Germany has been leading the opposition in the EU to any write-down of troubled euro-zone members' sovereign debt. Instead, it has agreed to establish bailout mechanisms such as the European Financial Stability Facility and the European Financial Stabilisation Mechanism, which can lend up to €500 billion (Dh2.51 trillion) combined, with the IMF providing an additional €250bn.
These are essentially refinancing mechanisms. Heavily indebted euro-zone members can apply to borrow from them at less than the commercial rate, conditional on their committing to ever more drastic fiscal austerity.
Principal and interest on outstanding debt have been left intact. Thus, creditors - mainly German and French banks - are not expected to suffer losses on their existing loans, while borrowers gain more time to "put their houses in order".
That, at least, is the theory.
So far, Greece, Ireland, and Portugal have availed themselves of this facility. In mid-July, Greece's sovereign debt stood at €350bn, or 160 per cent of GDP. The Greek government currently must pay 25 per cent for its 10-year bonds, which are trading at a 50 per cent discount in the secondary market.
In other words, investors are expecting to receive only about half of what they are owed. The hope is that the reduction in borrowing costs on new loans, plus the austerity programmes promised by governments, will enable bond prices to recover to par without the need for the creditor banks to take a hit.
This is pie in the sky. Unless a large part of its debt is forgiven, Greece will not regain creditworthiness.
By most accounts, it is about to default. And the same is true, albeit to a lesser degree, for other heavily indebted sovereigns.
Any credible bailout plan must require creditor banks to accept that they will lose at least half of their money. In the successful Brady Bond plan in 1989, the debtors - Mexico, Argentina, and Brazil - agreed to pay what they could. The banks that had loaned them the money replaced the old debt with new bonds at par value, which averaged 50 per cent of the old bonds, and the US government provided some sweeteners.
It was write-offs and devaluations, not austerity programmes, that allowed bond prices to recover. In the Greek case, creditors have yet to accept the need for write-offs, and European governments have provided them with no incentives to do so.
Germany's opposition to debt forgiveness is thus bad economics, bad politics (except at home) and bad history. In the Treaty of Versailles after the First World War, the victorious Allies insisted Germany should pay for "the cost of the war". They added up the figures, and in 1921 they presented the bill: Germany "owed" the victors £6.6bn (85 per cent of its GDP), payable in 30 annual instalments.
Within a year, Germany had asked for, and obtained, a moratorium. New bond issues, following a big debt write-down in 1924, enabled Germany to borrow the money to resume payments. There then followed a crazy system: Germany borrowed money from the US in order to repay Britain, France, and Belgium, while France and Belgium used a bit of it to pay back Britain, and Britain used more of it to pay back the US.
This whole tangle of debts was finally de facto written off in 1932 in the middle of the global slump. But, until 1980, Germany continued repaying the loans that it had incurred to pay the reparations.
From the start, the economist John Maynard Keynes had been a fierce critic of the reparations policy imposed on Germany. He made three main points: Germany didn't have the capacity to pay were it to regain anything like a normal standard of living; any attempt to force it to reduce its standard of living would produce revolution; and to the extent that Germany was able to increase its exports to pay reparations, this would be at the expense of the recipients' exports. What was needed was cancellation of reparations and inter-Allied war debts as a whole, together with a reconstruction loan to put the shattered European economies back on their feet.
In 1919, Keynes produced a grand plan for comprehensive debt cancellation, plus a new bond issue, guaranteed by the Allied powers, whose proceeds would go to victors and vanquished alike. The Americans, who would have had to provide most of the money, vetoed it.
The point to which Keynes kept returning was that the attempt to extract debt payments over many years would have disastrous social consequences.
Angela Merkel, the German chancellor, would do well to ponder that history.
Robert Skidelsky, a member of the British House of Lords, is professor emeritus of political economy at Warwick University
* Project Syndicate