The shackles of debt

This is my repsonse to Edward Hughs insightful post on the future of Spain found here.

As a hegelian antithesis:

If an internal devaluation occurs, wont this massively decrease wages available for debt repayments, causing further defaults -> bank balance sheet issues -> bank runs -> bailouts?

Even demanding loan haircuts to domestic loans on a 1-1 basis with any wage devaluation would likely cause most Spanish banks to collapse (I base this on the recent mergers of smaller banks in Spain, and absolutely no fundamental anaylsis).

Also, I can only assume this would be seen as an aggressively protectionist move within and without the Eurozone, treachery in fact, by the coalition of the willing (Sarkozy, and er, Merkel?) for the Eurozone project. Is it politically tenable to have the recent “all for one” measures if everyone is attempting to effetively slash wages and gain comparative advantages?

Assuming it’s not, would this internal devaluation only realistically by solved by a devaluation of the Euro as a whole, massively unpalatable to Germans and their fear of money printing madness, and also everyone else in the export driven world?

Seems like a no win situation: Discuss :)