Greece’s George Papandreou is trying to form a new government and survive a vote of confidence this weekend. His brave attempt to resolve his country’s intractable financial problems deserves respect but will not make any difference. Pictures of Greek protesters being restrained by riot police and tear gas have, understandably, convinced investors that a disorderly default is increasingly likely.

Economic crises generally come to a head when they force a political crisis. But Europe’s response to what could be the seminal moment of its sovereign debt saga is flawed. Leaders have mistaken a problem of insolvency for one of illiquidity. The latest agreement between the European Union and the International Monetary Fund appears designed to muddle everyone through until the end of 2014. But while this liquidity issue is easily solvable (if various actors do not mind finding €113bn more on top of the €57bn that Greece has received, calculates Capital Economics) the solvency problem is not.

Even if Greece successfully raised €30bn from privatisations, met all its tight budgetary goals and grew in line with the optimistic official forecasts, its government debt would still equal about 150 per cent of output in 2014. Furthermore, the bulk of outstanding Greek debt would be in public hands (European governments, the European Central Bank and the IMF) and would presumably have some seniority. Remaining private sector holders would then be squeezed into a greater share of any haircut – an alarming prospect for the European financial system and the reason for the scramble to avoid a default.