There is at last some evidence that the political mainstream is coming around to the idea that “places {in the same currency zone -PM} in deficit have to be easily financed by places in surplus”. At least there is, if we can consider John Redwood, a British Conservative MP, to be representative of the mainstream. He, himself, may well question that assertion, but nevertheless this recent quote shows that it isn’t just Greece’s Syriza and the political left who are making the argument.
John Redwood is, of course, meaning Germany although the same argument would apply to Holland who run an even bigger surplus, as a percentage of GDP than Germany. The Germans were always happy to finance their customers when they used the DM. They’d buy up the treasury bonds of the deficit countries, like the UK and US, and that way their surpluses were recycled to their customers by the process of government deficit spending. So why the problem now? From their POV now, they should be even keener to do that. It would keep “their” trade zone healthy. They could impose conditions , of course, but there would be no reason to impose such stringent conditions as they do.
They seem wedded to the idea that internal devaluations are now needed in the peripheral countries of the Eurozone. General devaluations are no longer possible within the common currency zone. But can internal devaluations work? We know external, or general, devaluations can work. Recently the Canadian dollar has fallen by about 20% against the US dollar. This isn’t particularly noticeable to Canadians until they cross the border into the US. Then they realise that their wages and salaries are now worth 20% less, in terms of US$, than before. Canadian prices, at least the ones unaffected by import costs, such as rents, in are now 20% less too. Imports from the USA are now 100*(0.2)/(1-0.2) =25% more expensive.
This shift is necessary for the Canadian economy to adjust to changing world conditions. But what would have happened if Canadians used the US$? Theoretically, if Canadians had reduced all prices and all wages by the same amount, and IF spending patterns were left unchanged, the outcome would be the same. I’ve used the big IF because IF prices were falling fast then the real level of interest rates would be very high, even if they were nominally zero, and which would make it irrational for any individual to spend more than they had to.
But would that have really happened? If Canadian companies had faced falling demands for their products, they would do what all companies do. They’d cut back. But there wouldn’t be pay cuts and price cuts. Maybe just no pay rises and no price rises. They’d lay off some of their staff and stop recruiting others. They would adjust to being 20% (or close to it) smaller in this way. That would be repeated right through the Canadian economy which would end up 20% smaller too. Unemployment would skyrocket and the US media would no doubt be making negative comments about the Canadians, especially if they’d dared say it was even partially the USA’s fault.
That’s exactly what’s happened in Greece, Spain and elsewhere. Except of course it is the Euro not the US dollar which is causing the problem. Economists, of the classical variety, will argue that this should not have happened. Some will be in complete denial and will argue that it can’t have happened, or if it has, it must be due to some other factor. Lazy Greeks maybe? They can , of course, show nice mathematical models of how an ideal economy would be able to restore its competitiveness if only people would just behave rationally – according to their definition of rationality. But real people behave rationally as they themselves see it, not how anyone else might see it. That needs to be understood by real economists too. Including real German ordo-liberal economists!
So instead of imposing austerity on countries like Greece and Spain, to force internal devaluations, the Germans need to find some new economic advisers who can come up with some other way to equalise the money flows. Otherwise, their dream of a united Europe will become ever more nightmarish as time passes.
Modern Monetary Theory: Real Economics 
I would estimate that Greece needs wages and prices to be about 30% less than they are for Greece to regain international competitiveness. I agree with you, the process of internal devaluation does not work, then what other
options are open other than Greece exiting the euro?
That’s the big question, of course. The first step towards finding an answer is defining the question properly itself. The second step is understanding the extent of the real problem. So far the narrative has all been about “sticking to the rules”, or “honouring previous agreements” etc. About how to get blood, or euros, out of a stone basically!
If the EU governing class can’t move on from that, and I’d agree there is little sign they can at the moment, then a Greek exit is the only option. Surely they can’t be so dense as to believe their own propaganda though? If they do have any intelligence, and it’s difficult to believe they don’t understand it all as well as anyone else, it should be possible to find a workable solution to keep Greece in the Eurozone. Just what that will be, I can only speculate. Biig changes to the SGP rules for instance! The Eurozone will have to function more like the USA with a workable system of surplus redistribution and a common taxation system.
We’ll see how it all pans out from here!
Canada isn’t really your best example here. The CAD is a petro-currency, and tracks to changes in oil prices; the recent currency change is tied to the drop in oil prices, and the deflationary impact is felt in a single industry (and those closely connected to it) and one or two regions. Canada has been suffering from Dutch Disease for a few years, as oil-inflated currency prices put the squeeze on other export industries (i.e. manufacturing) and created a national labor shortage by driving technical wages through the roof. Contrary to the model, when the tar sands slow down, you should expect Canadian employers to expand operations & hiring, not shut them down. But that’s just on the supply-side. If you flip the page and look to the demand side, you’ll discover legions of cash-rich young oil field workers going back to their home communities. Come the Spring thaw, look for a construction boom in rural communities, complete with new company-creation and capital investment.
I did think of choosing Iceland. A relatively small economy which saw the value of its currency crash – but this fall has allowed Iceland to recover well from the GFC whereas similar small economies like the Greek part of Cyprus have stagnated. I could have chosen the UK or Japan. They both have problems but still benefit from having a freely floating currency. I don’t believe that Canada is a worse example though. All economies have their own peculiarities.
Australia has a similar economy to Canada and its dollar is a very volatile currency – its fortunes depend on the price of iron ore, wheat, etc on the world markets. Naturally manufacturing industries in both Canada and Australia will find that volatility to be quite difficult. They’d prefer a stable and lower valued currency.
A freely floating non-convertible currency is still the best option, on balance, for both Australia and Canada. If either tried to tie their currencies to the US $ they’d end up with even bigger problems. Just like Greece and Spain have big problems now.
Its even worse than you suggest. I’ve just a seen a statistic that Greek wages have fallen by 32% since the 2008 GFC. So their attempt at internal devaluation has just stuffed their economy with SFA to show for it