A dark cloud has settled over the world's financial markets, as growing numbers of people are concluding the debt crisis in Europe could hammer global growth -- and even bring back recession barely a year after a patchy recovery took hold.
Government officials -- whose job it is to boost confidence -- downplay that risk, but many economists are warning that the much-feared -- "double-dip" recession could be starting in Europe.
It would be the next ugly chapter in the global financial and economic turmoil that began three years ago. And now as then, what is striking is the inter-connectedness of everything -- how near-default in Greece and weeks of dithering in Germany have affected commodities like oil and gold and, with demand and confidence waning, have bludgeoned stock markets around the world in a way that rattles ordinary people saving for retirement from Korea to California.
In 2007, the bad debt connected to repackaged subprime mortgages started undermining banks and hedge funds, and by early 2008 confidence in the system was slipping fast.
This time it is the exposure of banks everywhere to sovereign debt -- the IOUs of governments -- whose value has been falling for months.
The sheer size of the European economy is a factor, said Mauro F. Guillen, director of the Lauder Institute at The Wharton School in Pennsylvania. "If European demand goes down, global growth will slow down," he said.
"A European economy that lags is not necessarily enough to put the world economy back into recession. But a European economy that cannot stabilize its currency and capital markets certainly will push the global economy back into the red." Nicholas Colas, ConvergEx Group chief market strategist, told The Associated Press. "A double dip is a possibility."
It is a daunting prospect, because having already deployed their best countermeasures -- stimulus spending and central bank interest rate cuts -- governments everywhere may be out of ammunition.
Stephen Lewis, a London-based economist with Monument Securities, spoke for many of the pessimists Friday after a week of market turmoil in Europe when he saw "no guarantee that the upswing in the global economy from 2009's low point will be sustained."
At the heart of the crisis are fears that indebted eurozone governments will not be able to pay what they owe. Those fears have sent the prices of government bonds -- many of them held by big banks in Germany and France -- plummeting. Europe also faces low growth prospects because governments must cut back on spending to pay down heavy debt loads.
If banks in Europe and beyond suffer losses on marked-down government bonds, this would then make them afraid to lend the money that businesses need to operate and expand, choking off growth -- a replay, in a sense, of the freezing of credit markets after the Sept. 2008 collapse of the U.S. investment bank Lehman Brothers which led to a worldwide recession. The global economy shrank by 0.6 percent in 2009, its first dip since World War II.
"If sovereign debt concerns are accompanied by worries over bank liquidity any more significant than those currently influencing the credit market, another dip in world economic activity would seem a sure thing," Lewis said.
As fear spreads, stocks and the price of oil, both signs of expectations for future economic growth, have been drawn into the downdraft. And gold, traditionally a safe haven, has hit ominous all-time highs.
Most of the world's leading stock markets are below where they started the year as investors revise down their growth expectations for the global economy.
Reflecting the optimism that held sway until recently, the IMF in April slightly raised its 2010 global growth forecast to 4.2 percent, although eurozone growth was forecast at only 1 percent. Now even that looks optimistic.
Daniel Tarullo, a governor with the U.S. Federal reserve, told a Congressional House subcommittee Thursday that Europe's crisis was a "potentially serious setback."
Tarullo said that the worst case financial turmoil -- possible but still unlikely -- "could lead to a replay of the freezing up of financial markets that we witnessed in 2008."
The latest crisis erupted in October, when the new government in Greece admitted its predecessors had lied about the size of their budget deficit. Instead of a manageable 3.7 percent of gross domestic product, it was a destabilizing 12.7 percent, since revised up to 13.6 percent.
Fears spread for a similar scenario in other countries like Spain and Portugal, and that shattered confidence in the euro, which has in recent months lost some 20 percent of its value.
A bailout seemed necessary -- but eurozone leaders struggled to agree, with opposition especially strong in Germany, where the idea of paying for the profligacy of Greeks and other partners is extremely unpopular.
As Europe dithered Greece faced skyrocketing borrowing rates driven by fear of default and ultimately was shut out of bond markets. Eurozone governments -- with an assist from the International Monetary Fund -- eventually produced a euro110 billion bailout for Greece, followed two weeks ago by a euro750 billion backstop for other shaky governments.
The huge injection was surprising and impressive and seemed to halt the slide, at least temporarily. But while the sum might not be too little, it could still have come too late. Talk that would have been taboo a few years ago, of the eurozone breaking up, is starting to spread.
And even if it is only talk for now, such words can have ripple effects around the world.
World markets have always affected each other, but instant and constant connectivity and real-time trading and instant information have taken things to a new level; bad news in Milan can trigger instant selloffs in Tokyo or Chicago.
In China, the world's top exporter and the biggest economic engine in Asia, there is renewed fear that a slowing in exports -- its lifeblood -- could reverberate through the economy, squeezing manufacturers already grappling with rising costs and narrow margins, Commerce Minister Chen Daming warned this week.
A sell-off in the stock market this week signaled, among other things, a belief that the economy is headed for a slowdown later this year, after having expanded by nearly 12 percent in the first quarter from the same quarter the year before.
Guillen noted that as the euro sinks against the dollar, it also falls against Asian currencies linked to the dollar such as China's yuan, also called the renminbi. That makes it tougher on China's exporters. And it makes China more reluctant to let its currency rise against the dollar, a longstanding hope of U.S. administrations.
"A weaker euro makes it harder for China to agree to an appreciation of the renminbi relative to the dollar because China's exports to Europe would be taking a double flow," Guillen said.
The Fed's Tarullo said the direct effect on U.S. banks of losses on exposure to overextended governments in Greece, Portugal, Spain, Ireland and Italy "would be small." But if problems were to spread more broadly through Europe, U.S. banks would face larger losses as the value of traded assets dropped and loan delinquencies mounted.
U.S. money market mutual funds, which are major suppliers of short-term cash to European banks through their holdings of commercial paper, would likely also be affected, Tarullo said.
Neil Mackinnon, global macro strategist at VTB Capital in London, said it would be a mistake to think the problems on Europe's periphery represented only a local crisis.
"The problems in the eurozone debt markets, which many people thought was a regional problem, has morphed into a major global problem," Mackinnon said.
Germany's embattled Chancellor Angela Merkel, whose government is widely blamed for the dithering that so amplified the collapse of confidence, suggested this week that she understood the heavy stakes.
"The euro is in danger," she told lawmakers, urging them to approve Germany's portion of the wider bailout plan. "If we do not avert this danger, then the consequences for Europe are incalculable, and then the consequences beyond Europe are incalculable."
The lawmakers did as she asked.
Aversa reported from Washington and Pylas reported from London. AP Business Writer Elaine Kurtenbach in Shanghai and Associated Press writers Juergen Baetz in Berlin and Tomoko Hosaka in Tokyo contributed to this report.
Stocks end bumpy week with a pop
LATE-DAY RALLY: The Dow Jones industrial average started the day lower, falling below 10,000 points, but came back late in the day to end with a gain of 125. It gained 117 of those points in the last 30 minutes of trading.
TURBULENT WEEK: The Dow broke a three-day losing streak, but still ended a see-saw week down about 4 percent. It's about 9 percent below its recent high reached April 26.
CORRECTION MODE: Other major market indicators like the S&P 500 index are still more than 10 percent below their late-April peaks, a decline anaylsts call a "correction."