in a dozen meetings and phone calls with European leaders including Merkel, Sarkozy and British Prime Minister David Cameron over the past few months, said an administration official who wasn’t authorized to comment publicly.
Treasury Secretary Timothy Geithner has crossed the Atlantic three times since early September to confer with counterparts, including a rare appearance at the monthly meeting of European Union finance ministers. Borrowing from the philosophy he brought to the 2008 financial crisis as president of the Federal Reserve Bank of New York, he has urged speedy and forceful action.
Geithner’s presence at the finance ministers’ meeting “is incredibly unusual,” said Phillip Swagel, an assistant Treasury secretary under Bush. “It really is an internal European discussion.”
A disorderly Greek bond default that spreads to other European nations probably would plunge the U.S. back into recession and could drive up the U.S. unemployment rate as high as 11 percent by the 2012 election, Behravesh said. Even with the European leaders’ agreement yesterday, he predicts a 25 percent chance of the scenario.
’Single Biggest Risk’
“It’s the single biggest risk facing the U.S. economy and the world economy,” Behravesh said.
Geithner has played down the potential damage of European defaults to American banks in public comments, testifying to the Senate Banking Committee on Oct. 6 that direct U.S. loans to European governments “under most pressure” is “very modest.”
Still, the indirect risk to the U.S. financial system is much higher. The $493.4 billion of U.S. banks’ so-called other exposures, such as derivatives, guarantees, credit commitments and credit default swaps to public and private customers in Greece, Ireland, Italy, Portugal and Spain were three times larger than the $147.5 billion in direct loans to borrowers in those countries, according to data from the Bank for International Settlements.
Even without another blow to the economy, Obama is likely to face a higher jobless rate on Election Day than any president who has won a second term since World War II.
The unemployment rate during the fourth quarter next year will average 8.7 percent, according to the median forecast among 75 economists surveyed by Bloomberg between Oct. 5 and Oct. 11. The president re-elected with highest jobless rate in the postwar period was Ronald Reagan, at 7.2 percent in November 1984.
A quick resolution that financial markets find credible potentially could provide a jolt to the U.S. and world economies by bolstering business confidence, Kirkegaard said.
“The potential for catastrophic risk emanating from Europe does not help business confidence to invest,” Kirkegaard said. “If you talk to businesses, they remember what happened in the Lehman situation where all of a sudden they didn’t have access to their working capital. Well, they hoard it, basically.”
Equities, commodities and the euro rallied as Sarkozy said the euro region’s bailout fund will be leveraged four to five times, and investors have agreed to a voluntary writedown of 50 percent on Greek debt. U.S. treasuries fell as investors gained confidence to move toward riskier assets with higher yields.
Stakes for Leaders
European leaders must still work out crucial details such as how to leverage the 440 billion euro ($624 billion) rescue facility and what banks will get in return for accepting the Greek writedown.
Tensions over how to shoulder the burdens of the debt crisis continue and major European leaders such as Merkel, Sarkozy and Italian Prime Minister Silvio Berlusconi have all seen their domestic political support erode, said Conley, now director of the Europe program at the Center for Strategic and International Studies in Washington.
“The stakes for all three of these leaders, for their political futures, is so high,” Conley said. “It makes a conversation very difficult when the frustration is so great.”
Obama must try to nudge the European leaders toward consensus at a time when U.S. prestige as a global economic leader has been tarnished by the 2008 financial crisis, rising U.S. government debt and a domestic political standoff that took the country to the brink of default in August.
Obama has tried to strengthen his relations with European leaders.
His first encounter with Merkel was chilly, as the German chancellor rebuffed an attempt Obama made as a candidate to speak at the Brandenburg Gate in Berlin, forcing him to shift the venue to another location in the city.
Since then, Obama has feted her with a state dinner at the White House and presented her with a Presidential Medal of Freedom. He has met with her or spoken by phone 30 times since taking office, said the administration official who spoke on condition of anonymity.
Obama lacks the kind of “close relationships” with European leaders forged by such predecessors as Bill Clinton, George H.W. Bush or Ronald Reagan, Kirkegaard said.
“These aren’t Margaret Thatcher and Ronald Reagan or even Bill Clinton and Tony Blair-type relationships,” he said.
--With reporting by Roger Runningen in Washington and Scott Hamilton in London. Editors: Robin Meszoly, Justin Blum
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