By JAVIER C. HERNANDEZ and JACK EWING
Published: February 4, 2010
Just as America’s recession begins to ebb, trouble is brewing in Europe that may prolong a downturn on the Continent and ricochet through the global economy as it struggles toward a recovery.
High & Low Finance: Fraying at the Edges (February 5, 2010)
Floyd Norris: Crumbling Europe?
A rout in stock markets that began in Europe spread to Wall Street on Thursday and around the globe to Asia on Friday, amid fears that Europe may be the world’s next financial flashpoint. Pressure has been mounting across the Atlantic as Greece, Portugal and a handful of struggling countries that use the euro scramble to pay off mountains of debt accumulated from years of profligate spending.
The Dow Jones industrial average slid 2.61 percent, or 268.37 points, to 10,002.18 Thursday, after briefly falling below 10,000 for the first time since November, as American investors grew more uncertain about Europe’s economy.
Stock markets across Europe slumped as much as 6 percent, and worries that the troubles might push even big European nations like Spain into a financial crisis drove the euro to $1.37, a seven-month low against the dollar.
Markets in Europe slipped further on Friday, after a sharp sell-off in Asia, amid continued worries about government debt in several European countries and about the state of the U.S. labor market.
“The question now is, how big is this fire going to be?” said Uri D. Landesman, head of global growth at ING. “What is panic, and what is legitimate? We don’t know at this point.”
Like the United States, Europe has been slow to exit recession. France and Germany — the biggest of the 16 countries that use the euro as their currency — have tried to put their financial houses back in order quickly. But countries on the fringe, including Greece, Portugal, Spain and Ireland, are having trouble paying for years of debt-driven expansion.
Now the bill is coming due. In the worst case, they could default on their debts, prolonging the economic downturn.
While the tension simmering in Europe has gone largely unnoticed by most Americans, the mounting pressure on these countries to discipline their finances has raised questions about whether the currency union that has peacefully bound Europe’s economies for more than a decade risks unwinding.
Adding to the anxiety among investors Thursday was a bleaker-than-expected report on the United States labor market. Investors are watching unemployment closely as they try to gauge the strength of the recovery and determine whether it will be severely constrained by tepid consumer spending.
On Thursday, the eve of the release of the Labor Department’s monthly employment snapshot, the government said the number of people filing first-time claims for unemployment increased to 480,000 last week, above Wall Street’s estimates of 455,000. Analysts expect Friday’s employment report to show that the jobless rate remained at 10 percent in January, and that 15,000 jobs were created.
The Standard & Poor’s 500-stock index plunged 34.17 points, or 3.11 percent on Thursday, to 1,063.11, and the Nasdaq composite index fell 65.48 points, or 2.99 percent, to 2,125.43.
How Europe decides to deal with its problems will shape its future political landscape — and the future of the euro itself.
Fearful investors have started asking whether France, Germany and other rich countries should be forced to bail out their poorer cousins, or simply allow them to default — an outcome that would have major repercussions for Europe and financial markets worldwide.
The crisis in these areas “is reaching new proportions, and the contagion effect is getting more serious,” two Royal Bank of Scotland officials, Jacques Cailloux and Harvinder Sian, wrote in a note to investors.
The current troubles began in Greece, which qualified for membership in the euro club in 2001. But the government never curbed shortfalls in its budget when times were good, and drastically expanded employment by adding to government rolls, even as an inefficient tax collection system reduced tax receipts.
While investors initially brushed off these problems, their worries resurfaced in October when the government conceded it had again buffed up its statistics to suggest a bright fiscal picture. Now, Greece has acknowledged its budget deficit stands at nearly 13 percent of gross domestic product, while debt levels are among the highest in the European Union — well beyond what the rules of euro membership allow.
Greek officials are now trying to manage the country’s deficit by partially freezing the pay of civil servants and increasing the fuel tax.
The European Union endorsed those measures on Wednesday, but the proposals have met resistance from other quarters. Greek customs and tax officials began a 48-hour walkout on Thursday, choking the flow of imports, and there were threats of more strikes.
Meanwhile, the dispute has put Greece’s credit rating under renewed threat, and stoked worries that Greek government bonds might no longer be accepted as collateral by the European Central Bank.
The president of the bank, Jean-Claude Trichet, sought to temper the doubts about Greece on Thursday. He cautioned, however, that large deficits could be a problem for other euro-zone countries, unsettling investors. “When you share a common currency,” Mr. Trichet warned, “the counterpart is that you have to behave properly.”
Nonetheless, Europe’s politicians, and global investors, have become deeply unsettled about other European countries with huge debt and deficits, including Spain, Portugal and Ireland. Investors have been demanding bigger premiums to hold the debt of these countries, and this week drove the cost of insuring their debt to new highs.
These worries deepened Thursday as Spain, saddled with 19 percent unemployment and huge debt from an American-style housing bust, played down fears of a budget deficit that has ballooned to 11.4 percent of its gross domestic product.
Portugal, whose deficits have also spooked investors, suddenly had trouble raising as much short-term credit as it wanted.
There have been whispers that Europe’s better-off countries — France, Germany and the Netherlands among them — might come to the rescue with a bailout. If they do not, economists worry about the ripple effects of a default.
“There is a realization that the economy is still on very fragile footing globally,” said David Riedel, founder of Riedel Research, which provides market analysis. “There are definitely another couple of shoes to drop here with the European crisis.”
Amid the tumult, the European Central Bank and the Bank of England left their benchmark interest rates unchanged at record lows of 1 percent and 0.5 percent, respectively.
But in an illustration of the ragged nature of Europe’s recovery, the British central bank took steps to freeze measures to stimulate the economy. The bank, reacting to rising inflation and evidence that Britain has emerged from recession, announced that it would not extend its large purchases of government bonds.
In the United States, interest rates were lower. The Treasury’s benchmark 10-year note jumped 25/32, to 98 3/32 and the yield fell to 3.61 percent, from 3.70 percent late Wednesday.