One of the problems the Eurozone faces as a single currency area is the low level of labor mobility. True interregional labor mobility only came about in the US in the 20th century, once the transportation network was sufficiently developed. Europe faces a different problem, and it is cultural and linguistic. Moving from one country to another is a much bigger change than moving from one part of the US to the other. At least in the US, you'll still be able to speak the same language (yes, even in Miami, although knowing Spanish there is a very big plus), and you'll be surrounded by familiar chains of shops and restaurants. In Europe, the language will be the first big barrier, followed by the differences in culture and habits. This is much more of a problem for the middle segment of the labor market than the either the top or the bottom ends. At the top end, people will be sufficiently well-educated and intelligent (one presumes) that they can adapt to new circumstances with aplomb. The large expatriate communities of scientists and businessmen attest to this flexibility (insert obvious joke about businessmen's intelligence here. If you limit it to finance, I'll even agree.) At the bottom end, manual laborers can get by doing menial tasks without needing to know much of the language. But middle-class labor mobility is still very low, and is likely to remain so.

Widescale labor mobility is a necessary ingredient of a successful modern economy. This would not be such a problem had Europe not embarked on the project of the single currency. Fluctuation of exchange rates, even within the rigid structure of the Exchange Rate Mechanism that preceded Monetary Union, was one escape-valve for regional differences in economic performance. A country that had high inflation could devalue its way back to competitiveness, albeit at the cost of impoverishing the entire country by the devaluation. Now this transmission mechanism has been removed, and the relative exchange rates have been set in stone. The effects of differentials in economic performance will ripple through the Eurozone economy in the form of divergent inflation and unemployment rates. Can Germany deflate its way back to competitiveness? Lowering the aggregate price level is not unheard of. The cumulative inflation rate in the US from 1870 to 1920 was about zero. But that was in the era when the currency was backed by gold.

The few examples that we do have a countries with fiat money deflating over protracted periods of time are not happy ones. The specter of Japan's last ten years are easily invoked in this context. Even a weaker yen has not had much impact on Japan's problems, and the current campaign by the Japanese government to talk the yen down to 150 or 160 is not going to solve the problems either. Japan has tried all the Keynsian recipes for rekindling growth. The last ten years have seen a stupenous amount of money being wasted on "infrastructure" projects, which were supposed to kick-start domestic demand. At the end, Japan is facing a wrecked economy, government debt of 140% of GDP, a staggering budget deficit and a financial system that is on the verge of collapse. There's another Japan too, that of the exporters who've been restructuring and sharpening their operations, but their prospects have the threat of a systemic collapse hanging over them. Everything has been tried short of implementing free-market, supply-side reforms. Tax and spend has been tried and the Bank of Japan has been running interest rates at zero for years. This still means that real interest rates are positive, as inflation is negative. Succumbing to political pressure, the Bank of Japan has done a remarkable thing in the last year: it started creating money at an amazing rate. The monetary base in Japan is expanding at a rate 30% year-over-year, with a similar increase in narrow money as measured by M1. But if pushing on a string was ever an appropriate metaphor, this is its quintessential moment of glory. Broad money, as measured by M3 and M4 has barely budged; M4 is growing at just 1% year-on-year. The money multiplier which exists in a healthy economy has put a big Closed sign on its door and gone into hibernation.

So deflation is not exactly a good option. But what can Germany do? It can go for reforms to restore the competitiveness of its economy, but at the moment it seems more bent on slowing it down rather than reforming it. While Germany is not doing much about it, the some Germans are. They're leaving the country. This is nothing new at the top end of the labor market, but now we are seeing the bottom end looking abroad. Germany is now facing paradoxical situation where its own working class is seeking employment abroad, while it is still attracting immigrants itself from poorer countries. The numbers are still very small, so it's not making much of a difference right now. I do hope that Germany never actually ends up in a situation where a significant part of its population seeks work abroad, simply because that would imply a massive economic meltdown there. The situation right now is bad, but a meltdown is not. It has the potential to become one quite easily.