Could The Euro Crisis Derail The U.S. Recovery?

So far, the effects of the crisis in Europe have been pretty muted in the U.S.

Stock prices have fallen in this country over the past few days, but they're still higher than they were a couple months ago.

What's more, the troubles in Europe are driving up demand for U.S. Treasury bonds. That drives down the interest rate on U.S. debt, which makes it easier for people to borrow money in this country, and lowers the risk of inflation -- both of which help keep the recovery going.

So what would it take for Europe's crisis to derail the U.S. recovery?

For a start, there would have to be acute problems in a country bigger than Greece.

"If the problem can be contained to Greece, the impact on the U.S. is trivial," Ian Shepherdson of High Frequency Economics told me recently.

Portugal may be the next euro-zone country to run into trouble, but the real worry at the moment is Spain, whose economy is much bigger than those of Greece and Portugal combined.

If Spain (and/or Italy and Ireland, two other heavily indebted euro-zone countries) fall into a Greek-style bailout-austerity spiral, Europe's economy will suffer.

That would hurt U.S. exports in two ways. European consumers would buy fewer goods overall. And the euro would continue to fall against the dollar, making U.S. goods more expensive in Europe.

While that would doubtless slow the U.S. recovery, it wouldn't be enough on its own to send the U.S. back into recession, Shepherdson said. He pointed out that exports account for only 12% of U.S. GDP -- and only about a fifth of our exports go to Europe.

So even if U.S. exports to Europe "fell in half, it wouldn't push the U.S. economy into recession," he said.

But the hit to exports could be compounded by trouble in the U.S. financial sector. This sort of thing is harder to predict. But U.S. banks hold about $1 trillion of European debt -- and one of the lessons of the panic of '07-'08 was how quickly problems in the U.S. financial sector spread to banks in Europe, this morning's WSJ notes.

Perhaps the most important variable is the vaguest of all: fear. Even without a major downturn in exports or a significant hit to U.S. banks, growing debt problems in Europe -- and declines in the prices of European stocks -- could prompt investors to pull back in the U.S.

A shift out of U.S. stocks and corporate bonds and into cash and treasuries would reverse many of the gains of the last several months. If the shift were large enough -- a big if -- it could derail the recovery.

"This is like we've agitated a colony of prairie dogs, and everybody is looking out of their hole to see what's going on," a bond strategist in Chicago told the WSJ. "But it's no crisis, yet."