Rumors Swirl as Market Plunges, Stoking European Debt Fears

Amid a market growing increasingly paranoid about Europe's debt crisis, errors -- either human or mechanical -- were pointed to as potential reasons for Thursday afternoon's stock market plunge. But a more deliberate force could also be at work as investors short the markets and the euro sought to take advantage of the mounting alarm about Europe's situation.

Rumors began floating that Germany would seek to pull out of the euro ahead of a key vote on Greece's bailout package on Thursday, following other rumors that Spain was in talks with European authorities to get assistance with its financing on Wednesday. This, according to global intelligence firm Stratfor's senior Eurasia analyst Marko Papic. But Germany seems to not be considering such outlandishly dramatic measures, while Spain's prime minister rushed to dispel talk of financial assistance arrangements being made as "madness."

Short the Euro, Buy Gold

The euro, meanwhile, remains one of the favorite currencies to short for hedge funds around the world even as they pile into gold. Many have also now turned very bearish on equities with a recent Bank of America (BAC)/Merrill Lynch survey showing that net long positions were down to 25% -- "well below the historical average of 35%-40%."

Of course, with stocks richly valued and fears of contagion being very real, those positions have solid foundations. But the rumors in circulation that boost those holdings with uncanny precision are nonetheless striking. And the timing is especially odd given that some experts point out the situation in Europe may be becoming more manageable despite the unceasing images of chaos coming on the streets of Athens.

As much as Greek citizens howl and despise the bailout package, they ultimately have little choice but to accept it, says Papic. Greece, after all, needs access to financing in order to keep paying salaries and continue functioning as the state. The Germans, meanwhile, seem to have swallowed the bitter pill and decided that it is in their interest to make sacrifices to keep the euro going.

Many Have an Interest in Instigating Panic

No country benefits as much from the euro as Germany. Without it, Germany would reserve to a mere regional power, albeit a wealthy one. And Germany may formally insist on draconian austerity measures like higher taxes, cuts in social spending and manageable government finances. But that has hardly ever been the case in Greece's history as a modern state. Germany instead simply wants to stop a systemic risk and send a strong signal to Spain and Portugal next door.

"If you think we are just going to give you a blank check, turn on the TV and see what is taking place outside the parliament in Greece," says Papic. And despite real fears of contagion, other heavily indebted countries like Portugal and Spain are in far better shape than Greece and have more limited risks.

For heavily short hedge funds, then, moving swiftly to exploit the market turmoil may have been imperative before more agreements were reached. Indeed, short squeezes and relief rallies have been just as common as the preceding fears coming out of Europe.

"Many have an interest in instigating panic before the Champagne starts flowing in Brussels again," quips Papic.

Technical glitches may have well escalated Thursday's plunge and concerns about European debt are very real. But so are the incentives to take advantage of the precarious situation, much as recent rumors have masterfully done.