In this 2011 article “Can Europe Be Saved?”, Krugman, lays out various possible European outcomes. I am in pretty much full agreement (and much less knowledgeable). (See this for related stuff.) Krugman is perhaps the only liberal economist that I enjoy reading. I worry whenever I find myself agreeing with Krugman. In this case it is about flexible exchange rates which Krugman favors. My fear is assuaged when Krugman notes Milton Friedman’s cogent arguments for flexibility. I would agree with many of Krugman’s opinions but I feel that I need to say some of them perhaps less diplomatically.

Flexible exchange rates is a bit like a different form of bankruptcy law. As in bankruptcy law, the form of currency policy becomes the rules for a game between investors and nations. I do not hold with some simplistic rules about what to do with people, institutions and nations who cannot or shirk from fulfilling with their promises to pay. With flexible exchange rates the nation is able to welch on its promises in a continuous manner. This is usually better all around than an all or nothing debt restructuring.

Most current rhetoric on the current European debt crises assumes that Europe must bail out a country whose ability to repay its debt comes into question. Consequences of the alternative are seldom explored. Krugman explores them. Some seem to assume that if one European country’s bonds were to go into default it would reflect badly on all European countries. Certainly there would be some adverse impact on bonds of some weaker European countries, but not all. Such weakness would pressure other sub-performing countries to adopt more transparent and cautions financing, but is this not exactly what is required in any case? I would assume it superior to inflexible mandates from Brussels. I think that if I were a European I would prefer a Europe where Brussels lacked the authority to impose such necessary discipline. I would prefer that authority to reside in the distributed wisdom of the market for national debt. This comes in part from my preference for diversity in political mechanisms.

Presumably a country that defaults on its debts is unable to sell new bonds and must thus immediately begin living within its means, even contravening internal commitments and entitlements—thus interfering with internal political arangements. With flexible exchange rates this traumatic event can be spread in time but not otherwise ameliorated. Krugman refers to this advantage as ‘economic flexibility’.

I am amazed that I agree so well with Krugman’s analysis techniques, but so often disagree with his conclusions. Here he draws possibilities, not conclusions.

I would have one thing to add: It seems that culturally or biologically Germans are inclined to save for the future and depend on integrity of institutions in this matter. The Greeks and others are disinclined to such saving, or at least to trust financial mechanisms for this purpose.