Greek Election Results: Stock Market Impact Will Continue As Spain and Italy Woes Deepen

The European Union’s travails continue to drag along without any permanent solutions, leaving the rest of the world and global stock exchanges in a lurch as they parse every bit of news emanating from the continent.

On Saturday, there was a ray of hope as the leftist Syriza Party, the political bloc opposing austerity, lost the Greek election. The conservative and pro-bailout New Democracy was victorious. If it can form a coalition government, the country will continue the austerity alternative to recovery and remain in the euro zone. Negotiations will continue between the newly formed Greek government and the so-called troika of foreign creditors — the European Commission, the European Central Bank, and the International Monetary Fund — over the terms of a bailout agreement.

Greece is a small but symbolic piece of the economic puzzle in Europe. The government borrowed too much money and is now running out of cash for salaries and medical costs. The EU has already provided some financial support (two bailouts), which has not been enough. The bailouts include a number of austerity measures not yet implemented by Greece.

If a coalition is formed, most believe Greece will get the money it needs from continent-wide sources. Skeptics believe that a new bailout will only enable the Greeks to survive for a short period of time. Also, the government must deal with a flight of capital from the country. In a nutshell, Greeks, as well as Spaniards and Italians, are running on their banks and moving their deposits to safer places such as Germany and the Scandinavian countries. Only a guarantee of deposits by the EU will stem the tide of this flight to safety.

Next on the agenda is Spain. Its problems have mostly resulted from a weakening banking system that experienced serious loan losses in real estate. The country recently received a 100 billion euro bailout that has not been sufficient to create confidence among investors and depositors. And finally, Italy needs to clean up its financial problems and begin to pay down its significant debt or be subjected to higher interest rates and bank system issues. A worsening financial crises in either country would create a much greater risk to the global economic system than a default of Greece.

All three of these countries are struggling to find the best road to recovery. Is it stimulus, which will exacerbate their bloated debt situation? Or, is it austerity that will hit workers hard and worsen their unemployment problems? Does this dilemma sound familiar? Consider the debate about stimulus versus spending cuts in the U.S.

Most analysts believe that the euro zone will ultimately get back on track, but this will only be possible when Germany uses its considerable economic clout to resolve the continent’s economic problems. It should be noted that the U.S. is not just an innocent bystander as Europe receives about 20% of its total exports. It is conceivable that Germany will ask America and Great Britain (another highly interested party) for help in its rescue efforts. It is inconceivable that either will support the euro zone with any great enthusiasm given the domestic problems of each.

Lastly, the fate of the euro is at stake. The currency has declined precipitously since mid 2011, and reached a two-year low of $1.26 last week. The implications of a weaker euro on global trade should not be underestimated. Yet, many traders continue to bet against a short-term recovery as short sales of the euro have reached unprecedented levels.

The euro imbroglio must be rectified, the currency must survive and depositors must stop moving their money. European banks will need to be supported with huge bailouts and will then be able to play a major role in the reemergence of the zone. When this will all take place is up for debate. But, it will happen only if Germany is placated with austerity measures from those it supports financially, and its EU partners allow it to assume the leading role in euro-politics.

The impact on the U.S. is clear. Our financial markets will be disrupted until a long-term plan is in place to deal with the weaker European countries. 

The American stock market will experience volatile swings led by financial institutions, which face huge losses if any European banks default. The debt market will continue its upward spiral as it represents the safest place for global liquidity.