The Market Solution To The Euro Crisis

There was some excitement today over the announcement that Merkel and Sarkozy have decided that the European Union treaty needs to be rewritten to include sanctions on countries that exceed the 3% debt/GDP limit that they all agreed to way back when the EU was first established.

The problem with this "solution" is that the mechanism for enforcing sanctions is a deeply flawed concept. The best, and probably the only way to impose real sanctions on governments who spend and borrow too much is to let the market do it. When the yield on your bonds starts to skyrocket, you quickly realize that you can't continue to borrow. You either mend your ways and borrow less, and/or figure out how to grow more, or you default on your debt obligations. And even if you default, you will find it very difficult—if not impossible—to continue to be profligate. That's the way it has always worked in the bond market. It's quite simple: if lenders don't think you can repay your debts, they won't lend you any more money.