Europe's austerity initiatives are beginning to show signs of backfiring, even as governments prepare to tighten their belts further.
Waning growth in two key sectors of the European economy, another poor election showing by German Chancellor Angela Merkel's pro-bailout party and plunging bank shares heightened fears that a new recession cannot be avoided. Those fears gained momentum when Christine Lagarde, the new head of the International Monetary Fund, warned that the global economy is on the brink of a fresh crisis.
In London, the FTSE-100 index fell 3.6 per cent on Monday while the Eurofirst index, which measures the performances of Europe's 300 biggest companies, lost a hefty 4 per cent. Bank shares got slaughtered, partly because of fears that the debt crisis in Italy, the euro zone's third largest economy, is getting worse and partly because Deutsche Bank chief executive officer Josef Ackermann acknowledged that some European banks would not survive a writedown on their sovereign bond holdings.
On Monday, Deutsche Bank shares lost 8.6 per cent, taking their six-month loss to 47 per cent. Italy's UniCredit, one of Europe's largest banks, lost 6.5 per cent, putting the shares at a new 52-week low. The relentless selloff of banks across Europe is sending shares down close to their 2009 crisis levels.
More strategists and economists are now pointing to the severe austerity programs – the central feature of the European effort to put debt-choked economies on a stable footing – as part of the problem.
Efforts to rein in spending are hurting growth just when it is needed most to shake off the debt crisis, boost employment and restore consumer and business confidence. High growth rates allowed Canada to overcome its 1990s debt crisis relatively quickly. In contrast, European deficit-busting efforts are coming when growth is low to non-existent, implying there will be no quick fix to the debt problems.
"We see that there has been, particularly over the summer, a clear crisis of confidence that has seriously aggravated the situation," Ms. Largarde, France's former finance minister, said in an interview published Sunday in the German newsmagazine Der Spiegel. "Measures need to be taken to ensure that this vicious circle is broken."
As markets sank in Europe and Asia (those in Canada and the United States were closed for the Labour Day holiday), Citigroup reduced its 2011 global growth forecast to 3.1 per cent from 3.7 per cent. The forecast came after Friday's particularly grim U.S. jobs report, which revealed that the economy had failed to add jobs in August. On Thursday, president Barack Obama is to reveal new job-creation plans to Congress.
Oil and copper prices fell as investors took the view that slow global growth will crimp demand for commodities. That outlook was confirmed Monday by the sharpest slowdown recorded since 2001 in Britain's service's sector. A separate survey of the euro zone economy, done by Markit Economics, showed a sharp drop in the combined euro zone services and manufacturing index, with notable falloffs in business optimism in Italy, Spain, France and Germany.
At a banking conference in Frankfurt on Monday, Deutsche Bank's Mr. Ackermann predicted the global economy would grow by a mere 2.5 per cent his year.
The waning growth is bad news for the European finance ministers who implemented across-the-board government spending and employment cuts to try to crunch budget deficits and restore confidence in their sovereign bonds. The deficits are coming down – slowly – but the cutbacks are hurting growth. Growth rates in almost every European are expected to fall next year. Deutsche Bank predicts overall euro zone growth at 0.8 per cent in 2012, down from an expected 1.7 per cent this year.
"Debt sustainability also requires higher growth, which will not come simply as a result of better public finances and cost convergence," Stefano Micossi, director general of the Italian business association and think tank ASSONIME wrote Monday on the Vox economists' website. "Indeed, these measures are likely to initially depress economic activity and worsen debt sustainability."
Marshall Auerback, global portfolio strategist at Denver hedge fund Madison Street Partners, had a similar view. "All the data tells me that cutting public spending in an environment as fragile as we are now seeing is likely to put the recovery in reverse," he said.
As confidence in a broad-based economic recovery evaporates, so is confidence in the leaders of many of the biggest euro zone economies. As job-killing austerity programs kick in, protests and demonstrations, some violent, are paralyzing capital cities throughout Europe. Italy's largest union, CGIL, has called a general strike on Tuesday to protest the government's €45.5-billion ($63.5-billion) austerity program. New polls show that the popularity rating of Prime Minister Silvio Berlusconi has reached new lows.
In Germany, Ms. Merkel's party suffered its fifth loss of the year in regional elections. In Sunday's election in Mecklenburg-Western Pomerania, preliminary results show that her Christian Democratic Union took about 23 per cent of the vote, its worst showing since 1990. The election was won by the opposition Social Democrats, with about 36 per cent.
Economic stewardship has been one of the main issues in the German regional elections. Political scientists and pollsters say that Ms. Merkel is alienating voters because she seems to have no clear ideas on how to improve the German economy, whose growth is slowing considerably, or prevent taxpayers' money from being wasted on bailouts that may not work. As Europe's biggest economy, Germany has been the main sponsor of the bailouts of Greece, Ireland and Portugal.