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Today, there are two blocs within the monetary union: a strong currency bloc in the north and a weak one in the south.

Europe, of course, has no significant centralized tax authority, so this key automatic stabilizer is essentially absent.

Many Germans today rightly feel that any system of fiscal transfers will morph into a permanent feeding tube, much the way that northern Italy has been propping up southern Italy for the last century. Indeed, more than 20 years on, Western Germans still see no end in sight for the bills from German unification.

A logical corollary of the criteria set forth by Kenen and Obstfeld, and even of Mundell’s labor-mobility criterion, is that currency unions cannot survive without political legitimacy,

European policymakers today often complain that, were it not for the US financial crisis, the eurozone would be doing just fine. Perhaps they are right. But any financial system must be able to withstand shocks, including big ones.

Further complicating the picture, the Venezuelan government has not allowed companies to repatriate profits for the last five years.

The government has also failed to pay companies the hard currency it had promised them for imports bought on credit from suppliers, and in many cases suppliers are now refusing to ship more goods to Venezuela until they receive payment.

I regarded the European Union as the embodiment of an open society – a voluntary association of equal states who surrendered part of their sovereignty for the common good.

The process of integration was spearheaded by a small group of far sighted statesmen who recognised that perfection was unattainable and practiced what Karl Popper called piecemeal social engineering. They set themselves limited objectives and firm timelines and then mobilised the political will for a small step forward, knowing full well that when they achieved it, its inadequacy would become apparent and require a further step.

Unfortunately, the Maastricht treaty was fundamentally flawed. The architects of the euro recognised that it was an incomplete construct: a currency union without a political union. The architects had reason to believe, however, that when the need arose, the political will to take the next step forward could be mobilized. After all, that was how the process of integration had worked until then.

When the Soviet empire started to disintegrate, Germany's leaders realized that reunification was possible only in the context of a more united Europe and they were prepared to make considerable sacrifices to achieve it. When it came to bargaining, they were willing to contribute a little more and take a little less than the others, thereby facilitating agreement.

The financial crisis also revealed a near fatal defect in the construction of the euro: by creating an independent central bank, member countries became indebted in a currency they did not control. This exposed them to the risk of default.

Developed countries have no reason to default; they can always print money. Their currency may depreciate in value, but the risk of default is practically nonexistent. By contrast, less developed countries that have to borrow in a foreign currency run the risk of default. To make matters worse, financial markets can actually drive such countries into default through bear raids. The risk of default relegated some member countries to the status of a third world country that became over-indebted in a foreign currency. 

The emphasis placed on sovereign credit revealed the hitherto ignored feature of the euro, namely that by creating an independent central bank the euro member countries signed away part of their sovereign status.

In retrospect, that was the root cause of the euro crisis.

What happened in Cyprus undermined the business model of European banks, which relies heavily on deposits. Until now the authorities went out of their way to protect depositors

Banks will have to pay risk premiums that will fall more heavily on weaker banks and the banks of weaker countries. The insidious link between the cost of sovereign debt and bank debt will be reinforced.

In this context the German word "Schuld" plays a key role. As you know it means both debt and responsibility or guilt.

If countries that abide by the fiscal compact were allowed to convert their entire existing stock of government debt into eurobonds, the positive impact would be little short of the miraculous.

Only the divergences in competitiveness would remain unresolved.

Germany is opposed to eurobonds on the grounds that once they are introduced there can be no assurance that the so-called periphery countries would not break the rules once again. I believe these fears are misplaced.

It is up to Germany to decide whether it is willing to authorise eurobonds or not. But it has no right to prevent the heavily indebted countries from escaping their misery by banding together and issuing eurobonds. In other words, if Germany is opposed to eurobonds it should consider leaving the euro and letting the others introduce them.

Individual countries would still need to undertake structural reforms. Those that fail to do so would turn into permanent pockets of poverty and dependency similar to the ones that persist in many rich countries.

Second, the European Union also needs a banking union and eventually a political union.

If Germany left, the euro would depreciate. The debtor countries would regain their competitiveness. Their debt would diminish in real terms and, if they issued eurobonds, the threat of default would disappear. 

Now, if Spain were an American state rather than a European country, things wouldn’t be so bad. For one thing, costs and prices wouldn’t have gotten so far out of line: Florida, which among other things was freely able to attract workers from other states and keep labor costs down, never experienced anything like Spain’s relative inflation. For another, Spain would be receiving a lot of automatic support in the crisis: Florida’s housing boom has gone bust, but Washington keeps sending the Social Security and Medicare checks. But Spain isn’t an American state, and as a result it’s in deep trouble.

None of this should come as a big surprise. Long before the euro came into being, economists warned that Europe wasn’t ready for a single currency.

What we’ll probably see over the next few years is a painful process of muddling through: bailouts accompanied by demands for savage austerity, all against a background of very high unemployment, perpetuated by the grinding deflation I already mentioned.

Yes, some governments were irresponsible; but the fundamental problem was hubris, the arrogant belief that Europe could make a single currency work despite strong reasons to believe that it wasn’t ready. More Articles in Opinion »

The picture is one in which there are many fewer euros floating around the euro area than markets expected a half decade ago, and the distribution of those euros is moving northward.

It seems reasonable to argue that the distributional shift needed to occur, given the actual productivity performance.  The overall slowdown in euro spending growth, however, looks like an unnecessary and painful complication to adjustment.

This has all been the result of the commitment to keep just one euro. But that commitment is painful, and the alternative—more than one euro—is looking more attractive.

Since 2010, Spanish home prices have dropped over 20%, while German home prices are up a smidge.

Where prices were more flexible, as in asset markets, price adjustment was quick. Over the past two years, Spanish equities have fallen 24%, while German equities are up 8%.

The northward euro shift had two nasty effects, then: it shrank asset values while also (via wage rigidity) creating substantial unemployment.

This threatened to accelerate into a full-scale run and collapse until the ECB intervened.

as markets observed the periphery's reduced ability to pay off its debts, they moved their euros northward even faster

For the periphery to raise its external surplus (necessary in order to service its large and growing debts) it must rely much more on import compression than on export growth.

the time will come when the ECB will set a policy that is too tight for the outliers, leading to substantially higher unemployment than if they were free to set their own monetary policies. Even without discretionary monetary policies, the interest rates in countries with weak demand would naturally decline, and the external values of their currencies would fall, both acting as offsetting stabilizers of the countries weak demand. But this will not be possible within the EMU, where a single interest rate and a single exchange rate prevail. Result: higher average cyclical unemployment.

In the U.S., a fall in regional demand leads to lower wages, which help to maintain employment; to movements of labor to regions where demand is stronger; and to a net fiscal transfer from Washington (because lower regional income means lower federal tax liability). None of this happens in Europe, where wages are inflexible, mobility is severely limited by language and custom, and there are no significant fiscal transfers.

Politicians can now blame the ECB for high unemployment and complain that it is a powerful force beyond national control. Instead of seeking to make labor markets more flexible, European governments are talking more about "social wages," about mandatory 35-hour workweeks, and about rolling back even the small reductions in social benefits Germany achieved under Helmut Kohls government. Worse yet, there are attempts to eliminate differences in labor practices and even differences in wages among the EMU countries.

Moreover, these policies reduce the international competitiveness of many European industries and encourage the adoption of protectionist policies to keep out non-European products.

Forcing a single monetary policy on all of Europe will cause the countries that suffer what they regard as unnecessarily high unemployment to resent the actions of others. Attempts to force a Europewide tax system, especially if taxes are used to redistribute incomes among European countries, will compound the potential for conflict.

Consider an Italian corporation that owed a foreign bank 5 million euros, with a loan agreement struck under Italian law. If Italy left the euro, the bank might have less chance of getting euros back after the exit. In that case, the financial firm might be exposed to a new, less valuable currency.

Recognizing that threat, some banks are trying to move contracts into new jurisdictions like the United States or Britain. By transferring such loan agreements to English law, the banks may increase the chances of getting repaid in euros after an exit, according to legal experts.

Mr. Lim notes, however, that some large banks, including Deutsche Bank, still have a lot more loans than deposits in countries like Italy and Spain.

More importantly and less known to German taxpayers, Greece will also default on 155 billion euros directly owed to the euro system (comprised of the ECB and the 17 national central banks in the euro area). This includes 110 billion euros provided automatically to Greece through the Target2 payments system—which handles settlements between central banks for countries using the euro. As depositors and lenders flee Greek banks, someone needs to finance that capital flight, otherwise Greek banks would fail. This role is taken on by other euro area central banks, which have quietly lent large funds, with the balances reported in the Target2 account. The vast bulk of this lending is, in practice, done by the Bundesbank since capital flight mostly goes to Germany, although all members of the euro system share the losses if there are defaults.

No responsible bank would claim these sums are minor risks to its capital or to taxpayers. These claims also amount to 43 percent of German Gross Domestic Product,

Ford Motor Co. (F) (F) said at the end of last year it will increase capacity near Valencia as it shuts plants in the U.K. and Belgium.

In Ireland, U.S. companies such as EBay Inc (EBAY) (EBAY)., Google Inc. (GOOG) (GOOG) and Facebook Inc (FB). all have expanded in the past two years, taking advantage of a corporate-tax rate of just 12.5 percent compared to Spain’s 30 percent.

reducing social- security payments

aising the retirement age, making it easier to fire workers in downturns and preventing unions from clinging to boom-time wage deals.

The smaller trade imbalances really reflect a collapse in demand for imports as consumers and companies hunker down,

It’s the mirror image of the euro’s first decade, when historically low interest rates in the periphery fueled inflationary spending booms, reflected in credit bubbles and deteriorating current accounts and government budgets.

“At this stage it is still demand destruction which has helped current-account deficit countries balance their accounts,” said Mayer. “It’s not a healthy situation.”

They also say countries will need to run even healthier current accounts than now if they are to stabilize the debts they owe abroad.