A Simple Solution for the Euro

Arnold Kling of EconLog write a nice succinct post on what it will take to solve the Euro crisis:

The crisis will end only when the liabilities of the insolvent governments and banks have been properly discounted. Maybe Spanish bonds will be worth only 70 percent of their face value. Maybe creditors of some large banks will receive new notes worth, on average, 80 percent of their existing notes. (But will small depositors get 100 percent, and large creditors get much less than 80 percent?).

Another important issue arises from the nature of sovereign debt. For private debt issued within a country, creditors have recourse to the court system to try to recover their money. But there is no court with the power to force the government of Spain to pay anything to its creditors. So, even if the German government, in order to "save the European union," agrees as an agent for its citizens to buy existing Spanish debt at par in exchange for new debt worth 70 cents on the euro, how can we be sure that Spain will pay off the new debt?

In any case, the important point is that resolution of the crisis requires large markdowns in the value of the liabilities of some governments and banks. The crisis continues because the parties involved are unwilling to undertake this step. The crisis will end when they have exhausted the alternatives.