In Europe, Reality Has Set in Again

European Central Bank President Mario Draghi’s recent vow of allegiance to the single-currency European Union helped pull the debt-addled region back from the brink a few weeks ago. But Draghi’s words have proven no replacement for real economic growth.

The Dow Jones Industrial average surged more than 200 points on Sept. 7, a day after Draghi announced a plan to buy unlimited amounts of government bonds from countries such as Spain, Greece and Italy struggling to pay down their sovereign debts.

Cheered by Draghi’s pledge to do “whatever it takes” to preserve the euro, stock markets marched higher for nearly two weeks straight. The Dow Jones average hit a five-year high on Sept. 21, while the Nasdaq surged to a 12-year high.

Now the so-called ‘Draghi Effect’ has worn off and reality has set in (again).

“I think markets got caught up in the emotion and the indications that with the ECB being more aggressive, at least in attitude, that things were changing. Then the past two weeks have brought us back to the harsh reality that nothing in Europe goes smoothly or quickly and the economic woes remain,” said Peter Tchir, with TF Market Advisors in Connecticut.

All this week familiar images have emerged out of Spain and Greece as demonstrators have gathered in the streets to hurl stones and bottles in protest of severe austerity measures demanded by the ECB in exchange for bailout loans.

Meanwhile, Spain and Italy’s borrowing costs have risen sharply (again) after initially falling on the ECB’s bond buying announcement three weeks ago. Spain’s 10-year borrowing costs rose above 6% on Wednesday, just a shade below the 7% level at which Portugal, Greece and Ireland could no longer borrow because it was too costly.

But the worst news for Europe may have come Thursday, and it wasn’t solely focused on the usual suspects.

Across the 17-member eurozone business confidence has fallen to a three-year low and a number of important economic indicators are pointing directly at another European recession. Even Germany, long an oasis of economic health amid a sea of instability, is experiencing rising unemployment.

The eurozone’s economy was flat during the first quarter, then contracted 0.2% in the second quarter. Most economists are predicting that Europe’s economy will contract again during the third quarter, which would fulfill the definition of a recession – two straight quarters of economic contraction.

For nearly three years now, since the advent of the European debt crisis in late 2009, global markets have lurched up and down on a string of bailout announcements, while often ignoring the economic realities tied to those bailout. That’s precisely what happened throughout September. The reality is that the bailouts come at a substantial cost to the countries in line to receive them, a point not lost on the Spanish and Greek demonstrators protesting against ECB-imposed budget cuts and other austerity measures. On Thursday Spain’s government said it would pass 43 new laws in the next six months, all designed to scale back government spending.

But with austerity comes uncertainty, as many economists have wondered whether the draconian budget cuts demanded in return for bailouts will only make matters worse in countries already reeling from high unemployment and economic stagnation.

The ECB’s promise to buy government bonds, backed a short time later by Germany’s high court ruling in support of eurozone bailouts, helped temporarily calm global financial markets, but “there is still the big issue of non-existent growth," Carsten Brzeski, an economist at ING bank in Brussels, told Reuters.

"It is bad. Everything is down, we are heading towards another quarterly economic contraction," he said.