Groaning under an austerity program that has pushed its unemployment rate higher than the U.S. rate during the Great Depression, Spain announced that its economy shrank by 0.4 percent in the second quarter of 2012 and that it would remain in recession until 2013. The country’s borrowing costs soared to all-time euro-era highs as uncertainty about the finances of its banks and regional governments gripped investors.
The new bout of doubt about Europe’s financial stability sent investors fleeing to the safety of U.S. Treasurys and German government bonds, driving already low rates even lower. In Germany, the yield on two-year government bonds was slightly negative for the 12th consecutive day, meaning people were effectively paying the German government to keep their money safe for that period.
The Dow Jones industrial average fell 101.11 points, or 0.79 percent. The Standard & Poor’s 500-stock index fell 12.14 points, or 0.89 percent. And the Nasdaq fell 35.15 points, or 1.2 percent. In Europe, the major stock market indexes fell, with drops of 2.09 to 3.18 percent.
The ramifications of Spain’s financial woes are even broader than those linked to Greece. Greece’s economy is about the size of Maryland’s; Spain’s economy is the 12th-largest in the world, outstripping Australia, Mexico and South Korea.
Economists predicted that the European Central Bank would soon intervene again and that European leaders would be able to fend off pressures for now, but ultimately the fate of the euro zone is a political issue and not just a financial one.
“They have a lot of cards to play,” said Kenneth Rogoff, a Harvard University economics professor and former chief economist at the International Monetary Fund. “The arc of the crisis will continue to escalate, and responses will escalate.”
But, he added, “the only endgame is political union, and that’s not even in the conversation at the moment. And without a political union that establishes a strong central government, this thing is going to blow up.”
Spain was the biggest factor rattling confidence and markets Monday. Spanish borrowing costs soared for the third straight trading day as fears grew that the country’s teetering financial situation was too dire to be calmed by a limited bailout of its banking system.
European leaders working to stanch the economic crisis recently gave Spain a partial bailout targeting its banks and coupled it with additional European oversight. But the $120 billion bailout was smaller than Spain sought and came with the condition that the Spanish government accept full liability for the loan, thus effectively driving up the government’s ratio of debt to gross domestic product. Granting Spain’s full request would have exhausted the pan-European bailout funds. Investors responded Monday by trading 10-year Spanish bonds at 7.39 percent, up sharply from Friday and up 1.44 percentage points over the past three months.