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NEWS ANALYSIS

Europe's fiscal ills threaten the U.S.

April 29, 2010|Don Lee

WASHINGTON — A widening financial crisis in Europe is threatening to put a damper on the economic recovery here and abroad just as the American economy is gathering steam.

A credit contagion that began in heavily indebted Greece spread Wednesday to Spain, whose economy is much larger than Greece's, as Standard & Poor's cut the Madrid government's credit rating, just one day after slashing Athens' bonds to "junk" status and downgrading Portugal's debt as well.

European officials pledged Wednesday to act swiftly on a hefty package of loans for Greece, but skepticism remained that Germany, the continent's strongest economic power, would ultimately agree to the plan.

Even under the rosiest scenario in which a rescue package comes through and the problem is contained, analysts say, European economic growth will slow as more countries feel pressure to raise taxes and take other tough measures to get their fiscal affairs in order.

"It'll take years of savage spending cuts, wage cuts and welfare-pension reform to eventually grow out of the debt situation," said Ruth Stroppiana, an economist in London for Moody's Economy.com, which shaved its forecast for economic growth in the European Union this year to less than 1%.

That's not good news for American businesses, which count on Europe as a major market for a broad array of goods but already have felt the winds of an economic slowdown.

In the first two months of this year, U.S. companies exported $36.5 billion of products to EU nations, almost no change from the same period last year, even though American exports overall were up 17% in the same time frame.

The troubles in Europe probably contributed to the Federal Reserve's decision Wednesday to keep interest rates at historically low levels and to offer no timetable for raising them, economists said.

On the plus side, U.S. banks hold relatively little debt issued by Greece and other at-risk European countries.

But that isn't keeping some analysts from exploring a worst-case scenario.

Economist Nouriel Roubini, known as Dr. Doom for a perennial pessimism that helped him predict the worldwide financial crisis, says Greece's financial woes could batter global credit markets, disrupt the planet's economic recovery and potentially tear apart the 11-year-old European monetary union.

"The reality is that what has happened in the last few months is the first test of the viability of the European market" and the euro currency used by 16 countries, Roubini said. The odds are "significantly rising" that the European currency compact will come apart, he added.

Germany offered a hopeful word Wednesday, putting aside months of reluctance and saying it could rush through legislative approval of a plan to foot the country's share of an IMF-EU bailout for Greece that now looks to exceed $132 billion.

But Germany may lack the political will to back such a hefty bailout plan, and even if it does, the government is likely to face constitutional challenges to taking such measures, said Jacob Kirkegaard, a European specialist at the Peterson Institute for International Economics in Washington.

"If German parliamentary approval doesn't come through" -- officials said a vote could be taken next week -- "the risk of contagion goes up dramatically," Kirkegaard said.

The Greek crisis is already being felt by U.S. businesses.

Earlier on, with public protests against austerity plans escalating, the Athens government placed a $250,000 order for the body shields that Temecula-based Paulson Manufacturing Corp. makes for riot police and others.

Now, the order has been placed on hold. "We're waiting," the Athens government said in a short message to the company's international staff.

"Their money problems in Greece are dramatically affecting us," said company President Roy Paulson.

It isn't just shipments to Greece that some economists are concerned about. The spreading financial woes have sown fears about the stability of the European banking system and cast a deepening gloom over the continent's economy.

The crisis has helped cause a steady slide in the euro, which touched a one-year low against the dollar Wednesday. That has made U.S. exports more expensive in Europe and less competitive in some other markets as well. If the troubles persist, American companies face the prospect of softer overseas sales -- or a more dire result if global growth weakens.

In recent weeks, improving indicators in the U.S. had raised projections of the country's economic growth in January, February and March -- due to be reported Friday -- to an annual rate of more than 3%.

Federal Reserve officials noted the strengthening American economy in their statement Wednesday at the conclusion of a monetary policy meeting -- even as they stuck to their yearlong pledge to keep the central bank's benchmark interest rate near zero "for an extended period."

The central bank made no mention of Greece and the European financial storm, but they were undoubtedly discussed during the two-day meeting, said Lyle Gramley, a former Fed governor and now a senior economic consultant at Potomac Research Group.

don.lee@latimes.com

Times staff writer Walter Hamilton in Los Angeles contributed to this report.

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