Europe Fearing Financial Armageddon

Ireland's bailout was supposed to calm Europe. Instead, on Tuesday, contagion came back with a vengeance.

With Dublin's request for EU-IMF support effectively settled, investors turned their sights on the next dominoes: Portugal and Spain. Both countries' bond prices fell sharply, and the premium their bonds pay over German bunds — the market's fear gauge — hit fresh records. The euro slid below $1.34 for the first time in two months.

The fear was compounded from an entirely different direction: North Korean artillery shelled the South Korean island of Yeonpyeong on Tuesday, sending investors scrambling for the safe haven of the U.S. dollar and Treasurys. The Dow Jones fell 142 points, or 1.3%, to 11,036; Asian markets followed down in early Wednesday trading, with Japan's Nikkei off 1.5% and South Korea's Kospi down 2%.

In Europe, the mechanics of contagion were on full display. On Monday, Ireland's coalition government began to unravel — the Greens withdrew support — reminding markets that even a "solved" crisis has political aftershocks. Portugal reported that its ten-month budget deficit had widened from a year earlier. Spain was forced to issue short-term debt at sharply higher cost than a month before. German Chancellor Angela Merkel called the Irish crisis "very worrying" for the region.

Contagion works through two channels, and both were visible. One is financial linkage: losses on one country's assets shake confidence in banks elsewhere that hold them. The other is resemblance: investors look from a troubled economy and see familiar problems next door. Portugal lacks Ireland's banking catastrophe or Greece's deficit scale — but its mix of budget deficits, high debt, and low growth was enough.

The market's verdict on the week: these are systemic problems demanding systemic solutions, not a string of one-off rescues. Until Europe built one, the dominoes would keep wobbling.