So, I’m in jet lag city, which means that it’s time for a euro update. (I’ve been pretty focused on the US election, since it is, after all, my country; but still keeping an eye on the other side of the pond).

The basic story of the euro crisis remains the same: it’s essentially a balance of payments crisis, misinterpreted as a fiscal crisis, and the key question is whether internal devaluation is really workable.

What? OK: the roots of the euro crisis lie not in government profligacy but in huge capital flows from the core (mainly Germany) to the periphery during the good years. These capital flows fueled a peripheral boom, and sharply rising wages and prices in the GIPSI countries relative to Germany:

Photo

Then the music stopped.

The combination of deeply depressed peripheral economies (which meant surging budget deficits) and fears of a euro crackup turned this into an attack on peripheral-government bonds. But the root remains the balance of payments/cost problem. And any resolution must involve getting costs and prices back in line.

This is the context in which you have to see Mario Draghi’s actions. Twice now — first with the LTRO last fall, then with the plan to buy sovereign debt, he has stepped in to limit runaway bond yields, short-circuiting a possible financial “death spiral” of falling bond prices, collapsing banks, and high-speed capital flight. Here are bond yields (monthly averages, with the most recent data standing in for September):

Good for him. But you still need “internal devaluation”: a sharp fall in costs and prices relative to the core. And that’s a slow, painful process.

Where does austerity fit in to this story? Mostly it doesn’t. Shaving an extra couple of points off the structural deficit will make very little difference to long-run solvency, nor will it do much to accelerate the pace of internal devaluation. It will, however, depress employment even further and inflict a lot of direct suffering too through cuts in social programs.

Why do it, then? Partly it’s because Europe is still operating on the false theory that this is essentially a fiscal issue; partly it’s to assuage the Germans, who remain convinced that those lazy Southern Europeans are getting away with something. In effect, the policy is to inflict pain for the sake of inflicting pain.

Which brings us to the question: can this go on? When do the people of the afflicted economies say that they can bear no more?

The news from Spain, with vast protests and talk of secession, suggests that this moment may be approaching fast. Also, while Greece has long since ceased to be the epicenter, things seem to be breaking down there too.

I really do think Draghi has done very well. But he can’t make internal devaluation work on his own, and he can’t save Europe if its leaders continue to think that gratuitous infliction of pain is sound policy.