Debt woes in Greece turn violent as fears spread to other European countries

By Neil Irwin and Peter Whoriskey
Washington Post Staff Writer
Thursday, May 6, 2010; A01

MADRID -- Violence erupted in Greece on Wednesday when tens of thousands of demonstrators protesting stringent economic measures hit the streets in Athens, rioters heaved Molotov cocktails and three bank employees died after their building was torched.

The protesters were objecting to cuts in government wages and pensions required by a deal announced Sunday that would give Greece $141 billion in loans from the European Union and the International Monetary Fund, but only if the government promises to restore its tattered finances by imposing program cuts and tax increases.

Police resorted to barricades and tear gas, according to news media reports. Meanwhile, a growing fear that Greece's debt troubles and civil unrest could soon spread to other European nations spooked investors.

"A demonstration is one thing, and murder is quite another!" Prime Minister George Papandreou bellowed in Parliament during a session to discuss the economic reforms.

The chaos in Greece has raised the pressure on other countries in Europe, such as Spain and Portugal, where the government debt is staggeringly large and the economy relatively weak.

Although the streets of Madrid were quiet and average citizens described themselves as sheltered, at least for now, from the chaos in Athens, the European markets had the jitters once more. Spain's Ibex 35-stock index lost 2.3 percent. The euro dropped. And in Portugal, Moody's Investors Service announced that it had put the government bond rating under review for a possible downgrade based on the country's finances.

In Germany, Chancellor Angela Merkel urged lawmakers to approve their country's share of the international rescue package for Greece with a dramatic warning.

"Nothing less than the future of Europe, and with that the future of Germany in Europe, is at stake," Merkel told lawmakers. "We are at a fork in the road."

In the United States, administration officials and members of Congress are also closely monitoring the situation for signs that a feedback loop of bad news could send the economies in some fragile European countries spiraling downward. U.S markets registered a second day of losses: The Dow Jones industrial average slipped 0.5 percent, the Standard & Poor's 500-stock index dropped 0.7 percent, and the Nasdaq composite index fell 0.9 percent. The declines extended into Asia Thursday, with Japan's Nikkei average down more than 3 percent in early trading.

The United States should move aggressively to prevent a European sovereign debt crisis, said Rep. Mark Steven Kirk (R-Ill.), a former staff member at the World Bank and member of the House subcommittee that arranges funds for the International Monetary Fund.

"We need to urge Portugal and Spain to cut back on government spending," he said.

If the "contagion" in Greece spreads to other countries, he said, the United States might be called upon to offer direct assistance, as it did with Mexico in 1982.

The basic problem in Greece, and in the other struggling European countries, is that the government debts have grown as large, or nearly as large, as the gross domestic product, making the government's repayment difficult, if not impossible. The countries' imperiled finances, meanwhile, push up the rates at which they can borrow.

Economists say there are essentially two ways out of such crises: Cut the government budget deficits and run surpluses, a prescription that often entails public anger, or increase the GDP and the country's ability to pay.

"That's a tall order in any economy, but it's even harder if you're an economy that is contracting and you have unemployment and riots on the street," said Carmen Reinhart, director of the Center for International Economics at the University of Maryland and a specialist in financial crises.

Even if the bailout fails to prevent Greece from defaulting on or restructuring its debts, it offers the advantage of giving other European countries an opportunity to fix their fiscal shortfalls.

"In my view, [the bailout] is delaying the inevitable. I'm not suggesting the bailout was wrong," she said. "It is buying Europe time."

Whether tranquillity or fear is the right attitude toward Europe's immediate economic prospects is anyone's guess.

Spanish and Portuguese government debt is far lower than Greece's. But with Europe growing less than the rest of the world, those countries are growing slower still. Spain's economy, for example, is expected to contract about 0.4 percent this year, continuing in recession even as most of the world climbs out.

With higher returns available in emerging markets, and safer havens available in the form of U.S. or German government bonds, countries at the margins of Europe might be caught in the middle.

The countries "have very adverse competitive positions," said Julian Callow, chief European economist for Barclays Capital. "That's why markets start to see some similarities" with Greece.

There has been discussion of the European Central Bank intervening more aggressively, perhaps agreeing to invest in the government debt of threatened eurozone countries. The bank on Wednesday delayed enforcement of rules that would have prevented banks from using Greek bonds as collateral for loans. Its governing council is scheduled to meet Thursday in Portugal.

Underlying the situation: recognition that the problem is not just about government spending and borrowing in places like Spain, Portugal and Ireland, but broader economic problems that may leave those countries hobbled in their ability to borrow the money they need to operate.

In a country the size of Spain, which has an economy five times larger than Greece's, the bill for an international rescue would exceed the $141 billion offered to Greece.

"One wonders about the capacity of the rest of Europe to finance these countries," Callow said.

Yet at the Puerta del Sol, this city's central square, there is little sense of a pending economic crisis. Retired couples strolled to dinner, office workers bustled home and occasionally a person dressed as Mickey Mouse posed for pictures with tourists. Business types, economists and ordinary citizens suggested that Spain faces no imminent threat of a similar catastrophe.

Some were more focused on the longer-term economic challenges faced by a nation that experienced a massive home-building boom and house price bubble and now has 20 percent unemployment.

"The problem we are facing is for the next two or three years, not at the moment," Antoni Espasa, director of the Flores de Lemus Institute for Advanced Economic Study in Madrid, said Wednesday.

Espasa acknowledged, however, that the nation faces a longer-term challenge of closing its budget gap.

Spaniards in general were focused more on soaring joblessness than any creeping contagion of fiscal crisis.

"My biggest concern is unemployment," said Jos? Luis Rodr?guez, 43, who works in computer software. As for the rapid spread of the Greek financial crisis and its growing encroachment on Spain? "We Spanish are always optimists," he said.

From Asia, investors watched anxiously. In Taiwan, Jimmy Huang, a broker for sovereign wealth funds and other oil-rich parties from the Persian Gulf, said his clients are adamant that they want to shift money out of Europe and into China and other emerging markets. The global recovery that is taking shape, he said, involves increasing trust that strong emerging economies will keep expanding and a growing recognition that the weaker European nations are in for an era of slow growth and difficult choices.

"They've invested too much in Europe" and now want their money put elsewhere, Huang said of his clients -- a blunt bottom line that threatens to make a widening portion of Europe appear as also-rans in the competition for global capital.

Whoriskey reported from Washington. Staff writer Howard Schneider in Taipei, Taiwan, contributed to this report.

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