This is a repost, of one I did 14 months back, that’s once again relevant to what’s happening in Europe today. (I name actual countries this time in the post).
There are two countries, Germany and Portugal (let’s use Portugal as proxy for all PIIGS), who both use the common currency Euro. Neither of them issues its own currency. Currency is issued by a pan-European ECB (European Central Bank).
Even before the advent of the Euro, Germany was a more productive economy than Portugal, and Germany continues to experience a string of surpluses, while Portugal does not. In fact, just to try and catch up with Germany’s productivity, Portugal incurs debt (in Euro, of course) to finance its growth programs.
While Germany has its surpluses, Portugal does not, importing more than it exports. Germany’s string of surpluses is making the Euro, a floating currency, more valuable. This makes Portugal’s exports correspondingly more expensive for other countries. Being behind the curve, and now having more debt to carry, Portugal can’t replicate Germany’s surplus.
When Germany incurs its surpluses, ECB prints more Euro, so that other countries can exchange them with their own, and have the currency to buy Germany's goods. Implication is that for as long as Portugal is part of the Euro, and ECB can and will print the Euro when needed, Portugal will never run out Euro to borrow. But ECB normally won’t ‘print’ more of Euro just to hand out to Portugal, because doing so would be detrimental to Germany. (There are also other Euro countries, France, Netherlands, Switzerland, etc., who will also be adversely affected by the depreciating currency and inflation that comes with printing money without corresponding government spending) Neither would it just forgive Portugal’s debt. Moral hazard. Portugal is left in a bind.
Everything would be dandy if Germany would just hand out some of its excess Euro to Portugal. But that was not the point of incurring surplus in the first place. Anything its own citizens do not use, Germany recycles a savings in the default global currency, the USA’s.
How long before Portugal goes down and drags the entire Euro currency down with it? (Though realistically, there would likely be a chain reaction with the other PIIGS first). If Euro goes down, and everybody goes back to national currencies, which each one prints for itself, then that solves Portugal's debt servicing problem (No more Euro, or it can now offer to pay back the ‘equivalent value’ in its own currency).