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REVIEW & OUTLOOK
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April 27, 2012, 6:50 p.m. ET
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The Growth Deficit
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The slowest recovery plods along



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The weakest recovery on record continued in 2012's first quarter, with the Commerce Department's Friday report of 2.2% growth. That's down from 3% at the end of last year, but closer to the 1.7% for all of 2011. It's enough to give the word recovery a bad name.



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The economy has been growing for 11 quarters since the recession officially ended in mid-2009, and quarterly growth has averaged 2.4%. That's slower growth than in every modern expansion, and about half the growth rate of all recoveries since World War II, according to Congress's Joint Economic Committee. The first 11 quarters of the Reagan expansion in the 1980s, by notable contrast, grew an average of 6.1%.


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The details in the first quarter report help explain the growth deficit. Consumers have been spending (up 2.9%), but businesses weren't investing (down 2.1%). Car and truck sales riding pent-up demand from the recession accounted for half of the increase in GDP.



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This suggests more consumer confidence, but an upside-down recovery with questionable durability. Business capital investment in big ticket items such as plants, equipment and computers is one of the best forward-looking economic indicators. Consumers can't keep up this spending pace if businesses aren't investing to create new technologies or improve productivity.


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Consumers also can't continue to spend faster than their incomes are rising. Real disposable income rose by 0.4% in the quarter, but real disposable income is only up 0.6% in the last 12 months, as higher food and energy prices have sapped middle-class purchasing power.
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The growth numbers were also somewhat inflated by businesses building up inventories, which accounted for about 0.6 percentage points of GDP growth. Over the last six months businesses have stocked up by more than $120 billion, which could presage less spending in the months ahead to move those products off the shelf.


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The good news in the report is that government spending receded for the fifth straight quarter, down 3.1% in the last three months. Remember this is coming off the gigantic rise in the base level of government in 2009 and 2010. Private growth was a more respectable 2.8%.



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Keynesians decry this decline in government spending, but they're the ones who said we needed the "temporary, targeted" demand-side spending blitz. Flood the economy with government spending for two years, then pull back when the recovery is underway, they said. The problem is we never got the roaring recovery they promised.



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Economist David Malpass reports the startling fact that over the last year U.S. GDP has grown by roughly $600 billion but federal debt has climbed by $1.3 trillion. This is hardly "austerity," and it explains why the U.S. debt to GDP ratio is climbing so fast.



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The big picture is that this has been a traditional debt and spending demand-driven recovery, which typically has less staying power. The Obama Administration rejected supply-side incentives of lower tax rates and fewer regulatory burdens to boost noninflationary private output.



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There's more danger ahead, as the tax-increase cliff approaches at the end of this year. Even liberal economists and Treasury Secretary Tim Geithner are suddenly warning about the big tax increases that will hit the economy, but they are the ones who insisted that tax cuts be temporary. They created the cliff we may all leap off. President Obama says tax cuts don't work, but he has never explained why the Reagan recovery that followed policies Mr. Obama rejected was so robust while the current recovery is so anemic.


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A new Fox poll finds that 83% of voters think the country is still in a recession. It isn't, but it's understandable if Americans feel that way.
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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

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America's Renminbi Fixation 
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Stephen S. Roach

.26 April 2012





NEW YORK – For seven years, the United States has allowed its fixation on the renminbi’s exchange rate to deflect attention from far more important issues in its economic relationship with China. The upcoming Strategic and Economic Dialogue between the US and China is an excellent opportunity to examine – and rethinkAmerica’s priorities.


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Since 2005, the US Congress has repeatedly flirted with legislation aimed at defending hard-pressed American workers from the presumed threat of a cheap Chinese currency. Bipartisan support for such a measure surfaced when Senators Charles Schumer (a liberal Democrat from New York) and Lindsey Graham (a conservative Republican from South Carolina) introduced the first Chinese currency bill.


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The argument for legislative action is tantalizingly simple: the US merchandise trade deficit has averaged a record 4.4% of GDP since 2005, with China accounting for fully 35% of the shortfall, supposedly owing to its currency manipulation. The Chinese, insists a broad coalition of politicians, business leaders, and academic economists, must revalue or face sanctions.


This reasoning resonates with the US public. Opinion polls conducted in 2011 found that fully 61% of Americans believes that China represents a serious economic threat. As such, the currency debate looms as a major issue in the upcoming US presidential campaign. “Enough is enough,” President Barack Obama replied, when queried on the renminbi in the aftermath of his last meeting with Chinese President Hu Jintao. Obama’s presumptive Republican challenger, Mitt Romney, has promised to declare China guilty of currency manipulation the day he takes office.



But, however appealing this logic may be, it is wrong. First, America’s trade deficit is multilateral: the US ran deficits with 88 nations in 2010. A multilateral imbalanceespecially one that it is traceable to a saving shortfallcannot be fixed by putting pressure on a bilateral exchange rate. Indeed, America’s major threat is from within. Blaming China merely impedes the heavy lifting that must be done at home namely, boosting saving by cutting budget deficits and encouraging households to save income rather than rely on asset bubbles.



Second, the renminbi has now appreciated 31.4% against the dollar since mid-2005, well in excess of the 27.5% increase called for by the original Schumer-Graham bill. Mindful of the lessons of Japan – especially its disastrous concession on sharp yen appreciation in the Plaza Accord of 1985 – the Chinese have opted, instead, for a gradual revaluation. Recent moves toward renminbi internationalization, a more open capital account, and wider currency trading bands leave little doubt that the endgame is a market-based, fully convertible renminbi.



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Third, there has been significant improvement in China’s external imbalance. The International Monetary Fund estimates that China’s current-account surplus will narrow to just 2.3% of GDP in 2012, after peaking at 10.1% in 2007. American officials have long bemoaned China’s saving glut as a major source of global instability. But they should look in the mirror: America’s current-account deficit this year, at an estimated $510 billion, is likely to be 2.8 times higher than China’s surplus.



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Finally, China has evolved from the world’s factory to its assembly line. Research shows that no more than 20% to 30% of Chinese exports to the US reflect value added inside China. Roughly 60% of Chinese exports represent shipments of “foreign invested enterprises” – in effect, Chinese subsidiaries of global multinationals. Think Apple. Globalized production platforms distort bilateral trade data between the US and China, and have little to do with the exchange rate.

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Rather than vilifying China as the principal economic threat to America, the relationship should be recast as an opportunity. The largest component of US aggregate demand – the consumer – is on ice. With households focused on repairing severely damaged balance sheets, inflation-adjusted private consumption has expanded at an anemic 0.5% average annual rate over the past four years. Consumer deleveraging is likely to persist for years to come, leaving the US increasingly desperate for new sources of growth.


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Exports top the list of possibilities. China is now America’s third largest and most rapidly growing export market. There can be no mistaking its potential to fill some of the void left by US consumers.



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The key to realizing that opportunity lies in access to Chinese marketsall the more significant in light of China’s upcoming pro-consumption rebalancing. Historically, China has had an open development model, with imports running at 28% of GDP since 2002nearly three times Japan’s 10% import ratio during its high-growth era (1960-1989). As a result, for a given increment of domestic demand, China is far more predisposed toward foreign sourcing.


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As the Chinese consumer emerges, demand for a wide variety of US-made goods – ranging from new-generation information technology and biotech to automotive components and aircraft – could surge. The same is true of services. At just 43% of GDP, China’s services sector is relatively tiny. There is enormous scope for America’s global services companies to expand in China, especially in transactions-intensive distribution sectorswholesale and retail trade, domestic transportation, and supply-chain logistics – as well as in the processing segments of finance, health care, and data warehousing.


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The US needs to refocus the US-China trade agenda toward expanded market access in these and other areaspushing back against Chinese policies and government procurement practices that favor domestic production and indigenous innovation. Some progress has been made, but more is needed – for example, getting China to join the World Trade Organization’s Government Procurement Agreement. At the same time, the US should reconsider antiquated Cold War restrictions on Chinese purchases of technology-intensive items.



For a growth-starved US, the opportunities of market access far outweigh the currency threat. The long-dormant Chinese consumer is about to be unleashed. This plays to one of America’s greatest strengths – its zeal to compete in new markets. Shame on the US if it squanders this extraordinary chance by digging in its heels at the upcoming Strategic and Economic dialogue.



Stephen S. Roach was Chairman of Morgan Stanley Asia and the firm's Chief Economist, and currently is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

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04/27/2012 03:50 PM

The Debt Drug

How Long Will Hollande's Party Go On?

An Analysis By Wolfgang Kaden




François Hollande is predicted to win France's presidential election, but his victory could endanger the euro zone's carefully negotiated fiscal pact. He also wants to water down the European Central Bank's statutes, forcing it to lend more to promote economic growth. But his plans would do little more than borrow time -- and they could be very dangerous for Germany.



The whole ghastly process is now set in motion. Not just for Chancellor Angela Merkel, but also for anyone who still had a modicum of hope that the worst of Europe's debt crisis had already been overcome.



The opinion pollsters were right -- François Hollande won the first round of the French presidential election last Sunday. According to all the polls, he will also win the runoff vote on May 6. If he wins, he would become the second Socialist president of the Fifth Republic, following in the footsteps of François Mitterrand.


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For France's neighbors and the fight against the sovereign debt crisis in Europe, that will set everything back to square one. Hollande has said that if he's elected, he will seek to renegotiate parts of the already painstakingly negotiated European fiscal pact. He has disparagingly called it the "Merkel-Sarkozy" pact and says he wants to renegotiate it or block it if necessary. He is demanding that "austerity policies be complemented by growth." And while he's at it, he also wants to change the statutes of the European Central Bank so that it would also be given the official duty of facilitating growth.



One might argue that the calendar is about to be set back 40 years and that we are landing right back in the 1970s, in an era when economic policymakers had been infected by the ideas of John Maynard Keynes, and believed they could bridge economic downturns with ever more multi-million programs financed with debt. It was precisely this phase of recent economic history in which governments began to declare it as their right to accrue ever more debt, and it also laid the foundation stone for the policy of racking up debts that is now standard in all industrialized nations.



"The people of Europe expect that we, the people of France, will provide Europe with another perspective, another direction, another orientation," Hollande recently told his supporters. But what orientation will that be? It certain won't be one that leads to less debt and to living within one's means.



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Borrowed Time


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Of course it would be desirable to have greater growth, which would also help overcome national deficits that have gotten out of hand. But it would be even better if this happened through natural means -- through innovation and increased investment in the real economy. But that's not what politicians like Hollande -- and his friends here in Germany and in other European countries -- is talking about when he calls for more growth.



What he's talking about is artificially created demand: growth paid for with ever more borrowing. It's about building motorways through sparsely populated stretches of land, the construction of more trade fair halls where they aren't needed and building provincial airports that are totally unnecessary.



To see how such growth is to be conjured up, one need only look at the potential future French leader's political platforms. His miracle weapon is called "euro bonds," securities that would be jointly issued by the Europeans and that Germany would also be liable for. But there is no logic whatsoever behind this call, because Hollande is also aware that France now only enjoys limited creditworthiness on the financial markets.



To perfectly round out the whole plan, the European Central Bank (ECB) is also now expected to do its part in a cheerful new round of borrowing. According to the current statutes governing the ECB, the central bank's sole duty is to ensure price stability. But for some time now, this mandate has been "extended to the extreme," argues Jürgen Stark, the ECB's former chief economist and a member of its executive board. The ECB has spent way over €200 billion buying up government bonds and it recently flooded the market with €1 trillion in cheap central bank money. And now, if Hollande has his way, the ECB will also be held responsible for growth through a change in its statutes. In other words: It will be obliged to carry out even greater credit financing.



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Has Hollande Learned Nothing from Past Crises?



This melange of messages suggests that the expected new president of France, which is Germany's most important partner in the euro zone, hasn't learned a thing from the frequent crises that have emerged over the past 15 years. They were all fuelled by distortions that had been created through excessive borrowing -- by both private households and governments. But if politicians like Hollande have their way, the party will just keep going. Under their vision, growth is supposed to supplant urgently needed reforms -- a French pension system that allows 60-year-olds who are still capable of working to retire, a vastly oversized French state apparatus and a French labor market that is saddled with high wages and short working hours that is causing the country to become less and less competitive internationally.



But perhaps these fears are exaggerated. Perhaps Hollande will quickly learn the harsh, raw reality that campaign rhetoric and European reality aren't the same thing.


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The new man in the Élysée Palace may fare the same as Mitterrand once did. When France's first Socialist president came into office in 1981, he brought with him a classic leftist agenda: higher minimum wages, more generous pensions, a shorter working week and also a wave of nationalizing businesses. Two years after Mitterrand took office, France slid into a state of economic disaster. The president was forced to abandon his socialist utopia and subject the country to a bitter course of austerity.


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Will Merkel Risk Serious Discord with France?



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It probably wouldn't even take two years before Hollande arrives at a similar juncture. As long as German Chancellor Angela Merkel sticks with her "no" to euro bonds and to changes to the ECB's statutes, the Socialist president would fail based on a lack of funds alone. He simply wouldn't be able to obtain the money needed for his political adventure -- at least not at relatively acceptable conditions.



So what about the Germans -- in other words, Merkel and her government? Would she risk serious discord with the French by confronting her new French partner with an unequivocal "non"? When it comes to the European Union, governments have a tradition of solving their conflicts through compromise. But it is precisely that kind of compromise that could come with a huge price tag for Germany.



That also applies to the desire to weaken the European Central Bank's statutes. It would permanently lay to waste the German line that the central bank cannot be abused to finance government spending.



That is even truer of the call for the fiscal pact to be renegotiated and to give the go-ahead for euro bonds. With the collectivization of new loans, the cost of Germany's debt servicing would rise by billions of euros. It would also eliminate the necessary pressure on Europe's most heavily indebted states to implement austerity measures. Ultimately, the fiscal pact creates the necessary preconditions for solving the debt crisis in the longer term and builds a solid foundation for the common currency.


For some time now, Germany has shouldered more burdens for the countries of the euro zone than it can actually carry. Even today, the liability risks entailed by the bailout programs that have already been provided threaten Germany's future viability, in the event that those countries are unable to service their debts and Berlin's guarantees turn into actual payments.



Merkel will have no choice but to show François Hollande the limits of what she is willing to accept. It's going to be a hot summer.

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Ideas over Interests

Dani Rodrik  .
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26 April 2012


CAMBRIDGE – The most widely held theory of politics is also the simplest: the powerful get what they want. Financial regulation is driven by the interests of banks, health policy by the interests of insurance companies, and tax policy by the interests of the rich. Those who can influence government the most – through their control of resources, information, access, or sheer threat of violenceeventually get their way.


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It’s the same globally. Foreign policy is determined, it is said, first and foremost by national interests not affinities with other nations or concern for the global community. International agreements are impossible unless they are aligned with the interests of the United States and, increasingly, other rising major powers. In authoritarian regimes, policies are the direct expression of the interests of the ruler and his cronies.


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It is a compelling narrative, one with which we can readily explain how politics so often generates perverse outcomes. Whether in democracies, dictatorships, or in the international arena, those outcomes reflect the ability of narrow, special interests to achieve results that harm the majority.



Yet this explanation is far from complete, and often misleading. Interests are not fixed or predetermined. They are themselves shaped by ideasbeliefs about who we are, what we are trying to achieve, and how the world works. Our perceptions of self-interest are always filtered through the lens of ideas.



Consider a struggling firm that is trying to improve its competitive position. One strategy is to lay off some workers and outsource production to cheaper locations in Asia. Alternatively, the firm can invest in skills training and build a more productive workforce with greater loyalty and hence lower turnover costs. It can compete on price or on quality.



The mere fact that the firm’s owners are self-interested tells us little about which of these strategies will be followed. What ultimately determines the firm’s choice is a whole series of subjective evaluations of the likelihood of different scenarios, alongside a calculation of their costs and benefits.



Similarly, imagine that you are a despotic ruler in a poor country. What is the best way to maintain your power and pre-empt domestic and foreign threats? Do you build a strong, export-oriented economy? Or do you turn inward and reward your military friends and other cronies, at the expense of almost everyone else? Authoritarian rulers in East Asia embraced the first strategy; their counterparts in the Middle East opted for the second. They had different conceptions of where their interest lay.



Or consider China’s role in the global economy. As the People’s Republic becomes a major power, its leaders will have to decide what kind of international system they want. Perhaps they will choose to build on and strengthen the existing multilateral regime, which has served them well in the past. But perhaps they will prefer bilateral, ad hoc relations that allow them to extract greater advantage in their transactions with individual countries. We cannot predict the shape that the world economy will take just from observing that China and its interests will loom larger.



We could multiply such examples endlessly. Are German Chancellor Angela Merkel’s domestic political fortunes best served by stuffing austerity down Greece’s throat, at the cost of another debt restructuring down the line, or by easing up on its conditions, which might give Greece a chance to grow out of its debt burden? Are US interests at the World Bank best served by directly nominating an American, or by cooperating with other countries to select the most suitable candidate, American or not?



The fact that we debate such questions passionately suggests that we all have varying conceptions of where self-interest lies. Our interests are in fact hostage to our ideas.



So, where do those ideas come from? Policymakers, like all of us, are slaves to fashion. Their perspectives on what is feasible and desirable are shaped by the zeitgeist, the “ideas in the air.” This means that economists and other thought leaders can exert much influence – for good or ill.



John Maynard Keynes once famously said that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist.” He probably didn’t put it nearly strongly enough. The ideas that have produced, for example, the unbridled liberalization and financial excess of the last few decades have emanated from economists who are (for the most part) very much alive.



In the aftermath of the financial crisis, it became fashionable for economists to decry the power of big banks. It is because politicians are in the pockets of financial interests, they said, that the regulatory environment allowed those interests to reap huge rewards at great social expense. But this argument conveniently overlooks the legitimizing role played by economists themselves. It was economists and their ideas that made it respectable for policymakers and regulators to believe that what is good for Wall Street is good for Main Street.



Economists love theories that place organized special interests at the root of all political evil. In the real world, they cannot wriggle so easily out of responsibility for the bad ideas that they have so often spawned. With influence must come accountability.


 
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Dani Rodrik is a professor at Harvard University’s Kennedy School of Government and a leading scholar of globalization and economic development. His writings are a compelling combination of international and development economics, history, and political economy, and often challenge prevailing orthodoxy about which policies best promote growth. His most recent book is The Globalization Paradox: Democracy and the Future of the World Economy.




Copyright Project Syndicate - www.project-syndicate.org

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HEARD ON THE STREET

April 27, 2012, 1:12 p.m. ET

Austerity Fever Brings Down Romania's Government
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By ANDREW PEAPLE





European governments are dropping like flies. Romania's center-right government fell on Friday after losing a parliamentary vote of confidence, just two months after Prime Minister Mihai Razvan Ungureanu's government took office. Like other European leaders, Mr. Ungureanu has lost popular support for a tough austerity program. For Mr. Ungureanu—and whoever takes over in Romaniapressure from the International Monetary Fund is making things even more difficult.





Romania's economy has been performing relatively well. Like other emerging countries, Romania relied heavily on foreign investment before the 2008 financial crisis, while its current-account deficit reached 11.6% of GDP in 2008. Two years of recession followed, but Romania's economy recovered to grow by 2.5% in 2011. The government's budget deficit fell to 4.2% of GDP last year from 7.3% in 2009.



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Romania's Achilles' heel, though, is that foreign banks make up over 80% of its banking system. Sudden capital flight is an ever-present danger, so Romania agreed to a €5 billion ($6.6 billion) precautionary credit line with the IMF and European Union last March.



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In return, the country has accepted stringent conditions that would be tricky for any European country to meet, including reducing its budget deficit to 1.9% of GDP this year. Already, Romania has made painful cuts: Public sector employment has fallen 14% since 2008, and its remaining workers have had their wages frozen. But the IMF is also pressing Romania to liberalize its energy and transport sectors, and introduce more private-sector involvement in health care.


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Such reforms might come straight from the Washington Consensus textbook, but they have aroused huge domestic opposition. Protests against planned health system changes brought down the previous government in February: Romania's centre-left opposition has been increasingly critical of the now-fallen government's belt-tightening.



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But the opposition has already said it wants to retain the IMF's support. In truth it has little choice but to keep up the austerity, with market confidence already fragile: The Romanian leu fell 0.3% against the euro on Friday, its sharpest one-day fall this year.



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Like others in Europe, Romania is finding there is no easy way out of the economic blues.


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