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Europe's debt fix falters, rattling markets

By David Mchugh

Associated Press

Published: Monday, April 23 2012 4:35 p.m. MDT

Spain's Prime Minister Mariano Rajoy speaks during a meeting at the Moncloa Palace in Madrid Monday April 23, 2012. Spain is back in recession as the economy contracted 0.4 percent in the first quarter of the year, the central bank said Monday. The new conservative government has said the economy is shrinking and forecasts it will contract 1.7 percent this year. It has approved labor market and financial sector reforms, taken drastic deficit-reduction measures, and warned Spaniards to prepare for a rough patch as things will get worse before they better. The jobless rate is nearly 23 percent and expected to rise.

Pedro Acosta, Associated Press

FRANKFURT, Germany — Europe's plan to fix its debt crisis by imposing budget cuts frayed Monday. Heavy selling rocked financial markets, uncertainty gripped two governments, and the economic outlook darkened across the continent.

The German stock market suffered its worst day in six weeks. In the United States, the Dow Jones industrial average lost more than 100 points.

Across Europe, the debt crisis appeared at its most perilous point since December, when most of the continent united behind a plan to place strict caps on government spending, a strategy known as austerity, and the European Central Bank made the first of two infusions of cheap credit into the banking system. New governments in Spain and Italy got to work on improving growth.

Now the first pillar of Europe's approach — austerity — is faltering.

"Europe has not solved its problems, and the austerity programs are making things worse, not better," said Peter Morici, an economist at the University of Maryland.

Cutting government spending can weaken an economy and result in less tax revenue flowing back to the government. So the goal of cutting the deficit can backfire and make it grow.

And even if a country is reducing its deficit, it still has one, which means the debt is increasing. The European Union said Monday that governments did cut their budget deficits in 2011, but government debt nonetheless rose as a percentage of economic output.

Meanwhile, developments across the continent cast doubt on public support for Europe's austerity prescription: government layoffs and wage reductions, spending cuts on government programs and higher taxes.

The government of the Netherlands, which has loudly cricitized its European neighbors for inflaming the crisis by losing control of their budgets, submitted its resignation to Queen Beatrix after failing to agree on its own budget cuts.

The Dutch prime minister, Mark Rutte, had hoped to clinch a deal to cut the Netherlands' budget deficit to within a target range adopted by European countries last fall.

But his most important political ally, populist Geert Wilders, walked out of the talks. He said that slavish adherence to rules set by "the dictators in Brussels," the headquarters of the European Union, would hurt the Dutch economy.

France headed for a presidential runoff election May 6 after the Socialist candidate, Francois Hollande, took the most votes Sunday in the first round of voting.

Hollande edged Nicolas Sarkozy, the incumbent president. Sarkozy and German Chancellor Angela Merkel have been such forces in setting debt-fighting strategy that they have come to be known as "Merkozy."

Hollande took 29 percent of the vote and Sarkozy 27 percent. The Socialist has said he would push to add measures to stimulate economic growth to the fiscal pact.

If Hollande is elected, it will mean "the end of the common road for France and Germany," with negative repercussions for the markets and the euro, said Stefan Scharfetter of Germany's Baader Bank.

Most French polls had predicted that Hollande would finish slightly ahead of Sarkozy in the first round. But the far-right candidate, Marine Le Pen, captured a surprise 18 percent. Where her voters will fall in the Hollande-Sarkozy runoff is uncertain.

Financial markets generally hate uncertainty, and they did not respond well to it Monday.

Germany's DAX index dropped 3.4 percent, the equivalent of a 450-point decline in the Dow. The benchmark stock index dropped 3 percent in Paris, 3 percent in Madrid and 2 percent in London.

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