From Business Week
If the euro zone were to break up, it would make sense for member nations to regroup in more defensible configurations—ones more nearly resembling the optimal currency areas described by Columbia’s Mundell. To stop the market terror before it engulfs all of the euro zone, the fiscally strongest nations should gather behind an impregnable "cordon sanitaire," argues Simon Johnson, the former chief economist of the International Monetary Fund, who is a professor at Massachusetts Institute of Technology and a Bloomberg News columnist. As Johnson sees it, those strong nations would trust each other enough to promise one another unlimited financial support if any of them ran into trouble, which would stop the bond market vigilantes cold. In that group he puts Germany, Austria, the Netherlands, Finland, Slovakia, Slovenia, Luxembourg, and tiny Malta.
The scary thing about Johnson’s cordon sanitaire is that it would leave France, Italy, Spain, Belgium, Portugal, Ireland, Greece, and Cyprus on the outside, unshielded from market forces. At least a couple of the weaker shunned nations would be likely to default. In the long run, though, it could be a blessing for them to be spared from monetary and fiscal policies that just don’t suit them and debts that are, frankly, unpayable. Like serial defaulter Argentina, they would still find it possible to borrow money, albeit at a higher rate. And with depreciated national currencies, they would be able to match their exports to their imports.
The biggest downside of such a scenario would be the death of the dream of a united Europe. It appears, though, that Europe still isn’t ready for a full union. As in the nucleus of the elusive ununquadium atom, the forces of repulsion remain stronger than the forces of attraction. It might be wiser to acknowledge that reality than to sacrifice a generation of indebted Europeans to an impossible ideal.
