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European Leaders Reach Agreement, But Growth Crisis Still Lingers

First Posted: 10/27/2011 12:43 pm Updated: 12/27/2011 4:12 am

Investors welcomed a relatively bold agreement by European political leaders on Thursday, but some economists say that the crisis is still far from over.

European political leaders and large banks reached an agreement on Thursday to write down 50 percent of Greece's sovereign debt -- a move that will likely forestall a default by Greece but is likely not sufficient over the long term, some economists said.

European leaders also agreed to boost the size of their bailout fund to $1.4 trillion in order to prevent eurozone countries' borrowing costs from rising much further, though there were few specifics about how they plan to raise the money. Leaders agreed to require Europe's largest banks to raise $148 billion in additional capital by June, a move that is designed to protect financial institutions from bank runs that could put them in danger of bankruptcy.

"This is the biggest step forward they've taken so far," said Howard Archer, chief European economist at IHS Global Insight. "But all of this is putting a bandage over the wound. ... I suspect we'll still be talking about this next year and the year after."

Markets around the world rallied on news of the debt deal. The S&P 500 rose 2.9 percent as of 12:30 p.m., the DAX in Germany rose 5.35 percent, and the French CAC 40 rose 6.28 percent. The value of the euro also rose 2.1 percent, as investors became more confident that the Euro Zone was in less danger of falling apart.

Bank stocks led the stock market in an upward swing. Banks such as Goldman Sachs, JPMorgan Chase, and Bank of America rose more than 7 percent as of 12:30 p.m., and Morgan Stanley's stock price rose 15 percent.

Though investors were relieved that Europe reached an agreement early Thursday morning, some economists say that the sovereign debt crisis may drag on for years as long as some eurozone economies do not grow.

Economic growth in Europe has been very weak, and some economists say that Europe is in danger of slipping into another recession. Spain's economy is barely growing, Italy's economy is growing at a rate of just 1 percent per year, and Greece's economy has been shrinking at an annual rate of 7 percent as the unemployment rate has spiked to 16.5 percent.

Many economists agree that Greece's economy has been shrinking because Europe has forced Greece to slash spending at the moment when the economy has most needed it. The leaders of other European countries such as Spain and Italy also have pledged to reduce government spending. As long as European leaders refuse to increase spending to boost economic growth, it seems unlikely that their economies and tax revenues will grow.

Archer said that the current agreement will work only in conjunction with strong economic growth in the eurozone, so that higher tax revenues can pay down the debt, but said he thought the eurozone is "in very serious danger" of economic stagnation. And as long as the European economy does not grow, Archer said, "sooner or later, the fire will blaze up again."

California State University economist Sung Won Sohn predicted that since Greece is unable to service the remaining 50 percent of its debt, the crisis is likely to repeat itself: He said Greece would spend more than Europe has allowed and will be in danger of default, and that the borrowing costs for other troubled countries such as Spain and Italy would spike.

"Today, the market feels pretty good about this, but unfortunately this isn't the end of it," Sohn said. "This is going to drag on for quite a while."

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