A Song of Ice and Ire

Iceland Recovers from a Financial Crisis with Debt Writedowns by Mike Konczal

What Ails Europe? by Krugman

Things are terrible here [Lisbon, Portugal], as unemployment soars past 13 percent. Things are even worse in Greece, Ireland, and arguably in Spain, and Europe as a whole appears to be sliding back into recession. 
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In other words, the Hellenization of our economic discourse, in which we’re all just a year or two of deficits from becoming another Greece, is completely off base.

So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.

More specifically, the creation of the euro fostered a false sense of security among private investors, unleashing huge, unsustainable flows of capital into nations all around Europe’s periphery. As a consequence of these inflows, costs and prices rose, manufacturing became uncompetitive, and nations that had roughly balanced trade in 1999 began running large trade deficits instead. Then the music stopped.

If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation. Their debt crises are mainly a byproduct of this sad prospect, because depressed economies lead to budget deficits and deflation magnifies the burden of debt.