Contagion is a horrid word. But it is one European policymakers had better get to grips with quickly.
Anxiety about a debt crisis in Greece is one thing, but mounting fears that Spain and Portugal — and even Italy — are heading the same way were enough to spook Western stock markets yesterday. Spain and Portugal were both down 5%, with the UK reacting badly too. Fears about Europe's sovereign debts even reached the US (poor joblessness figures didn't help).
These financial crises develop in the same way — for days or weeks at a time, isolated problems grumble on, before suddenly breaking out into full-blown panics. And a breakout is something to fear for the European Union. It has felt able to rule out a bailout of Greece, but would find it much harder to tell bigger member states to sort themselves out. To see this through the prism of the banking crisis, you might describe Greece as Northern Rock, while Spain or Italy would be in HBOS territory.
Of these larger nations, Spain, in particular, looks increasingly vulnerable to a
Greek-style tragedy. The country's annual budget deficits are currently running at similar levels to those of Greece and the outlook is getting worse — on Wednesday, the Spanish government raised its deficit forecasts for the next three years.
Spain rightly points out that it is starting from a much lower base than Greece — total debt as a proportion of GDP is less than half as high. Yet with record unemployment and an economy still stuck in recession, borrowing will continue to mount up.
The European Commission had hoped to stamp out all these worries with its strict instructions to Greece on Wednesday. However, scepticism
remains about both Greece's ability to deliver the deficit-reduction plans it has promised, and Brussels' ability to hold it to account.
The first test will come next month, when Greece has been told to report back to the Commission on the progress it has made, with a detailed timetable for getting on top of its borrowing. If there is any sign of slippage, the Commission must think carefully about its next move.
Disciplinary action would be the conventional response, but there really doesn't seem much point in threatening Greece with legal action or fines. A better idea might be for the Commission to hand over the responsibility for sorting Greece out to an organisation with experience of resolving financial crises and supporting bust economies.
The Greeks have so far balked at any suggestion that an International Monetary Fund (IMF) intervention in their country is necessary. But if the Commission wants to convince investors that it is taking their fears about sovereign debt defaults seriously, it may soon be necessary to force Greece to call in the IMF.