As Americans fixate on the battle for the Republican presidential nomination and the continuing travails of the U.S. economy, the real story in financial land is what is happening in Europe. The issues aren’t new: concerns over the contagion of a default of Greek debt, or Irish or Portuguese or Italian, have been percolating for more than a year and a half. But there is a definite sense of late that these issues are potentially spinning out of control.
Having weathered the debt crisis and an August market sell-off and an absurd downgrade by Standard & Poor’s, the United States is now in danger of being sunk not by its own dithering economy but by the inability of the Europeans to manage their crisis. In that sense, America and Europe have almost completely switched places since this time exactly three years ago when the collapse of Lehman triggered what we now know was a near global financial collapse.
It’s a frustrating and frankly alarming position—to be at the whim of the decisions of others. And it is an unfamiliar one for the current generations of American who have known only one reality of America the colossus. It is we who have determined our economic fate and that of the planet—until now.
Americans have already come to the uncomfortable awareness of interdependence with China, which both supports and constrains the U.S. economy and both challenges and liberates U.S. companies. But the challenge of Europe is to accept a connection to a millstone that has the financial world teetering.
It’s not that the overall size of Greek sovereign debt is so immense. By most estimates it is in the neighborhood of $400 billion, which is less than the stimulus bill just proposed by President Obama. And even if Greece does default—which is what markets are now assuming will happen—it’s not as if the entire sum would just end up as losses for banks around the world. Some of that would be recouped. So let’s say that total losses are $250 billion spread around dozens of banks, many of them Greek. That would be bad, certainly, but nowhere near the trillions in derivatives that were put in question by the collapse of Lehman and hardly an amount that should imperil a global system that generates somewhere around $60 trillion a year of output.
But the Lehman lesson is that numbers only matter when they matter. When fear takes over, numbers are meaningless. The relentless need of financial players to calculate downside risk leads to a vicious circle of worst-case scenarios being “priced in” to stock and bond markets, which lead to more fear, more selling, more uncertainty and thus raise the tension and potential that the crisis will be self-fulfilling.
Here is one illustration of how bad sentiment becomes in finance-land: at a symposium of terrorism and security threats at the Council on Foreign Relations that I attended, the experts were markedly more sanguine in their tone and approach to issues such as biological warfare and hand-held missiles taking down a commercial airliner than market mavens are about the future movement of stocks and bond yields.
Living through these past weeks on Wall Street has been a dark tour through a bruised psyche. Yes, the Eurozone politicians ranging from Angela Merkel of Germany to the buffoon Silvio Berlusconi of Italy to the inscrutable (aren’t bankers always?) head of the European Central Bank, Jean Claude Trichet, have been less than inspiring in their assurances. They face domestic political opposition to further bailouts for weaker Eurozone members because there as here it has been easier for politicos to blame others than explain how the fate of postal worker in Athens is ineluctably bound to that of a burgher of Dusseldorf. And the continental drift does raise the specter that the Europeans will not pull a last-minute rabbit from their hat, that there will be no “debt deal” equivalent to the U.S. debt ceiling deal, which however ugly, was still utterly necessary.
Yet in the midst of this darkness (and in financial land, what with concerns about a U.S. recession combined with fears of a disintegration of the euro it is very, very dark just now), there has been one intriguing sign. U.S. stocks have done badly but not nearly as badly as European shares, especially those of European banks that are close to the lows they hit after the collapse of Lehman. Contrary to S&P’s intent in downgrading U.S. debt, interest rates on U.S. Treasuries have been falling as people pour into those and into gold, desperately seeking safety.
Whether this pattern is just a few anomalous days, we will see soon enough. But it does suggest a different aspect of a global interconnected financial system. To be in a system that is essentially unitary—where a crisis in Athens, Greece, becomes a liability for pensions in Athens, Ohio—does mean that what happens anywhere happens everywhere. It does not mean that what happens anywhere should always lead to a cascade effect. It does not mean that when one domino falls, all must fall.
The financial world, and Americans especially, would do well to learn a lesson from the political world, namely from the Cold War. Dominoes fell then, but contrary to the fears of staunch anti-Communists, a falling domino in one country did not lead Communism to spread like some unstoppable contagion.
Today, it is widely assumed that a default in Greece will send the world into a financial and then economic tailspin. That may be, but it is also possible given what has been happening the past days that the global system is developing antibodies to contagion in peripheral areas: frostbite in your fingers leads to a loss of fingertips, not death. Reports that China may help shore up Italy’s finances are one sign of those antibodies. The differential performance of the U.S. and European equity markets is another.
Admittedly, all of this is too soon to tell. What is demonstrably apparent is that financial players are panicking, sentiment is terrible, markets are weak, political leadership questionable, and uncertainty is rampant. Americans are facing a crisis that they haven’t created, which they are unprepared for, and which they are barely aware of. Not a propitious mix, yet it’s a drama unfolding in a world of massive resources, a surging new world of China, Brazil, India, Indonesia, and on, and a marked lack of war and pestilence.
In so many ways, the global system has rarely been more stable. More people are increasing their standard of living more rapidly and dynamically than ever in our collective history. Which of these forces will trump the other in the coming weeks? Will the cradle of Western civilization be its 21st undoing? Will Europe sink the United States and the world? Stay tuned. I’m betting no, but I’m hedging those bets.