Why Merkel and Sarkozy are kidding themselves

COMMENTARYGerman Chancellor Angela Merkel and French President Nicolas Sarkozy are quickly turning into the Abbott & Costello of the political and economic world. The more they talk, the more confused we get.

The two were at it again Monday, vowing to revise the treaty governing the European Union in order to restore confidence in the euro. As the Associated Press summarizes some of the key ideas they're batting around this week ahead of a meeting of European leaders on Friday:

-- Punishing any government that allows its deficit to exceed 3 percent of GDP

-- Requiring countries by law to promise to balance their budgets

-- Never asking private investors to take losses

-- Making Europe's bailout fund permanent by the end of next year, rather than mid-2013

-- Holding monthly European summits until the crisis is over

Got that? The solution to Europe's debt crisis is to turn the screw on government spending, always save bondholders and start a rainy-day fund to prepare for the next deluge. Oh, I almost forgot -- and schedule more meetings. Investors reacted to Merkozy's show of resolve as you might expect for a plan that effectively delivers more of what Europe needs less of -- they shrugged. 

Merkel, Sarkozy to push new treaty on euroPivotal week for EU debt crisis, euro's fate
Central banks' safety net won't save Europe from austerity

Will tweaking the EU's governing Maastricht Treaty as Germany and France envision -- a process Merkel admits will take years -- put Europe on the road to recovery? Not likely. Financial markets dollop out their patience in hours, not years. More fundamentally, the remedies above are based on a fundamental misreading of Europe's core problems.

Despite Merkel's fixation on austerity, the central challenge facing the eurozone isn't to rein in Mediterranean nations with a taste for the high-life. After all, if runaway sovereign debt were the killer here, then why would financial contagion have spread this year to a country like Spain, which until the financial crisis was well within Maastricht's debt limits? Why would Ireland, which had a budget surplus and low government debt before the meltdown, have required a bailout? And why would Germany, with its fiscal discipline and bounteous trade surplus, recently have had to beg investors to buy its debt?

All of this suggests that the main culprit in Europe isn't government spending. Economists Dimitri Papadimitriou and L. Randall Wray note that the growth of private debt in the region (and in the U.S.) over last 40 years has dwarfed the increase in public debt.

Since public spending didn't trigger the crisis, austerity won't cure it, says economist Joseph Stiglitz:

Public-sector cutbacks today do not solve the problem of yesterday's profligacy; they simply push economies into deeper recessions. Europe's leaders know this. They know that growth is needed. But, rather than deal with today's problems and find a formula for growth, they prefer to deliver homilies about what some previous government should have done. This may be satisfying for the sermonizer, but it won't solve Europe's problems -- and it won't save the euro.

Yet while Sarkozy issues platitudes about restoring investor confidence, France forges ahead with plans for 26 billion euro in tax hikes and spending cuts. Meanwhile, the austerity push in Europe is already stalling growth, causing private-sector debt to rise while widening the fiscal imbalances between stronger and weaker economies that have destabilized the entire continent. 

If that's the best solution Germany and France can muster, here's another question -- who's on first?