The Eurozone’s crisis fighting plan consists of two parts. Basically, the ECB provides liquidity to prevent market panics while internal devaluations in the periphery are given time to work. In the case that ECB actions are insufficient, the ESM and bailout apparatus of the troika stand ready.
The plan is flawed because the internal devaluations will not be sufficient to achieve the necessary level of competitiveness for the periphery to share a currency with Germany. Essentially, no matter how everyone tries, the Spanish will never become Germans.
Other countries have devalued in the wake of a financial crisis:
Let’s compare how each country performed after the devaluation:
Spain either the worst or second worst performer. Moreover, after twenty months all the crisis countries had achieved their former high GDP and continued growing. Spain’s economy is still shrinking, and this is the factor most responsible for its current account balance performance.
In order to run a current account surplus, Spanish wages must decrease 25% in total. Since wages are sticky, this implies that additional reduction in wages must occur through increased unemployment. A further increase in the stratospheric 26% official unemployment rate will lead to additional shrinkage of GDP with an increase Spain’s budget deficit.
While there may be improvement in the current account balance in the short run, in the long run the internal devaluation will fail. What will happen in the periphery when it becomes apparent that a change in tactics is necessary?