Once this isunderstood, the solution practically suggests itself. It can be summed up inone word: Eurobonds.

If countries thatabide by the EU’s new Fiscal Compact were allowed to convert their entire stockof government debt into Eurobonds, the positive impact would be little short of themiraculous. The danger of default would disappear, as would risk premiums.Banks’ balance sheets would receive an immediate boost, as would the heavilyindebted countries’ budgets.

Italy, for example,would save up to 4% of its GDP; its budget would move into surplus; and fiscalstimulus would replace austerity. As a result, its economy would grow, and itsdebt ratio would fall. Most of the seemingly intractable problems would vanish into thin air.It would be like waking from a nightmare.

In accordance withthe Fiscal Compact, member countries would be allowed to issue new Eurobondsonly to replace maturing ones; after five years, the debts outstanding would begradually reduced to 60% of GDP. If a member country ran up additional debts,it could borrow only in its own name. Admittedly, the Fiscal Compact needs somemodifications to ensure that the penalties for noncompliance are automatic,prompt, and not too severe to be credible. A tighter Fiscal Compact would practicallyeliminate the risk of default.

Thus, Eurobonds wouldnot ruin Germany’s credit rating. On the contrary, they would compare favorablywith the bonds of the United States, the United Kingdom, and Japan.

To be sure, Eurobondsare not a panacea.The boost derived from Eurobonds may not be sufficient to ensure recovery;additional fiscal and/or monetary stimulus may be needed. But having such aproblem would be a luxury. More troubling, Eurobonds would not eliminatedivergences in competitiveness. Individual countries would still need toundertake structural reforms. The EU would also need a banking union to makecredit available on equal terms in every country. (The Cyprus rescue made theneed more acute by making the field even more uneven.) But Germany’s acceptanceof Eurobonds would transform the atmosphere and facilitate the needed reforms.

Unfortunately,Germany remains adamantlyopposed to Eurobonds. Since Chancellor Angela Merkel vetoed the idea, it hasnot been given any consideration. The German public does not recognize thatagreeing to Eurobonds would be much less risky and costly than continuing to doonly the minimum to preserve the euro.

Germany has the rightto reject Eurobonds. But it has no right to prevent the heavily indebtedcountries from escaping their misery by banding together and issuing them. IfGermany is opposed to Eurobonds, it should consider leaving the euro.Surprisingly, Eurobonds issued by a Germany-less Eurozone would still comparefavorably with those of the US, UK, and Japanese bonds.

The reason is simple.Because all of the accumulated debt is denominated in euros, it makes all thedifference which country leaves the euro. If Germany left, the euro woulddepreciate. The debtor countries would regain their competitiveness. Their debtwould diminish in real terms and, if they issued Eurobonds, the threat ofdefault would disappear. Their debt would suddenly become sustainable.

At the same time,most of the burden of adjustment would fall on the countries that left theeuro. Their exports would become less competitive, and they would encounterheavy competition from the rump eurozone in their home markets. They would alsoincur losses on their claims and investments denominated in euros.

By contrast, if Italyleft the eurozone, its euro-denominated debt burden would become unsustainableand would have to be restructured, plunging the global financial system intochaos. So, if anyone must leave, it should be Germany, not Italy.

There is a strongcase for Germany to decide whether to accept Eurobonds or leave the eurozone,but it is less obvious which of the two alternatives would be better for thecountry. Only the German electorate is qualified to decide.

If a referendum inGermany were held today, the supporters of a eurozone exit would win hands down. But more intensive considerationcould change people’s mind. They would discover that the cost to Germany ofauthorizing Eurobonds has been greatly exaggerated, and the cost of leaving the eurounderstated.

The trouble is thatGermany has not been forced to choose. It can continue to do no more than theminimum to preserve the euro. This is clearly Merkel’s preferred choice, atleast until after the next election.

Europe would beinfinitely better off if Germany made a definitive choice between Eurobonds anda eurozone exit, regardless of the outcome; indeed, Germany would be better offas well. The situation is deteriorating, and, in the longer term, it is boundto become unsustainable. A disorderly disintegration resulting in mutualrecriminations and unsettledclaims would leave Europe worseoff than it was when it embarked on the bold experiment of unification. Surely thatis not in Germany’s interest.