The New York Review of Books, sept 27 2012
A two-tier eurozone would eventually destroy the European Union because the disenfranchised would sooner or later withdraw from it. If a political union is not attainable the next best thing would be an orderly separation between creditor and debtor countries. If the members of the euro cannot live together without pushing their union into a lasting depression, they would be better off separating by mutual consent.
In an amicable breakup of the euro it matters a great deal which party leaves, because all the accumulated debts are denominated in a common currency. If a debtor country leaves, its debt increases in value in line with the depreciation of its currency. The country concerned could become competitive; but it would be forced to default on its debt and that would cause incalculable financial disruptions. The common market and the European Union may be able to cope with the default of a small country such as Greece, especially when it is so widely anticipated, but it could not survive the departure of a larger country like Spain or Italy. Even a Greek default may prove fatal. It would encourage capital flight and embolden financial markets to mount bear raids against other countries, so the euro may well break up as the Exchange Rate Mechanism did in 1992.
By contrast, if Germany were to exit and leave the common currency in the hands of the debtor countries, the euro would fall and the accumulated debt woulddepreciate in line with the currency. Practically all the currently intractable problems would dissolve. The debtor countries would regain competitiveness; their debt would diminish in real terms and, with the ECB in their control, the threat of default would evaporate. Without Germany, the euro area would have no difficulty in carrying out the U-turn for which it would otherwise need Chancellor Merkel’s consent.