If the European Commission thought approving Greece's latest plan to rein in its bloated deficit would halt the country's debt crisis, Thursday's market action will make it think again.
Stocks and bonds fell in Greece and other vulnerable euro-zone countries. Investors are passing judgment on the credibility of Greece's effort to cut its deficit by over nine percentage points of gross domestic product by 2012.
Other highly indebted countries should take note. Greece's fate has implications for the global debate on when and how to withdraw fiscal stimulus.
The International Monetary Fund recently warned on the risk of a double-dip recession if governments pull back too quickly. But if bond markets decide that sustained public spending and high deficits in some countries risk creating an unsustainable debt position, they will take matters into their own hands.
That leaves governments in an invidious position, without considering the thorny question of whether politicians can force through the necessary cuts even if they want to.
Already, Greek public-sector unions are protesting against cuts required in the budget. If a bailout were ultimately required for Greece, it would likely come with even stricter measures in return for support from countries like France and Germany, which would be risking their own taxpayers' cash.
In a sign of investors' lack of confidence, the Markit iTraxx SovX Western Europe index of credit-default swaps on 15 countries closed at a record 1.065 percentage points Thursday, according to Societe Generale. It spiked by 0.12 percentage point on the day and is 0.5 percentage point higher than four months ago.
Spain and Portugal are next in the market's cross hairs. The cost of insuring their debt against default soared again Thursday, and their stock markets fell 6% and 5%, respectively. The uncertainty is starting to hit local companies. Credit-default swaps on utility Energias de Portugal have surged higher after previously being unaffected by the rising cost of Portuguese sovereign credit-default swaps.
Also vulnerable is the U.K., where the political rhetoric on the deficit has become more confused. The opposition Conservatives appear to be stepping back from promises to make quick, sharp cuts
Policy makers in highly indebted countries look set to face an unpalatable choice: cut pro-actively, and take the risk of a damaged recovery and social unrest; or have cuts forced on them in the midst of a market crisis. They may not have long to make up their minds.