Economic Malaise Threatens To Undermine European Unity

MADRID -- The fruits of Spain's economic transformation found their way to Maria Dolores Barroso's cafe. Fueled in large part by a massive building boom, the Spanish "miracle" brought new jobs to legions of construction industry workers -- many of whom would pack her cafe at sundown, dropping their euros on beer and savory tapas well into the madrileño night.

But as Europe confronts its toughest economic test since the official creation of the European Union in 1993, Barroso has hung a "for sale" sign on her cafe door. Business has dried up -- falling 80 percent in six months -- as Spain has joined a growing list of European nations slouching toward recession. The abruptly weakening European economies caused a sharp sell-off of the euro last week that sent the dollar to its biggest gain in more than six years on Friday. Those gains continued yesterday.

In Spain, the burst of the housing bubble has plunged the nation into a U.S.-style crisis, with house prices falling, delinquency rates climbing and unemployment spiking. "It disappeared so much faster than it came," Barroso marveled.

Spain's problems underscore a reversal of fortune for Europe, only a few months ago seen as a much-needed pillar of strength in a global economy that is sharply slowing alongside shocks from the U.S. financial crisis and soaring prices for energy and food. Europe is joining the United States and Japan in what is turning into First World economic malaise, leaving the still-healthy emerging giants of Asia and Latin America to sustain global growth for the first time.

The downturn is confronting Europe with a disturbing reality: Revised predictions show that it will slow as much, if not more, than the United States over the next 18 months, while some of its problems may prove harder to fix.

The vastly more generous social safety nets in Europe have made it so Europeans are likely to suffer less than Americans from the global slowdown. But as the once-sizzling economies in Europe go cold, discontent with the notion of the E.U. appears to be growing. Ireland, for instance, dealt a blow to the future of the union in June by rejecting a treaty that would have, among other things, created a full-time E.U. president.

"The deteriorating economic condition is putting new stress on Europe, which seems to be even weaker now than the U.S.," said Tom Mayer, chief economist for Deutsche Bank. "Some pessimists even talk now about the euro area breaking apart. I would not go that far, but we do know the honeymoon is over and this is the first real test of the marriage that we have seen."

Diverging Needs

Europe has prided itself on the convergence of its economies and cultures since six countries signed a cooperation treaty in 1951, laying the groundwork for today's European Union -- a political, economic and military coalition of 27 nations stretching from Portugal to Bulgaria. Over the past 15 years, living standards in Spain and Ireland have begun to catch up to those in France and Germany. It happened as the same low interest rates used by the European Central Bank -- the E.U. version of the U.S. Federal Reserve -- to prod Germany's and France's stagnant economies into growth also provided the Spanish and Irish with the cheap financing they needed to expand businesses and buy new homes.

But analysts say the financial interests of Europe are diverging, highlighting the fundamental challenges at the core of plans to build one integrated European economy. Years of relatively fast-rising wages in Spain, Ireland and other of Europe's former dynamos -- many of which became overly dependent on building booms and surging domestic consumption for growth -- have made them less competitive globally. That happens even as the continent's economic powerhouse, Germany, appears to be regaining its footing with leaner companies and lower labor costs.

The slowdown in Spain, as well as similar ones in Ireland and Denmark, bear more similarities to the one in the United States than to those in Germany and France. Some economists say the best prescription for jump-starting the economies might be the same formula used by the Federal Reserve -- lower interest rates. But Europe's central bank has taken the opposite tack, raising rates to control inflation, seen by some as the bigger threat to Europe's largest economies.

Concern is especially focused on Germany, where fears are mounting that higher prices will zap consumer demand. Take Antje Mueller, 33, and Jens Weinhold, 35, a Berlin couple with two young children. Gasoline in Germany now tops $8 a gallon, and the family's weekly food bill has jumped from $90 to $120. The couple scrapped plans for a vacation in Montenegro, have shifted to discount groceries and have stopped buying new clothes.

"It is harder for us," Mueller said. "Every two to three weeks, the prices are going up. We are buying less just like everybody else."

Cutbacks in Construction

From the golden earth of Castile-La Mancha, the stamping grounds of Don Quixote just south of Madrid, came the building blocks of Spain's economic miracle. Over the past 15 years, construction companies mined the soil here to churn out bricks, tiles and cement 24 hours a day, feeding the great Spanish housing boom.

As Spain integrated more closely with the rest of the Europe, Spaniards and other Europeans bought new vacation homes on the Costa del Sol. Low adjustable-rate mortgages even allowed the steady flow of Latin American immigrants to get in on the hot housing market, where prices surged an average of 150 percent over the past decade.

By late last year, almost one in five jobs in Spain was tied to construction and real estate. The unemployment rate fell from 25 percent in 1993 to 8 percent in 2007. But a combination of overbuilding, a slowing economy and tighter credit has left Spain with about two years' worth of housing inventory. Unemployment has surged above 10 percent. Home sales fell 34 percent in May compared with last year. Martinsa-Fadesa, one of Spain's largest developers, filed for bankruptcy last month.

In Castile-La Mancha, a short drive from the ancient city of Toledo, brick factories are mothballing operations or cutting shifts. At Cobert, a factory that tripled production over the past decade, more than 8 million unsold Spanish tiles are stacked up on the back lot. "We know this isn't going to be easy to bounce back from," said Juan del Amo Sevilla, the plant manager, as he gazed at the piles of tiles outside his window.

"Our problem is that we adopted an American model of growth, looking to services and construction and quick returns," said Candido Mendez, secretary general of Spain's United Workers Union. "It made us more like the United States and less like Germany. Now we see that was a huge mistake." And, like the United States, Spain imports far more than it exports, while Germany enjoys a trade surplus.

A Global Credit Crunch

The global credit crunch that spread from the United States has led banks here to tighten lending, hitting even companies unrelated to the construction industry. In a wood-scented warehouse factory not far from the brick plants, the makers of some of the world's finest Spanish guitars have laid off seven workers this year, bringing their staff down to 33. Sales -- including high-end business from connoisseurs and rocks stars overseas -- have remained relatively constant. But its suppliers, themselves under pressure from local banks, have reduced grace periods for payment from 120 days to about 30, disrupting production.

"The chain of credit is getting impossible here," said Manuel Rodriguez Jr, of Guitarras Manuel Rodriguez and Sons, whose clients have included Eric Clapton and Sting.

Mortgage delinquencies are climbing, while higher Europe-wide interest rates increase payments for millions in Spain, where the vast majority of mortgages have adjustable rates.

Marlon Flor, 42, a nationalized Ecuadorian immigrant who arrived in Spain in 2003, said he was filled with pride after buying a three-bedroom apartment in a working-class neighborhood of Madrid for his family last November. That was before he lost his job as an electrician at a construction company that fired half its staff earlier this year. At the same time, higher interest rates sent his mortgage payments up from $1,920 six months ago to $2,400 now. The $600 a month he is pulling in at the part-time job he landed at McDonald's doesn't begin to cover costs.

Behind on his payments, the bank has told Flor to sell, though he estimates that the condo is now worth nowhere near the $424,000 he paid for it.

The Spanish government is offering financial incentives to immigrants from outside the European Union to go back to their countries of origin. But Flor is not ready to give up on the Spanish dream. "I never thought it would come to this, but this is our home," he said. "We're working with the bank, and I'm looking for a better job. We will find a way."