Download Europe`s Crisis Widens

Europe's Crisis Widens
Italy, Spain See Bonds Sink, Portugal Faces
Rating Cut as Faith in Rescue Ebbs
DECEMBER 1, 2010
By MARCUS WALKER And BRIAN BLACKSTONE
Agence France-Presse/Getty Images
In Rome, students protesting spending cuts clashed with police
Investors dismissed European leaders' latest attempt to restore market calm, raising
doubts about whether governments can rebuild confidence in the region's common
currency amid signs that the debt crisis is creeping deeper into the Continent.
The euro fell to a 10-week low, and was below $1.30 in late New York trading. Bond
markets across Europe's vulnerable fringe sank, as the "risk premium" investors
demand for lending to Spain and Italy hit record highs. Standard & Poor's said after
European markets closed it is considering a downgrade on Portugal's credit rating,
citing economic pressures and increased risks to the government's creditworthiness.
Cutting Back
Voices from Europe's fiscal crisis.
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Timeline: Ireland's Woes
Europe's Debt Crisis
Take a look at events that have rattled European governments and global markets.
The bond selloff extended Monday's declines, suggesting that Sunday's agreement by
European governments to bail out Ireland and set up a permanent rescue fund has
left investors cold.
Germany and other European governments hoped the twin announcement would end
the near-panic that has gripped debt markets in recent weeks. Instead, a crisis of
confidence that began last year in Greece has continued to spread.
Particularly worrying to Europe's leaders are early signs the market turmoil is spilling
into countries thought to be less at risk: Italy and Belgium. "Tension is very high, in
part because the market has already raided three countries," said Luca Cazzulani,
deputy head of fixed-income strategy at Italy's Unicredit bank.
Economists generally agree Europe's current bailout fund is sufficient to rescue
Spain, should that be necessary. But if Italy, Europe's third-largest economy,
teetered, a rescue would test both Europe's economic resources and the will of
healthier countries such as Germany to shoulder the costs.
Italy is faring better economically than some neighbors and its budget deficit is
among the lowest in the euro zone. But Italy also has the region's second-largest debt
burden, and half of it is financed abroad.
In addition to the huge government debt of some countries, especially on Europe's
periphery, investors worry banks could face big losses. If problems among banks are
greater than disclosed, that would have effects on these countries' budgets—and the
size of any bailout they might need.
That concern is driven partly by a lack of trust in the integrity of "stress tests" of eurozone banks earlier this year. Ireland's passed, yet it was the weakness of those same
banks that forced Ireland to seek a bailout.
Now European officials are planning a new round of stress tests next year. While
some leaders are pushing for these to be broader and more transparent, the agency
that will oversee them says it might opt not to publicly disclose the results.
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Germany stands accused by critics, ranging from financial markets to European
capitals, of fueling the current anxiety by insisting Europe's future bailout fund
include rules that could see bondholders take a hit in government rescues.
Chancellor Angela Merkel pushed hard for that principle, saying it is unacceptable
that investors make profits from lending to governments while taxpayers cover all of
the losses. Even some economists who believe she is right in principle say the timing
was terrible, because it undermined fragile confidence in European debt markets.
German officials maintain the rules would affect only future bonds, not existing eurozone debt, which would be repaid in full. But merely talking about the issue of lenders
taking a so-called haircut has shattered the assumption that Western European
governments never default. By raising the cost of borrowing for Portugal and Spain,
this has made it more likely they may need a bailout, economists say.
"By their actions, the Germans have unsettled the markets and brought about what
they're hoping to prevent," said Simon Tilford, chief economist at the Center for
European Reform, a London think tank.
One reason the prospect of bailouts of weaker governments is no longer enough to
win back investor confidence, economists say, is that they don't solve the underlying
problem: Several countries have more debt than their economies can cope with.
Their rising cost of borrowing bodes ill for their plans to issue hundreds of billions in
new bonds in the coming years. Ireland, Portugal, Spain and Italy need to issue close
to €900 billion of government bonds over the next three years—about €500 billion in
Italy alone—according to Citigroup estimates.
Some observers say the euro zone will eventually have to choose between unraveling
or creating a deeper union that includes financial transfers from strong countries to
weaker ones. But creating the central budget authority that the euro-zone now lacks
would be a hard sell in countries such as Germany that would have to foot the bill.
On the other hand, giving up on the euro would undermine 60 years of political
efforts to build a united Europe, and could cause unpredictable economic and
financial disruption in a region whose trade and banking systems have become deeply
intertwined since the euro was created in 1999.
Continental Divide
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Europe's sovereign-debt crisis is exposing economic fault lines within the euro
currency zone
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A paradox of the debt crisis is that the 16-nation euro zone, as a whole, has a budget
deficit of around 6% of its gross domestic product and total public debts of around
84% of GDP. While not exactly low—6% is twice what's supposed to be the maximum
in euro-zone countries—that is healthier than in the U.S., which is running a budget
deficit of over 11% and has total debts of around 92% of GDP.
Germany is forcing Ireland and Southern European countries to pursue painful fiscal
austerity policies, in the hope that slashing deficits will win back investors' trust. But
many in financial markets doubt the strategy will work, saying that without better
economic growth, the euro zone's weaker members will struggle to pay down their
debts even with fiscal austerity. That makes many analysts believe the ultimate
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resolution will involve either a restructuring of debts in some countries or a financial
transfer, such as by forgiving rescue loans.
Such transfers wouldn't solve a growing problem that threatens the cohesion of the
currency area—economic divergence.
The gaps among countries are widening, suggesting that robust recoveries in
northern European nations such as Germany aren't spreading south or to Ireland.
Jobless rates are relatively low in Germany, at 6.7%, and below 5% in the
Netherlands. But Spain's is over 20%, according to the EU. Others in Europe's
periphery have double-digit rates, making deficit reduction hard to do without
triggering a backlash.
In a currency union with a single monetary policy and 16 different fiscal policies—
and, critically, 16 distinct sovereign bond markets—such gaps matter a lot,
economists say.
"These divergences give the markets something to sink their teeth into by attacking
individual countries and their bond markets," says Jonathan Loynes, an economist at
the consultancy Capital Economics. The divergences mean tiny countries like Ireland
and Greece, which combined account for just 4% of the region's output, "are almost
becoming pivotal to the financial stability of the region as a whole," he adds.
—Stephen Fidler and Alessandra Galloni contributed to this article.
Write to Marcus Walker at [email protected] and Brian Blackstone at
[email protected]
Printed in The Wall Street Journal, page A1
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