Old World Virtues

If America's economy stalls, will Europe's necessarily go into reverse? It's happened before, and economists worry that it could happen again. In the past few weeks, they've been nervously quoting Alan Greenspan, the closest thing their world has to papal infallibility, who said in October 1990 that "the economy has not yet slipped into a recession" — when subsequent data showed it had already begun that July. Lurking underneath the positive outlook of many forecasts for Europe is a recognition that unanticipated shocks could tumble into a global downturn, especially if the U.S. gets much sicker.

Still, there's good reason to think that Europe's economies should fare better than America's in the next six to 12 months. Despite the greater interdependence of developed economies — more trade and more ownership of foreign assets, which blur any neat division between regions — Europe appears relatively immune to the maladies that now beset Uncle Sam. As Bank of England governor Eddie George said last week: "I don't expect [them] to be deeply damaging to our own situation" — though he did say "that's something we are watching." Here are the reasons for guarded optimism:

No "Irrational Exuberance" In the words of William Dudley, chief U.S. economist with Goldman Sachs, "A few years ago, the U.S. was seen as sexy and Europe as boring. Europe is still boring, but now boring may be good." The U.S. has outperformed Europe over the last eight years, creating 22 million new jobs compared to approximately 8 million and maintaining average annual growth of 3.9% compared to 2.2%. But the Clinton boom didn't repeal the business cycle. Too much of recent U.S. growth relied on the "wealth effect" — the eagerness of U.S. companies and consumers to spend based on their ballooning stock portfolios, even if they borrowed to do it. U.S households routinely borrow more than they save, whereas in Europe, even taking loans into account, households manage to put away 10% of their income. "The feel-good factor coming from equity growth led to a big buildup in U.S. debt," says Julian Callow, chief Continental European economist at Credit Suisse First Boston in London. But now that stock prices have sagged, those fat debt numbers are making American consumers feel bad — bad enough, judging from sluggish Christmas buying, to put their wallets away.

Not so in Europe, where personal wealth is less tied to equity markets. Only 5% of private household wealth in Euroland is invested in stocks, compared to 25% in the U.S. That may be old-fashioned, but the happy result is that the worldwide stock slump hasn't dented European spending. Retailers all over the Continent report a healthy Christmas. Even in Britain, where more than 12% of private household wealth is in equities, Father Christmas has been good this year. "Sales started quite slowly in December, but now it looks like they are up 1% to 2% over last year," says David Smith of the British Retail Consortium. The investment plans of European companies suffer less than their American counterparts from stock market vagaries, since they rely mainly on bank loans for financing.

Low Tech Is Low Risk The high-tech sector has been a huge part of the American boom, accounting for almost one-third of overall U.S. economic growth last year. "In Europe, the technology sector has been making a much smaller contribution to growth, so the downturn is not so important," says Callow.

Lower Taxes, Higher Spending George W. Bush may or may not get his tax cut, but the Germans, French, Italians and Dutch will get theirs. And in Britain, the government will be spending more. According to the European Central Bank, cumulative tax cuts in 2000 and 2001 will amount to 1% of gdp. When first proposed, the cuts were controversial because some feared they would fuel inflation. "But now," says Robert van den Bosch, chief economist for the Dutch bank ABN Amro, "it looks like they'll come at just the right time" to raise consumer spending as storm clouds drift from across the Atlantic.

Black Gold Europe is more dependent on petroleum imports than the U.S., so the 30% drop in oil prices since their high of $37 a barrel in September is particularly sunny news. In the U.S., unusually cold weather is keeping natural gas prices high.

The Euro Rises The much-battered currency jumped 8% against the dollar in December to 93 — as fears about the U.S. economy intensified. Most economists expect it to keep rising, reaching parity or better this year. That will make European exports more expensive, but Goldman Sachs estimates that even if exports to the U.S. fall 10% that will take only .2% off Europe's GDP. A common currency has also stopped the jockeying to raise interest rates that used to be common among its members in hard times. "The euro erased the divisions within Europe that allowed problems in America to knock on here" through tighter credit, says Herve Goulletquer, chief economist at French bank Credit Lyonnais. The European Central Bank probably won't lower interest rates until the euro strengthens substantially against the dollar. But many analysts feel inflation is tame enough that rates could be reduced if a stimulus is needed to counteract a U.S. downturn.

Jobs Mean Confidence Europe still has relatively high unemployment — 8.6% in Germany (16.3% in its eastern regions), 9.2% in France and 9.1% overall, compared to 4% in the U.S. But the Continent is finally starting to create hundreds of thousands of new jobs, and that's expected to continue. "Good news on the employment front will mean stronger consumer confidence and spending," says Goulletquer.

Most forecasters expect U.S. growth to be substantially less than Europe's in the next few months but rebound later, so that overall for the year Europe will have only a slight advantage — perhaps 2.8% gdp growth compared to 2.5% for the U.S. There may even be a positive for Europe in America's problems: they could awaken the herd of investors hung over from their high-tech binge to the homelier virtues of economies free from America's excesses. "No one really wanted to know about European equity markets in 2000," says Callow of CSFB. "We would expect U.S. investors to look more favorably upon them this year."

More U.S. investors will mean higher stock prices — as well as increased demands for the more open, more transparent shareholder culture that many economists think European companies need to become truly world class. All that sounds good — but one word of advice to prospective U.S. investors. Please, leave your irrational exuberance at home. — With reporting by Bruce Crumley/Paris, James Graff/Brussels and Ursula Sautter/Bonn