Like an inmate on death row, the euro has received another last-minute stay of execution. It will survive alittle longer. The markets are celebrating, as they have after each of the fourprevious “euro crisis” summits – until they come to understand that thefundamental problems have yet to be addressed.

There was good news in this summit: Europe’s leaders have finallyunderstood that the bootstrap operation bywhich Europe lends money to the banks to save the sovereigns, and to thesovereigns to save the banks, will not work. Likewise, they now recognize thatbailout loans that give the new lender seniorityover other creditors worsen the position of private investors, who will simplydemand even higher interest rates.

It is deeply troubling that it took Europe’s leaders so long to see something so obvious (and evidentmore than a decade and half ago in the East Asiacrisis). But what is missing from the agreement is even more significant thanwhat is there. A year ago, European leaders acknowledged that Greece couldnot recover without growth, and that growth could not be achieved by austerityalone. Yet little was done.

What is now proposed is recapitalizationof the European Investment Bank, part of a growth package of some $150 billion.But politicians are good at repackaging,and, by some accounts, the new money is a small fraction of that amount, andeven that will not get into the system immediately. In short: the remedies – far too little and too late – are based on a misdiagnosis of the problem and flawed economics.

The hope is that markets will reward virtue,which is defined as austerity. But markets are more pragmatic:if, as is almost surely the case, austerity weakens economic growth, and thusundermines the capacity to service debt,interest rates will not fall. In fact, investment will decline – a vicious downward spiral on which Greece and Spain have already embarked.

Germany seems surprised by this. Like medievalblood-letters, the country’s leaders refuseto see that the medicine does not work, and insist on more of it – until thepatient finally dies.

Eurobonds and a solidarity fund couldpromote growth and stabilize the interest rates faced by governments in crisis.Lower interest rates, for example, would free up moneyso that even countries with tight budget constraints could spend more ongrowth-enhancing investments.

Matters are worse in the banking sector. Each country’s banking system isbacked by its own government; if the government’s ability to support the banks erodes, so will confidence in the banks. Evenwell-managed banking systems would face problems in an economic downturn ofGreek and Spanish magnitude; with the collapse of Spain’s real-estate bubble, itsbanks are even more at risk.

In their enthusiasm for creating a “single market,” European leaders didnot recognize that governments provide an implicit subsidyto their banking systems. It is confidence that if trouble arises thegovernment will support the banks that gives confidence in the banks; and, whensome governments are in a much stronger position than others, the implicitsubsidy is larger for those countries.

In the absence of a level playing field,why shouldn’t money flee the weaker countries, going to the financialinstitutions in the stronger? Indeed, it is remarkable that there has not been more capital flight. Europe’sleaders did not recognize this rising danger, which could easily be averted by a common guarantee, which wouldsimultaneously correct the market distortion arising from the differentialimplicit subsidy.

The euro was flawed from the outset,but it was clear that the consequences would become apparent only in a crisis.Politically and economically, it came with the best intentions. The single-marketprinciple was supposed to promote the efficient allocation of capital andlabor.

But details matter. Tax competition means that capital may go not to whereits social return is highest, but to where it can find the best deal. Theimplicit subsidy to banks means that German banks have an advantage over thoseof other countries. Workers may leave Irelandor Greecenot because their productivity there is lower, but because, by leaving, theycan escape the debt burden incurred by their parents. The European CentralBank’s mandate is to ensure price stability, but inflation is far from Europe’smost important macroeconomic problem today.

Germany worries that, without strict supervision of banks andbudgets, it will be left holding the bag for its more profligateneighbors. But that misses the key point: Spain,Ireland,and many other distressed countries ranbudget surpluses before the crisis. The downturn caused the deficits, not the other way around.

If these countries made a mistake, it was only that, like Germany today, they were overly credulous of markets, so they (like the United Statesand so many others) allowed an asset bubble to grow unchecked.If sound policies are implemented and better institutions established– which does not mean only more austerity and better supervision of banks,budgets, and deficits – and growth is restored, these countries will beable to meet their debt obligations, and there will be no need to call upon theguarantees. Moreover, Germanyis on the hook in either case: if the euroor the economies on the periphery collapse, the costs to Germany will be high.

Europe has great strengths. Its weaknesses today mainly reflect flawed policiesand institutional arrangements. These can be changed, but only if theirfundamental weaknesses are recognized – a task that is far more importantthan structural reforms within the individual countries. While structuralproblems have weakened competitiveness and GDP growth in particular countries,they did not bring about the crisis, and addressing them will not resolve it.

Europe’s temporizing approach to the crisiscannot work indefinitely. It is not justconfidence in Europe’s periphery that is waning. The survival of the euro itself is beingput in doubt.