September 22, 2023

Austerity Reigns Over Euro Zone as Crisis Deepens

Saying that Europe was facing its “harshest test in decades,” Chancellor Angela Merkel of Germany warned on New Year’s Eve that “next year will no doubt be more difficult than 2011” — a marked change in tone from a year ago, when she praised Germans for “mastering the crisis as no other nation.”

Her blunt message was echoed in Italy, France and Greece, the epicenter of the debt crisis, where Prime Minister Lucas Papademos asked for resolve in seeing reforms through, “so that the sacrifices we have made up to now won’t be in vain.”

While the economic picture in the United States has brightened recently with more upbeat employment figures, Europe remains mired in a slump. Most economists are forecasting a recession for 2012, which will heighten the pressure governments and financial institutions across the Continent are seeing.

Adding to the gloomy outlook is the prospect of a downgrade in France’s sterling credit rating, a move that analysts say could happen early in the new year and have wide-ranging consequences on efforts to stabilize Europe’s finances.

Despite criticism from many economists, though, most European governments are sticking to austerity plans, rejecting the Keynesian approach of economic stimulus favored by Washington after the financial crisis in 2008, in a bid to show investors they are serious about fiscal discipline.

This cycle was evident on Friday, when Spain surprised observers by announcing a larger-than-expected budget gap for 2011 even as the new conservative government there laid out plans to increase property and income taxes in 2012.

Indeed, even in the country where the crisis began, Greece, the cycle of spending cuts, tax increases and contraction has not resulted in a course correction, and the same path now lies in store for much larger economies like those of Italy and Spain.

“Every government in Europe with the exception of Germany is bending over backwards to prove to the market that they won’t hesitate to do what it takes,” said Charles Wyplosz, a professor of economics at the Graduate Institute of Geneva. “We’re going straight into a wall with this kind of policy. It’s sheer madness.”

Rather than the austerity measures now being imposed, Mr. Wyplosz said he would like to see governments halt the recent tax increases and spending reductions, and instead cut consumption taxes in a bid to encourage consumer spending. More belt-tightening, he said, increases the likelihood that Europe will see a “lost decade” of economic torpor like Japan faced in the 1990s.

In fact, economists and strategists on both sides of the Atlantic have been steadily ratcheting down their growth expectations for 2012.

“Europe is likely to have a meaningful recession in 2012,” said Tobias Levkovich, Citigroup’s chief equity strategist. While Mr. Levkovich does not see that as a significant threat to the bottom line of most American businesses — he estimates that Europe accounts for about 8.5 percent of sales for the typical company in the Standard Poor’s 500-stock index — the psychological effects on global markets will be magnified if political opposition to austerity increases.

“Powerful street protests could bring it back to the front pages,” he said. “We’ve seen episodic crises in Europe over the past two years. It’s a recurring event.” He expects Europe to remain a key worry for investors worldwide in 2012.

Neville Hill, head of European economics at Credit Suisse, expects gross domestic product in the euro zone to shrink by 0.5 percent in 2012, with the worst of the pain being felt in the first quarter. At the same time, borrowing needs will remain elevated, with Italy and Spain planning to raise more than 100 billion euros in the first quarter alone.

“We shouldn’t underestimate the scale of the challenge the euro zone faces in early 2012,” Mr. Hill said. “Italian and Spanish sovereign borrowers are at the foot of the mountain, rather than the top. The first quarter is a crunch point.”

The Continent’s economic outlook will take center stage on Jan. 9, when Mrs. Merkel and President Nicolas Sarkozy of France will discuss a new fiscal treaty intended to impose stringent budget requirements on European Union nations. Then on Jan. 30, European Union leaders will gather in Brussels to discuss ways to spur growth.

Melissa Eddy contributed reporting.

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Stocks & Bonds: Stocks Slide as Greek Talks Drag On

Financial markets were focused in part on a conference call between Greek officials and the so-called troika of foreign creditors — the International Monetary Fund, the European Commission and the European Central Bank — as well as further meetings among senior officials in Athens struggling to close a budget gap.

But the Greek finance ministry tried to deflate expectations of a speedy result. The conversation lasted around two hours on Monday evening before it was adjourned until Tuesday morning.

In Europe, market indexes fell about 3 percent, the euro declined and the price of safe assets like German bonds rose as investors continued to fret about the possibility of a Greek default. In the United States, stock indexes traded most of the day about 2 percent lower and bond prices rose.

Late Monday, Standard Poor’s announced it was cutting the credit rating of Italy’s sovereign debt, to A from A+, with a negative outlook. S. P. cut its forecast for Italy’s economic growth, a slowdown that would make the country’s fiscal targets difficult to hit, the agency said.

On Wall Street earlier Monday, stocks firmed slightly at the close, with the Standard Poor’s 500-stock index down nearly 1 percent, or 11.92 points, to 1,204.09. The Dow Jones industrial average was down 0.9 percent to 11,401.01, and the Nasdaq briefly reached into positive territory late in the day before closing 0.4 percent lower at 2,612.83.

Financial stocks were hard hit. Bank of America was down more than 3 percent at $6.99. Wells Fargo declined 2.5 percent to $24.33, and Citigroup fell 4.4 percent to $27.71. JPMorgan Chase was 2.8 percent lower at $32.49.

The 10-year Treasury bond rose 29/32 to 101 17/32, sending its yield down to 1.96 percent from 2.06 percent on Friday.

The Federal Reserve’s policy-making committee meets on Tuesday and Wednesday, and investors say they believe the Fed may announce new measures to promote economic growth.

Anthony Valeri, a fixed-income investment strategist for LPL Financial, said he believed that investors had already priced in the expected action, making Monday’s movements in bonds “exclusively risk aversion” caused by the lack of progress in Europe.

Some analysts now fear that given the legal complications in some euro zone countries, and the apparent reluctance of Greece to push ahead on the kind of commitments on spending, wages and privatizations being sought by its partners, Greece might soon default, starting a domino effect on other countries like Portugal, Italy or Spain.

Those fears were compounded after the party of Chancellor Angela Merkel of Germany lost ground in a regional election in Berlin on Sunday, amid voter anger over her handling of the debt crisis.

“The background noise of the Greek debt crisis resembles a continuous alarm tone,” Rainer Guntermann and Peggy Jäger, analysts at Commerzbank, said in a research note. “With few tangible results coming from the finance ministers’ meeting over the weekend and still little official indication that the Greek debt swap may go through, speculation remains high and bonds remain in demand.”

The economic outlook was also downbeat after the secretary-general of the Organization of the Petroleum Exporting Countries, Abdalla Salem el-Badri, said Monday that global demand for oil was rising less than expected, Bloomberg News reported. Oil prices in New York fell more than 2.4 percent to $85.81.

“We have risk aversion, profit taking and a stronger dollar on the back of the ongoing concerns both in Europe and domestically,” said Peter Cardillo, chief market economist for Rockwell Global Capital.

Niki Kitsantonis contributed reporting.

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Economix: Podcast: I.B.M., Diamonds and Paying for Medicare

Like countries, companies rise and fall, and some of them rise again.

I.B.M., which dominated the business of mainframe computers, is perhaps the best contemporary example of such a phoenix-like giant. It celebrated its 100th birthday last week, although as Steve Lohr says in the new Weekend Business podcast, it hasn’t always been clear that I.B.M. would make it to this milestone.

After running into serious trouble in the 1990s, when its mainframe business was threatened by the rise of personal computers, I.B.M. has flourished by moving beyond the mainframe and building a business increasingly based on software and services. On the cover of Sunday Business, he writes about some lessons from I.B.M. that may apply to giant tech companies like Microsoft, Google and Apple.

The Graff diamond business is the focus of another cover article on Sunday, this one by Geraldine Fabrikant, which she discusses on the podcast with David Gillen. Laurence Graff, the business’s founder, specializes in the buying and selling of seriously big diamonds. It is a global enterprise, and like so many other businesses these days, it has been expanding rapidly in China.

In another podcast conversation, N. Gregory Mankiw, the Harvard economist, says that while political campaigns tend to polarize opinions on public issues, Democrats and Republicans actually have a fair amount in common when it comes to health care.

Here’s one example: While Republicans generally oppose taxing the rich to close the budget gap driven largely by soaring health care costs, some prominent members of the G.O.P. favor “means testing” Medicare. In the Economic View column in Sunday Business, Professor Mankiw says this means that wealthier people might be required to pay higher premiums. When you pay an extra $10 in premiums, he asks, is that really different from paying $10 extra in taxes?

In the Strategies column in Sunday Business, I point out that recent financial news has a very familiar ring to it. Headlines from May and June 2010 could just as easily appear today, with absolutely no changes required. (“Concerns Over Europe Flare Again, Pushing U.S. Shares Lower” is but one example.) As Mark Twain is often reputed to have said — although there’s no convincing evidence that he ever actually said it — “History doesn’t repeat itself but it often rhymes.”

The Greek debt crisis, concerns over Federal Reserve policy, and fears that the economy is weakening have all rocked the markets lately. But as I point out in the podcast, the markets absorbed very similar news last year and managed to rise anyway.

You can find specific segments of the podcast at these junctures: I.B.M. (29:55); news roundup, and financial history that rhymes (20:41); diamonds (16:22); health policy (9:33); the week ahead (2:20).

As articles discussed in the podcast are published during the weekend, links will be added to this post.

You can download the program by subscribing from The New York Times’s podcast page or directly from iTunes.

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News Analysis: Pain of British Fiscal Cuts Could Inform U.S. Debate

But in Britain, one year into its own controversial austerity program to plug a gaping fiscal hole, the future is now. And for the moment, the early returns are less than promising.

Retail sales plunged 3.5 percent in March, the sharpest monthly downturn in Britain in 15 years. And a new report by the Center for Economic and Business Research, an independent research group based here, forecasts that real household income will fall by 2 percent this year. That would make Britain’s income squeeze the worst for two consecutive years since the 1930s.

All of which has challenged the view of Britain’s top economic official, George Osborne, that during a time of high deficits and economic weakness, the best approach is to aggressively attack the deficit first, through rapid-fire cuts aimed at the heart of Britain’s welfare state.

Doing so, says Mr. Osborne, the chancellor of the Exchequer, secures the trust of the financial markets, and thereby ensures the low interest rates necessary for long-term economic growth.

That approach, and the question of whether it risks stifling an economic recovery that might itself help narrow the budget gap, lies at the root of the deficit debate in the United States. On one side is the go-slow strategy favored by President Obama. On the other is the more radical path championed by the Republicans. The two camps are no doubt closely watching Britain’s experiment.

On paper, at least, both countries face broadly similar deficit challenges. Britain aims to close a fiscal gap of about 10 percent of gross domestic product. The comparable figure in the United States is 9.5 percent.

In Washington, the Republican proposal recently sketched out by Representative Paul D. Ryan of Wisconsin calls for broad and significant cuts in social spending, including Medicare and Medicaid, and wide-ranging tax cuts.

On Wednesday, President Obama called for a more balanced approach, one that he said would combine some tax increases for the wealthy with selective spending cuts that he said would not break the “basic social contract” of programs like Medicare and Medicaid.

While severe in its approach to spending cuts, the British plan lacks the stark sweep of the Republican proposal. Britons will certainly feel pain at the local government level as money dries up for care of the elderly, youth programs and trash collection. But icons like the National Health Service have largely been spared.

Other notable differences suggest that even Europe’s most conservative party is markedly to the left of the mainstream Republican position in the United States, and in some ways is more liberal than the position Mr. Obama has taken.

To strike a political balance, the coalition government led by Prime Minister David Cameron of the Conservative Party, Mr. Osborne — himself a Conservative — has retained a 50 percent income tax rate on the wealthiest individuals. That is among the highest in Europe, and it imposes more of a burden on the rich than anything Mr. Obama or anyone else in Washington would find politically feasible.

But in Britain, the big worry now is not tax rates. Instead, the fear is that Mr. Osborne’s emphasis on cuts in social spending — which aim to achieve an approximate budget surplus by 2015 and are likely to result in the loss of more than 300,000 government jobs — might tip the economy back into recession.

Already the government has had to slash its growth estimate to 1.7 percent, from 2.4 percent, for this year, as consumer incomes are under pressure from high inflation, weak wage growth and stagnant economic activity.

“My view is that we are in serious danger of a double-dip recession,” said Richard Portes, an economist at the London Business School. “This is going to be a cautionary tale.”

Not all economists agree, of course. And this week’s slight improvement in the unemployment rate, to 7.8 percent from 7.9 percent, suggests it is still too early to declare a second slump inevitable.

No one would disagree with Mr. Portes that a deficit of 10 percent of G.D.P. is unsustainable in the long run. But, with the opposition Labour Party, he argues that moving so quickly in the face of weak economic growth is not justified.

Mr. Osborne proposes to slash the deficit to 1.5 percent by 2015. By comparison, the stark program Mr. Ryan offers does not project reaching that deficit target until 2021.

Besides the difference in speed, a crucial distinction is how each plan would reach its goal. Mr. Osborne’s plan calls for 75 percent of savings to come from spending cuts, and the rest from mostly indirect revenue and tax increases — an increase in the sales tax, for example.

Mr. Ryan, on the other hand, proposes to slash spending by $5.8 trillion but — in contrast to the British approach — would allow most of the spending reductions to be offset by $4.2 trillion in tax cuts, rather than applied to closing the deficit gap. In other words, while Mr. Ryan would lean heavily on spending cuts to close the deficit, he also hopes to spur the sort of supply-side economic growth most often discussed when Ronald Reagan was in the White House.

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