How the U.S. and Europe drag each other down

The financial turmoil in Europe certainly isn’t helping America’s own recovery effort. But the reverse is true as well: The stagnant U.S. economy is also putting a damper on Europe’s ability to get back on its feet. It’s a negative feedback loop that has exacerbated the downturn on both continents. And the danger is that this cycle could become self-reinforcing, not only dragging down those economies but also triggering a longer-term downturn in the global economy — one fed by multiple crises that don’t have any single solution.

The immediate cause of the European debt crisis is internal, the result of fundamental fiscal problems in Greece, Italy, Portugal and Spain that have had a ripple effect across the euro zone. But the U.S. recession has been yet another drag on the European economy, which could make its own financial recovery all the more challenging. The doubts about whether U.S. consumer spending will recover have weighed particularly heavily on Europe, one of the biggest U.S. trading partners, as its own growth has stagnated as well. More than half the companies in the Standard & Poor’s 500-stock index are overseas, for instance, with the majority of them in Europe. “It creates yet another level of uncertainty in a situation in Europe that’s already very, very fragile,” says Tu Packard, senior economist at Moody’s Analytics.

So European markets are discouraged by the grim U.S. economic outlook, and U.S. markets have been rocked by the European fiscal crisis, among other events out of its own control. What does this all amount to? On Thursday, the Dow industrials closed down more than 512 points — 4 percent of its value. The Stoxx Europe 600 Index dropped 3.4 percent, reaching its lowest point in nearly a year, as anxious investors pulled money from stocks and raced to the bond market in the U.S., U.K., Germany, and other havens instead. “It’s almost like this East to West tsunami of share price activity that starts with the trading day in Asia, moves to the Europe, then the U.S.,” says Sam Stovall, chief investment strategist for Standard and Poor’s equity research.

Today’s stomach-wrenching market drops aren’t tied to any single precipitating event: a terrible U.S. jobs report, or one lone European country about to default. Instead, some fear the downward turn may be symptomatic of more intractable problems in the global economy. If the 2008 financial crisis revealed how just how interdependent the global economy is, 2011 may make it clear that the biggest nations’ problems are, to a certain extent, still intertwined. “The U.S. had been recovering, but the debt crisis in Europe put a real damper on the U.S. recovery. And vice versa,” says Gus Faucher, director of macroeconomics for Moody’s Analytics. “There are multiple drags on multiple economies. To some extent they are synergistic.”

That being said, Faucher says he is encouraged that Europe has tried to be more proactive about curbing its own debt crisis. Last week, Europe saved Greece from default by distributing the risk to banks across the European Union, and the European Central Bank announced this week that it would buy bonds from indebted governments to prevent Spain and Italy from being engulfed. And the E.U. is in a better position to use monetary policy to help grease the wheels of its economy than the U.S., where the Federal Reserve has nearly run out of tools to help the economy rebound.

But Europe’s markets have yet to be assured that the continent’s financial crisis has been contained, as investors made clear on Thursday. With the West’s two economic powerhouses both struggling to ward off a double-dip recession, there aren’t any concrete assurances of recovery yet on either end. “The U.S. was seen as a very stable place in many ways, with very large bond market, such an important anchor. And Europe was well. Suddenly, both these anchors [are in trouble], and the world is unmoored,” Packard says.