March 3, 2021

News Analysis: With Prospect of U.S. Slowdown, Europe Fears a Worsening Debt Crisis

It is that prospect — that Americans will again retrench and stop buying goods from China and Europe and everywhere else — that is putting new pressure on debt-ridden euro zone economies, most recently Italy and Spain.

Telephone lines were buzzing Sunday, with heads of government, economic ministers and central bankers from Asia to Europe to the United States discussing what might be usefully said before the markets’ opening on Monday. They all seem to agree about one thing, however: the need to defend the idea that the United States remains a reliable credit risk, despite a downgrade of a notch by Standard Poor’s.

But the United States’ problems, including the probability of a double-dip recession, have depressed forecasts for growth.

“There is a real psychosis, but everything is mixed, and that creates the problem,” said Cédric Thellier, an economist at the French investment bank Natixis. “It’s the fear of the markets, so the rates climb and a negative spiral begins.”

It is less clear how Europe can stop the downward spiral. The European Central Bank can buy some Italian and Spanish bonds, but Italy and Spain together are too big to bail out. And Europe — dilatory and incremental, requiring unanimity — does not do shock therapy.

Europe already has historically lower growth than the United States, and the likelihood that it will continue to slow will make the debt crisis worse. For the best way to reduce sovereign debt, everyone agrees, is through economic growth. With growth, there are more jobs and more tax receipts, adding to government revenues, while the debt shrinks as a percentage of a rising gross domestic product.

But recession puts even more pressure on governments trying to contain deficits: tax receipts drop, spending on social benefits increases and the debt rises inexorably, unless governments slash spending further, which further undercuts growth.

That is the “debt trap” that is dragging down Greece, Portugal and other European countries, and it is the cycle that is pushing Spain and especially Italy to the edge of default. Markets now see growth sputtering further, making those large debts larger and harder to finance, and putting at risk a number of banks holding sovereign debt. Italy can manage its debt at a 4 percent interest rate, but it becomes unaffordable when the rate is 6.5 percent on a debt that is 120 percent of gross domestic product.

As much as the American drama and talk of a new recession added to Europe’s ills, Europeans themselves must accept most of the blame. The last in a series of emergency summit meetings, all intended to calm markets and end the crisis, was less than three weeks ago, on July 21. Steps taken then — including an effective though modest restructuring of Greek debt and new powers for the bailout fund, called the European Financial Stability Facility — seemed to calm the markets. But everyone knew that the problem was not really solved, and that the fund’s new powers had to be drafted and ratified by member parliaments, which would take until autumn, and that Spain and Italy remained vulnerable.

But then came the American debt-ceiling crisis and negative growth projections. Leaders are on vacation, trading is thin and speculators have a larger impact.

As stocks fell and the markets went after Italy and Spain, there were other mistakes. José Manuel Barroso, president of the European Commission, made ill-advised comments, as in a letter on Thursday, when he called for a “rapid reassessment of all elements” related to the stability fund, so that it was “equipped with the means for dealing with contagious risk.”

Maïa de la Baume contributed reporting.

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