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Dow Jones Plunges 513 Points, Suffering Worst Single-Day Drop Since October 2008

First Posted: 08/04/11 05:14 PM ET Updated: 10/04/11 06:12 AM ET

NEW YORK -- Stocks plunged Thursday in the worst one-day drop in more than two years, as investors absorbed fears that the American economy could enter a new recession.

The Dow Jones Industrial Average dropped 4.3 percent during the day, and the Standard & Poor's 500 Index lost 4.8 percent, as investors dumped risky assets and clambered for safety.

A week's worth of declines in the stock market erupted into an outright plunge as a stream of bad news kept coming: The American economy is barely growing; the federal government is preparing to slash spending; and a growing crisis in Europe increasingly threatens to send shock waves through the system.

Experts say investors have factored in a terrifying risk -- that the economy might begin to contract.

"With the policymakers out of bullets and the economy slowing, the market is re-pricing the possibility of a genuine double-dip recession," said John Richards, head of strategy at Royal Bank of Scotland in the Americas.

"It isn't like that's everybody's mainline scenario, and it doesn't have to be for markets to go down," he continued. "All you've done is increased the risk of the double dip from one-in-20 to one-in-five, or maybe one-in-three. That's enough to cause a major sell-off in a market like this."

The bad news started Friday, when the government announced the economy grew at an annual rate of just 0.85 percent in the first half of the year. Seen in relation to population growth, gross domestic product actually shrank during the first three months of the year.

Over the weekend, lawmakers in Washington struck a deal that suggested help would not be on the way. Instead of renewing economic stimulus programs, the debt ceiling deal enacted large spending cuts over the next decade, a program that many experts say could threaten economic progress.

A plan for fiscal tightening could hardly be coming at a worse time, as key economic indicators point to a weakening recovery. The Institute for Supply Management announced Monday that the manufacturing sector had barely grown at all in July. Consumer spending fell in June, the government announced Tuesday, for the first decline in nearly two years.

Much as the end of a real estate boom in Japan in the 1990s set that country up for a so-called lost decade, the sense seems to be taking hold that the United States may now be following suit.

"The realization is dawning on the world that the future of the United States is bleak, that what we have been seeing is what we got. It's not going to really get much better," said Allen Sinai, chief global economist at Decision Economics.

"Our situation is not unlike Japan's," he continued. "When that realization dawns on financial markets, you get a huge shift in sentiment. It's always extreme."

The gloomy situation at home got an unwelcome jolt from abroad on Thursday, as investors began to fear for the economic health of Italy. After an announcement by the European Central Bank made it seem that the monetary authority might not intervene to assist the economies of Italy and Spain, investors entered panic mode, causing the yields on Italian debt to shoot higher.

It was only the latest sign of the worsening crisis among countries that share the euro currency. With Greece mired in a fiscal disaster, experts fear a widespread loss of confidence among investors, a scenario that could raise the cost of borrowing for a group of weak nations -- and even push governments into default.

"The crisis has entered a self-fulfilling phase," said Biagio Lapolla, a rates strategist at Royal Bank of Scotland in London. "We're not talking anymore about a specific country's problem. We're talking about a euro-wide systemic crisis."

Interest rates on Italian debt rose to fresh highs as the Italian stock market plunged. Yields on 10-year Italian debt rose above 6.2 percent Thursday, as the difference between that rate and the rate of relatively safe German debt reached a new record.

Meanwhile, stocks in the U.S. were dropping. The Dow lost 513 points by the stock market's close.

Investors piled into safe-haven Treasury debt as they sold equities, pushing U.S. debt yields lower. The interest rate on the 10-year Treasury note plunged to 2.4 percent, a level not seen since last fall, Bloomberg data show.

All eyes are on Friday's unemployment report. The jobless rate, at 9.2 percent in June, has risen for three straight months, intensifying worries that the economy could slow to a stall.

"Fears the U.S. economy is headed for another recession have started to grow again," said Paul Dales, senior U.S. economist at Capital Economics. "It really started around the end of last week, when we had a really weak GDP report in the United States, and then it's just grown from that."

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