If Greece leaves the Eurozone and devalues its currency (the drachma), for example, debts denominated in euros or other hard currency will rise proportionally. So Greece cannot leave without repudiating its debts in today’s litigious global economy. Yet Mr. Krugman believes in the old neoclassical nonsense that all that is needed is “devaluation” to lower the cost of domestic labor. It is as if he is indifferent to the suffering that such austerity imposes – as Latin American countries suffered at the hands of IMF austerity plans from the 1970s onward. Costs can “be brought in line by adjusting exchange rates.” The problem thus is simply one of exchange rates (which translates into labor costs in short order). Currency depreciation will (in Mr. Krugman’s trade theory) reduce labor’s cost and other domestic costs to the point where governments can export enough not only to cover their imports, but to pay their foreign-currency debts (which will soar in depreciated local-currency terms).
If this were the case, Germany could have paid its reparations debt by depreciating the mark in 1921. But it did so by a billion-fold and even this did not suffice to pay. Neither neoclassical trade theorists nor Chicago School monetarists get the fact that when public or private debts are denominated in a foreign (hard) currency, devaluation devastates the economy.