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As Greece Votes, Germans Shouldn't Cheer For An EU Pullout

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Carmen Reinhart, chronicler of the debt cycle. (Photo credit: Wikipedia)

If Greece votes Sunday to walk away from its debts and by extension, the European Union, the Germans might have the most to lose. Their best example lies right across the border in Switzerland, where prudent fiscal management led the Swiss franc to soar 48% between 2009 and 2011. As the world financial system crumbled, investors poured their money into the little mountain nation and bid its currency up so high that exporters have had a hard time selling their goods until the Swiss National Bank began furiously selling francs to drive down its value.

"Right now, deposits are pouring into Germany from throughout the periphery" of Europe, said Carmen Reinhart, an economist at the Peterson Institute for International Economics whose 2009 best-seller with Kenneth Rogoff of Harvard, "This Time It's Different," largely predicted the current sovereign debt crisis. "With these kind of inflows the Deutschmark would be appreciating through the roof."

There is no Deutschmark, of course, so Germany's export machine continues to chug away with the help of the sagging Euro. Germany is the world's largest exporter, shipping out 1.1 trillion Euros' worth of goods last year for a E300 trade surplus. That's kept Germany's unemployment rate at 5.2%, compared with 23% in Greece and 8.2% in the U.S.  The Germans could hardly want to return to the 1970s, when their currency jumped 60% after the collapse of the Bretton Woods regime and unemployment soared, Reinhart said.

"When people talk about what’s in it for Germany, think about it: Countries go to great lengths to avoid currency appreciation," Reinhart told me Friday, home in the U.S. after a tour of Spain and other troubled European countries. "Why do you think China is sitting on all those near-zero yield Treasuries?"

So German voters, if they think about it, might not mind bailing out Greece if it allows them to maintain the benefit of the relatively cheap Euro.

The Greek vote also isn't likely to change the financial trajectory of Spain, since it is suffering from an entirely different set of problems. Greece's government borrowed the nation into insolvency. In Spain, it was the banks, Reinhart said. And an EU-led bailout won't end the problem.

"Their own fundamentals, irrespective of whats happening in Greece or anywhere else, are extremely worrisome," she said. Spain's external debt -- private and public -- exceeds 200% of gross domestic product, compared with a little more than 100% for the U.S. That's well within the danger zone where the government simply can't step in and substitute its borrowing capacity for that of the banks.

Much of the debt was lent out against real estate and related assets that have collapsed in value, leaving the banks insolvent even if they won't admit it. So it would be foolhardy for Spain to borrow from the rest of Europe to bail out its banks; better to force external bank creditors to write down the value of their loans to Spanish banks.

"Thus far the policy prescription has been you do austerity and pray for growth," she said. "With these outstanding stocks of debt that is not enough. You need to deal with the overhang of debt and that means restructuring. It means haircuts."

While a Greek vote to repudiate the EU austerity plan and that country's external debts will disrupt the rest of Europe, Reinhart thinks its unlikely Greece will really embrace pariah status. It would be too hard on that country -- and a breakup of the EU would be too hard on its ultimate benefactor, Germany. But all the nations with excess debt, public or private, will have to accept the idea that much of that debt will have to be written off as uncollectable before the EU economy can recover.

For Reinhart the future is merely an echo of the many past debt crises she described in "This Time It's Different":

What is unsustainable has to stop. You're not really sure in the end what is the first trigger mechanism that causes it to stop. You could say it's Greece, you could say it was subprime in the summer of 2007. But somewhere between subprime and Greece the benign attitude toward debt disappeared.

For another look at what's behind the current sovereign debt crisis, see my January 2010 package, "The Global Debt Bomb."