Europe May Be Headed for a Double-Dip Recession

In China, the problem is an economy that could be overstimulated. In Europe, it's an economy that could be falling back to sleep. After expanding at a 0.4% rate in the third quarter of 2009, GDP in the 16-country eurozone grew by only 0.1% in the year's last three months. Germany -- the group's largest exporter and biggest economy -- showed zero growth. Economists had been forecasting a 0.4% fourth-quarter increase, so the drop in growth is fueling speculation that Europe is headed for a double-dip recession.Greece, which is in the midst of a debt crisis, saw its output shrink 0.8%. Spain's fell 0.1% and Italy, the third-largest economy, shrank by 2%. Portugal's output was flat after two quarterly increases.

Cash-for-Clunkers Boosted France

Only France, the second-largest economy in the group, posted a respectable increase of 0.6%, which helped keep the eurozone in positive territory for the fourth quarter. But that boost could be short-lived because it was largely fueled by a temporary cash-for-clunkers plan to help the French auto sector.

On an annual basis, the eurozone contracted 2.1% in 2009, with the 27 countries in the European Union shrinking 2.3%. Recent austerity measures in several countries, such as Greece, Spain, Portugal and Ireland, will put more downward pressure on the region's growth prospects.

In fact, sovereign debt problems will likely stall any progress already made as massive interest payments will constrain spending in other areas that could boost growth. In countries not tied to the euro, central banks can print money and buy government debt. The European Central Bank, however, can't do that, so austerity will rule the day. Further, eurozone countries can no longer devalue their currencies -- as they could before joining -- to help cope with the mounting financial crisis.

Debt Problems Likely to Stall Progress

Greece is definitely most at risk, with a debt-to-GDP ratio of 120%, but Ireland, Spain and Portugal are not far behind. Italy's and Belgium's debt is also high as a share of their gross domestic product, and France has borrowed more as a share of its economy than any country in Europe except Spain, Greece and Ireland. None of these, however, comes even close to Japan's debt-to-GDP ratio of 200%. But unlike in the eurozone countries, Japan's central bank can print money and buy government bonds. Eurozone countries have to pay whatever interest rate investors demand to buy those bonds. If these debt-ridden countries all start trying to raise more money, interest rates could soar.

Yet, if Europe does end up in a double-dip recession, it'll will see shrinking government revenues and the need to spend more on unemployment and other benefits. Clearly, the weak economic news from the eurozone means governments may need to consider additional stimulus.

So, with the costs of maintaining its debt rising as its recovery falters, the eurozone is showing more and more signs that it will head back into recession. And as China tries to cool it's economy, European nations may not be able to count on exports to help fend off their financial woes.
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