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Greece Gets the Boot, Germany Takes the Lead: Europe's Endgame

However, bilateral assistance will come at a cost. I believe that the first option mentioned by the Bundesbank president is the most viable. A revamp of the Treaty of Lisbon to give it some teeth. I have said in previous blog postings that there must be clear penalties, including possible expulsion from the Eurozone, for violators of the Treaty. There can be no exceptions.

Indeed, there is a logic to excluding Greece. They will be the example of what could happen.

There will be no more kicking the can down the road. You will notice fewer consultations between Merkel and Sarkozy. It will be Merkel calling all the shots.

The changes in the Treaty would be very controversial under usual circumstances. However, in a time of crisis, they are easier to push through.

This will be a meaningful step toward a fiscal union, but a full fiscal union will have to wait.

Can Germany afford it? German debt/GDP is forecast to be 81.7% of GDP in 2011 -- not much different from France's 85.4%.

German GDP is 2.5 trillion euros. Importantly, almost half is due to exports. If the euro falls apart, a new German currency would substantially appreciate. This could put half of the exports at risk. So a ballpark (one year) cost of lost exports might be about 600 billion euros (in today's currency terms). You might argue that this barely covers Italy's rollover next year. However, it is naive to think that all of Italy's debt has zero value. That is, 600 billion euros can go a long way.

German decision makers need to weigh the cost of a broken Eurozone versus the cost of keeping it together. Importantly, keeping it together cannot not mean more of the same. A new Eurozone model must be shaped by lessons from the current debacle.

Campbell R. Harvey is the J. Paul Sticht Professor of International Business at the Fuqua School of Business at Duke University and a research associate of the National Bureau of Economic Research in Cambridge, Mass. He is editor of The Journal of Finance. Professor Harvey also runs a blog.

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