Outlook: Eurozone leaders deal with future but not present

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Let us say this for Angela Merkel and Nicolas Sarkozy: having copped flak all year for being so far off the pace of the eurozone's sovereign debt crisis, they have now pulled off the neat trick of getting too far ahead of the curve.

The disappointment in the markets yesterday following proposals from the German Chancellor and the French President for a eurozoneeconomic government was not a reflection on the soundness of that idea. Rather, investors moved back towards safe haven assets because while the proposals might prevent a sovereign debt crisis of the future, they do not deal with the one facing us right now.

With the benefit of hindsight, the flaw in the single currency should have been easy to spot. In difficult times, there was nothing to prevent individual members of the eurozone borrowing far too much and then expecting other members to bail them out – which is exactly what has happened.

In a fiscal union, effectively what the French and Germans are now proposing, that would no longer be possible. Assuming the new "government" is given the right powers, it would veto the budget of anymember at risk of breaching agreed borrowing limits.

There may be some pretty big questions concerning democratic accountability with that idea, but in terms of dealing with the sovereign debt issue the scheme looks pretty sound. What it completely fails to do, however, is address the debts that already exist within the eurozone. Hence the adverse market reaction.

Ms Merkel says she is fed up with those who think there is some sort of magic bullet that will resolve the debt crisis (she was talking about the calls for the launch of eurobonds, though she might equally have been thinking about the introduction of short-selling bans in parts of Europe). But while her frustration at those who think the crisis could be solved so simply is understandable, it is no excuse for failing to offer any solutions at all.

This is the dilemma: investors in eurozone debt think some members have borrowed so much that they will not be able to stay on top of the repayments. So unless they get guarantees that the debt will be repaid, they will charge prohibitively high rates of interest when funding has to be rolled over, or simply refuse to lend altogether.

The guarantees can be offered in lots of different ways – via the European Central Bank's bond purchases, by the European Financial Stability Fund, or with eurobonds – but they amount to the same thing: the stronger eurozone members, that is Germany and to a lesser extent France, acting as a backstop for the weaker.