The immediate concern is that Europe could be entering a downward spiral that will harm the world economy. New elections in Greece are barely two weeks away, and that isn't the only eurozone nation where the ability to repay debts is in doubt. Spain's woes, including its new effort to prop up a private bank, are a major factor in Wednesday's stock-market slide.
The yield on the 10-year Treasury note fell to just 1.63 percent in mid-day trading – a record low. Translation: Investors are so worried about stocks that they're putting their money in US Treasury bonds, which are safe but hardly a bullish investment. At the 1.63 percent yield, the bonds are earning less than the rate of inflation.
By contrast, bond prices were falling in Europe, pushing interest rates up on perception of rising risk of default. Borrowing costs rose for governments in Spain and Italy, nations that pose a high risk of default if the eurozone fails to work out a survival plan.
Some economists say it's not too late to save the currency union, even if Greece ends up exiting in a messy default later this year. But talk of a possible eurozone "divorce" has been growing louder in recent weeks.
"We think that the ramifications of a Greek exit are more serious than the market anticipates," said an analysis released Wednesday by the investment firm Morgan Stanley. "While a eurozone break-up is not our base case scenario, we raise our subjective probability to 35% from 25%," the firm said. And the firm said this outcome could transpire over the next year or so, rather than the longer time frame it had forecast previously.
A partial or total breakup of the eurozone would impose hardships on Europe and the global economy – affecting everything from European demand for imported goods to the financial health of private-sector banks. Even if Greece were to become just a one-off departure, that event would heighten uncertainty about other nations and impose steep costs on both the Greek economy and on creditor institutions in the rest of Europe.
If other nations exited, or the euro currency fell apart entirely, the economic fallout would be even greater.
The economists at Morgan Stanley say they expect the eurozone to find a path forward. "We believe there are still significant incentives for both debtor and creditors to negotiate an outcome that results in Greece remaining in the single currency," says the new report, by Elga Bartsch.
To save the currency union, however, member nations including a reluctant Germany may need to take some big and costly steps. Those might include greater guarantees for bank depositors (to prevent bank runs), restructuring and injecting fresh capital into weak private-sector banks, and a version of "fiscal union" in which member nations collectively stand behind new debt called eurobonds.
All this could help prop up the struggling European economy while member nations impose needed fiscal discipline and other reforms.
Some forecasters are more pessimistic than Morgan Stanley. In a blog post this week, economists Peter Boone and Simon Johnson argue that an outright breakup appears unavoidable.
"For the last three years Europe’s politicians have promised to 'do whatever it takes' to save the euro. It is now clear that this promise is beyond their capacity to keep," they write. "It requires steps that are unacceptable to their electorates. No one knows for sure how long they can delay the complete collapse of the euro, perhaps months or even several more years, but we are moving steadily to an ugly end."
They argue that a default by Greece, driven by dire economic conditions there, will reveal the large sums at stake as European leaders lean on taxpayers and the central bank to support nations like Spain and Italy.
"The euro system will appear far more fragile and dangerous to taxpayers and investors," write Mr. Boone of the London School of Economics and Mr. Johnson of the Massachusetts Institute of Technology.
Could Europe find some muddle-through scenario, in which the eurozone survives? That's what many investors are still expecting, but Wednesday's move revealed a rise in concern.