The markets have been having second thoughts about the European situation lately. The euro is down, and there's a fair bit of uncertainty about what happens next.
The problem has to do with governance. That trillion-dollar package still needs to be approved by the national parliaments, and until it's actually done, there's room for uncertainty, and markets hate uncertainty: it could still fall apart, and if it does, we're right back where we started.
The other uncertainty relates to the macroeconomic impact of the austerity measures being planned. It'll certainly hit the directly affected countries hard, but it's impossible to know how hard, and how long the adjustment will take.
While I'm feeling less sanguine about this shit than last week, I'm still fairly confident that we'll sort out this mess. In the meantime, the weaker euro will help us export our way out of trouble. We built this house, and now it's up to us to fix it.
To go off on a bit of a tangent… people who believe in Austrian economics, such as our mudsling here, say that if we put ourselves on the gold standard, wages and prices would deflate as the economy grows, keeping things in balance. I wonder how come actually observing deflation in practice completely fails to dent their faith?
The weaker Eurozone countries are now in the same situation as a country that's on the gold standard—their wages and prices need to go down relative to their neighbors, but they have no say over the value of their currency; they can't devalue the euro any more than they could devalue gold. Reality being what it is, this is, indeed, what is happening. But it is very slow, and very very painful. Latvia has unemployment around 22%. According to Paul Krugman's arithmetic, the wage level there has to fall by 20-30% relative to Germany. Two years into their adjustment, they've fallen by about 4%.
Meaning: prices and wages are sticky. People are incredibly reluctant to accept wage cuts. Only prolonged and very severe unemployment will do the trick. That's why fiat currencies are useful—they can always be devalued, effectively imposing a wage/price cut on everybody. And that's the major problem the eurozone is struggling with—with economies as different as Greece and Germany, there just isn't an exchange rate that would be right for both.
But there's more to monetary policy—and monetary unions—than just arithmetic. This is IMO what many folks on the other side of the Atlantic—such as Paul Krugman—easily miss. I think the euro will survive, and Europe will come out of this crisis stronger and less out of balance… and I think that some of this painful but ultimately beneficial structural change could only happen with the constraint of a common currency.
Greece's problems are primarily of governance, and if they were still on the drachma and could just devalue it, they would be in another kind of trap: it would be politically much cheaper just to apply the short-term Band-Aid of devaluation while skipping the surgical intervention needed to cure the structural problems causing the crisis. That would put off the day of reckoning a bit further, but it would come—and the shape it would take would be a collapse of the currency, up to and including hyperinflation.
IOW, from where I'm at, the real problem is governance; the difference the euro makes is that it brings the crisis to a head earlier and puts more pressure for real, structural changes. Tools of monetary and fiscal policy are only useful if they're used sensibly; a crappy government is in trouble no matter what currency it uses, it just gets a different set of acute problems once it runs into trouble.
