If I were Germany and the Northern European countries that do well with the euro, and do not have spreads against Germany, I would tell all the countries that need rescuing, particularly Italy and Spain and in a smaller proportion Greece and Portugal, that Europe will guarantee their sovereign debt but in exchange they have to cut spending where it hurts less.
One area that can easily endure spending cuts is military. Why should these countries buy any weapons for the next 5 years? Greece for example has an absurdly high military budget because of unreasonable fears of a potential war with Turkey. Other than the military, these countries have to cut government spending and increase tax collection in general.
The alternative is that Northern European countries tell Southern European countries that they are on their own. In that case, those countries would default, need to restart their own central banks and go back to their own currencies. For Northern Europe this would mean enormous losses for anyone who owns Southern European bonds, and assets. Northern Europe would also lose export markets and the overall ability to consider Europe its domestic market.
I still think that Northern Europe has a lot to lose from this happening and that a deal will be reached.
Let’s say at this point I give 80% probability to a deal that saves Europe and 20% that Europe falls apart.
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