The Wages of Fear

Is Ireland in trouble? Yes. But it's psychology, not reality, that is roiling global financial markets

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Illustration by Harry Campbell for TIME

Here we go again. After a relatively placid summer, European debt woes resurfaced dramatically in the past week, with Ireland assuming the role of the main protagonist. The concern isn't new. In the spring, the prospect of the Greek government's defaulting on its debts raised the specter of a financial pandemic. That led to scrutiny of other European countries that were deemed vulnerable, including Spain, Portugal and Ireland. The Greek crisis was settled by a partial intervention and bailout by the European Union, led by a disgruntled Germany, which resented having to rise to the aid of a Greece it deemed undisciplined and profligate. Then came the summer holidays, but now the markets are again being roiled by the fear of European debt and its contagion throughout the global financial system.

Fear is the operative word here. There was no shoe that dropped this week, just the culmination of months of simmering concern combined with a demand from Germany that the E.U. adopt a consistent policy for national debt crises such as Ireland's — once the roaring "Celtic Tiger" of European economies, now transformed by the bursting credit bubble into a meek cat.

How bad is it? Yes, Irish banks are saddled with bad debts, and yes, banks throughout Europe would be exposed if those banks were to default. Different numbers have been bandied about, but at a minimum, both British and German banks have several hundred billion dollars at risk.

That seems pretty bad. But doomsday scenarios usually are. The likelihood of complete default is slim. Unlike Greece, the issue with Ireland isn't sovereign debt but precarious banks. The Irish government has been loudly claiming that it is able to prop them up, that it is flush with cash — at least through mid-2011 — and in no need of a Greek-style intervention. Yet E.U. officials have warned that the Irish crisis might lead to an economic unraveling of the monetary union. Piling on, the economist Nouriel Roubini counseled investors that Ireland is "on a path to near or complete insolvency."

Such statements haven't helped. Debt markets, which haven't psychologically recovered from the body blows of the past two years, went into triage. Fears of default raised borrowing costs not just for Ireland but also for Spain, Greece and Portugal. U.S. equities sold off, currencies traded aggressively, and suddenly the system was girding for another plunge into panic.

With panic comes its own logic. Irish officials may be correct that they don't need a bailout — until the financial world makes them such a pariah that they do, in fact, need a bailout. There may be no specific cause of this wave of panic until the panic itself becomes a source of panic. And so European Ministers meet in emergency sessions to come up with a "rescue" plan for Ireland to restore order.

You could be excused for thinking that this seems like throwing someone into the water just to declare the necessity of rescuing him. Yes, there are issues with Ireland's economy, but the greatest issue here is the proclivity to freak out. The near collapse of the global financial system in the fall of 2008 left scars. This latest eruption — coming as it does amid a modest economic recovery with substantial global expansion outside the developed world — is the mark of fragile psychology.

Given that markets rest on trust and confidence, such fears can easily become realities — and destructive ones. Calming markets sounds infantile, but it is also essential, and the Europeans need to calm theirs before they spin out of control.

The bigger issue is that the world is still adjusting to systemic risk that no law or regulation can eliminate. The best analogy is the aftermath of 1945. Then, after the detonation of the first atomic bombs over Hiroshima and Nagasaki, the world was gripped by nuclear fear. The results were panic, bomb shelters and bouts of paranoia that only deepened as the Soviet Union developed its own nuclear arsenal. Over time, the fear subsided — but not because the nuclear threat did. Instead, people learned to compartmentalize and accept that threat as a regrettable part of life.

The financial crises of the past two years made clear that we are all susceptible to contagion from unlikely places — obscure derivatives, Greek debt — that can spread everywhere with astonishing speed. No bailout, no law, no accords will change that. And we probably wouldn't want it to. The connectivity of finance is facilitating the emergence of a global middle class even as it raises the specter of unified collapse. A new system is in its birth pangs, and only time will bring a sense of balance. Ireland is the latest name of the fear, and it will subside.