Good-bye Euro?

From Paul Krugman's blog:

Did the euro just enter its death throes?

OK, I know that sounds over the top, and I hope it is. But recent developments are really, really bad.

The best guide to recent events is actually a paper written this spring, by Paul De Grauwe (pdf). I have to admit that when I first read De Grauwe’s paper I didn’t grasp the full force of his argument about liquidity crises; but he now looks absolutely prescient.

The key point, which I’ve finally taken fully on board, is that in addition to the huge problems of adjustment created by a rigid exchange rate in the aftermath of a bubble, the fact that European nations no longer have their own currencies leaves them vulnerable to self-fulfilling debt crises – in effect bank runs on governments rather than banks (although those too).

To head off this risk, somebody – the EFSF, the ECB, whatever – has to be ready to act as lender of last resort; Eurobonds would have served much the same purpose.

By resigning from the ECB, Juergen Stark has conveyed, deliberately or not, the message that there will be no such lender of last resort, that there isn’t enough political cohesion in the eurozone to stand behind countries under market attack. And this translates directly into soaring spreads for Spain and Italy; the self-fulfilling crisis is on.

You little know, my friends, with how little wisdom the world is governed.

Krugman's summary of De Grauwe's paper can be found here. Take a look at it; it's very instructive.