In today's FT Martin Wolf, as ever, nails it (The riddle of German self-interest - FT.com). One of the peculiar features of the crisis is that the Euro was created with the express purpose of facilitating financial and commercial integration, and yet at the first crisis the Eurozone institutions have refused to backstop the cross-border financial commitments that have been made, leading to a flight for safety which has created havoc. Didn't anyone think this could happen?
Certainly the history of financial globalization offered a few hints. Eric Helleiner's excellent book States and the Emergence of Global Finance details the myriad ways in which governments backstopped the increasing financial integration of the period after the 1970s, most notably by stepping in to halt financial crises with bailouts. These bailouts confirmed governments' commitments to the newly integrated financial order and gave investors the confidence to continue treating the global financial arena as a properly functioning market.
The saddest thing about this whole crisis is that it underlines the fatal lack of understanding on the part of policymakers, and the academics who advised them, of how markets actually work. They designed institutions which essentially, like in Alan Greenspan's 'flawed' model, relied on market participants behaving rationally (whatever that means). Rational behaviour is, of course, difficult to define and operationalize, but one thing that we know for sure is that piling money into indebted states with a history of reneging on commitments and overinflated real estate markets was obviously outside any meaningful theory of the self-regulating market. It's time to recognize that the theory was wrong, and that the Eurozone, like any other economy, needs a government.