Will it be Germany? The German constitution rules out fiscal union; the current arrangements only made it past the constitutional court because of the no-bail-out clause. I don’t know whether the German government will be able to find a work-around to stave off this particular crisis. Even if it does, it will be politically costly and thus won’t happen for a while; if it does not, we will have to wait for constitutional change, which would require a major crisis.
Despite the problems of a German bailout, the ECB approach is worse. As I said back in May, if no group or nation is prepared to accept a responsibility to pay Europe’s debts (as was the case in Weimar Germany), there is a risk the ECB would step in to monetise the debt and keep the Euro together. Printing money explicitly to finance the government would be a very different thing in the market’s eyes than printing money as an instrument of monetary policy, and Eurozone governments could become completely dependent on the ECB for funding. That way lies disaster.
Set against the difficulty of getting Germany to guarantee any other country’s debts and the potential for disaster if the ECB steps in, sovereign default starts to look like a reasonable option. Some bailouts could then happen at the level of national banks that took a hit on their sovereign debt; some banks might have to be allowed to fail. And there are the seeds of Lehman II.