Spillover

Joseph P. Quinlan is Managing Director and Chief Market Strategist at US Trust, Bank of America Private Wealth Management. He is also a Senior Fellow at the Paul H. Nitze School of Advanced International Studies of Johns Hopkins University, Washington DC.

Given the depth and deep integration of the transatlantic economy, with no two economies more fused than the United States and Europe, problems in one half of the partnership are ultimately transmitted to the other. Current circumstances bear this out, with Europe's ongoing financial crisis and impaired economic climate exacting more of a toll on the United States with each passing day.

The negative spillover effects from the Eurozone have become so severe that some observers in America believe Europe's simmering problems, and attendant effects on the U.S. economy, could ultimately influence the outcome of the US presidential elections.

That remains to be seen. More certain is this: the United States is squarely in the cross-hairs of Europe's financial crisis; the US economy is likely to avoid recession this year, but the odds of slower-than-expected US growth are mounting.

Europe's financial crisis is being transmitted to the United States and the world via three channels: through the global financial markets, through cross-border trade, and through U.S. multinationals and their European-based foreign affiliates whose activities across the continent have decelerated sharply over the past few quarters.

Due to Europe's ongoing financial crisis, volatility in the global capital markets has become a daily staple, undermining investor confidence around the world. As the crisis has spread from Greece to Spain to Italy, so has the risk of contagion and the flight to safe assets like U.S. Treasuries, British gilts and German bunds. Financial uncertainty, in turn, has made it harder for European sovereign nations to deal with their debt problems and raised fears about the health of European banks, and by extension, the health of U.S. banks.

Key risk

The latter are well capitalized but nevertheless exposed to the contagion and panic that is slowly gaining momentum across Europe. A key risk to the United States: that Europe's crisis undermines the euro, driving the currency lower against the US dollar, which in turn undermines the price competitiveness of U.S. goods and services.

And speaking of U.S. exports and America's trade with the European Union, the damage has already been done. In 2011, the U.S. posted a trade deficit in excess of $100 billion (79 billion euros) with the EU, one of the largest trade gaps in years. Meanwhile, in the first four months of this year, America's trade deficit with the EU was roughly $32 billion, 11.1 percent larger than the same period a year ago. America's $17.8 billion trade deficit with Germany in the January-April period was nearly 20 percent larger than a year ago. As a result of slower growth in Europe, U.S. exports in April fell from the levels of March and are poised to decelerate even further in the months ahead due to weakening demand across the Atlantic.

Finally, besides the effects on U.S. finance and trade, the euro-zone crisis has also been felt on the bottom line of U.S. multinationals with significant exposure to Europe. This is not surprising given the fact that since corporate America is the largest foreign investor in the European Union.

Simply put: no other region of the world is as important to the global success of U.S. multinationals as Europe.

In it together

Why? Because over the past 50 years, no other region of the world has attracted more U.S. foreign direct investment (FDI) than Europe, with the latter accounting for 56 percent of total US global FDI stock in 2010. America's global footprint is largest among the wheezing economies of Europe versus the spry and vigorous economies of Asia, South America and Africa. To this point, America's investment stock in Ireland - $190 billion on a historic cost basis - is more than three times larger than the comparable figure for China. In other words, notwithstanding the fact that the entire population of Ireland, some 4.5 million people, would not even rank as a large city in China, the one-time Celtic Tiger is more important to U.S. firms than the 1.2 billion folks who reside in the Middle Kingdom.

Meanwhile, corporate America's investment stakes in Belgium are 11.4 percent larger than America's investment position in Brazil. U.S. investment in Spain is double the U.S. investment position in India; ditto for Spain compared to South Korea, where U.S. investment in the former ($58 billion in 2010) is nearly double the stake in the latter ($30 billion).

In the end, America's foreign direct investment position is overweight in Europe. Whatever the variable - the number of foreign affiliates, affiliate employment, R&D expenditures, affiliate income, compensation, total assets - Europe ranks at the top of the list, underscoring the exposure of US firms to the region. Looked at another way, what's good for Europe is good for corporate America. By the same token, when things go bad in Europe, U.S. multinationals are hardly immune.

To the latter point, many U.S. multinationals have warned of weaker-than-expected earnings growth this year on account of problems in Europe. And the weaker or uncertain earnings are for U.S. firms, the more hesitant U.S. companies are to hire and invest at home and abroad. In other words, weak or declining earnings growth on account of Europe's financial difficulties carry negative implications for the macro and micro picture in the United States.

In the end, Europe matters. As America's transatlantic partner struggles with one of the worst financial crises in modern history, the stakes are high for all parties involved - Europe and its member states, the emerging markets dependent on Europe for export growth and the United States. The transatlantic partnership will survive this crisis but not without more pain in the coming months.

Editor: Rob Mudge