European leaders appear to be warming to the idea of increasing the size of their bailout arsenal, a prospect that eased the high anxiety in global financial markets at the end of a tumultuous week.
Facing mounting diplomatic pressure from the United States, Canada and others, French Finance Minister François Baroin and Olli Rehn, the European Union's head of monetary affairs, signalled that they were open to using "leverage" to expand the scope of the €440-billion ($611-billion) European Financial Stability Facility (EFSF), a temporary bailout fund established in May, 2010.
That helped calm the markets, but it didn't eliminate the fear among investors that a serious global downturn – including a recession in Europe and anemic growth in the United States – is imminent. While European stock markets staged a modest rally, in Canada the S&P/TSX composite index fell almost 100 points, or 0.86 per cent.
The drop was led once again by mining and oil shares, which are highly sensitive to projections of global economic growth. The TSX dropped 6.53 per cent for the week, its worst weekly decline since the stock market hit bottom in March, 2009. The composite is now at its lowest point since mid-2010. The Canadian dollar also took a heavy hit this week, falling from about $1.01 (U.S.) to 97.14 cents.
European officials, who have come under heavy criticism for their failure to halt the euro zone crisis, are contemplating a number of measures. One is a broad-based repurchase of Greek debt, which could ease the pressure on a country that many investors assume is on the brink of default, according to a European Union document obtained by Bloomberg News in Brussels. They also are considering advancing the implementation of a permanent rescue fund, Bloomberg reported.
European Central Bank president Jean-Claude Trichet reminded an audience in Washington that it takes time to get so many governments to agree on a common approach, but assured his listeners that he and others are committed to fending off the crisis.
"We are fighting hard in Europe," he said.
There was more to the market turmoil this week than the European debt crisis. The U.S. Federal Reserve on Wednesday unveiled further measures to stimulate borrowing, warning of "significant downside risks" to its outlook for modest economic growth. The U.S. central bank's show of concern, followed by evidence that Chinese and European factory production is slumping, stirred fears of a recession, sparking a broad selloff around the world on Thursday.
The market collapse was alarming because Fed officials had made clear already that they were anxious about the recovery. Some put the blame at the feet of politicians, who have failed to show they are serious about avoiding another recession. Domestic politics is slowing action in Europe, and in the U.S., Democrats and Republicans refuse to co-operate on any substantive economic measures.
"This is not the same as 2008," Rick Waugh, chief executive officer of Bank of Nova Scotia, said in an interview in Toronto. Banks and companies are profitable and can handle some turbulence, Mr. Waugh said. "This is more about a breakdown in trust in governments."
At the centre of the anxiety about Europe is whether the euro zone's bailout fund, the EFSF, is big enough to handle a worst-case scenario. For example, Italy's sovereign debt is 120 per cent of its $2.2-trillion (U.S.) gross domestic product. German banks hold about €70-billion in capital and hold Portuguese, Italian, Irish, Greek and Spanish assets equal to more than €500-billion, according to Hedgeye, a hedge fund.
"This problem needs to be overwhelmed as the Americans overwhelmed their problem in 2008-2009," Canadian Finance Minister Jim Flaherty said at a press conference. On Thursday night, finance ministers and central bank governors from the Group of 20 issued a surprise statement that included a pledge by European authorities to be "flexible" in their use of rescue funds, which Mr. Flaherty described as "progress."
But many European leaders have resisted calls for a more aggressive response because the steps they have taken already are unpopular at home. Politicians agreed in July to increase the EFSF to €440-billion, an enlargement that must be approved by all 17 euro zone legislatures. Less than half have done so, and votes are scheduled into early October, creating uncertainty about whether the EFSF will be made functional.
"We have to do one thing at a time," the EU's Mr. Rehn said Thursday in Washington, before adding that "it is important that we look at the possibility of leveraging the EFSF resources and funding to have a stronger impact and make it more effective."
Oil, gold and other commodity prices continued to drop Friday, suggesting investors remain wary about the prospect for economic growth. Odds that the Bank of Canada will cut borrowing costs by January surpassed 80 per cent, up from about 60 per cent earlier this week, according to yields on overnight index swaps, securities that are closely linked to short-term interest rates.
With files from Jacquie McNish in Toronto