The latest problems in Iceland are bad (and in terms of their political implications, they may be a warning bell), but, however theoretically, the country (which is not in the EU) does still have some freedom of maneuver as it tries to extricate itself from the mess in which it finds itself. Those trapped in the eurozone periphery are not so lucky. With Greece in the news, the FT’s Martin Wolf takes up the story here. The entire article is a must-read, but the key points are as follows:

What would have happened during the financial crisis if the euro had not existed? The short answer is that there would have been currency crises among its members. The currencies of Greece, Ireland, Italy, Portugal and Spain would surely have fallen sharply against the old D-Mark. That is the outcome the creators of the eurozone wished to avoid. They have been successful. But, if the exchange rate cannot adjust, something else must instead. That “something else” is the economies of peripheral eurozone member countries. They are locked into competitive disinflation against Germany, the world’s foremost exporter of very high-quality manufactures. I wish them luck. . . .
In its first decade of existence, the imbalances inside the eurozone (and associated bubbles) finished up by doing massive damage to the credit of the private sectors of the booming economies. But now it is damaging the credit of their public sectors. While risk spreads have fallen in financial markets, those on sovereign debt in the eurozone are an important exception. Spreads over German 10-year bunds have soared from what used to be negligible levels: in the case of Greece, spreads recently reached 274 basis points…
This leaves peripheral countries in a trap: they cannot readily generate an external surplus; they cannot easily restart private sector borrowing; and they cannot easily sustain present fiscal deficits. Mass emigration would be a possibility, but surely not a recommendation. Mass immigration of wealthy foreigners, to live in now-cheap properties, would be far better. Yet, at worst, a lengthy slump might be needed to grind out a reduction in nominal prices and wages. Ireland seems to have accepted such a future. Spain and Greece have not. Moreover, the affected country would also suffer debt deflation: with falling nominal prices and wages, the real burden of debt denominated in euros will rise. A wave of defaults – private and even public – threaten. The crisis in the eurozone’s periphery is not an accident: it is inherent in the system. The weaker members have to find an escape from the trap they are in. They will receive little help: the zone has no willing spender of last resort; and the euro itself is also very strong. But they must succeed. When the eurozone was created, a huge literature emerged on whether it was an optimal currency union. We know now it was not. We are about to find out whether this matters.

Wolf’s analysis is spot on. Note, however, that he’s focused on the economics. There will be political consequences, too. They are unlikely to be pretty . . .