December 2, 2022

Scottish Independence Would Mean Loss of Pound, Osborne Warns

LONDON — With the euro crisis still smoldering, currency unions have a pretty bad name in Europe right now. That raises an awkward question for supporters of independence for Scotland: Could Scots opt to leave Britain but keep their currency, the pound?

On Tuesday, the British chancellor of the Exchequer, George Osborne, said the answer was no and warned that Scotland would enter “unchartered waters” if it voted for independence next year. Drawing lessons from the euro zone’s continuing problems, Mr. Osborne added, London would be unlikely to agree to share the pound sterling with an independent nation that might pursue incompatible economic policies.

The pro-independence Scottish government accused him of scaremongering and published a study suggesting that sterling would continue to circulate in Scotland if the country votes yes to independence in a referendum planned for September 2014.

But the testy exchange illustrates the passions being stoked by the debate over Scotland’s future, and the extent to which economic, legal and constitutional questions remain unanswered.

Unhappily for supporters of Scottish independence, the argument is unfolding against the backdrop of recession or stagnation in the euro zone — one of the worst advertisements imaginable for the notion of a currency union.

Advocates of independence argue that if Scots vote yes next year, it would be in everyone’s interest to agree to an amicable divorce. Pragmatism will prevail and the terms under which Scotland stays within a British currency union will be quietly resolved, they say.

By contrast, opponents portray independence as a leap into the unknown. They point to the euro zone as a warning of what can go wrong if economies of differing sizes pursue divergent economic policies with a common currency.

The lesson of the euro crisis, they say, is that to keep the pound, an independent Scotland would need to adhere to rigid directives on taxation and spending, and to establish with the remainder of Britain joint structures like a banking union.

Yet doing so would negate the very point of independence, which is to bring economic decision-making from London to Edinburgh.

Wading into the controversy, Mr. Osborne argued Tuesday that a vote for independence would force Scots to confront a series of unpalatable options, including setting up their own currency, joining the euro zone, or using sterling as Panama uses the U.S. dollar.

“Let’s be clear,” Mr. Osborne told the BBC. “Abandoning current arrangements would represent a very deep dive indeed into uncharted waters.”

His comments followed the publication of a report by the Treasury in London that also warned that an independent Scotland would “have a narrower economic and fiscal base, and be exposed to a number of volatile sectors such as finance and energy (including North Sea oil and gas).”

A separate report, commissioned by the Scottish government, considered the options of keeping sterling, joining the euro, having a Scottish currency pegged to sterling, or having a currency that was fully flexible.

While it said that Scotland “could choose any of these options and be a successful independent country,” the report recommended retaining sterling as part of a formal monetary union.

The Scottish finance secretary, John Swinney, said the Treasury was “playing with fire” by deploying arguments that implied that Scotland would no longer be able to use sterling if it voted for independence.

Mr. Osborne’s comments and the Treasury report were the latest in a string of veiled warnings from London on the repercussions of Scottish independence.

In February, the British government released the text of a legal opinion holding that Scotland would have to renegotiate membership in the European Union and other international organizations if it voted for independence in a referendum next year.

Last month, the defense secretary, Philip Hammond, warned that an independent Scotland would be hard pressed to defend itself with its share of the Royal Navy: one frigate and a handful of aircraft.

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Portuguese Debt Crisis Brings New Trouble for Euro

In an address to his beleaguered nation on Sunday, Prime Minister Pedro Passos Coelho warned that his government would be forced to cut spending more and that lives “will become more difficult” after a court on Friday struck down some of the austerity measures put in place after a bailout package two years ago.

The renewed tension in Portugal raised the threat of further trouble elsewhere in the euro zone, where ailing members have struggled to rebuild economic growth after enduring wrenching spending cuts.

“The risks in the euro zone have increased markedly over the past six weeks or so,” wrote Nicholas Spiro, managing director of Spiro Sovereign Strategy, a London-based consultancy that assesses risk on sovereign debt.

A critical moment for the latest trouble took place on Friday, when Portugal’s Constitutional Court struck down four of nine contested austerity measures that the government introduced as part of a 2013 budget that included about 5 billion euros, or $6.5 billion, of tax increases and spending cuts. The ruling left the government short about 1.4 billion euros of expected revenue, or more than one-fifth of the 2013 austerity package.

Specifically, the court, which began reviewing the legality of the government’s austerity measures in January, ruled as unconstitutional and discriminatory the government’s plans to cut holiday bonuses for civil servants and pensioners, as well as to reduce sick leave and unemployment benefits.

Since Greece’s bailout in 2010, spikes in the borrowing costs of troubled euro countries have spread from one country to another as investors have tried to anticipate possible problems elsewhere in the currency union.

With that contagion risk in mind, politicians in Spain wasted no time over the weekend trying to distance their country from the latest turmoil in Lisbon.

Esteban González Pons, a senior official of the governing Popular Party, told a gathering of the party on Sunday that “Spain is not in the situation of Portugal.” He added, “If Portugal is in worse shape than Spain, it is because they have not taken the necessary measures that we have taken in our country.”

In May 2011, Portugal became the third euro zone country, after Greece and Ireland, to negotiate an international bailout. Lisbon received 78 billion euros from the International Monetary Fund and European creditors in return for introducing spending cuts and tax increases. Since then, however, Portugal has failed to meet its promised budgetary goals. Its economy has instead continued to sink into one of Europe’s most severe and prolonged recessions, spurring labor strikes and huge street demonstrations.

But Mr. Passos Coelho, in his first public address since the court ruling on Friday, defended the record of his nearly two-year-old government and pledged to do “everything to avoid a second bailout.” He ruled out, however, introducing tax increases.

The prime minister addressed the nation on Sunday after an emergency meeting of his cabinet on Saturday, as well as talks with the Portuguese president, Anibal Cavaco Silva.

Cyprus received a bailout of 10 billion euros from international creditors last month. It may need even more to save its banks, a top German policy maker said on Sunday.

“The situation in Cyprus has stabilized in the last few days,” Jens Weidmann, president of the Bundesbank, the German central bank, told Deutschlandfunk radio. “However, I wouldn’t rule out that the need for liquidity in Cyprus could increase.”

The crisis in Cyprus reflects how urgent it is for the euro zone to establish a means to shut down failed banks without burdening taxpayers or endangering the financial system, Mr. Weidmann said.

“There continues to be a problem with banks that may be too connected and too big to wind down without creating a danger for the financial system,” he said.

Jack Ewing contributed reporting.

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Inside Europe: Germany Appoints Itself Parent to Restive Euro Children

BERLIN — Buoyed by solid finances, roaring exports and low unemployment, Germany increasingly sees itself as the only grown-up in Europe, responsible for bringing wayward children into line to hold the family together.

The children are not enjoying it. Some, like the Cypriots and Greeks and many Italians and Spaniards, are openly resentful of “Mutti,” or Mom, as Berlin officials privately call Chancellor Angela Merkel. Others, like the French, are sulking.

The mood among German politicians and officials is one of economic self-confidence tinged with a sense of parental duty to provide the euro zone with stiff-backed leadership, even if that makes them unpopular in Europe.

“German policy makers have taken to their newfound status with something close to gusto,” Simon Tilford, chief economist at the Center for European Reform, said in the latest edition of that London-based research institution’s bulletin. “They routinely tell other euro zone countries how to run their economies, citing Germany as a model for the currency union as a whole.”

The view from Berlin, set out by a range of policy makers who spoke on condition of anonymity, is that Germany, which has the largest euro economy, has a unique responsibility for the survival of the single currency.

The subtext is that since the Germans are the main bailout contributors and have the most to lose in any collapse of monetary union, they must ensure that their partners cut their deficits, implement reforms and avoid mistakes that could sink the euro.

German confidence in the ability of the European Commission and the European Central Bank to hold to a firm course without yielding to political pressure is limited. Hence Berlin’s insistence on involving the International Monetary Fund in all euro zone financial rescues and its own willingness to play bad cop, even if that means effigies of Ms. Merkel are burned or dressed in Nazi uniforms by protesters.

Some European partners and many economists argue that her recipe of a synchronous fiscal contraction across Europe means deepening recession and rising unemployment and could turn the sovereign debt crisis into a social and political tsunami.

“Prolonging austerity today risks not achieving a reduction in deficits but the certainty of making governments unpopular so that populists will swallow them whole when the time comes,” the French president, François Hollande, warned last week.

“I perfectly accept that European countries have to be rigorous, and France first of all,” he said. “But not austerity, because sticking with austerity would condemn Europe not just to recession but to an explosion.”

In Berlin, such comments elicit a rolling of eyeballs. From Ms. Merkel on down, German leaders feel the French have not fully accepted the depth of the crisis facing Europe and their own economy.

“There is a lack of will, a lack of awareness,” a Francophile German lawmaker said. “What is needed is an emergency U-turn. There is still no clarity over their deficit reduction plans.”

German leaders like to remind visitors that a decade ago their own country was depicted on the cover of The Economist as the “Sick man of Europe” for its rigid labor market, ineffective bureaucracy and low competitiveness.

“We are quite a good example of a success story,” said one senior politician who was in opposition in 2003 when the chancellor then, Gerhard Schröder, a Social Democrat, pushed through a tough overhaul of labor laws and a reduction in unemployment benefits.

The bipartisan celebration last month of Mr. Schröder’s “Agenda 2010” program highlighted a broad agreement that the changes had led to a jobs miracle, even though thousands of people in Germany now work for as little as €3, about $3.85, an hour.

Whatever the outcome of the general election in September, a “grand coalition” also exists of Ms. Merkel’s center-rightists and the Social Democrats, providing a buttress on many policy issues.

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In Cyprus, Feeling the Pain of a Bailout

“The screen says 20 cents, but according to the troika it’s zero,” he said angrily. He was referring to the three international lenders — the European Commission, the European Central Bank and the International Monetary Fund — that had devised the tough new program that requires shareholders, bondholders and depositors to share with European taxpayers the cost of bailing out Cyprus’s two biggest banks and preventing the government from going bankrupt.

“We were a member of the European family,” he continued. “Now it seems they want to push us out of the euro.”

For 20 years, Mr. Agrotis was a stockbroker at Bank of Cyprus, the country’s largest financial institution, and until the shares were recently wiped out, he and his family had much of their wealth tied up in the bank via shares, bonds, retirement funds and — now — frozen deposits. Under terms of the bailout, shareholders’ equity in the bank has been eliminated.

But while Mr. Agrotis and his compatriots may be feeling enormous pain, the broader reaction by investors in Europe and beyond was more or less muted on Thursday, as it has generally been since the Cypriot bailout negotiations burst into chaotic public view the weekend before last. For the broader world of finance, the prevailing view — for now, at least — seems to be that the implosion of this tiny island economy of 20 billion euros ($25.6 billion) need not wreak broader market havoc.

Within Cyprus, though, as the realization sinks in of how badly the national economy might be ravaged by the combination of capital controls on the flow of money out of the country and an indefinite freeze on the bulk of bank deposits, frustration is flaming into full rage. Some establishment figures are now openly discussing the option of leaving the euro currency union and defaulting on the country’s loans.

“Two weeks ago exiting the euro was never mentioned; now it is being widely discussed and a lot of people are considering it,” said Nicholas Papadopoulos, the chairman of the Cypriot Parliament’s finance committee, whom many here see as a future candidate for the presidency. “Europe has destroyed our banking system; now we need to consider all our options.”

Like Mr. Papadopoulos, Mr. Agrotis, who is 56, is no one’s version of an extremist. He is a solid member of Cyprus’s financial establishment, and his ancestors were founders of Cyprus’s most venerable financial institutions.

So convinced was he, even in recent weeks, that Bank of Cyprus was too big to fail that Mr. Agrotis even increased his stake, buying additional shares as the stock hit new low after new low.

Now, like just about everyone on this shellshocked island, he is groping for answers.

Turning from the carnage on his computer screen, Mr. Agrotis took off his glasses and rubbed at eyes bloodshot from the many sleepless nights he had spent poring over economic papers, analysts’ reports and political histories. It was all part of a fruitless search for a theory or precedent that might explain the terrible predicament that had fallen upon him and his countrymen.

On a computer screen, the downward fever chart is the symbol of loss in the world of money, equally understood by the day trader in his living room or the globe-trotting hedge fund investor.

But for Mr. Agrotis and many others in this tiny country of fewer than a million people, Bank of Cyprus’s plunging chart line means much more than the mere evisceration of a lifetime’s savings.

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Poland Affirms Desire to Join Euro Zone

With the tiny island of Cyprus fighting to avoid a messy exit from the euro, it would seem a particularly inauspicious time for Poland, an economic powerhouse of Eastern and Central Europe, to be clamoring to join the currency union.

Yet in what appears to be a calculation that he can convince a skeptical nation to give up the zloty, the Polish prime minister, Donald Tusk, has opened the door to a referendum on joining the euro zone. Analysts warned that the move could backfire amid a growing backlash against the currency stoked by the euro zone’s long-running debt crisis.

“I would be in favor of reaching an agreement to change the Constitution, where there would be a referendum about joining” the euro zone, Mr. Tusk said at a news conference on Tuesday, according to Reuters.

Ever since coming to power in 2007, Mr. Tusk has argued that Poland risks being relegated to the second tier of European decision-making if it remains outside the euro. Analysts said the prime minister was determined to prepare the ground for a national debate on the euro before a possible entry in 2017. Mr. Tusk has indicated that his government would only set a date for euro entry after the next election, which is expected in 2015.

Broaching the referendum issue was also tactical. Mr. Tusk has in the past opposed a demand by Law and Justice, a euro-skeptic opposition party, to hold a popular vote on the euro. Analysts said the prime minister was now raising the possibility of allowing a referendum on the condition that the opposition agree to changes to the Constitution necessary to adopt the currency.

Under the current Constitution, only the zloty can serve as Poland’s currency. Mr. Tusk’s Civic Platform party and its junior coalition partner, the agrarian Polish People’s Party, together lack the two-thirds majority necessary to change the Constitution.

Even though any referendum is likely to be years away, analysts said Mr. Tusk faced an uphill struggle at a time when the crisis in Cyprus had made Poles extremely wary of joining the euro zone and being encumbered with spiraling costs associated with paying for the profligacy of other euro zone nations.

According to a survey conducted this month by TNS Polska, 53 percent of Poles think that adopting the euro would have a negative effect on the country, with 69 percent believing it would adversely affect their households. The margin of error was roughly three percentage points.

Witold Orlowski, a professor of economics at the Warsaw University of Technology Business School and a member of an economic council advising the government, said Mr. Tusk wanted to send a strong signal to Poland’s E.U. partners that the country was determined to be at the heart of the European project, regardless of the challenges ahead.

“Who loves the euro today? Nobody. Of course, there are risks that Poles could vote no in a referendum, and the aim to expand influence could backfire,” he said. But he stressed that for Poland, tugged between Russia and Germany over the centuries, joining the euro was not primarily about economics but about the political imperative of being cemented more firmly to the Union.

But Mr. Orlowski said that not being straitjacketed by the euro’s one-size-fits-all monetary policy had helped Poland to weather the crisis gripping much of the Continent. Those benefits have been somewhat offset by Polish companies’ complaints that being outside the euro zone saddles them with cumbersome and expensive transaction costs.

The Polish economy has proved relatively robust, although it grew by just 2 percent in 2012, down from 4.3 percent in 2011. A flexible exchange rate and tight monetary policy have helped the country to sustain growth while many of its E.U. partners have stagnated or seen their economies shrink.

Among the former communist countries in the Union, Slovakia, Slovenia and Estonia have already adopted the euro, while Latvia has indicated it wants to join as early as 2015. But enthusiasm for the currency is tepid across the former Soviet bloc countries that have yet to join, according to a recent Eurobarometer poll, with 54 percent of people in these countries, which include Hungary, the Czech Republic and Romania, believing the euro would have negative consequences for their countries.

Ryszard Petru, president of the Association of Polish Economists, said it remained doubtful that Law and Justice would agree to the necessary changes in the Constitution, even if that meant securing a referendum on the euro.

But if there were a referendum today, he added, “the no side would win.”

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Britain Takes on Brussels in Fight Over Bank Pay

BRUSSELS — The British finance minister, George Osborne, is expected Tuesday to urge his European Union counterparts to water down proposed rules restricting the size of bankers’ bonuses.

The proposal is a sore point for Britain, which is home to Europe’s main financial hub, and where many in government and the financial industry worry that mandated limit to bonuses could make it harder for London to compete in international banking circles.

A failure by Mr. Osborne to win concessions during a monthly meeting here on Tuesday of the European Union’s 27 finance ministers could fuel disenchantment with the Union among restive members of Britain’s ruling Conservative party. Prime Minister David Cameron has already called for a referendum on Britain’s membership in the Union.

Yet if Mr. Osborne pushes too hard against the bonus cap, his government risks criticism at home for succoring bankers. They are unpopular with large swaths of the British electorate for earning lavish salaries even as a prolonged economic downturn forces many households to scrimp. Many voters also resent the banking industry for receiving a series of giant bailouts paid for by taxpayers.

The meeting Tuesday will follow a Monday evening session by 17 of the same finance ministers, representatives of the euro currency union, who discussed but deferred action on a bailout request by Cyprus. That country is seeking about €17 billion, $22 billion, to shore up government finances and its banks, which were badly exposed to a debt write-down in Greece.

But for Britain, which is not a member of the euro zone, the banker bonus proposal is the main issue. The Cameron government considers the bonus cap “misguided and fear it could impact negatively on London without even combating the excessive risk-taking it was meant to address,” said Simon Tilford, chief economist at the Center for European Reform, a research organization based in London.

“But London is caught between a rock and a hard place, as there’s much popular antipathy toward the bankers,” Mr. Tilford said. The issue of banker remuneration “is pretty toxic stuff Britain,” he added.

Further undermining Britain’s position ahead of the meeting is the result of a referendum over the weekend in Switzerland, also known for its business-friendly climate but where voters approved tighter restrictions on executive compensation. That vote will give shareholders of companies listed in Switzerland a binding say on the overall pay packages for executives and directors.

The bonus cap legislation that concerns the British leadership cleared an important hurdle last week when representatives of E.U. governments and the European Parliament agreed that the coveted bonuses many bankers receive would be capped at no more than their annual salaries, starting next year. Only if a bank’s shareholders approved could a bonus be higher — and even then it would be limited to no more than double the salary.

The rules are drafted so that a banker working in New York for a British bank like Barclays would be subject to the rules, as would a banker in London working for a U.S. bank like Citigroup.

Another reason Mr. Osborne may be hesitant to oppose the bonus rules too vociferously is that they are part of a legislative package that includes something his government favors: tougher rules about how much capital European banks most hold in reserve to protect against losses.

Britain and Mr. Osborne have strongly backed the higher capital requirements as essential for preventing another financial crisis.

In any event, European Union diplomats said ministers were unlikely to formally approve the rules on Tuesday because details still needed to be nailed down. That could still give Britain weeks, or even months, to press for concessions.

There are also questions among some European countries about how strictly to apply parts of the legislation requiring banks to publish detailed information on profits, taxes and subsidies on a country-by-country basis across the globe.

In the case of the separate Cyprus bailout discussions Monday evening, euro zone finance ministers were taking up talks that stalled with the country’s previous, Communist-led government. That government was replaced late last month by a center-right administration, a change that has been welcomed in other European capitals.

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Euro Watch: Data Point to Slow Recovery in Euro Zone

The euro zone economy took a step closer to recovery this month as the rate of decline in the bloc’s private sector eased more than expected, a business survey showed on Thursday.

But in an indication of the hurdles left to scale, Spain’s unemployment surged to 26 percent in the fourth quarter, a record high since measurements began in the 1970s, as a prolonged recession and deep spending cuts left almost 6 million people out of work at the end of last year.

The manufacturing survey published by Markit supports European Central Bank President Mario Draghi’s assertion that the 17-nation currency union is benefiting from “positive contagion” but still hints at an economic contraction in the first quarter of 2013.

Markit’s Flash Composite Eurozone Purchasing Managers’ Index, which surveys around 5,000 companies and is seen as a good growth indicator, jumped to 48.2 from December’s 47.2, beating expectations for a rise to 47.5.

While the index has now held below the 50 mark that separates growth from contraction in all but one of the last 17 months, Markit said the data suggested conditions in the bloc were improving.

“We shouldn’t get too gloomy about those numbers,” Chris Williamson, a data collator at Markit, said. “There is a turning point that took place towards the end of last year and the beginning of this year so things are picking up. Any downturn is looking likely to end in the first half.”

He added, however, that the manufacturing index was “still consistent” with gross domestic product in the 17-country bloc falling at a quarterly rate of about 0.2 percent to 0.3 percent.

The euro zone economy contracted in the second and third quarters of last year, meeting the technical definition of recession, and the downturn is expected to have deepened in the fourth quarter.

Earlier data from Germany, Europe’s largest economy and the bloc’s growth engine, showed its private sector expanded at its fastest pace in a year.

In neighboring France, data from Markit showed that business activity shrank in January at the fastest pace since the trough of the global financial crisis. The preliminary composite purchasing managers’ index, covering activity in the services and manufacturing sectors combined, came out at 42.7 for the month, slumping from 44.6 in December.

Spain’s unemployment rate rose to 26 percent in the fourth quarter of 2012, or 5.97 million people, the National Statistics Institute said on Thursday, up from 25 percent in the previous quarter and more than double the European Union average.

“We haven’t seen the bottom yet and employment will continue falling in the first quarter,” José Luis Martínez, a strategist with Citigroup, said.

Spain sank into its second recession since 2009 at the end of 2011 after a burst housing bubble left millions of low-skilled laborers out of work and sliding private and business sentiment gutted consumer spending and imports.

Efforts by Prime Minister Mariano Rajoy’s government to control one of the euro zone’s largest deficits through billions of euros of spending cuts and tax increases have fueled general malaise, further hampering demand.

Still, Mr. Draghi of the E.C.B. is taking an optimistic view, declaring earlier this month that the euro zone economy would recover later in 2013 and that there was now a “positive contagion” effect in play.

Europe’s top central banker cited falling bond yields, rising stock markets and historically low volatility as evidence for this, causing several forecasters to ditch expectations for an imminent cut in euro zone interest rates.

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DealBook: In Euro Zone, Signs of Progress and Fears of Complacency

Mario Draghi, the president of the European Central Bank, with the German chancellor, Angela Merkel, at an E.U. summit meeting in Brussels in June.Francois Lenoir/ReutersMario Draghi, the president of the European Central Bank, with the German chancellor, Angela Merkel, at a European Union summit meeting in Brussels in June.

PARIS – This may be the year that Europe stops being the ticking time bomb of the global economy.

Ireland is on track to leave international bailout limbo by summer. Talk of Greece leaving the euro is off the table. And financial speculators have generally stopped betting the euro zone will blow up.

But even as the sense of emergency fades, Europe is potentially facing a starker problem.

World Economic Forum in Davos
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For three years, Chancellor Angela Merkel of Germany and a phalanx of policy makers have been working to shore up the euro’s foundations to prevent the currency union from unraveling. As they gather with academics, executives and various experts this week at the World Economic Forum, which opens Wednesday in Davos, Switzerland, the biggest concern is that leaders might become less vigilant now that the heat is off, ushering in a raft of new troubles that could dog the euro for years to come.

“The risk is that complacency takes hold because there is no more urgency in the crisis, and that everything that has been done up until now will be deemed sufficient,” said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. If that happens, he warned, “Europe will turn into the next Japan, and become a permanently depressed or stagnating economic area.”

Ms. Merkel might be forgiven for feeling a sense of vindication. Her deliberate approach to crisis management and refusal to get too far ahead of German public opinion has often frustrated her euro zone peers and foreign allies. And yet, the strategy seems to have worked — so far, at least. Ms. Merkel, who is to speak at Davos on Thursday, and other European leaders have generally done just enough to contain the crisis without alienating taxpayers.

Much of the credit for the current calm in Europe goes to Mario Draghi, the president of the European Central Bank. He appeased financial markets with his promise last summer to do whatever it took to preserve the euro, including buying the government bonds of Spain if necessary to keep a lid on the country’s borrowing costs.

The effect of Mr. Draghi’s promise has been evident: financial markets have stopped driving the borrowing costs of Spain and Italy toward the danger levels that led Ireland, Greece and Portugal to reach for international financial lifelines. Today, few people fear that Europe’s southern countries will break away from the euro union.

Other dire prospects, like Germany and other Northern European countries fleeing the euro union to avoid getting caught in a quagmire, have also dropped off the watch list. If anything, the focus of anxiety is the fiscal situation in the United States, where gridlock in Washington has become just as debilitating for the country’s finances as the euro policy paralysis was for European politicians.

“Some European policy makers who visited the United States recently were delighted to see that because of the fiscal cliff, Europe wasn’t on every channel,” said Kenneth S. Rogoff, a professor of economics at Harvard University. “There is an ecstasy over the fact that they won’t blow apart tomorrow.”

Still, Mr. Rogoff added, Europe must revive economic growth to fully address its problems. “And even if they do, that’s not a long-term solution,” he said. “They need to integrate more fully, or they will fall apart.”

Europe’s political leaders have taken important steps to improve spending discipline among euro members, to provide a financial backstop for troubled euro zone countries and to consolidate supervision of banks. Despite many imperfections, the measures seem to have been enough to convince investors that officials are slowly constructing a more resilient currency union.

“European countries have shown their resolve in making the euro a success and reaffirmed the deep political commitment to work together toward a stronger union,” Vítor Constâncio, the vice president of the European Central Bank, told an audience in Beijing on Jan. 12.

But leaders have yet to address some serious flaws in the structure of the euro zone. For example, they have not solved the problem of how to wind down terminally ill banks without sticking taxpayers with the bill. And they are far away from a deposit insurance fund for Europe, which means the risk of bank runs remains.

“In order to define a turning point, you need a lot of factors besides the stabilization of financial markets,” Mr. Draghi said this month.

But coming events could undermine confidence. Germany will hold national elections in September, which could make Ms. Merkel even more cautious than usual and stall euro zone decision making. Already, her main rivals pulled off an upset in regional elections this weekend in Lower Saxony.

Italian elections are also looming. Mario Monti, the prime minister who has restored Italy’s international credibility and is to speak at Davos on Wednesday, faces a public that is grumpy about a rollback of job protections and other policy overhauls. Silvio Berlusconi, a former Italian prime minister who presided over years of economic standstill, is attempting a populist comeback.

In France, President François Hollande’s pledge to bring the deficit down to 3 percent of gross domestic product this year to adhere to the rules governing euro membership may be challenged if France’s military engagement in Mali and the surrounding region turns into a drawn-out affair.

Across the channel, Prime Minister David Cameron of Britain, who is scheduled to speak at Davos on Thursday morning, has sounded warnings that the country might leave the European Union if changes in its administration are not made. “The danger is that Europe will fail and that the British people will drift toward the exit,” according to prepared text of a speech Mr. Cameron postponed delivering last week because of developments in the hostage crisis in Algeria.

In the meantime, the severe effects of prolonged austerity in several European countries are leaving deep social scars. Tax increases and steep spending cuts have ground many European citizens deeper than ever into hardship, prompting millions to demonstrate in Greece, Italy, Portugal and Spain. Recessionary economies in those countries are expected to get worse before they improve.

In Greece, where austerity has hit the hardest, people are burning trash and wood this winter for lack of money to pay electricity bills, and the government’s efforts to enact structural overhauls needed to turn the economy around and attract foreign investors continue to lag.

And then there is Germany, which itself is being tugged into a slowdown as its cash-poor southern neighbors continue to refrain from buying Audis and other high-priced German goods.

Unemployment in the euro zone continues to climb: the jobless rate in the 17 countries of the bloc hit a record 11.8 percent in November. Youth unemployment has surpassed 50 percent in Spain and Greece, a stratosphere of despair. Thousands of bright young people continue to flee Greece, Ireland, Spain and other countries every month for the booming economies of Australia and Canada.

Portuguese workers are even going to Africa in search of a better future, as the middle class there grows along with improving economic conditions on the southern part of the African continent.

Yet painful adjustments are starting to bear some fruit. Labor costs have come down in countries including Spain and Portugal, helping make their work forces more competitive within the region. In Spain, for instance, where unit labor costs have fallen 4 percent since the onset of the financial crisis in 2008, the labor market is now so alluring that Ford, Renault and Volkswagen have announced plans to expand production there.

In addition, the alarming flight of deposits from banks in Spain has come to a stop.

The euro zone’s problems have proven an opportunity for some countries to remove structural impediments to growth. In France, where Mr. Hollande has promised to make the economy more competitive, labor unions have agreed to a deal to overhaul swaths of the notoriously rigid labor market.

The deal would tame some of the French labor code’s most confounding restrictions, including lengthy hiring and firing procedures and outsize business taxes, as the country tries to lift its competitiveness, curb unemployment and improve the budget.

“Is the worst over? Probably yes,” analysts at Barclays Capital wrote in a recent note to clients.

That will be especially true if leaders and businesses persist in using the crisis as a chance to renew European competitiveness.

While some countries may have made enough economic overhauls to enjoy substantial growth, once the crisis is past, said Nicolas Véron, a senior fellow at Bruegel, a research institute in Brussels, “there are a lot of nuts still to crack.”

Jack Ewing reported from Frankfurt.

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Hedge Funds the Winners if Greek Bailout Arrives

That, more or less, is the bet that a growing number of investors are making now as they load up on Greek government securities that mature in March. That is when Athens hopes to receive a potentially make-or-break bailout payment — a lifeline of as much as 30 billion euros ($38 billion) from the European Union and the International Monetary Fund.

Greece’s new prime minister, Lucas D. Papademos, has warned that without that infusion, his country might well default on its debts, a move that might force Greece to leave the euro currency union.

So even though Greece is already effectively bankrupt, some investors are buying and holding the country’s short-term debt — gambling that, at least in March, Athens will make a point of paying its creditors. The risks those investors run, though, include the possibility that their very actions could help prompt the European Union and I.M.F from handing Greece the March bailout installment that would enable Athens to pay make those debt payments.

With the stakes so high, investors are betting that Europe will go the extra mile to keep Greece afloat. And if the price to do that means that taxpayer funds end up bolstering the returns of a few hardy speculators — then, as far as those investors are concerned, all the better.

Such a trade-off, however, carries ramifications that go well beyond the profit motives of its participants.

For months now, Greece has desperately been trying to persuade its private sector creditors — its bondholders that are not other governments — that it is in their interest to exchange their existing Greek bonds for longer-term securities, while accepting about a 50 percent loss as part of the bargain. The negotiations are known as the private sector involvement, or P.S.I., to employ the widely used shorthand.

A few months ago such a deal looked doable, as the large European banks that held most of this private sector debt, estimated to be about 200 billion euros, recognized that it was probably a better alternative than a default by Greece, which could wipe out their holdings. Moreover, the banks were vulnerable to political pressure from their home countries, where they have a big stake in remaining on good terms with the government and important officials.

But as the talks have dragged on, many of these banks, especially big holders in France and Germany, have sold their holdings. Among the buyers have been London hedge funds and other independent investors that are now questioning why they should accept a loss — if at least in the short run Greece keeps meeting its debt payments.

And as the number of such hedge funds holding Greek debt has grown, so has their ability to forestall a restructuring private sector agreement, thus bringing them closer to being able cash in on their high-stakes gambit.

“They are calculating that Greece will not default before March,” said Mitu Gulati, a sovereign debt expert at the Duke University School of Law and a co-author of a recent paper on the dynamics of the debt restructuring process in Greece.

Mr. Gulati points out that it is these investors that are in many ways behind the delay in executing a private sector involvement. deal. “If you own a bond that matures in March and it is January, then you have every incentive to delay,” he said.

Yet private sector involvement could prove a crucial component of the set of provisions that Greece must meet to receive its next lifeline payment from Europe and the I.M.F.

The private sector loss agreement was expected to lower Greece’s borrowing expenses by as much as 100 billion euros through 2014. The agreement was also supposed to reduce Greece’s ratio of debt to gross domestic product to 120 percent by 2020, down from about 143 percent today. In short, the private sector involvement represents a crucial pillar of the 199 billion euros in financing that Greece will need from outside sources in the next three years.

The German chancellor, Angela Merkel, the most vocal proponent of requiring some sacrifice on the part of private sector lenders, has been the most forceful political leader in pushing for a resolution of the negotiations. Mrs. Merkel met with Christine Lagarde, the managing director of the I.M.F., in Berlin on Tuesday. They issued no statement, but aides said Greek debt was high on the agenda. Ms. Lagarde was then to meet Wednesday with the French president, Nicolas Sarkozy, in Paris.

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Stocks & Bonds: Rating Agency Warnings Bring Down the Markets

PARIS — The market euphoria over last week’s deal by European leaders to shore up the euro currency union succumbed to a darker mood Monday.

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

And the yield, or interest rate, on the 10-year Italian government bond — perhaps the most crucial barometer of the euro crisis — rose to 6.5 percent, heading back into a range that could make it hard for Italy to pay off its staggering debts.

Also pulling down stocks, the chip maker Intel said before trading began in New York that its fourth-quarter revenue would be lower than expected because of supply shortages of hard disk drives, as a result of flood damage to factories in Thailand. Intel now expects fourth-quarter revenue of $13.4 billion to $14 billion, down from a previous forecast of $14.2 billion to $15.2 billion.

Shares of Intel, a component of the Dow, lost 4 percent, to close at $24.

Hank Smith, the chief investment officer for Haverford Trust, said the combination of the Intel announcement and downbeat reassessments of the European summit meeting were too much for investors to digest.

“All of that just breeds uncertainty and I think you are just seeing that reflected in the market,” he said.

Fitch warned Monday that European politicians were taking a “gradualist” approach to creating a true fiscal union among the 17 euro zone member nations — a protracted effort that Fitch said would impose additional economic and financial burdens on the region. “It means the crisis will continue at varying levels of intensity throughout 2012 and probably beyond,” 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.

Cuts in credit ratings for crucial euro zone countries could play havoc with financing European bailout plans.

In United States, the Standard Poor’s 500-stock index was down 1.49 percent, or 18.72 points, to 1,236.47. The Dow Jones industrial average fell 1.34 percent, or 162.87 points, to 12,021.39. The Nasdaq composite index lost 1.31 percent, or 34.59 points, to 2,612.26.

American financial stocks as a group were off more than 3 percent, dragged down by Morgan Stanley’s 6 percent plunge, to $15.38, and Citigroup’s 5 percent drop, to $27.22.

The Treasury’s benchmark 10-year note rose 13/32, to 99 27/32, and the yield fell to 2.02 percent from 2.06 percent late Friday.

In Europe, the Euro Stoxx 50, a barometer of euro zone blue chips, closed down 3.1 percent, while the FTSE 100 in London fell 1.8 percent. The DAX in Frankfurt lost 3.4 percent and the CAC in Paris fell 2.6 percent.

President Nicolas Sarkozy of France acknowledged Monday 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 European deal struck Friday if he were elected president in May, saying the pact would stifle growth.

With markets and rating agencies expressing disappointment with last week’s Brussels 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 central bank took a crucial step to help the biggest European commercial banks by agreeing to provide them with unlimited funds for up to three years.

While that may ease the pressure on the financial system, any further downgrade in the credit rating of European governments could escalate 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.

Liz Alderman reported from Paris, and Christine Hauser from New York. Reporting was contributed by Jack Ewing from Frankfurt, Stephen Castle from Brussels, and David Jolly from Paris.

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