Austerity now dirty word in Europe, but what next?

Political upheaval across Europe highlights rising voter discontent with budget tightening. France's new president Francois Hollande

won by denouncing austerity, while weary Greek voters practically shouted "no more" after two years of cutbacks demanded in return for bailout loans. Austerity, however, isn't going anywhere just yet. Strained government financies mean even Hollande lacks money to spend on stimulus. He and other European leaders might finally seek more ways to soften its deadening impact on growth and jobs. But there aren't many obvious options. More ominously, Greece faces turbulent and uncertain days. The prospect that voter rejection of the tough terms of its bailout by a deeply polarized electorate could lead to another debt default — or even abandoning the euro. Uncertainty over how Europe will handle its government debt crisis in the weeks and months ahead left stock markets volatile on Monday. They fell sharply in the morning but recovered in some countries by the close. The sharpest selloff was in Greece, where the main stock index plunged almost 7 percent. The euro briefly spiraled to a three-month low against the dollar, hitting $1.2972. More turmoil in the eurozone would affect markets and the global economy. A financial disaster such as a government default or bank failure could spread quickly to banks around the world, while American exporters would face headwinds if sagging confidence in Europe shrinks the value of the euro against the dollar. Exports have been one of the U.S. economy's few strengths since the recession ended three years ago. Hollande, France's first Socialist president in more than a decade, campaigned for "change now" and promised higher taxes on the rich and more government spending to stimulate the economy. "Austerity can no longer be inevitable!" he shouted in his first speech after Nicolas Sarkozy conceded Sunday night. The question remains whether Germany — which is Europe's powerhouse driving the austerity agenda — will allow at least some countries in the eurozone to spend more freely in the face of a recession that is spreading across the continent. And any loosening of spending risks provoking trouble from bond markets and ratings agencies. One agency has already stripped France of its coveted AAA rating. The most nerve-wracking development occurred in Greece, where political parties that backed two bailouts lost their majority in Parliament. That opens up the possibility that Greece's new leaders could renege on commitments made to secure the country's massive rescue loans — or even decide to leave the euro. The conservatives got the first try but failed — leaving a new left-wing, party to take its turn to try. If no party can assemble a majority coalition, that would usher in another month of financial chaos before new elections, probably in June. Merkel pressed Greek leaders to stay the course. "Of course the most important thing is that the programs we agreed with Greece are continued," she said Monday. The European commission called for the "full and timely" implementation of agreed cuts. Those include €11.5 billion in new cutbacks that must be found in June in order for Greece to keep getting money under the terms of its second, €130 billion bailout. Economist Christoph Weil at Commerzbank said that if aid is cut off Greece would be unable to pay its debts by autumn, leading to a second default following a writedown of €107 billion in March. European leaders may cut a bit more slack on the terms — as they have in the past. "There is certainly room for negotations that could save face for both sides," said Weill. But "patience is wearing thin" with Greece and that "if I were Greek I would not count on this happening." Greece isn't the only problem. The 17 countries that use the euro — and 9 other European countries — agreed in March to a fiscal compact that seeks to make countries balance their budgets. But as Europe's economy gets weaker, the public and politicians are growing weary of the budget-cutting that is required to make this fiscal compact work. Eight of the 17 eurozone nations are already in recession and unemployment across the bloc rose to 10.9 percent in March — its highest ever. Over the past two years, France and Germany have steered Europe through the debt crisis — though not always well — and declared an end to the flouting of deficit limits that led Europe into the debt crisis. But the crackdown could not have come at a worse time — with the world economy slowing — and propelled Europe into a vicious austerity spiral. Cutting spending — which meant laying off state employees and ending stimulus programs — further slowed nations' economies and produced less tax revenue, which meant more cuts were needed to meet deficit targets. Now a backlash has begun and for many, Hollande is its leader. The new French leader has promised to end the negative loop, demanding that the fiscal compact that targeted spending be re-negotiated to include measures to promote growth. Many economists have long advocated for a greater emphasis on growth, but that idea seemed to gather steam among European policymakers only as Hollande promoted it. "At the moment that the (French vote) result was proclaimed, I am sure that in many European countries, there was relief, hope," he told supporters in his central hometown of Tulle. Other officials have been taking notice. European Central Bank President Mario Draghi called for a "growth compact," while not relenting on his calls for balancing budgets. The Dutch government, long a supporter of such discipline, fell over the issue of too much austerity and too little growth. And even Germany, the primary architect of austerity, has said a growth pact should be drawn up. Still, concrete proposals for stimulating short-term growth have been few. European officials have talked about boosting funding for the European Investment Bank, and economists have urged making more targeted and aggressive use of EU structural funds for infrastructure projects such as roads. Yet with a budget only around 1 percent of EU gross domestic product, the EU's prospects for large-scale spending are limited. Merkel and Sarkozy were so close they were known as "Merkozy" — and the big question now is if there will be a "Merkollande" in Europe's future. "There can be some short-term friction when they have to adjust to each other," said Laurence Boone, chief European economist at Bank of America Merrill Lynch. "But it doesn't seem to me that there is an alternative, because Spain and Italy are not strong enough." Hollande's plans to jump-start the French economy by investing in infrastructure and buoying small businesses will determine how bumpy the road ahead is. He has promised to keep the deficit in check by also raising taxes on the wealthy and closing some corporate loopholes — but some investors say that will kill the very growth he hopes to foster. If he does start wildly increasing spending, France will no doubt see its borrowing costs rise — which could make his policies untenable and prompt a shift back to austerity. It was those rising borrowing costs that eventually forced fellow eurozone nations Greece, Ireland and Portugal to seek bailouts. Some are hoping that Hollande will turn out to be more pragmatic.