“We’re not Greece!” “We’re not Ireland!” “We’re not Portugal!”

While the name of the country changes, the "We're not _____!" plea from a revolving panoply of European officials has become all too familiar.

Can any of Europe's politicians -- or anyone at all -- definitively state at which country's doorstep the rolling European debt crisis will ultimately stop? The short answer is no.

Europe's Two Big Challenges

The Economist has a comprehensive summary of the latest developments in this sad saga; the violence, which first turned deadly in Greece this spring, unfortunately shows no sign of abating in Ireland. From the article:

"[Germany's] Mrs Merkel and Mr Schäuble are continuing to insist on two proposals.

One is that the EU treaties must be amended to give permanent status to the European Financial Stability Facility. Without this, they say, the rescue fund will expire in 2013. But investors know from experience that treaty amendment is neither simple nor quick (it took years to push through the Lisbon treaty). Insistence on treaty change makes them nervous.

So, even more, does the second German demand: that future bail-outs must include debt-restructuring provisions to impose some losses (“haircuts”) on investors."

With respect to challenge #1, it is quite clear that Eurozone popularity is waning in certain quarters. Any treaty change could prove problematic, particularly in Ireland where such changes must be put to a referendum vote.

Europe's Web of Debt

On #2, haircuts to bondholders, it is worth taking another look at the complex edifice of european debt. The interlocking nature and size of cross-border debt holdings explains why European leaders fear allowing any one domino (Greece in May, Ireland this week) to fall.

Germany is the biggest checkbook in the EU and, quite understandably, is insisting that the private sector share in the cost of any future sovereign debt defaults. Otherwise what is the point of distinguishing between the debt of different countries?

But can Europe's delicately interwoven debt and banking market cope with haircuts, particularly to senior debt? The current Irish crisis was sparked by discussion of losses on subordinated debt (80% in the case of Allied Irish Bank). Tellingly, Irish debt costs have continued rising even after its bailout was confirmed. This is in part due to rumors that senior debt holders may also be forced to take losses.

As former chief IMF economist Simon Johnson and LSE's Peter Boone recently wrote "market participants are good at thinking backwards: if they can see where a Ponzi-type scheme ends, everything unravels". In other words, the market for troubled sovereign debt depends on the ability of countries like Ireland and Spain to 'roll over' their borrowings until their economies begin growing again. (Ireland's economy began shrinking again earlier this year, and Spain's is projected to shrink for 2010.) Without economic growth the odds that troubled sovereign debts will ever be repaid in full (without outside help) is almost certainly nil.

In the months since the spring Greek crisis, the quasi-explicit bailout guarantee by the "troika" (EU, IMF, and ECB) has been the Eurozone debt market's linchpin. Now the bond market is calculating that Germany's insistence on private sector loss sharing by 2013 means than holders of certainly Greek, Irish, Portuguese debt, and perhaps the debt of other nations, will be forced to incur losses. Instead of waiting  around to find out the precise haircut percentage, investors are exiting risky pan-european sovereign debt positions post-haste.

China to the Rescue?

Ultimately, the answer to the question of where the Euro-debt unmerry-go-round stops depends on how far the ECB, IMF and German taxpayers are willing to go.

Simon Johnson thinks the ECB and Germans neither can or will, respectively, step up to the plate. He also questions whether the IMF has enough resources to bailout a country the size of Spain, let alone Italy or France. He goes on to speculate that if one of the large Eurozone nations needs a bailout that China, with its $2.6 trillion in reserves, may be asked to recapitalize the IMF. The attraction for China: increased global standing and leverage on contentious issues, such as its policy of maintaining an artificially low currency.

I believe that China may expand its existing role in Europe's debt crisis. However, European and U.S. officials will be reluctant to surrender center stage to China and will minimize Beijing's participation. While the exact form of the ultimate resolution is unclear, it will be a European-U.S. led solution.

Looking Ahead

The question of whether membership in the euro currency union is a good idea has taken root. Iceland's President has recently been talking up his country's relatively quick bounce back from bankruptcy abyss. Part of Iceland's rebound can be explained by the fact that it was able to devalue its own currency, which helped its export sector. In contrast to Ireland, Iceland also chose not to bail out its insolvent banks. The Czech Republic, slated to become part of the currency bloc, recently demurred on whether it would follow Sweden's path of never adopting the euro.

On the subject of whether any countries will abandon the euro currency all together, the consensus view popularized by Professor Barry Eichengreen was that joining the euro was irreversible due to the risk of sparking a bank run. But as NY Times columnist Paul Krugman states, this incentive to keep the euro vanishes when a bank run (like the one currently underway in Ireland) has already taken place.

Many questions remain, but one thing is certain: even with Ireland's bailout (the specifics are expected to be announced on Sunday before Asian markets open) the Eurzone crisis is far from over. Investors looking to insulate themselves from events may want to consider hedging currency risk through various inverse Euro ETFs, or by investing in precious metals.