Rising economic woes test Europe's leaders

From the lush emerald hills of Ireland to the gritty steel plants of Ukraine, Europe faces multiplying economic headaches.

Perhaps a longtime European Union member such as Greece or Spain will default on its sovereign debt. Or one or more of the heavily indebted ex-communist states in Eastern Europe will capsize and require a costly rescue.

Either way, an economic crisis that Europeans once regarded as fundamentally American in origin and consequence is testing the continent's resilience. So far, the results are not reassuring. Germany, Europe's economic engine, ardently resists talk of a bailout for either old or new Europeans, fearing it will inevitably get stuck with the tab. A top EU official, meanwhile, unsuccessfully seeks to calm fears that some countries will be left to fail, by insisting there is a rescue plan but that its details are secret.

"Europe doesn't have the institutional capacity to deal with the situation — either Ireland within the eurozone or Hungary outside it," says Marc Chandler, senior vice president for currency strategy at Brown Bros. Harriman.

The U.S. Treasury has drawn fire for its handling of the increasingly costly bailouts of banks, insurers and automakers in this country. But imagine what the economy would look like if there were no Treasury to do the bailing — no marble building adjoining the White House; no bronze statue of Albert Gallatin, the longest-serving Treasury chief, out front; nothing.

That's why Europe is flailing amid a worsening recession, talk of sovereign defaults and quaking banks. A decade after the launch of a single currency, the euro, the European Union has a central bank but no federal financial policy organ. Where the U.S. has Gallatin's descendent, Treasury Secretary Timothy Geithner, Europe has 27 national finance ministers.

Worries for USA

The consequences of Europe's incomplete union ultimately could boomerang on American banks and companies. Simon Johnson, former chief economist for the International Monetary Fund, calls Europe's financial woes "a dagger pointed at the heart of major U.S. banks." Links among major global banks mean that massive losses by European institutions, which loaned massive amounts to Eastern borrowers, could ripple onto already weakened U.S. behemoths, Johnson says.

"They're all interconnected. … If the Europeans have a problem in the banking system, it will come through to American banks," he says.

As eurozone economies contract, European customers are buying fewer American products. Intel's fourth-quarter sales in Europe fell 27% from the fourth quarter in 2007, to $1.6 billion. Overall, U.S. exports to Germany in December of $3.8 billion were down 5.6% from the same month in 2007. And trade flows have only shrunk since then.

In recent years, the European Union expanded to include former Warsaw Pact states such as Poland, Hungary and the Czech Republic, and laid plans for those new members to adopt the euro. Lenders from Western Europe and borrowers in the ex-communist East both assumed the road to the euro would be smooth. Eastern countries embarked on borrowing sprees in a rush to match the living standards of their Western cousins. Soon, the Baltic nations and countries such as Hungary and Romania were running chronically large current-account deficits.

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