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As Euro Crisis Continues, Bank Downgrades, Credit Squeeze Signal Possible Return To 2008

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The situation in Europe is hitting global credit markets, making it harder for companies and banks to secure loans. Investors are buying fewer corporate bonds, and banks are finding it more difficult to borrow from each other. On Thursday, as the European Central Bank again resisted pleas for it to rescue the eurozone, worries about a severe credit crunch along the lines of the 2008 crisis grew.

"In some ways this is part two of the U.S. financial crisis," said Srinivas Thiruvadanthai, an economist at the Jerome Levy Forecasting Center.

Credit rating agency Fitch Ratings downgraded nine major banks on Thursday, including Goldman Sachs, Bank of America and Morgan Stanley. While acknowledging that the banks are in better shape now than in 2008, the rating agency cited vulnerability to the increased market turmoil stemming from "economic developments and regulatory challenges."

Many fear that one cataclysmic event -- such as the default of Italy or a major European bank failure -- could freeze credit markets, plunging the world into a recession similar to the downturn resulting from the bankruptcy of Lehman Brothers in 2008.

"As the situation in Europe goes, so does the global economy," said Adrian Miller, fixed-income strategist at Miller Tabak Roberts Securities.

Miller said that the bond markets have been moving in sync with the European crisis; recently he's noted that investors are growing wary of lending even to so-called safe businesses. Global investors are buying about 40 percent fewer new high-quality U.S. corporate bonds than in mid-May, according to Miller. Meanwhile, there's been about a 70 percent plunge in the purchasing of new, risky U.S. corporate bonds: While global investors bought about $8 billion of these bonds per week in mid-May, now they are buying just $2.5 billion.

As European banks slash lending in order to meet new capital requirements, European companies have been hit somewhat harder. Purchases of newly issued risky European corporate bonds have plunged about 80 percent since mid-May, according to Miller.

Banks also are finding it harder to borrow from one another. It is now more than twice as expensive to secure a three-month loan from another bank than at the beginning of August, according to Rich Gordon, managing director of fixed-income market strategy at Wells Fargo Securities.

On Thursday Fitch downgraded Bank of America and Goldman Sachs' long-term debt to A from A+, Barclays' long-term debt to A from AA-, BNP Paribas' long-term debt to A+ from AA-, Credit Suisse's long-term debt to A from AA-, and Deutsche Bank's long-term debt to A from AA-.

The downgrades reflect "balance sheet damage" emanating from the increased riskiness of European sovereign debt, but they would not result in any major economic repercussions, said Michael Spence, a Nobel Prize-winning economics professor at New York University's Stern School of Business. "There has been some significant credit tightening already," Spence said.

He added that the Federal Reserve ultimately would step in if credit markets dry up. "If left unattended, it will cause some damage, but I don't think it will be left unattended," he said.

In a speech in Berlin on Thursday, European Central Bank President Mario Draghi disappointed investors when he repeated that the bank would not come to the rescue and step in to buy large amounts of government bonds. "There is no external savior for a country that doesn't want to save itself," Draghi said. In an attempt to reassure the audience and jittery investors across the globe, Draghi said that "a return of confidence," stemming from government budget cuts, likely would materialize and mitigate the economic damage of austerity measures in struggling countries.

Observers were not reassured. "There isn't any likelihood of it [confidence] returning," said Jay Bryson, global economist at Wells Fargo Securities. Bryson added that the ECB is the only organization with the firepower to save European countries and banks from default, and that ultimately when it seems to have no other choice, it will most likely step in.

"Authorities at least in the past have always blinked, or generally have always blinked," Bryson said.

Markets slightly recovered but remained cautious on Thursday after the previous day's turmoil. The interest rate on 10-year Italian government bonds fell slightly but remained above the unsustainable 7 percent level. Russian leaders said that they would step in to help, indicating that the country would lend more than $10 billion to the International Monetary Fund, as a backstop for struggling European governments.

Europe's troubles first came to light in 2010 when Greece's debt troubles caused a financial panic. And the situation continues to evolve, reminding some of the slow motion pace of the U.S. housing market collapse, which took hold in 2007 and triggered the financial crisis in 2008.

After Lehman Brothers declared bankruptcy in September of that year, banks stopped lending to each other, fearful that more failures were coming. Banks hiked the cost of their loans to other banks (like they're doing now), making it more difficult for banks to come up with the capital necessary to cover all of their liabilities. Meanwhile, as more investments in the housing market fell apart, banks were forced to pay out insurance on those mortgage defaults. But they didn't have the money.

Companies that relied on short-term financing to maintain their daily operations found themselves on the brink of shutting down, as loans became prohibitively expensive. Major banks were about to fail.

After the U.S. Treasury and Federal Reserve rescued the U.S. banking system from collapse, credit remained tight in 2009, and companies that were unable to secure loans ended expansion plans and laid off workers, reducing consumer demand and worsening the economy. That forced companies to cut even more workers and making lending even tighter.

Though the vicious cycle of layoffs and reductions in lending has ended, it could resume again if the crisis in Europe spirals out of control with a default by the Italian government, said Stijn van Nieuwerburgh, associate finance professor at New York University's Stern School of Business. "As banks become less and less solvent, or their bottom lines are hit, they'll be less inclined to do risky lending," he said.

Catherine New contributed reporting.

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Investors in global stock markets lost .3 trillion in wealth in 2011 largely because of fears of a eurozone breakup, according to The Financial Times. The value of global stock markets fell 12 percent to .7 trillion.

From the FT:

The S&P 500 is flat this year while the FTSE 100 has only dropped 5.5 per cent. But the Eurofirst 300 gauge of blue-chip European companies has lost 11 per cent, led by the French and Italian exchanges. The MSCI Emerging Markets index has shed a fifth of its value despite strong growth in China and other emerging markets.

Asian equity markets were hit particularly hard with Japan’s Nikkei index losing 17.3 per cent this year, Hong Kong’s Hang Seng index 20 per cent and the Shanghai Composite 22 per cent.

--Bonnie Kavoussi

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Up to 100 Italian newspapers will be forced to close after the Italian government slashes subsidies to newspapers in the name of shoring up its finances, according to The Financial Times.

The subsidy cut amounts to a 69 percent cut in funding for newspapers, according to the FT. It was ordered by the government of the previous prime minister, media magnate Silvio Berlusconi, and approved by the new government of Mario Monti. Though the newspaper industry is in decline, some say that these local and sometimes partisan newspapers give voice to stories that the mainstream media ignores, according to the FT.

Staffers at the communist daily Liberazione, which has 5,000 readers, are staging an occupation of the newsroom this weekend to prevent the owners from shutting down the paper after its possible last issue is released on Saturday, the FT reports.

--Bonnie Kavoussi

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Investors were unmoved by the steep fall in Italy's short-term borrowing costs on Wednesday, as Italy's long-term borrowing costs stayed elevated and European stocks fell.

The interest rate on Italy's six-month government bonds fell by half to 3.25 percent at an auction on Wednesday: a vote of confidence in Italy's ability to pay off its debts for half a year.

But investors remained skeptical about Europe's long-term economic prospects. The DAX in Germany plunged 1.04 percent on Wednesday, the CAC in France fell 0.38 percent, and Italy's FTSE Italia All-Share neither gained nor lost ground. The interest rate on Italy's ten-year government bonds remained unsustainable at 6.80 percent.

--Bonnie Kavoussi

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The European Commission admitted in a report in mid-December that its medicine for the sovereign debt crisis may be poison for Europe's long-term economic outlook.

The report said, according to The Wall Street Journal, that the imminent economic slowdown in Europe, caused in part by a contraction in government spending, will worsen job prospects for young people, and "young people remain the hardest hit by the crisis and its aftermath." The report added that "income shocks may prove permanent."

The youth unemployment rate in the European Union is disastrously high at 20 percent, with a high of 48 percent in Spain, according to the WSJ.

--Bonnie Kavoussi

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The European sovereign debt crisis is turning into a banking crisis.

After breaking a record just a day earlier, the amount of overnight deposits parked at the European Central Bank's overnight deposit facility reached another record high on Tuesday: 1 billion, a 10 percent increase from 8 billion the day before, according to The Wall Street Journal.

The deposits attract an interest rate of just 0.25 percent and could translate into a loss for banks, highlighting the rising level of banks' distrust in any risky lending as banks seek to shore up capital to meet new regulatory requirements.

--Bonnie Kavoussi

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Italy suffered from the worst Christmas shopping season in ten years, according to the Italian consumer group Codacons, Bloomberg News reported.

Italians spent .75, or 48 euros, less per person during the holidays this year than the average of the past five years, according to Codacons.

Shoe and clothing stores suffered the most, with sales in that sector plunging 30 percent compared to previous years, according to Codacons.

As the Italian government seeks to rein in its debt by slashing spending and collecting more in taxes, Italians are cutting back in their spending, which will continue to hurt the economy. Italy's latest austerity plan will cost every Italian family about ,476, or 1,129 euros, according to the Italian consumer group Federconsumatori, Bloomberg News reported.

The FTSE Italia All-Share, Italy's main stock index, fell 0.85 percent on Tuesday.

--Bonnie Kavoussi

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Banks parked a record high number of deposits in the European Central Bank's overnight deposit facility, which is considered to be a safe haven, according to The Wall Street Journal.

Banks deposited 8 billion, or 412 billion euros, overnight at the ECB on Monday, up 19 percent from 3 billion, or 347 billion euros, on the Thursday before Christmas, according to ECB data cited by the WSJ.

The high level of overnight deposits reflects the rising level of distrust in inter-bank lending, in conjunction with continued liquidity in the eurozone markets as the ECB lends more to banks, the WSJ noted.

--Bonnie Kavoussi

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The number of people without jobs in France reached a 12-year high in November, placing pressure on French President Nicolas Sarkozy's reelection campaign, according to Reuters.

France's labor ministry reported that the number of registered jobseekers in France rose to 2.85 million, 1.1 percent more than in October and 5.2 percent more than during the same period last year, according to Reuters.

The unemployment rate in France rose in the third quarter to 9.3 percent from 9.1 percent in the second quarter, according to France's national statistics office, Reuters reported.

--Bonnie Kavoussi

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The stock prices of European retailers rose after reports of shoppers flooding stores both in Europe and the United States on Monday, the day after Christmas, according to The Financial Times.

The stock price of German retailer Metro rose 1 percent on Tuesday, France's Carrefour rose 0.6 percent, and Swiss watchmakers Swatch and Richemont rose 0.7 percent, according to the FT.

The DAX stock index in Germany rose 0.23 percent, while the CAC 40 in France fell just 0.03 percent.

--Bonnie Kavoussi

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In the face of growing youth unemployment across Europe, the European Commission has launched what it calls the Youth Opportunities Initiative, a program aimed at getting more of the continent's young people into the workforce.

Per a press release from the European Commission, the program will allocate 4 million euro toward getting young people into employment, education or training within four months of leaving school.

At the moment, the EU has a youth unemployment rate of about 21 percent, meaning that 5 million young people are out of work. According to the European Commission, a total of 7.5 million people age 15 to 24 are not employed, attending school or involved in work training.

The lack of opportunities for Europe's young people has inspired protests and riots in some countries and mass migrations in others. The problem is expected to grow worse if Europe tips into a recession, or if the EU's many heavily indebted countries impose austerity measures to rein in deficits.

-- Alexander Eichler

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Italy -- whose debts currently exceed 1.8 trillion euro, or more than 120 percent of the size of its economy -- appears to be considering an auction of six digital frequencies, according to Bloomberg.

Earlier this week, the Italian government walked back plans to assign the frequencies for free. It now seems to be weighing a proposal to auction the frequencies to the highest bidder. Such a sale could net the government about 2.4 billion euro, according to a professor at University of Rome La Sapienza.

"It doesn’t make any sense to give away for free scarce resources such as frequencies, especially in light of the financial troubles Italy’s in,” said Dino Bortolotto, head of the telecommunications company Assoprovider, as quoted in Bloomberg.

-- Alexander Eichler

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Mindful of the stigma associated with bank bailouts, some European governments are using workaround methods to generate quick cash for their countries' financial institutions.

Nations including Germany, Italy, Portugal and Spain are moving assets around to help ease the debt burden on their major banks, according to the Wall Street Journal. The hope is that by eschewing any measure that can be characterized as a full-on bailout, the countries can avoid spooking investors with the appearance of vulnerability.

One such method, in use in Italy, involves the government selling its unwanted property to banks, then leasing the property back. Banks can bundle the properties as asset-backed securities and use them as collateral to get loans from the European Central Bank.

Analysts have warned that these solutions are only a temporary fix and that more comprehensive action will be needed to guarantee the safety of European banks, the WSJ reports.

-- Alexander Eichler

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The euro dipped below the .30 mark Monday afternoon as markets closed out a day of disappointing news and developments of uncertain import.

At the end of trading Monday, the euro stood at .2997, a 0.4 percent decline on the day and close to an 11-month low versus the dollar, according to Bloomberg.

There were a number of reasons investors may have been wary during Monday's trading, including a rescue package deal for the International Monetary Fund that fell short of expectations, and tumbles for Asian currencies like the won and the yen as the international community assessed the death of North Korean leader Kim Jong Il.

Monday also saw a sell-off for Bank of America stock that left the company trading at just .99 at the closing bell. Overall, the Dow ended the day 100 points down.

On Tuesday, Spain will auction a series of three- and six-month securities. In the past week, Spain has raised about €11 billions, in debt auctions an unexpectedly good performance aided by falling interest rates.

Alexander Eichler

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Several nations agreed Monday to provide €150 billion (5 billion) to the International Monetary Fund, a rescue package that incorporates commitments from eurozone and non-eurozone countries alike, yet may not be far-reaching enough to reassure nervous investors.

The €150 billion will consist of contributions from 13 eurozone nations, as well as four countries -- Poland, Denmark, Sweden and the Czech Repoublic -- that are not part of the currency union, Bloomberg reports.

Notably absent is the United Kingdom, whose refusal to pledge money to the IMF means that the architects of the deal will fall short of their €200 billion goal. The U.K. will "define its contribution early in the new year," according to a statement from EU finance ministers.

Also not participating in the deal are Greece, Ireland and Portugal, three heavily indebted eurozone countries that have received international bailout funds.

Alexander Eichler

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With recession looking more and more likely in Europe, the problem of high youth unemployment is unlikely to diminish any time soon, according to a report issued Friday by the European Commission.

Europe's economy is widely expected to shrink in the coming months, which bodes ill for the prospect of a labor market recovery. Youth unemployment in the European Union is at 20 percent, according to The Wall Street Journal, and runs significantly higher for some individual countries. In Spain, for example, 48 percent of young people are unemployed.

Compounding the problem is the ubiquity of low-paying temporary job contracts in Germany, France, Sweden and other countries, according to the WSJ. Many young people are employed under temporary contract arrangements, but these positions offer relatively little chance of moving into a full-time job, and can create a lasting wage gap between temporary and permanent employees.

-- Alexander Eichler

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Mariano Rajoy, who will be sworn in as prime minister of Spain on Wednesday, has lain out some of the measures his government intends to take to address Spain's looming budget deficit.

Rajoy told members of Parliament Monday that his government will pass a provisional 2012 budget by the end of December, according to the Financial Times.

Under Rajoy's plan, public sector hiring is expected to drop off sharply, and all forms of public spending except pensions will be vulnerable to cuts, the FT reports. The proposed budget aims to reduce Spain's deficit by €16.5 billion, according to BBC News.

Spain has an unemployment rate of nearly 23 percent, the highest of any developed economy. Rajoy told Parliament that measures to reform the labor market would be devised by the end of March.

Alexander Eichler

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Dominique Strauss-Kahn, the former managing director of the International Monetary Fund, had harsh words for eurozone leaders Monday, according to the Financial Times.

Speaking at a conference in Beijing, Strauss-Kahn said that European debt crisis was in fact "a growth crisis," and that "[b]ehind the growth crisis is a leadership crisis."

Strauss-Kahn cited German Chancellor Angela Merkel and French President Nicolas Sarkozy as two leaders who were not cooperating as effectively as they could, saying he doubted whether they "clearly understand each other."

Monday marked Strauss-Kahn's first formal address since being charged with the sexual assault of a hotel housekeeper in May, an accusation that was ultimately dropped.

-- Alexander Eichler

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The U.S. dollar -- not gold -- now is the ultimate safe haven.

While gold prices fell to their lowest level since September, the U.S. dollar index rose to its highest level since January as investors fled risky investments after the unsuccessful European Union summit last week, according to The Financial Times.

"Gold evidently failed to uphold its primary role as a safe haven asset," Ross Norman of Sharps Pixley, a retail bullion brokerage, told the FT.

--Bonnie Kavoussi

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The European Central Bank has given banks a weapon that could serve as a backdoor bailout for troubled European governments: cheap money. But banks are likely to use the money to pay down their own debts rather than save European governments from higher borrowing costs and the threat of default, according to Thomson Reuters' International Financing Review.

From the article:

Burned by Greek losses, and under the scrutiny of shareholders, banks have slashed their exposure to weaker European sovereigns over recent months. Senior bankers say they will cut further, despite pressure to use newly available, longer-term ECB loans to buy government debt as part of an officially-sanctioned carry trade.

"I can't think for a moment why anyone would want to [buy eurozone government debt]," said the head of capital markets at one European bank that is also reducing its exposure to eurozone sovereign bonds. "Everyone is trying to protect capital. It's counter-intuitive. It would be digging a deeper hole for yourself."

--Bonnie Kavoussi

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Credit rating firm Moody's Investors Service downgraded Belgium's credit rating two notches on Friday: from Aa1 to Aa3.

Moody's attributed the downgrade to the increased risk that the Belgian government took on by bailing out the bank Dexia, "increasing medium-term risks to economic growth" due to budget cuts in the eurozone, and higher borrowing costs for eurozone countries such as Belgium.

The interest rate on ten-year Belgian government bonds was 4.32 percent as of Friday afternoon.

--Bonnie Kavoussi

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The German airline Lufthansa, Europe's largest airline by market value, plans to detail a cost-cutting plan early next year as Europeans turn to cheap airlines and built-in expenses such as the cost of fuel rise, according to The Wall Street Journal.

Christoph Franz, Lufthansa's chief executive, said that the company's operating profit this year will be "well below the figure we require in order to secure our company and our jobs in the future," according to the WSJ.

Air France also plans to announce cost-cutting measures in mid-January, according to the WSJ.

--Bonnie Kavoussi

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Francois Hollande, the Socialist Party candidate for president of France, said on Friday that if elected, he would seek a eurozone rescue from the only institution that he believes can save Europe, according to The Wall Street Journal: the European Central Bank.

Hollande, French President Nicolas Sarkozy's main election opponent, said that the ECB is the only institution with the funding and credibility to be able to provide a full backstop for troubled European governments, according to the WSJ.

"Everyone knows that without a powerful intervention by the ECB, it will be impossible to restore calm on markets," he said.

Knowing that Germany would resist any change to the treaty preventing the ECB from buying bonds directly from governments, Hollande said that he would like to work within the current legal framework, according to the WSJ. "I would rather have a change in practice than a change in the treaty," he said.

--Bonnie Kavoussi

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Standard and Poor's released a report Friday saying that five of Europe's strongest economies may experience an even sharper contraction than other countries.

S&P wrote that the eurozone's five "net exporter" countries -- Germany, the Netherlands, Austria, Belgium, and Finland -- will suffer at least as much as other eurozone countries from the imminent European recession, and that they may suffer even more since they are so dependent on external consumer demand. Consumption comprises 73 to 80 percent of those economies, according to S&P.

S&P wrote that the Netherlands is the most vulnerable "net exporter" country, followed by the Netherlands.

--Bonnie Kavoussi

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Ireland, which implemented austerity measures earlier than other European countries, saw its economy shrink 1.9 percent between July and September, according to figures from Ireland's national statistics office cited by The Financial Times.

Ireland thus was the worst-performing economy in the eurozone: a steep turnaround from the previous three months, when the Irish economy performed second best, according to the FT. The Irish economy shrank largely because of a steep decline in corporate investment and consumer demand, the FT wrote.

--Bonnie Kavoussi

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The euro fell in value on Friday after Fitch Ratings issued a warning that it may downgrade several countries in the eurozone, according to Bloomberg News.

Fitch Ratings revised its outlook to negative on Friday on the credit ratings of Spain, Italy, Belgium, Slovenia, Ireland, and Cyprus. After the announcement, the value of the euro fell to .3019 at 1:49 p.m. ET, after gaining earlier in the day, according to Bloomberg News. The value of the euro has fallen 2.7 percent this week: the largest such decline since early September.

--Bonnie Kavoussi

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German Chancellor Angela Merkel's junior coalition party, the centrist Free Democratic Party (FDP), gave Merkel a limited vote of confidence in her handling of the eurozone crisis.

Though the FDP did not reach a quorum in the vote, they backed the decision to create a permanent eurozone bailout fund: the European Stability Mechanism, according to The Wall Street Journal.

Nonetheless, the sizable minority in the FDP that is skeptical about the euro probably will prevent Germany from pursuing larger bailout efforts, according to the WSJ.

--Bonnie Kavoussi

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The sovereign debt crisis ironically could boost economic growth in Europe through one avenue, however short-term: exports.

Investors are selling euros as they lose confidence in the future of the eurozone, which is driving down the value of the euro and making European exports more competitive around the world.

The value of the euro has plunged 13 percent since its peak in May to .30, which economists say could raise economic growth in the eurozone by at least 0.5 percent as long as the fall in the value of the euro sticks, according to The Wall Street Journal.

But the fall in the value of the euro also could keep struggling European countries dependent on exports that no longer will stay competitive over the long term. For example, Portugal's textile industry accounts for 10 percent of the country's exports, according to the WSJ and the head of Portugal's textile association told the WSJ that the weaker euro "will help Portuguese textiles exports, especially for countries outside the European Union."

But this is not a sustainable strategy, said Stijn van Nieuwerburgh, associate finance professor at New York University's Stern School of Business.

"The future of Portugal does not lie in textiles," van Nieuwerburgh told The Huffington Post, noting that the textile industry in emerging economies has boomed. "It will have to lie in something else -- in R&D [research and development] -- and it's going to have to undergo structural reform, and that's just a very painful and slow process."

--Bonnie Kavoussi

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Two of Europe's strongest economies now seem to be in a competition to see which one will shrink the least.

"It is true that the economic situation in Britain is very worrying today and one prefers to be French than British at the moment on the economic level," French finance minister Francois Baroin said on Friday, according to The Financial Times.

The French statistics agency Insee recently forecast that the French economy will have shrunk 0.2 percent between October and December of this year, and that it will shrink another 0.1 percent during the first three months of 2012, according to the FT. It also forecast that the unemployment rate in France, which is currently 9.7 percent, would rise to 10 percent by the middle of 2012.

The Organization for Economic Cooperation and Development (OECD) forecast in late November that the British economy would fall back into recession during the winter because of government spending cuts and the eurozone crisis, according to The Guardian.

--Bonnie Kavoussi

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Mario Monti has survived his first vote of confidence over austerity, Reuters reports (via CNBC). His predecessor, SIlvio Berlusconi, barged his way through more than 50. Markets have not reacted to much today and have been flat, although the CAC-40 has started to drop a bit.

The plan, contested by Italy's unions and the opposition Northern League, has been in effect since Monti's government approved it on December 4. But it needed full parliamentary approval within 60 days to remain in force.

The upper house, where Monti is a life senator, is expected to approve the package definitively next week, most likely in another confidence vote.

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Italian Prime Minister Mario Monti has said in a speech that the EU must look for more sustainable, long term solutions to its sovereign debt crisis, and politicians must overlook the short term needs for "rigour" in order to achieve the goal of stability, Reuters reports.

Italian Prime Minister Mario Monti said Europe's response to the debt crisis "should be wrapped in a long-term sustainable approach, not just to feed short-term hunger for rigour in some countries."

"To help European construction evolve in a way that unites, not divides, we cannot afford that the crisis in the euro zone brings us ... the risk of conflicts between the virtuous North and an allegedly vicious South," he told a conference in Rome.

The speech could be interpreted as a thinly veiled attack on Germany, which has routinely blocked market-friendly approaches, such as European Central Bank (ECB) intervention or discussions of collectively-issued eurobonds.

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