The events of the last few weeks have shone a very harsh searchlight on the nature of sovereign debt within the European Monetary Union. Although critics of EMU have always argued that monetary union without fiscal union is “impossible”, it was only when Angela Merkel started to call for a procedure to handle a possible default on the sovereign debt of a member state that the markets began to focus on the fact that such a default really is possible. In substance, nothing much has changed with Mrs Merkel’s remarks: it always was possible for a sovereign state within the EMU to default. But now that the markets have realised that some key elements of “sovereignty” are missing from the EMU member states, market psychology has changed. It will be very hard to put this genie back into the bottle.

The twists and turns in the European sovereign debt crisis have been more than usually bewildering in recent days, so I thought it would be useful to take a step back and look at the longer term budgetary fundamentals which will ultimately decide whether the troubled sovereigns in the eurozone can avoid default. The eurozone as a whole is in better fiscal shape than other developed economies (notably the US and Japan), and even the most indebted economies could yet dig themselves out of the hole they are in. But the eurozone is still plagued by the contradictions of trying to operate a monetary union without supporting this with a fiscal union.

It is becoming clear that these contradictions can only be solved if there is genuine burden sharing inside the eurozone, along with some much tougher budgetary and regulatory rules which prevent this situation ever happening again. Otherwise, there will be more discussion about default, on the lines of Nouriel Roubini’s piece in today’s FT. Or, in extremis, the currency union will be in real trouble.