The eurozone crisis will not be resolved until this internal imbalance is reduced to a sustainable level, which requires not only fiscal adjustment in the troubled peripheral economies, but also balance of payments adjustments across the eurozone as a whole. That, in turn, implies the need for a real exchange rate adjustment inside the eurozone, with peripheral countries production costs falling relative to those in the core.

First, eurozone countries must implement reforms aimed at boosting wage and price flexibility through enhanced competition and improved labor and capital mobility within and between member countries. Second, wealth transfers to peripheral countries, while controversial, are necessary.

But, if one considers what might underlie capital movements of this sort, suspicion must also fall on unsustainable policies that extend to countries well outside the eurozone. In the wider European Union, countries like the United Kingdom or Hungary are as much afflicted by structural deficiencies as some peripheral eurozone countries are.

For starters, Chinese officials should be under no illusion that the country will be immune to financial contagion. A Grexit would hit European banks that hold peripheral eurozone countries sovereign bonds.

The government bonds of peripheral eurozone countries thus became toxic. Given the unprecedented nature of the Greek default, the market valuation of peripheral debt has been fluctuating widely, still searching for fundamentals, such as deficit or debt levels, that could explain the evolution of risk premia over time.

Similarly, with its outright monetary transaction (OMT) program, the European Central Bank has offered to buy peripheral eurozone countries sovereign bonds in the secondary market provided that they sign up to agreed reforms.

Above all, any realistic strategy for dealing with the eurozone crisis must involve massive write downs (forgiveness) of peripheral countries debt. These countries massive combined bank and government debt the distinction everywhere in Europe has become blurred makes rapid sustained growth a dream.

Sixth, even if Greece and other peripheral eurozone countries are given significant debt relief, economic growth will not resume until competitiveness is restored. And, without a rapid return to growth, more defaults and social turmoil cannot be avoided.

All of these developments are now visible in the eurozone, particularly in its peripheral countries. Risk premiums started rising above benign levels in 2009, and then more strongly in 2011 2012, while capital flight became rampant in 2011.

System peripheral

On the other hand, refusing to accept the growing consensus that fiscal union is the key to resolving the debt crisis exposes the eurozone, and Germany, to serious risks. Sticking to half measures exacerbates markets impatience and provokes increasingly determined speculative attacks, not only on the weaker peripheral countries, but also on core AAA rated countries like France and, eventually, Germany itself whose banking sectors hold large volumes of peripheral countries debt.

Where do the European Union, the eurozone, and the EU s highly indebted countries go from here? Will Europe be able to roll back its welfare states biggest excesses without economic distress and social unrest toppling governments and, in the peripheral countries, undermining already tenuous agreements with creditors?

Generic system peripheral

Unknown system peripheral

A similar adjustment within the eurozone, assuming similar productivity performance, would require wages in the troubled peripheral countries to rise more slowly than in Germany for a number of years, thus restoring their competitiveness. But, because Germany and the other northern surplus countries remain hawkish on price stability, real exchange rate adjustment within the eurozone requires actual wage and price deflation in the distressed southern economies.

That is why I believe that these countries and the eurozone more generally would benefit from euro depreciation. Although a weaker euro would not increase their competitiveness relative to Germany and other eurozone countries, it would improve their competitiveness relative to all non eurozone countries.

Eurozone leaders must recognize that spending cuts will do nothing to stabilize the balance sheets of core country banks that are over exposed to peripheral countries sovereign debt. Until Europe rejects austerity in favor of a growth oriented approach, all signs of recovery will prove illusory.

The Sun burns our peripheral vision.

Deflation discourages optimism about the future. Shifting the entire adjustment burden onto peripheral countries with current account deficits, while core countries continue to run surpluses, obstructs adjustment.

And that happens at every peripheral node.

Since 2011, the ECB s analysis of weak eurozone growth has stressed the negative impact of an impaired and fragmented financial system, with high sovereign bond yields and funding costs for banks resulting in prohibitive lending terms in the peripheral countries. Major progress in fixing these problems has already been achieved.

But, although the current European political process will not create strong fiscal discipline, financial markets are likely to force eurozone governments to reduce their sovereign debts and limit their fiscal deficits. During the single currency s first decade, private investors belief in the equality of all eurozone sovereign bonds kept interest rates low in the peripheral countries, even as their governments ran up large deficits and accumulated massive debt.

Thus, its relevance to groundwaters is rather peripheral.

Moreover, national banking systems can now separate more easily, because the peripheral countries current accounts have already achieved a rough balance, with all but Greece expected to record a small external surplus in 2014. With the exception of Greece, the peripheral countries will not need any capital inflows in the near future.

If the peripheral countries remain mired in a deflationary trap of high debt, falling output, weak competitiveness, and structural external deficits, eventually they will be tempted by a third option default and exit from the eurozone. This would enable them to revive economic growth and competitiveness through a depreciation of new national currencies.

Some 90 of the refinancing debt that the commercial banks of the GIPS countries (Greece, Ireland, Portugal, and Spain) hold with their respective national central banks served to purchase a net inflow of goods and assets from other eurozone countries. Two thirds of all refinancing loans within the eurozone were granted within the GIPS countries, despite the fact that these countries account for only 18 of eurozone GDP.

Ever since the eurozone was established, its members have issued official fiscal forecasts that are systematically biased in the optimistic direction. Other countries do this, too, but the bias among eurozone countries is, if anything, even worse than it is elsewhere.

Germany and the other countries of the eurozone core are signaling that debt mutualization within the monetary union is out of the question, and that bailouts of countries or financial institutions will be balanced by bail ins of their creditors. Increased uncertainty concerning the safety of deposits will push up interest rates and deepen Europe s recession, and may also trigger capital outflows from the eurozone s weaker peripheral economies to the core.

Improve individual countries domestic policy mix in a manner that targets debt sustainability through both growth promotion and deficit reduction, especially in the most vulnerable peripheral economies

Some eurozone countries borrowed excessively and have been punished by the markets, perhaps deservedly so, while others, in the resulting climate of anxiety, have become targets for speculators. On July 21, eurozone leaders agreed to make more extensive use of the new European Financial Stability Facility (EFSF) by permitting it to purchase endangered eurozone countries debt in secondary markets.

But allowing Greece to default and still remain in the eurozone is not an option it would signal that other eurozone countries could amass huge debts, funded by the ECB, without having any intention of repaying. Fiscal responsibility in the eurozone would be fatally undermined.

Even outside Europe, the IMF has long given too much credence to sitting governments, rather than focusing on the long term interests of the country and its people. The Fund is doing Europe s people no favor by failing to push aggressively for a more realistic solution, including dramatic debt write downs for peripheral eurozone countries and re allocating core country guarantees elsewhere.

But the creation of the euro caused a sharp fall in interest rates in the peripheral countries, leading to debt financed housing bubbles and encouraging their governments to borrow to finance increased government spending. Amazingly, global financial markets ignored the credit risks of this sovereign debt, requiring only very small differences between interest rates on German bonds and those of Greece and other peripheral countries.

No wonder that fringe political movements are gaining traction throughout the eurozone. And no wonder that voters in almost two thirds of eurozone countries have turned out the incumbents in their most recent elections.

One could argue that the euro has been and still is overvalued, and that this has hindered many eurozone economies productivity relative to non eurozone countries. But the relative productivity deficiencies within the eurozone are more important for growth, and have nothing to do with the exchange rate.

To be sure, central bank intervention is not the only way to quell self fulfilling crises in the eurozone. Fiscal transfers, whereby eurozone countries commit to provide funds to their distressed counterparts, could also work.

This is likely to happen soon. At this point, peripheral countries will regain their fiscal sovereignty and will be able to ignore Reinhart and Rogoff s warning at their own risk.

This year, the G 8ers are talking about interesting but peripheral issues, such as the economic impact of the Internet. Worse, they are talking about important issues, like food security, in a peripheral way.

Scotching the Eurozone

Demokratisasi di Eurozone

Optimizing the Eurozone

Poland s Eurozone Tests

Rebalancing the Eurozone

That also means that Germany and the ECB have less power than they seem to believe. Unless they abandon asymmetric adjustment (recessionary deflation), which concentrates all of the pain in the periphery, in favor of a more symmetrical approach (austerity and structural reforms on the periphery, combined with eurozone wide reflation), the monetary union's slow developing train wreck will accelerate as peripheral countries default and exit.

Implementing this idea also implies embracing a new concept of sovereignty, given the complex interdependence that exists between eurozone countries. But it is ultimately in the interests of all eurozone citizens that these changes be made.