Darkening Economic Clouds EU and Germany Face Challenges But No Immediate Recession

The euro-zone debt crisis has become a significant drag on the real economy, according to a report issued on Thursday by leading German economic analysts. The experts lowered growth forecasts and warned of potential recession -- and also urged European politicians to finally find a solution.

The German economy is slowing as concern about the euro-zone debt crisis grows.
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The German economy is slowing as concern about the euro-zone debt crisis grows.


There is some good news. According to the report from Germany's leading economic think tanks released on Thursday, even if European banks do run into trouble as a result of a possible Greek insolvency, "contagion of the same extent as after the Lehman Brothers bankruptcy (is) very unlikely."

In terms of solace, though, that's about all there is. The report, which is compiled twice a year for the government in Berlin, says that following rapid growth at the beginning of the year, the German economy has all but stagnated. Indeed, analysts expect that the German economy could even contract slightly in the third quarter. The group's economic growth forecast for 2012 has been slashed from 2.0 percent to a mere 0.8 percent.

And it's not just Germany. The report forecasts that production in the euro zone as a whole could actually contract slightly this winter as global demand dries up. A recent report on euro-zone economic activity issued by global consulting firm Ernst & Young lowered its 2011 growth forecast for the common currency area from 2 percent to just 1.6 percent. For 2012, the consulting firm expects a growth rate of 1.1 percent, down from an original forecast of 1.6 percent. Although the economists did not identify an immediate threat of recession, they are pointing to a more challenging economic situation.

The reasons for the darkening mood are not difficult to divine. In Thursday's report, German economists pointed to Europe's ongoing inability to solve its growing debt crisis coupled with concerns that it could now be spreading to the Continent's banks. "The debt and confidence crisis in the euro area," the report reads, "is having increasingly adverse effects on the German economy."

Orderly Insolvency

Furthermore, the report was very clear about what must now be done to restore confidence in Europe's handling of the crisis. "Economic policy in the EU has been heavily focused on using all possible means to prevent the insolvency of a euro country," the report reads. "Instead of this course, it should create a workable insolvency mechanism for states and a European procedure for the recapitalization and, where necessary, an ordered insolvency of banks."

In addition, the majority of the economics experts who participated in the study were sharply critical of the European Central Bank policy of buying sovereign bonds from heavily indebted euro-zone countries. The practice, the report wrote, has put the ECB's independence "at risk."

Many of the conclusions reached in the study would appear to be increasingly shared by euro-zone leaders. In recent weeks, a consensus seems to be building within the euro zone that a significant debt haircut for Greece has become unavoidable, with Reuters reporting on Wednesday that it could be as high as 50 percent, well above the 21 percent agreed to by the private sector in July. In addition, the expanded European Financial Stability Facility (EFSF), will include measures for the emergency recapitalization of struggling banks.

Beyond that, there have also been recent reports that Europe is considering pushing through a forced recapitalization of its banks given the danger that many of them could be hit hard by a Greek insolvency.

Such a plan, however, is far from popular. On Thursday, Deutsche Bank head Josef Ackermann attacked the idea saying that, because any such recapitalization would rely on public money, it would simply drive up sovereign debts of euro-zone countries even higher, thus exacerbating the crisis.

Silver Lining?

He also voiced serious doubt as to the ability of European politicians to manage the broadening crisis. Doubt is increasing among market participants, he said, about the ability of policymakers to find a lasting solution to the crisis. "Market participants aren't just wondering if those responsible have the necessary political will to solve the crisis, but also if they even have enough time and resources left."

The economic report released on Thursday seemed to hold out a large carrot to policymakers to find a solution. Whereas most economic mood indicators show a stagnating economy, the report said that real economic indicators have not fallen as far. Indeed, euro-zone industrial production rose an average of 1.2 percent in August over July despite production in Germany -- the euro zone's largest economy -- falling slightly in that time period. Data from countries like Portugal, Ireland and Italy was surprisingly positive.

"If policy-makers were able to find a way out of the debt crisis in the near future," the report says, "the mood could quickly improve and the economic outlook would brighten."

cgh -- with wire reports

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