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Why America should care about Europe’s economy

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The EU has dragged its feet on how it will deal with the unavoidable Greek default and second bailout, which in turn raises the question of how it would address an increasingly likely new rescue of Ireland and Portugal. And if there is no clarity on what happens with the small, more manageable peripheral countries, then it’s all together uncertain what would happen if Spain or Italy needs funds eventually.

It’s not a question of solvency per se, that is, about European countries being able to pay back their debts, but of liquidity. Market concern is that Europe will not be able to agree on a timely strategy to make sure all the contingencies are in place. And if there is no liquidity, then the solvency issue becomes real, not psychological.

Many investors can’t take that chance and thus are rebalancing their exposure just in case, moving their money to safer assets, which explains why markets plummeted globally in the past few days.

“It’s quite hard to disentangle anymore. In general it’s risk aversion,” says Luigi Speranza, a London-based economist with BNP Paribas. And even if there is little new evidence to justify a run on Italy or Spain, “the market is on high alert. And you can’t underestimate market reaction because it can be self-fulfilling."

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