What will not work, at least for most eurozone countries, is internal devaluation—that is, forcing down wages and prices—as this would increase the debt burden for households, firms, and governments (which overwhelmingly hold euro-denominated debts). And, with adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.
If internal devaluation were the solution, the gold standard would not have been a problem in the Great Depression. Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the hemorrhaging of banking systems) is a toxic combination.
Europe’s leaders repeatedly vow to do everything necessary to save the euro. European Central Bank President Mario Draghi’s promise to do “whatever it takes” has succeeded in providing a temporary calm. But Germany has consistently rejected every policy that would provide a long-term solution. The Germans, it seems, will do everything except what is needed.
Of course, the Germans have reluctantly come to accept the necessity of a banking union that includes common deposit insurance. But the pace with which they accede to such reforms is out of kilter with the markets. Banking systems in several countries are already on life support. How many more will be in intensive care before a banking union becomes a reality?
Yes, Europe needs structural reform, as austerity advocates insist. But it is structural reform of the eurozone’s institutional arrangements, not reforms within individual countries, that will have the greatest impact. Unless Europe is willing to make those reforms, it may have to let the euro die to save itself.
The EU’s Economic and Monetary Union was a means to an end, not an end in itself. The European electorate seems to have recognized that, under current arrangements, the euro is undermining the very purposes for which it was supposedly created. That is the simple truth that Europe’s leaders have yet to grasp.