The answer is both. But I think the nominal aspect may be greater than people realize. First let me concede that there are severe real problems in the heart of the eurozone. Here is Wolfgang Munchau:
What is the size of the problem? International Monetary Fund estimates suggest that the eurozone is well behind the US in terms of writing off bad assets. I have heard credible reports suggesting that the underlying situation of the German Landesbanken is even worse than those estimates suggest. Last year, a story made the rounds in Germany, according to which a worst-case estimate would require write-offs in the region of â‚¬800bn – about a third of Germany’s annual GDP. If you were to add this to Germany’s public debt, you might jump to the conclusion that Greece should bail out Germany, not the other way round. While that is probably a little exaggerated, there are serious questions about whether the eurozone is still in a position to issue such massive guarantees. So, given what happened to those subprime CDOs, what hypothetical rating should we then attach to that â‚¬440bn eurozone SPV? A triple A?
By they way, I found this in an excellent Arnold Kling post, which also links to a rather astounding aspect of our new health care bill.
But let’s also consider the recent trends in asset prices. Since the peak of May 3rd, the Greek crisis (along with some other related issues) have depressed commodity prices more sharply in American than Europe. No surprise there, as the dollar has appreciated. But look at these recent stock market movements in local currency terms:
US S&P500: Down 12%
Belgium: Down 6.6%
France: Down 13%
Germany: Down 8%
Holland: Down 9.6%
(Update: My apologies, the Dutch and Belgian numbers were off, down 12% and 9.4%. So the difference is perhaps too small to be significant.)
So stocks in the heart of the eurozone, the area with many banks that are highly exposed to Greek and Spanish debts, are actually down a bit less (on average) than the US. Perhaps the strong dollar is part of the reason. Perhaps monetary policy has become tighter in the US than Europe. I’d be the first to admit that these data are merely suggestive, and next week the stock markets may tell a completely different story. But when combined with commodity prices, TIPS spreads, etc, it suggests to me that the problem is not just the real effects of financial turmoil, but the way the real sector shocks interact with monetary policy to cause unintentional tightening.
Just to be clear, I think the problems in Greece and Spain are mostly real. Tight money has made their problems worse, and that’s unfortunate. But they also had real fiscal and housing problems than can’t be papered over with modestly higher NGDP in the eurozone. Tyler Cowen has a very good article on Greece.
There are a couple blog posts by David Beckworth and Ryan Avent that discuss whether we are in danger of a second dip. I basically agree with Ryan, although at the risk of sounding wishy-washy I think David’s prediction will be right in the end. By that I mean that financial market indicators have reached worrisome levels, as Ryan notes, but are not bad enough to push the risk of a double-dip recession over 50%. Indeed I think it’s more like 20% or so, if I had to guess. But avoiding an outright double-dip shouldn’t be the measure of success, so I am with Ryan on the need for central banks to be more aggressive.
Update: Well that didn’t take long; the late day rally in the S&P somewhat reduced the US market’s decline since May 3rd. But until the European markets have a chance to react, we won’t know whether the gap has actually been narrowed. (Maybe traders read my post and realized; “Wait, Sumner’s right, there’s no reason for the US market to fall more sharply than European markets.”)