Europe's debt fix falters, rattling markets

By David Mchugh

Associated Press

Published: Monday, April 23 2012 12:00 a.m. MDT

Stocks also fell broadly in the United States, where a resurgence of fear about the fate of Europe has ended the steady ascent that the market enjoyed during the first three months of the year. The Dow fell back below 13,000 and was down a 0.8 percent for the day.

In the bond market, interest rates for U.S. Treasury securities dipped, a sign that investors were seeking safety by pulling money out of stocks and putting money into bonds.

The borrowing rate for Spain, probably the most closely watched thermometer of investor fear about Europe, remained close to 6 percent. Seven percent was the level that forced Greece and Ireland to seek international bailouts earlier in the crisis.

The central bank of Spain said that country had slipped back into recession. Its economy shrank 0.4 percent from January through March after shrinking 0.3 percent the quarter before. Two straight quarters of economic contraction is the generally accepted definition of a recession.

Spain's new conservative government has warned that its economy will get worse. A contraction of 1.7 percent is expected for the year. Spain, struggling after the collapse in 2008 of a housing bubble, emerged from a two-year recession in 2010.

Suggesting more obstacles to economic growth, an index of the European manufacturing and services industries dipped in April to a five-month low. It even declined in Germany, the economic bulwark of Europe and the country that has most insisted on budget cuts.

When the financial crisis struck in the fall of 2008, governments on both sides of the Atlantic Ocean rushed out big stimulus programs to protect their economies. Governments spent more and cut taxes. The U.S. Federal Reserve and the European Central Bank slashed interest rates.

But the Europeans gave up on stimulus a lot faster than the Americans did. The European Central Bank, worried about the prospect of rising inflation, raised interest rates last April and again in July, then reversed course and lowered them late last year as Europe slipped back toward recession.

The Fed, by contrast, cut short-term interest rates essentially to zero in late 2008, then in January promised to keep them there until at least 2014 if the U.S. economy remains weak.

The White House and Congress also extended unemployment benefits and tax cuts that were scheduled to expire at the end of 2010, and enacted a separate cut in the payroll tax that pays for Social Security.

In Europe, the bigger, more financially stable countries pushed for firmer limits in a so-called fiscal union agreed upon in December by every country in the 27-member European Union except Britain and the Czech Republic.

For three months, the bond market stayed calm. But recently, investors have worried that deficits will keep rising in Spain and other countries, and that those countries will have trouble financing these deficits by selling bonds. So investors have demanded higher rates, re-igniting the crisis.

The European Central Bank has bolstered the continent's financial system with €1 trillion in cheap loans to banks, in December and February, but the effects are wearing off.

Officials from the European Central Bank are resisting calls from the United States and the International Monetary Fund to offer more support to the struggling economies of the countries that use the euro.

Jens Weidmann, Germany's top central banker and a member of the ECB's governing council, said lower interest rates and more credit for the financial system were not the solution to the debt crisis.

"Monetary policy is not a panacea, and central bank firepower is not unlimited," particularly within the constraints of a currency shared by 17 countries, he said.

Spain's most recent budget slashed spending across government departments by an average of 17 percent, froze pay for civil servants and hit companies with new taxes.

That came on top of an austerity package in late December that raised income taxes, froze practically all government hiring and is slowing Spain's economy.

Spanish finance minister Luis de Guindos calls the austerity vs. growth dilemma a "lose-lose situation": If you cut spending, you risk slowing the economy. But if you borrow to stimulate the economy, you make the debt bigger.

The effects of government cuts, at least, are painfully clear. On top of Monday's news that the country is in recession again, Spain's unemployment rate is 24 percent.

Its debt is rising as a share of economic output. At the end of last year, the ratio stood at 68.5 percent, below the average for euro countries. But it is forecast to rise above 80 percent by the end of this year.

Spanish Prime Minister Mariano Rajoy and Italy's Monti, the two leaders on the front line of the debt crisis, are also trying to promote long-term reforms to their economies. Those include cutting regulation and easing labor market rules to make it easier for businesses to fire people and adjust workforces to global competition.

But structural reforms can take years to show results. And sometimes changes such as easing firing can make things worse in the short term, with the gains coming years later.

In the meantime, said Eswar Prasad, a professor of trade policy at Cornell University, "political support for fiscal austerity and structural reform measures are eroding all across Europe."

AP Business Writers Sarah DiLorenzo in Paris, Gabriele Steinhauser in Brussels and Paul Wiseman in Washington contributed to this report.

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