March 26, 2023

Today’s Economist: Inflationphobia, Part III


Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of the forthcoming book “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”

Today’s Economist

Perspectives from expert contributors.

When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. But it soon became apparent that this economic downturn was having an unusually negative effect on the financial sector that threatened to implode in a wave of bankruptcies. The Federal Reserve reacted by doing exactly what it was created to do — be a lender of last resort and prevent systemic bank failures of the sort that caused the Great Depression and made it so long and severe.

As the Fed lent freely to banks and other financial institutions, its balance sheet grew very rapidly. The reserves of the banking system grew concomitantly; reserves are funds that banks have available for immediate lending that theoretically should lead to credit expansion and new investment by businesses, durable goods purchases by households and so on.

Federal Reserve Bank of St. Louis

During the inflation of the 1970s, most economists became convinced that if the Fed adds too much money and credit to the financial system it will inevitably cause prices to rise. Since the increase in the money supply in 2008 and 2009 was unprecedented, many economists reacted fearfully to the Fed’s actions.

Given the order of magnitude of the increase in bank reserves, from virtually nothing to more than $1 trillion almost overnight and now to more than $2 trillion, it was not unreasonable to be concerned about the potential for Zimbabwe-style hyperinflation.

But inflation fell rather than rising. In the five and a half years since the start of the recession, the consumer price index has risen a total of 10.2 percent. In the five and a half years previously, it rose 17.7 percent. That is, the rate of inflation fell by almost half.

Now, I don’t expect all the people who filled The Wall Street Journal’s editorial page in 2008 and 2009 predicting an imminent rise in inflation to offer a mea culpa, but at some point I think the inflationphobes should at least stop saying that hyperinflation is right around the corner.

By 2010, the annual inflation rate was down to 1.5 percent, and the yield on the Treasury’s 10-year bond had fallen to 3.2 percent from 4.3 percent in 2007 – historically, long-term interest rates rise when inflationary expectations rise. In short, there was no evidence that Fed policy was causing inflation to rise.

Yet in November 2010, both Sarah Palin and Paul Ryan warned that inflation was imminent. As they are Republicans, one can assume they were just playing politics, pandering to their constituency. But a week later, a group of professional economists signed an open letter to the Fed chairman, Ben Bernanke, warning that continuation of an easy money policy risked “currency debasement and inflation.”

In 2011, there were still no signs of actual inflation, but the economist Allan Meltzer nevertheless asserted, “Inflation is coming.” He wisely chose not to say when. Writing in The New York Times, the former Fed chairman Paul Volcker made the time-honored slippery-slope argument: a little inflation always leads to higher inflation.

The inflationphobe Niall Ferguson at least acknowledged that official data showed no evidence of inflation but asserted that the data were wrong, that the consumer price index is “a bogus index.” He cited the authority of a Web site called ShadowStats, which, like the Unskewed Polls site that said all polls showing Mitt Romney losing were simply wrong, just arbitrarily adjusts the data to make it conform to its belief that inflation is high, not low.

In 2012, the consumer price index rose just 1.7 percent, but the inflationphobe Amity Shlaes feared that inflation could suddenly appear out of nowhere, apparently because there was hyperinflation in Germany in the 1920s. Representative Ron Paul, Republican of Texas, was so alarmed by the danger of inflation that he suspended his presidential campaign to lead a Congressional hearing on the subject in June.

In October 2012, Rick Santelli of CNBC said “printing money” caused the German hyperinflation and the same thing was happening in the United States. He, like other inflationphobes, saw the rising price of gold as an ominous sign of a takeoff of consumer prices.

Since Mr. Santelli made his prediction, the seasonally adjusted monthly inflation rate has been negative 0.2 percent in November 2012, zero in December and January 2013, 0.7 percent in February, negative 0.2 percent in March, negative 0.4 percent in April, 0.1 percent in May and 0.5 percent in June. Without seasonal adjustments, the annual inflation rate was 1.4 percent over that time.

Many conservatives, including the publisher Steve Forbes and Larry Kudlow of CNBC, always say that gold is the perfect forward indicator of inflationary expectations. I’ve often heard Mr. Forbes say that the price of gold is like a thermometer that continually gives us inflation’s temperature in real time.

Most economists think that’s ridiculous, but insofar as the gold price reflects inflationary expectations, its falling price is impossible to reconcile with Fed policy. The Fed has not decreased the money supply and continues its policy of “quantitative easing,” which means further increases in the money supply.

To inflationphobes, all increases in the money supply are inflationary; indeed, many define the word “inflation” to mean a money supply increase rather than a rise in the price level.

Hard-core inflationphobes like Peter Schiff simply ignore the reality of today’s economy and assert without evidence that it is exactly like the inflationary 1970s. Inflation is due any day now and gold is “on the verge of its biggest rally ever,” he said. On June 18, Mr. Paul said gold could go to “infinity.”

To be sure, some inflationphobes never believed their own rhetoric; they were just trying to score political cheap shots or con unsophisticated investors into buying gold – from which the inflationphobe reaped a commission. But many others were sincere in their belief that higher inflation was inevitable.

Intellectually honest inflationphobes need to explain why they were wrong and stop crying wolf or else it will be reasonable to assume they are simply cranks and crackpots.

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Monte dei Paschi, Venerable Italian Bank, Yields to Change

While the move was considered essential to the survival of the bank, Italy’s third-largest, it was seen as tragic by local residents, who lined up at the shareholder meeting to hurl invective at bank management.

“You did nothing to relaunch the bank,” Gabriele Corradi, a former Monte dei Paschi employee and candidate for the mayoral race in 2011, said to the three top managers of the bank sitting in front of him. The new management team arrived last year, brought in to salvage the operation.

“The bank is still doing badly,” Mr. Corradi said. “It’s still losing money.”

Nonetheless, shareholders on Thursday passed changes in bank bylaws to weaken dominance by the Monte dei Paschi Foundation, a charitable organization. The foundation owns one-third of the shares and for decades lavished bank profits on the community of Siena — until there were no more profits.

Financially devastated and with little choice, the foundation supported Thursday’s change. Previously, no shareholders other than the foundation could exercise votes equal to more than 4 percent of the total. Other changes approved at the meeting will allow more frequent turnover on the board, which had been dominated by the foundation and Sienese political interests.

The problems of Monte dei Paschi, which led to a 4.1 billion euro ($5.4 billion) government bailout late last year, have contributed to a nationwide debate about the powerful and secretive foundations that play a large role in the Italian banking system.

In the 1990s, many Italian banks were privatized and converted to stock corporations, but with local foundations receiving large, sometimes controlling stakes. For Monte dei Paschi, the change was mostly formal because it had always belonged to the city in one way or another.

In recent times, no major decision was taken without the approval of the foundation, which supported the ill-advised acquisition of a rival that stretched bank finances and led to its downfall.

Despite the bank’s overwhelming problems, many citizens of Siena refuse to accept that the bank can no longer serve as all-purpose community benefactor and patron, one that has subsidized the local university and a hospital.

“The abolition of the 4 percent limit simply cancels the Sienese identity of the bank,” Paolo Emilio Falaschi, a lawyer in Siena who in the past has also represented the bank, said at the shareholder meeting, which was held in a local auditorium owned by the bank. “It’s incredible.”

Monte dei Paschi plans to sell 1 billion euros of new shares next year to replenish its capital after a loss of 3.2 billion euros last year. That move will inevitably water down the foundation’s stake in the bank, and perhaps allow another institution or a private equity fund to become the largest shareholder.

Alessandro Profumo, who became chairman of Monte dei Paschi last year in the effort to salvage the bank, said at a news conference that he hoped the change in bank governance would make it easier to sell the new shares. The bank also needs cash to repay the 4.1 billion euro bailout loan, known as a Monti bond for former Prime Minister Mario Monti, who was still in office when the bailout was granted.

“The fact that M.P.S. has a chance to restore itself totally and reimburse the Monti bonds is good news for the country,” Mr. Profumo told reporters after the five-hour shareholder meeting.

There had been little doubt about the outcome of the shareholder vote. Still, dozens of Sienese citizens, wearing linen shirts or short sleeves in the heat, used the event to vent their anger at previous managers, who accumulated huge debts; at the Monte dei Paschi Foundation, for giving up all its power; and at current managers, whom they said they doubted would be able to reverse the bank’s fortunes.

Gaia Pianigiani reported from Siena, Italy, and Jack Ewing from Frankfurt.

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China’s Economic Problems Unlike Those Elsewhere

So many speculators want to move money into China that its biggest problem has been how to keep them out.

In the United States, the European Union and Japan, central banks have struggled with hangovers from past housing bubbles, anemic or no economic growth and even deflation, in the case of Japan. In China, a possible housing bubble is still going strong.

The central bank is keeping interest rates low partly to discourage speculators from pushing even more money into China. But low mortgage interest rates — as little as 5.2 percent, in an economy with consumer price inflation running at 2 to 4 percent a year — have set off further surges in home prices.

After a sharp slowdown last summer, economic growth rebounded vigorously last winter in China. But an unexpected weakening of growth in recent weeks has created a problem that the People’s Bank of China, the central bank, is just starting to acknowledge.

Further monetary stimulus — which might seem to be the answer for a slowing economy — could drive housing prices even higher. Rising home prices are a source of tremendous anxiety across China, because very few young people can afford to buy an apartment when even an 800-square-foot unit can cost 35 times a young college graduate’s first-year salary.

China’s banking system has been awash with credit for years, with one result being that financing has been provided for even seemingly uneconomical projects like skyscrapers in third-tier cities or high-speed train lines to economically depressed areas. But the government’s response to economic weakness in recent weeks has been to encourage the state-controlled banking system to engage in another round of heavy lending at low rates.

“It’s very disappointing; this splurge in credit creation has taken off again,” said George Magnus, a senior economic adviser to UBS. “What you need to put this genie back in the bottle is quite a stern application of oversight and supervision.”

In its recent quarterly report on monetary policy, the People’s Bank of China warned against being “blindly optimistic” that inflation was under control, given continued brisk growth in lending and the money supply. The central bank has allowed lending to race ahead while pursuing an unexpected approach to trying to limit inflation: letting the renminbi appreciate gradually against the dollar, which makes imports less expensive and helps them compete on price with domestic goods.

The renminbi has climbed 1.3 percent against the dollar, mostly since the start of April.

Chinese central bankers face another puzzle that their Western and Japanese counterparts have not had to worry about: mysterious mass deaths of pigs and their effect on inflation.

Video of thousands of dead pigs floating in a river near Shanghai in March temporarily made pork much less appetizing for tens of millions of Chinese. The occurrence of a new form of bird flu in the same area several weeks later turned many people away from chicken.

Because meat makes up one of the largest slices of household spending, the abrupt national experiment in something approaching vegetarianism — beef and lamb are much less popular in China — has sharply slowed consumer price inflation, to 2.4 percent in April.

That has made it hard for the central bank to argue that inflation is a problem. But no one knows — not veterinarians, not the World Health Organization and certainly not the central bank — how long livestock will continue to be infected, much less how much longer Chinese families will be put off chicken or pork.

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India Lowers Benchmark Interest Rate to Fuel Growth

MUMBAI — India’s central bank lowered its key policy rate on Tuesday, as expected, for the first time in nine months to support an economy that is poised for its slowest growth in a decade, but signaled there was less room for aggressive cuts because of concerns over inflation.

The Reserve Bank of India cut its benchmark rate by 0.25 of a percentage point to 7.75 percent, in line with a Reuters poll this month.

The central bank unexpectedly also reduced the cash reserve ratio, the share of deposits banks must keep with the central bank, by 0.25 of a percentage point to 4 percent, which will pump an additional 180 billion rupees, or $3.3 billion, into the banking system.

India’s headline inflation rate moderated to a three-year low of 7.18 percent in December, and the central bank said there was likelihood that inflation would remain around current levels heading into the 2013-14 fiscal year, which starts in April.

“This provides space, albeit limited, for monetary policy to give greater emphasis to growth risks,” the central bank said in its quarterly monetary policy review.

Bond and stock markets were largely unmoved as dealers had already priced in a quarter-percentage-point rate cut. The 10-year bond yield was flat at about 7.87 percent. India’s main NSE index was also flat, with the bank sub-index up 0.2 percent, paring initial stronger gains.

The Indian rupee strengthened to 53.79 to the dollar from about 53.84 before the decision.

“RBI has not abandoned its cautious stance, stressing on the ‘calibrated and limited’ nature of rate support,” said Radhika Rao, an economist at Forecast Pte in Singapore. “The scale of rate cuts is closely tied to the government’s sustained efforts to correct the twin imbalances and moderating inflation trajectory.”

The central bank, however, reiterated its concerns over a bloated fiscal and current account deficits, adding that its pro-growth stance would be conditioned by the management of the risks posed by them.

“Financing the CAD with increasingly risky and volatile flows increases the economy’s vulnerability to sudden shifts in risk appetite and liquidity preference, potentially threatening macroeconomic and exchange rate stability,” the bank said, referring to the current account deficit.

Since a 0.5 percentage point cut in April, the central bank had kept interest rates on hold as inflation stayed stubbornly high, ignoring repeated calls from the government for a cut.

Having grown at near-double-digit pace before the Lehman Brothers crisis, the economy has suffered a rapid deceleration.

The central bank cut its G.D.P. growth forecast for Asia’s third-largest economy to 5.5 percent for the current fiscal year, from 5.8 percent previously, and lowered its projection for headline inflation in March to 6.8 percent from 7.5 percent earlier.

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Renault to Build Auto Assembly Plant in Algeria

PARIS — Renault will sign a deal with Algeria on Wednesday to build an assembly plant near the city of Oran, giving the French automaker wider access to one of the world’s hottest car markets and a chance to further diversify beyond Europe.

The automaker will sign the pact, three years in the making, on the first day of a state visit by President François Hollande, Rochelle Chimenes, a Renault spokeswoman, said Tuesday. That will pave the way for the construction of a factory to build Renault and Dacia model cars to service a market that grew by 50 percent in the year through October.

Mr. Hollande is embarking on a two-day visit to smooth France’s tricky relations with Algeria and and expand economic ties with the petroleum-rich north African country of 37 million people. Algeria, administered as a department of France during the colonial era, won its independence in 1962 after a bloody war. France is nonetheless Algeria’s largest trading partner.

Mr. Hollande, accompanied by a legion of French government and business leaders, is scheduled to meet with his Algerian counterpart, Abdelaziz Bouteflika, and to address a joint session of the country’s Parliament.

Algeria — the second-largest car market in Africa after South Africa — is eager to reduce its dependence on the petroleum sector, which accounts for about one third of its economy. But restrictions on foreign investment enacted after the financial crisis, along with a failure to modernize the banking system, continue to hold back Algeria’s economic development, according to the U.S. State Department.

Oliver Masetti, an economist at Deutsche Bank, estimates that, depending on the oil price, the Algerian economy will grow by up to 2.6 percent this year and as much as 3.4 percent in 2013 — modest, by developing world standards.

Renault controls about 27 percent of the Algerian market, and its sales have soared about 57 percent there this year. Its Clio supermini car is the country’s best-selling model. Renault this year opened a factory in Tangier, Morocco, to make cars for export to the European and Mediterranean markets.

Renault is better diversified on a global basis than its ailing French rival, PSA Peugeot Citroën, partly thanks to its alliance with Nissan Motor. But it is looking for growth outside the European Union, which is gripped by recession and faces the possibility that budget austerity will mean years of stagnation.

La Tribune, a French financial daily newspaper, reported Tuesday that Mr. Hollande would raise with his hosts the possibility that the Algerian government might dip into its $200 billion of foreign reserves to take a stake in Peugeot, which is undergoing a painful restructuring to stay afloat. Any such request will likely fall on deaf ears, the newspaper cited an unidentified Algerian official as saying.

Cécile Damide, a spokeswoman for PSA Peugeot Citroën, declined to comment.

Sales of new cars in the 27-nation region fell 7.6 percent in the first 11 months of 2012 from the same period a year earlier, according to the European Automobile Manufacturers’ Association. Sales declined in every major market except Britain, bringing absolute sales to a level last seen in 1993.

The Algerian government will hold 51 percent of the new factory, with Renault holding the rest, the French daily newspaper Le Figaro reported Tuesday, without identifying its source. The company declined to comment on the details, but such an arrangement would be consistent with the standard foreign investment contract in Algeria. Le Figaro also said the plant would begin operation in 2014 with annual production of about 25,000 vehicles, which could grow to 75,000.

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DealBook: Geithner Urges an Overhaul of Rules on Money Market Funds

Treasury Secretary Timothy F. Geithner on Thursday urged the regulatory team that he leads to push ahead with new rules aimed at America’s money market funds, which manage $2.6 trillion.

In a letter to the Financial Stability Oversight Council, a special committee of senior regulators set up after the 2008 financial crisis, Mr. Geithner said the changes were “essential for financial stability.”

The Securities and Exchange Commission, which is the primary regulator for money market funds, had proposed the main changes favored by Mr. Geithner in his letter.

But the commission dropped its attempt at a money market fund overhaul last month after it become clear that a majority of its commissioners were not going to vote for the measures. Large mutual fund companies fiercely opposed the reforms, saying they were unnecessary and could harm a type of investment fund that had proved to be popular.

“You can be sure that the firms on the receiving end won’t take this passively,” said Jay G. Baris, a lawyer at Morrison Foerster, which represents money market funds.

During the 2008 crisis, investors fled money market funds in droves, which worsened the credit freeze that gripped the banking system. Money funds then received a big bailout from the Treasury and the Federal Reserve.

Before the passage of the Dodd-Frank Act, attempts to make changes to the money market fund industry would most likely have died after the commission dropped them. But the Financial Stability Oversight Council, set up by the Dodd-Frank financial overhaul legislation, can choose to take over from the commission.

Mr. Geithner lays out a number of ways in which the council, which meets Friday, can act.

In his letter, he urges the council to gather public comments on a range of reforms and then make a final overhaul recommendation to the Securities and Exchange Commission. The commission would be required to adopt those changes, or explain why it did not. Mr. Geithner said the council’s staff was already working on recommendations and he hoped they would be considered at the council’s November meeting.

The recommendation would include two changes supported by the commission. One would require money market funds to hold loss buffers. The other would end the money market funds’ practice of valuing investors’ shares at $1 even when the funds’ assets should reflect a value slightly below $1.

Mr. Geithner said in his letter that, while the S.E.C. is best positioned to regulate money market funds, the Financial Stability Oversight Council could move forward without waiting for the commission. The council, he wrote, could designate certain money market fund entities as systemically important and subject those firms to regulation by the Federal Reserve, which could then impose an overhaul.

Mr. Baris, the lawyer, said that a designating a money market fund as systemically important could make it hard for it to stay in business. “Who would want to invest in a fund that has been designated by the federal government in this manner?” he said. “It will drive investors away.” Mr. Baris said he believed that Mr. Geithner might face resistance on the council if any new rules single out specific money market funds.

In addition, the council could designate money market fund activities as critical to the working of the financial system’s plumbing. That would allow regulators to impose heightened risk management standards on money market funds.

Mr. Geithner wrote that without the changes, “our financial system will remain vulnerable to runs and instability.”

If the council acts, the mutual fund industry will almost certainly fight back. The industry’s lawyers will most likely contest the council’s interpretation of Dodd-Frank and perhaps even the council’s authority to act.

Geithner Letter to FSOC

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DealBook: A Third Option for Regulators in the Money Market Fund Fight

Timothy F. Geithner, the Treasury secretary, with Mary L. Schapiro, the Securities and Exchange Commission chairwoman.Alex Wong/Getty ImagesTimothy F. Geithner, the Treasury secretary, with Mary L. Schapiro, the Securities and Exchange Commission chairwoman.

The biggest battles are sometimes decided by the most arcane tactics.

That could turn out to be the case in a fierce fight between the mutual fund industry and top financial regulators.

At issue is whether to impose more regulations on the nation’s $2.6 trillion of money market funds.

Regulators think the funds pose a risk to the financial system. In the 2008 financial crisis, investors fled the funds in droves, which worsened the credit freeze that gripped the banking system. Money funds then received a big bailout.

In a bid to lessen the chances of such events reoccurring, the Securities and Exchange Commission proposed measures, including requiring the money funds to hold a capital buffer against losses. But the commission dropped the reforms last week, after it became clear that a majority of its commissioners weren’t going to vote for the reforms. This was a big win for the mutual fund industry, which says some reforms made in 2010 are sufficient. The industry also argues the latest reforms would needlessly damage a popular investment product.

The regulators, however, may be able to effectively override the S.E.C. They can do that by involving the Financial Stability Oversight Council, a special committee of senior regulators set up after the crisis by the Dodd-Frank financial overhaul legislation.

The council’s job is to spot big risks in the financial system and take action to address them, even if it means acting itself or pressuring individual regulators.

After the money fund reforms were blocked at the S.E.C., much speculation began on how the council might act. At first, there appeared to be two separate paths laid out in Dodd-Frank. But both had drawbacks for the regulators.

Now, a third option may exist. And it appears to get around the headaches involved in the other two.

The council, which is chaired by the Treasury secretary, Timothy F. Geithner, and has publicly backed the S.E.C.’s money fund reforms, is scheduled to meet toward the end of September.

Initially, one of the council’s perceived options was to designate fund companies or individual money funds as systemically significant, and give them to the Federal Reserve to regulate. The problem: This approach would remove money fund regulation from the S.E.C., a potentially wrenching move that could undermine the standing of that agency. This option could also lead to a two-tier, unevenly regulated money fund sector, where larger funds might come under Fed oversight and smaller ones wouldn’t.

The second option was to declare the general activity of money market funds as risky to the system. But if this route were taken, Dodd-Frank lays out a series of steps that puts the issue back to the S.E.C., where the majority of commissioners may still oppose reform. If that happened, Dodd-Frank then appears to move the issue to Congress, but it doesn’t define how the stalemate would be broken.

Enter option three.

With this, the council would use a part of Dodd-Frank, called Title VIII, that addresses regulation of the plumbing of the financial system. It refers to “utility” activities like organizing financial payments and processing transactions.

Using Title VIII, the council could take a two-step approach. It could designate a single activity or feature of money funds as a systemically important utility function. Next, it could then require reforms to buttress that function.

For instance, money funds have a special feature called a fixed net asset value, which allows them to say each share in a fund is worth $1 when in reality it may be worth slightly less. Regulators fear the stable net asset value could mask the risks of money funds from investors, who tend to use the funds like bank accounts.

The council could designate the stable net asset value as systemic and require that the funds hold capital.

The big apparent advantage for the regulators is that it avoids the pitfalls of the other options. It would keep money fund regulation at the S.E.C. And, unlike option two, this part of Dodd-Frank doesn’t map out steps that could lead to stalemate. Instead, it allows the council to require the S.E.C. to introduce the sort of reforms that the council favors.

But there is a weakness with this approach. While this part of Dodd-Frank does give the council a lot of leeway in determining a systemically important activity, opponents of reform may argue that money funds simply aren’t part of the payment functions of the financial system, which is what title VIII was written for.

“On the face of it, this is not what Title VIII was designed to regulate,” said Jay G. Baris, a lawyer at Morrison Foerster. “To me, it’s a last resort.”

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After Brief Calm, Europe Again Worries Over Debt

The euro currency fell to its lowest level in more than 15 months on Thursday, below $1.28. And France had to pay slightly more than in recent auctions to find buyers for its government bonds that mature in 10 years. Those were among fresh signs that the late-December market calm that fell over Europe might not last much longer.

Next week, investors will probably force the Italian and Spanish governments to pay higher borrowing costs in exchange for billions of euros in new loans that the countries must obtain to pay down a mountain of other bonds whose payments will come due shortly.

In trading Thursday, Italy’s existing 10-year bonds crept back up above the 7 percent mark — to 7.09 percent — which is considered an unsustainably high borrowing rate for the Italian government. Spain’s 10-year bonds were also higher Thursday, at 5.64 percent, compared with just over 5 percent at the end of December.

Stocks in Europe were also down broadly Thursday, led by bank shares.

“It’s indicative of the sense that things aren’t great in Europe,” said Jacob Funk Kirkegaard, an economist at the Peterson Institute for International Economics in Washington. “The panic that the euro was bound to collapse in the next six months has subsided, but that doesn’t mean that Europe is in any way out of the line of fire.”

After nearly three years of halting political response to Europe’s crisis, financial markets appear to be paying far closer attention these days to the vigorous efforts by the European Central Bank to prevent the debt problems of most euro zone governments from damaging Europe’s weakened banking system. A new program of low-interest loans to commercial banks that the central bank started in December had contributed to that sense of year-end calm.

But the calm has already been shattered. Trading in shares of Italy’s biggest bank, UniCredit, was suspended Thursday in Milan after the stock lost nearly one-quarter of its value. The stock plunged on concerns that UniCredit might have trouble raising the billions of euros in new capital that regulators are demanding to insulate the bank from any worsening of the European crisis.

Spanish bank stocks were also sharply lower after Luis de Guindos, the new Spanish finance minister, was quoted in a Financial Times interview Thursday saying that Spain’s banks might need to set aside an additional 50 billion euros ($64 billion) to clean up their balance sheets.

And with much of Europe seen as heading into regional recession this year, it is not clear whether the European Central Bank can continue to put out all the fires that keep breaking out across the Continent.

What is more, a new crisis is emerging outside the euro zone, where the European Central Bank does not operate.

Hungary, a member of the European Union but not one of the 17 countries in the euro currency union, was teetering on the brink of collapse Wednesday amid fears that its center-right government was alienating the International Monetary Fund and the European Commission in Brussels at a time when Budapest was hoping for their help.

Beset by deteriorating finances and a confrontation between the government and the Hungarian central bank, Budapest’s credit rating was recently cut to junk by two ratings companies. The prime minister, Viktor Orban, recently risked having a monetary fund rescue line cut off when he introduced laws to strip the Hungarian central bank of its political independence.

The developments have unnerved investors, who shied away from buying some of the bonds the Hungarian government offered in a sale Thursday, and forced the nation to pay a higher interest rate to compensate for the risk. Hungary sold only 35 billion forints ($140 million) of the 45 billion forints in one-year Treasury bills it offered Thursday, with the average yield rising sharply to 9.96 percent.

But the main focus of attention remains the immediate problems of the euro zone — especially the ability of Italy, Spain and even France to continue shouldering their rising borrowing costs. When the European Central Bank last month began providing commercial banks with cheap loans for up to three years, one expected the consequence of that action to be that some of the money made available would end up being used to buy government bonds.

That bond buying is expected to help reduce the governments’ borrowing costs, at least for terms shorter than three years. But investors are wary of how Europe’s big economies might fare more than three years from now — which is one reason they are forcing France, Italy, Spain and others to pay higher borrowing costs on 10-year government bonds.

David Jolly contributed reporting.

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Celebration Succumbs to Concern for Euro Zone

In European trading and on Wall Street, shares fell sharply after Moody’s Investors Service and the Fitch Ratings warned that European efforts to protect the common currency had not resolved the immediate dangers of a significant economic downturn and troubles in the banking system.

By taking a “gradualist” approach to forging a true fiscal union among the 17 euro zone members, politicians were imposing additional economic and financial costs on the region, Fitch warned. “It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond, until the region is able to sustain broad economic recovery,” the agency said.

Moody’s said it was putting the sovereign ratings of European Union countries on review for a possible downgrade in the coming months. Standard Poor’s issued a similar warning last week, saying it could lower the sterling credit ratings of Germany and France and cut other countries’ credit scores as Europe headed into a probable recession next year.

On Monday, President Nicolas Sarkozy of France acknowledged that a loss of the nation’s triple-A rating could come soon, but said it would not pose an “insurmountable” difficulty. Mr. Sarkozy has made it a priority of his coming presidential campaign to keep the country’s top credit rating, and repeated a pledge to reduce the nation’s debt and deficit without cutting wages and pensions.

Mr. Sarkozy’s rival, the Socialist candidate François Hollande, said Monday that he would try to renegotiate the terms of the Europewide deal struck Friday if he were elected president in May, saying the pact would stifle growth.

With markets and rating agencies expressing mild disappointment with the deal, the spotlight returned to the European Central Bank, the only institution with overall responsibility for maintaining the health and integrity of the euro.

Amid last week’s political theater, the E.C.B. took a crucial step to help prevent the biggest European banks from succumbing to an increasingly volatile economic and market environment by agreeing to provide banks with unlimited funds for up to three years.

“That reduces the possibility of a Lehman moment quite substantially,” Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington, said during a conference call on the crisis. “It says to every bank in the euro area that even if you’re shut out of the market, we are the lender of last resort and provide you with necessary funding.”

While that may ease the pressure on the financial system, any further downgrade in the credit rating of European governments could raise the fever of the crisis by making it more expensive for the weakest countries to service their debts. It could also make it more difficult for banks in Italy, Spain and even France to get credit from other banks, causing a potential pullback in lending to consumers and businesses at a time when economic growth is already being squeezed.

In the lightning-fast world of financial markets, the efforts by Mr. Sarkozy, Chancellor Angela Merkel of Germany and other euro zone leaders appear to be moving too slowly to satisfy the demands of investors.

While the summit meeting in Brussels on Thursday and Friday marked a major step toward greater fiscal union among the core countries, the architecture will take months, even years, to construct.

In the meantime, the decision to embrace significant new spending cuts and tax increases across much of Europe at a time of economic weakness is expected to undermine growth in the immediate future, analysts said.

Carl B. Weinberg, the chief economist at High Frequency Economics, said some European banks that were already selling assets to keep enough money on hand were also curbing lending.

“We are now moving off the charts in terms of normal procedures, and moving into a grim time for European banks,” Mr. Weinberg said. “This is not a good time to be thinking of European bank shares because a contraction of credit has already begun and will get worse.”

Indeed, despite the political will to bring the euro zone under more centralized management, ratings agencies, banks and businesses are increasingly considering the possibility that countries could default, or leave the currency union.

Many governments and investors are hoping the E.C.B. will ride to the rescue by buying the bonds of troubled governments in Italy and Spain, in a bid to keep their borrowing costs from rising to levels that forced Greece, Ireland and Portugal to take international bailouts.

But Germany has opposed that move as being outside the bank’s mandate, and the E.C.B. president, Mario Draghi, made clear last week that the bank remained loath to take such steps.

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Moody’s Warns of Possible Downgrade to Some Euro Zone Economies

The announcement follows a similar warning last week by the Standard Poor’s ratings agency, which said it could lower the credit ratings of Germany and France and cut other countries’ credit scores as a possible recession settles over the Continent and a crisis of confidence in Europe’s political management puts pressure on its banks.

S.P. is expected to announce the results of its review as soon as this week. The agency said last week that it hoped to complete its assessment “as soon as possible” after the summit.

Any downgrade in the credit rating of Europe’s governments would raise the fever of the crisis by making it more expensive for the countries to service their debts. It would make it more difficult for banks in those countries to get credit from other banks, causing a possible pullback in lending to consumers and businesses at a time when economic growth is already being squeezed.

Euro zone leaders agreed Friday to sign an intergovernmental treaty that would require them to enforce stricter fiscal discipline in their budgets, a move that addresses the euro area’s governance issues but does little to resolve current problems in the banking system and in the region’s teetering economies.

The leaders also agreed to add €200 billion, or $268 billion, to a bailout fund designed to keep the crisis from spreading.

Gary Jenkins, a strategist at Evolution Securities in London, said Monday that “high levels of debt, the rising risk of a recession and tightening credit conditions are all still with us after the summit and there was little in the way of real action to deal with any of them.”

Financial markets welcomed the plan Friday, pushing stock prices up on the Continent and on Wall Street, and Asian markets opened higher Monday. But a bigger test comes this week as investors digest whether the series agreements by the Europeans still leaves Europe vulnerable to a variety of shocks.

European markets opened lower, with major indexes trading down between 1.5 percent and 2 percent at mid-morning.

Moody’s said Monday that one of its biggest concerns was the widening growth gap between the euro zone’s weaker southern countries and their wealthier neighbors to the north.

Leaders agreed Friday to hew to a German prescription for greater austerity across the entire euro region in order to improve countries’ widening deficits and heavier debt loads. But credit markets remain volatile, and the longer that persists, the greater the risk it will weigh on governments’ efforts to repair their finances, the agency said.

“The crisis is in a critical and volatile stage, with sovereign and bank debt markets prone to acute dislocation which policymakers will find increasingly hard to contain,” the agency warned.

“Moreover, the longer the incremental approach to policy persists, the greater the likelihood of more severe scenarios, including those involving multiple defaults by euro area countries and those additionally involving exits from the euro area,” Moody’s said.

Despite clear political will to bring the euro zone under more centralized management, ratings agencies, banks and businesses are increasingly considering the possibility that countries could default or exit the currency union. Such uncertainty has caused banks worldwide to pull back on the loans they used to make freely to their counterparts in Europe. As a result, a growing number of European financial institutions have turned to the European Central Bank to obtain funding for their operations in recent weeks.

The E.C.B. last week made it easier for banks to continue such borrowing, by taking the unusual step of easing the terms and conditions of the credit it offers. But amid staunch opposition from Germany, Mario Draghi, the E.C.B. president, has not signaled that the central bank would act more aggressively to keep the borrowing costs of countries like Italy from rising by buying more of those governments’ bonds. Investors say that without such help, troubled countries would face greater resistance from financial markets.

That, in turn, would send further ripples through big European banks that hold large amounts of these governments’ bonds. Last week, the European Banking Authority said euro zone banks — including Commerzbank and Deutsche Bank of Germany — needed to raise a total of €115 billion of fresh capital by next summer to insure themselves against a worsening of the storm.

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