If the Greek riots had happened six months ago, the markets would have shrugged. Back then, the world knew the Greek budget deficit was out of control. But everyone assumed its paymasters in Berlin and Paris would fix the problem. And markets elsewhere were on roll as far bigger economies waved goodbye to their recessions.
Today, Greek riots (which resulted in three fatalities Wednesday in Athens) are an entirely different matter. They are the symbol, and symptom, of a sovereign debt crisis, one that has infected other highly indebted European Union countries, threatening their liquidity, their solvency and their banking systems.
Add the sense that there is no clear way out of the EU debt swamp and the new fear that the global engine of recovery - Asian growth - will lose some horsepower, and you have a recipe for a global markets plunge. The big selloff finally came this week, culminating in a wild ride on Thursday, when U.S. stocks fell nearly 10 per cent before finishing down 3.2 per cent. Volatility measures went through the roof, the euro fell to a 14-month low against the dollar, bond yields of weakling EU countries surged to near distress levels, oil sank and gold climbed above $1,200 (U.S.) an ounce.
Friday's markets, initially buoyed by stellar job creation figures in the United States and Canada, were somewhat calmer, though they lost ground later in the day. It was the worst week for the European stock markets in 18 months. The pan-European Stoxx 600 index lost 3.9 per cent, taking the weekly loss to 8.7 per cent. In London the FTSE-100 lost 2.6 per cent as investors took the view that the outcome of Thursday's general election - a hung parliament - would dampen the political will to rein in Britain's gaping budget deficit.
Few strategists are bold enough to say the worst is over, quite the opposite in fact. They were spooked by the ever-climbing yields of short-term Greek, Spanish and Portuguese bonds. Yields on two-year Greek bonds reached 20 per cent - default levels - and the bonds had trouble finding buyers. "In our view, the lack of a clear end-game for sovereign risk in Europe means that, despite recent sharp declines in markets, this is not a buying opportunity," a UBS team of strategists and economists wrote on Friday.
The selloff delivered a rude reality check to investors who had apparently placed too much emphasis on the good news - economic recovery in big chunks of the world - while ignoring much of the bad, including the true extent of the Greek debt contagion, the EU's slow-motion response to cure it and the possibility that strong Asian growth can't be relied on forever.
If the bad news outweighs the good, the V-shaped recovery may be in trouble. The Standard & Poor's 500 index bottomed out in March, 2009, and rose 60 per cent in the next six months. In the past year, it is up by 35 per cent. But most of those gains came in 2009. While the smart money started to flee a few months ago, many investors hung in. The S&P was up for the year until Friday, when the 1.5-per-cent loss wiped out the last of the gains.
The possibility of tempered growth in Asia, particularly, China, is the crocodile lurking in the market shallows. "Australia and countries in Asia are beginning to raise interest rates," said Mike Lenhoff, the chief strategist at British investment manager Brewin Dolphin. "The contribution being made by Asia to the global upswing will moderate. Therefore momentum behind earnings will moderate too."
Australia has raised rates six times since October. South Korea, which skirted recession in 2009, is expected to raise rates this year as growth picks up momentum, taking inflation up with it. Ditto Taiwan. India and China are starting to withdraw stimulus spending. Last week China ramped up its effort to mop up excess cash in the economy by raising the proportion of deposits that lenders must keep in reserve at the central bank. China's goal is to temper rising inflation rates and house prices.
The benchmark Shanghai composite index plunged to its lowest level in seven months this week, dragged down by skidding real estate firms and shares of banks which were expected to flood the market with new stock to raise capital following the latest increase in reserve requirements. "The risk Beijing now faces is that the measured, targeted approach it has taken so far will not be enough to keep these price pressures under control," Royal Bank of Canada's emerging markets research team wrote. "This would then force policy-makers to tighten more aggressively later on, leading to greater economic volatility and disruption."
The market's clear and present danger, however, is Greece and the sovereign debt crisis it spawned. The markets have moved much faster than governments' ability to deal with them, said Jose Manuel Amor Alameda, international financial analyst with AFI, a Spanish financial and economics consultancy. "It has reached the point where there is essentially no market for Greek, Portuguese and Spanish bonds," he said, citing the climbing bond yields in the three countries.
It wasn't supposed to be this way. Greece's out-of-control budget deficit - the latest revision took it up to 13.6 per cent of gross domestic product - was known shortly after George Papandreou's socialist government took office in October. As Greece's fiscal situation went from bad to worse, the healthier EU countries promised support, but did nothing until a genuine crisis threatened to destroy the credibility of the euro and make the weaker euro zone countries un-fundable.
It wasn't until Friday that the German parliament formally backed the €110-billion ($146-billion) rescue planned offered by the EU and the International Monetary Fund (Germany's initial contribution is €8.4-billion). If the EU had moved earlier, the bailout tab likely would have been cheaper. "This was mismanaged from the beginning," Brewin Dolphin's Mr. Lenhoff said. "Germany is as much to blame as Greece. Now the concern is that we'll have another credit crunch in Europe."
Indeed, the euro zone debt crisis is proving explosive. The ballooning yields on Greek bonds suggest investors think the EU-IMF bailout will only delay the inevitable - a default, following by a debt-crunching exercise that could leave investors, including many European banks, with potentially crippling writedowns of 50 per cent or so.
Some of the banks, of course, barely survived the credit crunch. According to the Bank for International Settlements, European and American banks have $1.7-trillion (U.S.) of exposure to Portugal, Ireland, Spain and Greece, the euro zone countries suffering the debt bomb's worst damage. The spiking interbank lending rates provide evidence that European banks are suddenly wary about lending to one another.
The widening debt crisis is like waving a red flag in front of bond and currency speculators. Eighteen years ago, George Soros and other currency traders made vast fortunes betting against the British pound and forcing it out of the exchange-rate mechanism (the narrow currency trading band set up in preparation for monetary union). This time, it seems, the new generation of traders is bent on testing the euro zone's very ability to survive. Betting that the worst of the damage has already been inflicted might be foolish.
With files from reporter Andy Hoffman in Vancouver