Thursday afternoon, the markets went on something of a joyride. Actually, it was more like a distress ride. After plummeting more than 900 points, the Dow Jones Industrial Average closed down about 3 percent. Why? It's unclear. CNBC said traders warned of a "black hole effect." A chief culprit, as Reuters pointed out, seemed to be fears of financial contagion from Greece, where residents are engaging in the ancient pastime of rioting. If it turns out that concerns over Greek defaults set off this bout of selling, then there's something a little ironic about the timing and origins of this meltdown.
Until very recently, U.S. credit and stock markets had been immune to the volatility building in Europe over the fiscal straits of Greece (and, by implication, Spain, Portugal, and the whole Euro zone). The recovery in the markets has been largely fueled by cheap money, a reflation of risky assets, a compelling global growth story, and a domestic economy that is coming back stronger, better, and faster than many people expected. Europe's woes had been something of an afterthought. And at the beginning of this week, it seemed that Europe, with an assist from the International Monetary Fund, was going to take care of its own problems.
On Monday, European finance ministers and the IMF agreed to give Greece a massive, $146 billion bailout, intended to help ease Greece through its current fiscal shoals. Europe was moved to act in part because the markets began to express fear not only that Greece might default on its debt, but that Portugal and Spain, whose economy is several times larger than Greece, might follow the Greeks into fiscal ignominy. In other words, the bailout was aimed in large measure at stopping contagion from the Greek debt markets from infecting other European markets.
In order to receive the bailout (and avoid contaminating its neighbors) Greece agreed to a new set of austerity measures that would help lower its deficit. On Thursday, Greece's parliament passed the new measures, which involve sharp budget cuts, reductions in public salaries and benefits, and tax increases. All the measures were deemed necessary by both the Greek government and its bailout buddies to stop the contagion.
The Greek citizenry, which doesn't like the austerity measures, began rioting on Wednesday. Three people died. Smaller-scale unrest continued after the parliament passed the austerity plan; the markets have responded to this unrest with unrest of their own. If Greece, whose economy represents only 3 percent of the Eurozone, can't push through the measures needed to stop contagion without igniting violent social unrest, how are larger European countries (that's you, Spain and Italy) going to deal with their looming fiscal crunches? It's possible that the vitriolic reaction to Greece's efforts to stop the broader effects of its debt markets might make it more difficult for other countries to cut budgets with alacrity, thus encouraging further contagion. It's as if the chemicals and booms deployed in the Gulf of Mexico to stop the oil slick from spreading were to act as an accelerant.
Daniel Gross is also the author of Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation and Pop!: Why Bubbles Are Great For The Economy.