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In Euro Zone, Debt Pressure Tightens Grip

With August fast approaching, Europe’s summer just got a lot less relaxing.

European Union Flag
Jonathan Kitchen | Image Bank | Getty Images
European Union Flag

Signs that cracks in the euro zone are widening sent markets on the Continent down sharply on Monday, as doubts grew about Greece’s ability to make good on its debt payments and Spain’s economy — the region’s fourth largest — was straining under the pressure of the government’s austerity measures.

Additionally, in a blow to the euro zone’s most stable countries, Moody’s Investors Service late Monday cut the outlook for its AAA credit ratings for Germany, the Netherlands and Luxembourg to “negative” from “stable.” The agency cited the fallout from an increased likelihood of a Greek exit from the euro and possible greater costs for supporting countries like Spain and Italy.

In recent years, financial turmoil has tended to materialize in August, when the trading volumes in stocks, bonds and currencies shrink, making it easier for sellers — no matter their size — to move markets as they head to the hills, or the beach, for a long holiday.

All signs again point to a nerve-racking end of summer.

Greece must pay 3.1 billion euros ($3.75 billion) in bond payments to the European Central Banknext month, and will be in default if Europe does not somehow provide it with the cash. In Spain, soaring bond yields on Monday had government officials pushing hard for help from central European authorities as well.

“Europe has become incapacitated,” said Alessandro Leipold, a former deputy director at the International Monetary Fund .

The immediate concern is that if Greece does not present an acceptable budget-cutting plan — as it has promised to do as a condition of its bailout — Europe will not give it the money it needs to make interest payments. That in turn could lead to a default on its debt, causing financial contagion as investors worry about what will happen to bigger economies like Spain’s and Italy’s.

European leaders have pulled the region back from the brink of collapse time and again. But many investors, economists, government officials and international monetary officials are worried that finding a solution keeps getting tougher now that Europe’s debt crisis is in its third year.

“Everyone is looking for an easy way out, but there isn’t one,” said Stephen Jen, a former economist at the monetary fund who runs a London-based hedge fund.

German officials on Monday continued to sow doubt about Greece’s future in the euro monetary union. The German finance minister, Wolfgang Schäuble, said in an interview published Monday in the German tabloid Bild that Greece must renew its efforts to comply with the terms of its bailout.

In Madrid, the Spanish economy minister, Luis de Guindos, insisted that his nation would not seek a government bailout, having already requested up to 100 billion euros in rescue money for its troubled banks. Just last Friday, euro zone finance ministers agreed to release an initial 30 billion euros of that loan, though that has evidently not been enough to appease the markets.

Bond Yields At Danger Levels

Spain’s interest rate on 10-year government debt spiked to 7.51 percent, its highest level since the euro currency was established in 1999, before ending Monday at 7.43 — still well above the 7 percent level that many analysts fear could eventually shut Spain out of public markets and force it to seek a bailout.

Italy’s 10-year bond yield climbed to a six-month high Monday, to 6.35, as it wrestled with its own debt problems and the risk of an economic collapse in its autonomous region of Sicily.

Spanish and Italian stocks hit new lows for the year, down about 30 percent and 27 percent, with banks and conglomerates leading the way. And while the government in those two countries took steps to stop the slide by barring investors from making negative bets by selling stock short, there was little to be done to halt the persistent decline of the euro; the currency settled at a low of 1.21 to the dollar — down 6 percent for the year.

Greece has survived for nearly three years on money doled out by European taxpayers. But among the Greek people, the new prime minister, Antonis Samaras, is under pressure to make good on election pledges to soften some of the harshest austerity terms linked to Greece’s loans.

The country is burdened by debt that is 165 percent of overall economic output and an economy set to shrink by 7 percent this year. Now the new government is proposing to cut 11 billion euros in spending without laying off any of its 150,000 or so public sector workers — a trick that most economists see as impossible.

“I don’t see how you do that without firing people,” said Miranda Xafa, a former investment banker and independent consultant based in Athens.

Officials from the troika overseeing the Greek bailout — the International Monetary Fund, the European Central Bank and the European Commission in Brussels — say privately that they doubt the country will be able to meet its official target of bringing its debt down to 120 percent of economic output by 2020.

Greece must make the 3.1 billion euros in bond payments to the central bank on Aug. 20.

While analysts believe that Europe will figure out a way to get Greece the cash to make good on this obligation, they are not so sure about what will happen after that.

According to one official from the group, it is near certain that the official target that underpinned the debt restructuring agreement last spring will need to be revised. That in turn would force Europe to come up with more bailout money because the monetary fund was not expected to volunteer more funds.

The escalation of the crisis has renewed calls, including from Spanish government authorities, for the European Central Bank to offer its own support via a program that would aggressively buy Spanish and Italian bonds. The thinking is that would drive down yields and make the debt attractive to investors again.

However, some analysts believe that holding out for such an intervention is futile. Germany, these people say, will not budge from its core belief that all the weak European nations — from those that have been bailed out like Greece to those on the verge of a bailout like Spain — must bring down their deficits and debts to manageable levels if they intend to stay in the zone.

“In the end, I believe the euro zone will break up, it is just a question of how many more crises we will live through before that happens,” said Douglas McWilliams, the chief executive of CEBR, a London-based economic forecaster.

Mr. McWilliams believes that a Greek exit, if it comes, would prompt investors to question the membership of other countries with competitiveness problems like Spain and Italy. And he disputes the view, said to be held by a growing number of German public figures, that Europe can afford to let Greece leave the zone, as its new 500 billion euro rescue facility can serve as a firewall to halt the spread of contagion.

“Once Greece goes, then you start to look at the other troubled countries,” he said.

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