Correcting the economic imbalances underlying the euro zone's debt crisis will demand years of austerity from the likes of Italy and Spain. It could also require a sea change in German economic thinking to accept stronger domestic demand and higher inflation.
Beyond the urgent steps needed to keep the euro zone together, countries on the bloc's periphery face a daunting task to increase domestic productivity and restore external competitiveness lost since the launch of the single currency by bringing their unit labour costs down closer to German levels.
Before exchange rates were fixed with the creation of the euro in 1999, countries had the option of devaluing versus the Deutsche Mark.
Now, the same shift in inflation-adjusted exchange rates must be engineered by an internal devaluation: keeping down prices so a country's goods and services can compete with those of other euro zone members.
Latvia did just that, but at the cost of the sharpest recession on record anywhere. Its economy shrank 25 percent in two years. Ireland is also rapidly regaining competitiveness thanks to wage discipline.
While the onus will remain squarely on debtor countries, the required changes in relative prices could prove politically and economically unfeasible unless Germany chips in by letting costs rise more quickly and reducing its big current account surplus, according to a growing number of economists.
The problem isn't Greece or Italy; it's Germany, said one European policy adviser, who, like others cited in this article, spoke in recent days on condition he not be named. Adjustment is going to be harder as long as Germany remains mercantilist. Germany needs to have its surplus disciplined.
BACK TO BASICS
Germany rejects the tag of mercantilism, which regards exports as good and imports as bad, and says its world-beating engineering companies should be emulated not excoriated.
But the crisis has nullified the assumption made by the architects of the euro, finalised in the Dutch town of Maastricht in 1991, that national current account imbalances would not matter within monetary union.
This theory has failed. It was a big collective mistake not to have a balanced current account criterion in the Maastricht Treaty, a central banking official said. We see now that the current account balance is an element of sovereign creditworthiness.
In other words, markets are no longer willing to fund, at a sustainable cost, countries they perceive as living beyond their means -- as sharply higher bond auction yields in France and Spain showed on Thursday.
But not every euro zone member can be in surplus -- unless the 17-member bloc were to run an impossibly huge surplus with the rest of the world. So to help current account deficit countries dig themselves out of the hole, Germany and others with big surpluses need to save less and spend more.
Heiner Flassbeck, head of the globalisation and development strategies division at the United Nations Conference on Trade and Development (UNCTAD), said the only solution was to let wages rise in northern Europe to spur consumer spending and bring costs closer in line with those in the south.
Companies need to stop believing that they can conquer the world from Germany, Flassbeck, a former senior German finance ministry official, told Reuters in Frankfurt.
It is amazing that companies didn't know for years what to do with all their cash and never got the idea of giving some of it to their workers so they can spend it on their products, for instance by buying cars, he added.
Increasing labour's share of national income is not enough for some. An academic who advises the German government argued for higher marginal taxes to reduce income inequality, which he said was throttling demand and darkening the growth outlook.
Stimulating the economy risks stoking inflation. This horrifies Germans but would help suffering southern Europeans by raising Germany's real exchange rate.
Indeed, a number of economists believe the European Central Bank should grease the wheels for the needed shift in relative prices by flexibly interpreting its mandate of price stability.
So new ECB President Mario Draghi should explain that if the goal is average euro-zone inflation of close to 2 percent, that is consistent with inflation in Germany of 2.5 percent to 3.0 percent, a leading academic economist said.
An economist at an international institution went further.
Keeping average inflation within 2 percent would make internal devaluation impossible for southern countries without plunging them into deflation and stagnation. That would be disastrous for those such as Spain with heavily indebted private sectors.
This is a problem the Germans are not facing up to, he said.
In a pamphlet released last week, the Centre for European Reform, a think tank in London, advocated an inflation target of 3 percent with inflation allowed to deviate by 1 percentage point in each direction.
Ingrained fear of inflation is a major reason why Germany is opposed to the ECB's becoming a lender of last resort for the euro zone. But in a sign that the debate might be shifting, one of the wise men group of economists that advises the government in Berlin said the central bank should step in if financial market pressures threatened to tear the euro apart.
If politics can't do it, then the ECB must do all it can to bring interest rates down to more reasonable levels, Peter Bofinger, an economics professor at Wuerzburg University, said.
As unpalatable as that prospect might be for the man in the street or the Bundesbank, Germany's central bank, the possible alternative of letting the single currency fall apart would spell economic disaster for Germany, several prominent economists said.
A safe-haven flight into a shrunken euro with Germany at its core would send its exchange rate soaring, decimating the country's exporters. The recent experience of Switzerland, which was forced to print money to cap the surging franc, provides a salutary lesson.
I don't think they could stand the shock, an international economist said. There would be huge deflation and the Bundesbank would have to do something really radical in response. So they might as well do it now.
The onset of recession or heavy losses by the country's banks and insurers on their exposure to euro zone debt could also lead German politicians and public opinion to reconsider their refusal to pay more for rescuing the euro.
If Germany were to relent, it would not be without precedent. Under pressure from the United States as it is again today, Germany agreed to play the role of economic locomotive at the 1978 Bonn summit of the Group of Seven rich nations.
Inflation duly spurted to more than 6 percent by 1981 and, some say, cost Chancellor Helmut Schmidt his job.
That history lesson will not be lost on Chancellor Angela Merkel. But the stakes today are immeasurably higher, both for Germany and the world economy.
Flassbeck with UNCTAD said that without decisive action the euro zone risked precipitating a crisis that would be much worse than that triggered by the collapse of U.S. investment bank Lehman Brothers three years ago.
The first country that exits the euro will have to massively devalue its currency. And if that is the case for several southern European countries, then Germany's exports will collapse, he said. We will see 2008 to the power of two.
(Additional reporting by Maria Sheahan in Frankfurt, editing by Mike Peacock)