Martin Wolf says rough times are ahead for the eurozone:
What would have happened during the financial crisis if the euro had not existed? The short answer is that there would have been currency crises among its members. The currencies of Greece, Ireland, Italy, Portugal and Spain would surely have fallen sharply against the old D-Mark. That is the outcome the creators of the eurozone wished to avoid. They have been successful. But, if the exchange rate cannot adjust, something else must instead. That "something else" is the economies of peripheral eurozone member countries. They are locked into competitive disinflation against Germany, the world's foremost exporter of very high-quality manufactures. I wish them luck. ...
The late Charles Kindleberger of MIT argued that an open economy required a hegemon. One of its roles is to be spender and borrower of last resort in a crisis. The hegemon, then, is the country with the best credit. In the eurozone, it is Germany. But Germany is a lender, not a borrower, and is sure to remain so. This being so, weaker borrowers must fulfil the role, with dire results for their credit ratings. ...
A wave of defaults - private and even public - threaten.
The crisis in the eurozone's periphery is not an accident: it is inherent in the system. The weaker members have to find an escape from the trap they are in. They will receive little help: the zone has no willing spender of last resort; and the euro itself is also very strong. But they must succeed. When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters.
Well, many economists (esp. American economists) thought it wasn't an optimal curency zone. But then again, neither is the United States. Right now California should be practicing different fiscal and monetary policies than Minnesota, but it can't. But these problems are exacerbated in the eurozone.
Interestingly, the European Commission recently published a sneering paper titled "The euro: It can’t happen, It’s a bad idea, It won’t last. US economists on the EMU, 1989-2002." It takes a look at pessimism among American economists on the prospects for the euro, and concludes that they were universally wrong: the euro has been a big success, they say, so neener neener.
But is it that simple? The last sentence of Wolf's op-ed is key... the American economists were absolutely right that the eurozone is not an optimal currency union, but does that really matter? P. O. Neill comments at A Fistful of Euros:
And whether that matters is ultimately a political decision. To dig into the pop culture well, the US-based economists who form the sample in the Jonung-Drea paper were giving the Star Trek answer: “Damn it Jim I’m an economist not a politician.” Looking at the predicament of Ireland, Greece, Spain, Portugal, and Italy, they may still be right.
One of my favorite IPE books is Beth Simmons' Who Adjusts? It's about economic policies in the interwar period, specifically about the determinants of states' policies when faced with a choice between devaluing their currency (i.e. abandoning the gold standard) in an attempt to maintain full employment or maintaining the strength of the currency while accepting the misery of deflation. In other words, it's about whether states adjust internally or externally. The modern analogue is whether troubled states will make domestic structural adjustments or whether they will flout the ECB's authority and try to pass on the costs of adjustment to other states in the eurozone. And if they choose the latter, what the ECB will do: allow it, or play hardball.
If I manage to find any spare time in the coming weeks I hope to re-read it. I expect this to be one of the most intriguing (and important) issues in the global economy in the coming year.