In my opinion the current set of crises, beginning with the sub-prime crisis in the US and spreading throughout the world, is not a short-term liquidity crisis like LTCM, the Asian Crisis, or the Mexican crisis of 1994. I think this is likely to be one of those big events, one that represents a major re-adjustment in the world during which time the massive imbalances that had been built up during the long globalization cycle that started around the late 1980s and early 1990s are finally worked out.
1. The euro is toast
2. This is the end for the latest expansion of globalization.
3. The trade-deficit countries of Europe will have to reverse their deficits, leading to a big shock in international trade patterns.
4. Greece and probably a few other European countries will have to reschedule their sovereign debts before their economies can recover.
5. Policy makers will pretend otherwise and instead these insolvencies will be papered over for a while in order to try to help the banks that own most of the bonds.
I agree with (4) and (5). I hope that (2) is wrong. I think that new patterns of specialization that increase cross-border trade would be a good thing. Leaving aside sovereign debt issues, I think one does well to keep in mind Don Boudreaux' point that international capital flows are not a collective responsibility. We do not track whether Floridians are running a trade deficit with New Yorkers that is financed by capital flows, and I am not sure that we should wring our hands if this sort of thing happens across national borders.
Point (3) has to be parsed carefully. It is not that Europe as a whole is running such a huge trade deficit. Within Europe, there are countries running trade surpluses and countries running trade deficits, and the question is whether or not that is acceptable with a common currency. In that sense, (1) and (3) are linked.
I see Greece as a sovereign debt crisis, not a euro crisis. If Greece were to somehow gracefully get out of the euro tomorrow, they would still have bloated pensions, a bloated public sector, and ineffective tax collection. In other words, it would not really solve their problems. At best, devaluation could make fiscal cutbacks less painful, but even that assumes that devaluation results in lower real wages and that lower real wages result in much higher private-sector employment, which might or might not turn out to be the case.
If market forces really were determined to rebalance trade within Europe, then German wages would be rising. Would that be catastrophic? I guess you could tell a story in which the European Central Bank keeps money tight, so that overall European employment falls as German wages rise. Seems far-fetched to me, although probably not to a lot of macroeconomists.
On the other hand, suppose Germany keeps running a surplus. Then perhaps that shows that surplus is innocuous. Individual debts matter for individuals. Government debts matter for constituents. But what is the significance of aggregate non-government debt of specific geographic territories within a currency union? Why is Germany's balance of trade with Spain more important than Tuscany's balance of trade with Lombardy?