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Crisis slices deep into core of euro zone

A trader is pictured at her desk in front of screens at the Frankfurt stock exchange.


A botched German bond offering and fears of a French credit downgrade are driving the two-year-old sovereign debt crisis into the heart of the euro zone.

Investors shunned an offering of 10-year German bonds Wednesday, demonstrating that even the gold standard of European bonds is proving a tough sell with rattled investors.

"If Germany can't sell bonds, what is the rest of Europe going to do?" BMO Nesbitt Burns senior economist Benjamin Reitzes wondered ominously in a research note.

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The fear is that if Germany can't finance its debt then the euro itself may be doomed. Germany is the rock of the 17-member euro zone – rich, financially sound and boasting the largest economy in Europe. It is the antithesis of Greece, Spain or Italy.

But it's now apparent Germany can't immunize itself indefinitely from the struggles of its weaker neighbours if investors no longer have faith in the euro.

Germany's Financial Agency blamed "the extraordinarily nervous market environment" for the weak response to its latest issue of 10-year bonds, noting that investors scooped up just two-thirds of the €6-billion ($8.4-billion) offering.

Equally worrying to investors is that, even as the crisis deepens, European leaders seem incapable of agreeing on what to do next. Indeed, many of the euro member countries are still dragging their feet on implementing earlier reforms.

The near-constant bickering among European leaders has sparked alarm around the world, including in Ottawa.

Canadian Finance Minister Jim Flaherty said the weak German bond offering demonstrates that Europe must quickly "ring-fence" the problem before the crisis drags down the global economy.

"Delay is the enemy. Things get worse," Mr. Flaherty told reporters in Ottawa.

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"I would hope that we would not have to get to this, but here we have yet another country being affected by the contagion within the euro zone and we're starting to see countries around the world affected, including some of the poorer countries. So this is becoming increasingly a global problem."

Mr. Flaherty said he's in constant contact with his peers from non-European, Group of 20 economies about what is required to stabilize the global economy.

Speaking to reporters in Montreal Wednesday, Bank of Canada Governor Mark Carney said the euro zone economy is likely already in recession – a slight escalation from his previous warnings that one would probably occur – and noted the debt crisis, which he said "appears barely contained," is affecting the whole region.

"European authorities need to put into place a mechanism to ensure that all countries in Europe can finance at sustainable rates while they undergo a period of adjustment in those countries – budgetary, structural adjustment," he said, adding that Europe must also "re-found" the terms of its monetary union.

Within Europe, however, consensus remains elusive. German Chancellor Angela Merkel pre-empted European Commission President Jose Manuel Barroso's formal endorsement Wednesday of a plan to issue euro bonds by publicly rejecting the plan in the German parliament.

"It is extremely troubling, I might say inappropriate, that the Commission is now focusing on proposals on euro bonds in different varieties," Ms. Merkel told German legislators.

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Ms. Merkel argued that "collectivization of the debt" isn't the answer to the "currency union's structural flaws." Germany has long opposed the use of euro bonds, worried that pooling European debt would dilute its bond market advantage and force it to pay higher interest rates.

Right now, euro zone members have a common currency, but issue their own bonds to finance government activities. One by one, however, member countries have faced problems in the sovereign debt market, inflating their borrowing costs. Greece can't borrow and is now dependent on instalments of a European bailout to stay afloat. Spain and Italy face interest rates of about 7 per cent on their 10-year bonds.

Even France and Belgium are running into problems. Analysts have warned that France's triple-A credit rating is at risk.

"Conditions continue to be acute in Europe," BMO's Mr. Reitzes said. "More definitely needs to be done."

And the solution, he said, need not involve euro bonds. He said the European Central Bank must get more involved in shoring up the euro zone's bailout fund – the European Financial Stability Facility, or EFSF.

The euro zone is unlikely to survive its sovereign debt crisis without an overhaul, according to a majority of leading economists and former policymakers polled by Reuters. And half said the most likely outcome is a new "core" euro zone with fewer members – most notably without Greece.

With files from reporter Jeremy Torobin in Ottawa

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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