When you are trapped in the straitjacket of an ill-advised currency union, the only way you can put off the inevitable endgame is by an internal devaluation. Note that I am not averring that this internal devaluation will lead to a sustainable fiscal and economic outcome for the devaluing country, merely a delay in adopting an external devaluation to avoid an de jure default.
Read the book This Time is Different by Rogoff and Reinhart. They examined 224 financial crises up to 2007. There is not one example of a country successfully using an internal devaluation and avoiding default in these case studies.
In an internal devaluation, wages are cut to the bone so that the country’s products remain competitive with the rest of the world. Wages must be reduced because of the crash in consumption associated with the recession or depression caused by the financial crisis.
In Spain’s case, the adoption of the euro lowered interest rates leading to a real estate bubble. When the bubble burst, banks were stuck with dodgy loans. Real estate development,which accounted for a quarter of the Spanish economy, ground to a halt. This negative development led to a reduction of consumption and a drop in wages through a higher unemployment rate.
Spain is now attempting to cut the budget enough to offset the decrease in revenue, but this is futile. Budget cuts lead to even greater revenue decreases due to the reverse multiplier effect. While Spain and Greece are not models of transparent government, this is not the reason they keep missing their budget deficit projections:
Meanwhile, the price of everything in Spain, houses, cars and stocks to name a few, is deflating, too. Do you know what is not deflating? The value of the debt issued by Spain and its businesses and subjects.
Spain attempts the pay down these debts by austerity but the true value of them is actually increasing due to the deflation caused by the attempted internal devaluation.
The only way out of this trap is an external devaluation, or at least it was in the 224 financial crises up until 2007. According to the editors, a few policy changes can make this time different.
But it will be the same. The question is how long will the people of the periphery be made to suffer before they readopt their old national currencies and devalue.