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The FT is reporting that a Greek default might be back on the table.   European leaders are clearly failing to come to some sort of workable long-term solution to the single currency system.  As I’ve previously discussed, the great flaw in the Euro is that it results in trade imbalances where the core’s current account surplus results in an ever expanding current account deficit for the periphery.  Because there is no floating exchange rate between the nations (as a result of the single currency system) there is no mechanism by which trade can balance itself.  The result is the world you see today where the periphery nations are forced to counter their current account deficits via large budget deficits.  Obviously, there is a limit to how much these revenue constrained nations can borrow.  This leads to the solvency concerns we are currently seeing across the region.

Ultimately, there is only one solution to this issue.  These countries MUST become monetarily autonomous.  That can only occur in one of two ways – via fiscal union or defection.  I have been rather clear that I believe the end result here will be a more unified Europe.  But that doesn’t necessarily mean it will include all of these periphery nations.  As this drama unfolds it’s becoming clear that European leaders are not going to simply allow the Euro to collapse.  But as they fumble for a workable solution the risk is rising that the situation becomes politically untenable and results in the citizenry of the periphery nations essentially forcing a default and defection as they recognize that austerity is not helping matters.

In many ways, this all has a very Lehman-like feel to it.  There’s clearly a systemic problem and the politicians are unwilling to recognize it and resolve it.  Instead, they continue to kick the can and hope that these economies will recover to a point where the issues essentially resolve themselves.  But as I mentioned above, this is not an issue that is going to solve itself.  The problem is not just temporary.  There is a fundamental error in the construct of the single currency system.  I still think Europe has to move towards fiscal union at this point or risk Euro collapse.  And as we fail to resolve the critical error in the monetary system the risk of substantial turbulence rises with every day.

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