The big question for today's international monetary system is: will the Euro survive? I believe that it will, and that Euro-land will muddle through its current serious difficulties.
The common currency in Europe has run into two problems. One was well understood by skeptics of the entire plan of a monetary union in Europe, while a second was less anticipated. The first is the fact that countries with very different levels of productivity growth are tied together by a common exchange rate and monetary policy.
Countries like Greece, Portugal, Spain, and Italy would benefit, at least temporarily, from a devaluation of their currencies to help them overcome their economic stagnation, which seems to have followed the Great Recession of 2008-2009. Other means of adjustment certainly exist, but those would imply lower growth or even a reduction in monetary wages to compensate for the relatively strong Euro and the low productivity growth in these countries. Such adjustments are also politically difficult, and devaluations would, at least in the short run, help. In addition, the European Central Bank will have to follow a monetary policy not only specifically targeting the needs of these countries, but also considering the needs of the Euro area as a whole, which includes other economies on more solid ground like Germany.
The second problem emerged from the ability of many countries to borrow at very low rates during the first decade of the Euro. Greece, Spain, Ireland, and Portugal could borrow abroad at rates close to those of Germany because the exchange risk was removed. These countries thus went on borrowing sprees and became intoxicated by the temptation of low interest rates in world markets. Ultimately, however, the market woke up, realized that Greece is not Germany in terms of fiscal solidity, and demanded compensation for risk. The system then unraveled, and the higher interest rates demanded by markets increased the fiscal problem of these indebted countries. The worse the finances of these countries became, the more the market demanded compensation for risk and higher interest rates. This demand, in turn, caused deficits to rise, ultimately creating a vicious circle that started with Greece, went to Ireland and Portugal, and marginally touched even Spain and Italy.
At this point, a third problem of a political nature surfaced: the lack of an institutional process to deal with crises of this nature. Europe was like a town hall deciding how to organize its fire department while several houses burned. …