Will the PIIGS sink the euro or will the European monetary union jettison the PIIGS?
As the stakes get ever higher, we are rapidly approaching the end game for the European debt crisis.
With the specter of default now hovering over major European economies such as Italy and Spain, the potential liability for German and French taxpayers becomes staggering. This is why they are now insisting on a rewrite of the terms for the monetary union. Having already lost their monetary sovereignty, the debt laden PIIGS will soon be asked to surrender their fiscal sovereignty as well.
German taxpayers will never agree to common issuance of euro bonds with profligate and undisciplined spenders unless they have direct control over those countries' budgets. Nor will they cough up anywhere close to what would be required to bail out Italy or Spain if either loses access to the bond market.
But Italians, like their Hellenic neighbours, will soon realize the futility of complying with these demands. Since Italy's problem is its outstanding debt as opposed to simply its current budget deficit, there is no fiscal course of action it can take that will satisfy the bond market. Even if Italy could miraculously balance its budget in a contracting economy, the accomplishment would make a negligible difference to the country's sky-high ratio of national debt to GDP or the amount of money it has to borrow next year.
The idea of Germany and other creditor nations dictating even harsher deficit reduction measures for countries such as Greece and Italy may sound reassuring to market, but for people in the streets of Athens and Rome, it sounds like nothing short of serfdom. As that option is politically rejected, bond yields on Italian and Spanish debt will once again rise to thresholds their governments simply can't afford to pay.
Unless the European Central Bank is going to engage its own form of quantitative easing and start printing billions of euros to buy up long dated Italian and Spanish bonds, the end is in sight for the European Monetary Union as we know it.
The longer creditor countries try to save the PIIGS, the closer the debt crisis is coming to their home markets. Standard & Poor's has already put the remaining six AAA-rated countries in the European monetary union - Germany, France, The Netherlands, Austria, Finland and Luxembourg - on credit watch, which is normally a prelude to a downgrade.
As interest rates in creditor countries start to rise, the appetite for further bailouts will diminish just when huge borrowers such as Italy and Spain turn to their euro zone partners for funding.
The end game seems pretty clear. The European monetary union will, of course, survive in some form. But the next time you go to Europe, don't be surprised if you see the drachmae and the lira back again with a new lease on life.