Once again, Europe has reminded us that its sovereign debt crisis is far from over, and its impact on the global financial markets is substantial. Last week, rising concerns over Greece’s viability within the euro zone pushed equities down for a second week in a row. The Dow closed at 12,820, while the S&P 500 dipped to 1,353.
The political gridlock in Greece continues after no party won a majority in parliamentary elections and efforts to assemble a governing coalition were unsuccessful. There is a growing possibility that new elections will be held next month, increasing the likelihood that an anti-bailout party could win and deviate from the path of austerity. At the same time, European officials put pressure on Greek politicians to stand by its fiscal commitments or face leaving the euro zone, as political chaos in the country has cast doubt on whether it will abide by the terms of its latest €130 billion bailout.
If Greece leaves the euro zone, this would open the door for other countries in debt crisis to exit as well. The moment Greece is out of the currency union, the country will experience a bank run similar to the Northern Rock run of 2007, only this time it will be more severe because the problems will not stop there. It will take no more than a day for similar bank runs to develop in Italy and Spain. Luckily, while these events are not implausible, they remain unlikely at least in the near term due to incentives for Greece and the euro zone to continue with the slow and painful process of deleveraging. The ECB has the resources to keep Greece on life support for some time, but it does not have the means to deal with a default that engulfs larger economies like Italy and Spain. At this point, the most likely scenario is that the eventual new government in Greece will comply with the terms of the most recent bailout and that the union will remain intact for now. The debt crisis will continue reemerging, pushed to the brink by markets and then pulled back by policymakers. Europe will remain a drag on global growth and be a key source of volatility in financial markets for some time to come.