This distinction between foreign and domestic debt is particularly important in the context of the euro crisis, because eurozone countries cannot devalue to increase exports if this is required to service foreign debt. And the evidence confirms that the euro crisis is not really about sovereign debt, but about foreign debt.

A couple of years ago, the eurozone was in the latter situation. That is why European Central Bank President Mario Draghi s pledge to do whatever it takes to save the euro immediately brought the eurozone s debt crisis to a halt.

That is where the eurozone is today. A debt crisis that erupted in Greece, the eurozone s outer periphery, has migrated with a vengeance towards the core, so much so that the survival of the eurozone itself is at stake.

A New Approach to Eurozone Sovereign Debt

The eurozone sovereign debt crisis appears to have been the worst managed financial crisis since Argentina s default in 2001. The European Union and eurozone leaders have seriously discredited themselves.

To do the same thing with bank debt could pull hitherto sound economies into the abyss, because bank s balance sheets are much larger than the volume of government debt. In Spain, the public debt to GDP ratio is 69 , but the debt of the Spanish banking system totals 305 of GDP, or about 3.3 trillion about as much as the combined public debt of all five crisis stricken eurozone countries.

Europe s Time to Learn

Europe is our number one priority stabilizing the eurozone and resolving its current crisis are essential to stability and economic recovery in France.

Most importantly, while the average debt GDP ratio is no higher than it is in other advanced countries, and consolidation efforts started earlier, the eurozone has been mired in a severe crisis of confidence for the past two years. This points to a systemic dimension of the crisis that cannot be reduced to profligate behavior by fiscal sinners.

The Emerging Economies Eurozone Crisis

The Seven Year Ditch

The euro crisis is a complex mixture of banking and sovereign debt problems, as well as divergences in economic performance that have given rise to balance of payments imbalances within the eurozone. The authorities did not understand the complexity of the crisis, let alone see a solution.

The Eurozone s Delayed Reckoning

The eurozone today does not have a foreign debt problem all of the debt in question is in euros, and most of it is owed by European governments to their own countries banks. But this is a toxic combination, as Greece and Italy have discovered.

One of the problems that had made the crisis more difficult after 1982 was the US dollar s appreciation. Likewise, today s euro crisis is harder to resolve because of the euro s strength in currency markets.

In 2011, Europe s foundations began to tremble, as the eurozone s sovereign debt crisis, set in motion by the global financial and economic crisis that erupted in 2008, moved from the eurozone s periphery to its core countries. The EU s resilience indeed, its very survival is being called into question at a time of profound geopolitical transformation, in which a stronger Europe is essential.

One example is Eurobonds, which Merkel has declared taboo. Yet they are the obvious solution to the root cause of the euro crisis, which is that joining the euro exposed member countries government bonds to the risk of default.

A recurrent theme of the Greek crisis since it erupted in late 2009 is that both the Greeks and the eurozone s creditor countries have been reluctant to consider lessons from previous emerging market crises. After all, they said, Greece was a eurozone member, not a developing country.

Germany, for its part, will have to opt for a fiscal union. Ultimately, that means guaranteeing the eurozone s survival with Germany s economic might and assets unlimited acquisition of the crisis countries government bonds by the European Central Bank, Europeanization of national debts via Eurobonds, and growth programs to avoid a eurozone depression and boost recovery.

Assuaging doubt about the sustainability of public debt in the eurozone would thus probably require a deep restructuring as well. The eurozone crisis could certainly be resolved if all existing public debt were transformed into 20 year Eurobonds with a yield of 3 , and a five year grace period on debt service.

In the first stage, beginning in the spring of 2008, the locus of the North Atlantic crisis moved from the United States to the eurozone. Banks in the eurozone came under pressure, and interbank tensions increased.

This also implies that Eurobonds will never constitute the silver bullet that some had hoped would solve Europe s sovereign debt crisis. As long as member states remain fully sovereign, investors cannot be assured that if the eurozone breaks up, some states will not simply refuse to pay or will not refuse to pay for the others.

Back in 2010, creditor countries were concerned about contagion to the rest of the eurozone. If Grexit had succeeded, the entire monetary union would have come under threat, because investors would have wondered whether some of the eurozone s other highly indebted countries would have followed Greece s lead.

Since the 2008 financial crisis erupted, there has been something of a renationalization of financial behavior in Europe. Up to the late 1990 s and the advent of monetary union, most European Union sovereign debt was domestically held in 1998, the overall ratio of foreign held debt was only one fifth.

The difference with the largest debtor in the euro area, Italy, was 68.2 percentage points. Despite the most severe financial and economic crisis in almost a century, the Finnish national debt actually decreased by 2009, to 39.7 .

Pushing up asset prices and pushing down the euro s exchange rate will require the ECB to buy bonds on the secondary market not the crisis countries bonds per se, but those of all eurozone members. In other words, it will require quantitative easing.

For the second time in less than four years, Asia is being hit with a major external demand shock. This time it is from Europe, where a raging sovereign debt crisis threatens to turn a mild recession into something far worse a possible Greek exit from the euro, which could trigger contagion across the eurozone.

Indeed, only those countries that were running large current account deficits before the crisis were affected by it. The case of Belgium is particularly instructive, because the risk premium on Belgian sovereign debt has remained modest throughout most of the euro crisis, although the country s debt GDP ratio is above the eurozone average, at around 100 , and it went without a government for more than a year.

Both are cases of severe economic crisis, to be sure. But the eurozone s problems stem from high levels of government debt, while South Korea faced massive capital flight and a collapsing currency and almost all of the debt was in the corporate sector.

Of course, I am confident that the eurozone s ongoing sovereign debt crisis will be overcome, and that a more integrated and effective Europe will emerge. But, to get to that improved Europe, not only must the sovereign debt crisis be resolved relations with three major countries to Europe s east Turkey, Russia, and Ukraine will need to be put on more secure footing.

The ECB directed the central banks of all Eurozone members to buy huge quantities of Italian government bonds during the crisis. While the national central banks have not revealed how much they bought, the aggregate stock of all government bonds purchased rose from 74 billion ( 102 billion) on August 4, to 165 billion this month.

In the eurozone, mutualization was realized through generous ESM bailouts and some 1 trillion ( 1.27 trillion) worth of TARGET2 credit from national printing presses for the crisis stricken countries. Moreover, the European Central Bank pledged to protect these countries from default free of charge through its outright monetary transactions (OMT) scheme that is, by promising to purchase their sovereign debt on secondary markets which functions roughly as Eurobonds would.

Some eurozone countries borrowed excessively and have been punished by the markets, perhaps deservedly so, while others, in the resulting climate of anxiety, have become targets for speculators. On July 21, eurozone leaders agreed to make more extensive use of the new European Financial Stability Facility (EFSF) by permitting it to purchase endangered eurozone countries debt in secondary markets.

But fiscal stimulus is constrained within the eurozone, where member countries no longer issue their own currency and sovereign debt therefore carries a default risk. Aggressive monetary expansion through quantitative easing is also far more complicated and politically contentious in a currency area with no federal debt for the central bank to buy.

The common currency, once portrayed as the start of a quasi federal Europe, instead created serious tension between creditor and debtor countries when many debtors faced a protracted economic downturn. Just as Europe seemed finally to be escaping the euro crisis, refugees, especially from Syria, began flooding in.

Eurobonds plus fiscal rules this formula is the euro s best hope for salvation. Unfortunately, another crisis or two might be necessary before European leaders consider it seriously.

But the fundamental crisis of the eurozone has not been resolved, and another year of muddling through could revive these risks in a more virulent form in 2014 and beyond. Unfortunately, the eurozone crisis is likely to remain with us for years to come, sustaining the likelihood of coercive debt restructurings and eurozone exits.

That left individual eurozone members exposed to brutal pressure by financial markets at a time when excessive private debt was turned into unsustainable public debt. Suddenly, the eurozone had become a straightjacket.

Greek Lessons for Europe

When the European Union was created, it was the embodiment of an open society a voluntary association of equal states that surrendered part of their sovereignty for the common good. The euro crisis is now turning the EU into something fundamentally different, dividing member countries into two classes creditors and debtors with the creditors in charge.

The IMF s Euro Crisis

These differences imply that the return to normal market conditions will be slower in the case of the euro crisis. Nevertheless, the crisis should abate somewhat, because the most risk averse institutions have by now sold their holdings of peripheral countries sovereign debt.

A second school of thought also portrays the crisis as a pure liquidity problem, but views long term insolvency as an outside risk at worst. The problem is not that the debt of countries on the eurozone s periphery is too high, but that it has not been allowed to rise nearly high enough.

Now that the Fund has squarely acknowledged the huge capital holes in many European banks, it should start pressing forcefully for a comprehensive and credible solution to the eurozone debt crisis, a solution that will involve either partial breakup of the eurozone or fundamental constitutional reform. Europe s future, not to mention the future of the IMF, depends on it.

In this context, Greek negotiators might have considered another proposal, circulated informally by the German finance ministry, recommending that Greece receive immediate debt forgiveness, in exchange for leaving the euro temporarily. If Greece remained in the euro, no relief would be granted a proviso consistent with the German position that debt restructuring for eurozone countries would be illegal.