BY THE standards of past summits, European leaders finished early—shortly before 10pm on January 30th. And by the acrimonious standards of past gatherings, notably last month’s bust-up with Britain, this event was uneventful, even amicable. Agreement was reached on the fiscal compact, the new treaty to toughen budget rules, in record time: less than two months.

A final row between France and Poland over who gets to attend which summits was resolved with a complicated compromise. This involves variable configurations of meetings involving 17 countries (the euro zone), 23 (the largely-forgotten Euro-Plus Pact, 25 (the signatories of the fiscal compact), 27 (all EU member states, still in charge of the single market) and 28 (involving soon-to-join Croatia).

It shows that, at the very least, European leaders can negotiate rapidly when they have the political will to do so—and when the British and the Czechs decide to step aside. Whether electorates will be quite so quick to shackle themselves to Germanic fiscal rules is another matter.

But did the leaders achieve anything useful to stem the crisis in the latest of their interminable summits? Their compact—now called the “treaty on stability, co-ordination and governance in the Economic and Monetary Union”, has as its main aim the imposition of balanced-budget rules on members. This may be a useful discipline in good times. But many worry that, at a time of widespread crisis, such pro-cyclical rules risk imposing too much austerity too widely, thus darkening the spectre of recession and making it even harder to balance budgets. This may explain why leaders suddenly want to be seen talking about their plan (declaration is here in PDF) for growth and jobs, particularly in tackling the problem of youth unemployment.

Nevertheless, Angela Merkel, the German chancellor who had pushed hard for the treaty, hailed it as a great success. Many others, however, dismiss the compact with so much faint praise. “It is an important distraction”, says one diplomat. “It has gone from damaging to merely useless,” says a member of the European Parliament. Even Mario Monti, these days everybody’s favourite Italian, judged the compact little more than “a decorative songbird”.

By contrast the two issues that could affect the course of the euro-zone debt crisis in the coming weeks—the fate of Greece and the possibility of creating a bigger firewall—were for the most part ignored or relegated to side-meetings. With Greece and its private creditors still negotiating the scale of haircuts to be imposed on bondholders, this may have been too delicate a time for leaders to discuss Greece. A statement from the euro zone says little that is new.

Moreover, Mrs Merkel was keen to dampen emotions after her officials floated the idea of placing the country under a commissar with the power to reject Greek budgets. When asked about such a prospect, Mrs Merkel expressed “frustration” with Greece’s lack of compliance with its austerity-and-reform programme, but backed away from imposing such a draconian loss of sovereignty on Greece. President Nicolas Sarkozy of France, for his part, said "there is no question of placing Greece under tutelage.”

All leaders of the euro zone are insisting that forcing private creditors to take a hit on Greek bonds constitutes a “unique” event, for fear of causing contagion. But spreads on Portuguese bonds are rising to alarming levels, and the outlook for Italy and Spain is still wobbly.

“An inability to tackle a problem the size of Greece inspires little confidence in the ability of the EU to tackle Italy and Spain,” says Sony Kapoor, head of Re-Define, a financial think-tank in Brussels.

Germany parried demands, from Mr Monti and others, to enlarge the firewall by merging the existing temporary European Financial Stability Facility (EFSF) and the permanent new European Stability Mechanism (ESM). This would enlarge the fund from €500 billion ($659 billion) to €750 billion. Mrs Merkel said the matter should be discussed in March, as decided in last December’s summit.

The British have decided not to be awkward about the compact, despite the falling-out at the previous summit, where Britain threatened to veto a change to the EU’s treaties unless it were able to secure greater protection from financial-services legislation. The stalemate forced the other 26 countries to negotiate the compact outside the EU treaties (with Britain sitting in as an observer). 

Mr Cameron is under pressure from Eurosceptic backbenchers to wage legal warfare to prevent signatories to the pact from using EU institutions, such as the European Commission and the European Court of Justice. “We will only take action if our national interests are threatened. And I made clear today that we will be watching this closely,” said Mr Cameron.

Nevertheless, Mr Sarkozy and Mr Cameron are still sparring. The French president’s barb in a television interview a day earlier, when he mockingly said that Britain had “no industry left”, prompted Mr Cameron to rattle off a list of great British car companies—among them Honda, Toyota and Nissan (all Japanese). He said he relished the prospect of French banks moving operations across the Channel to London if Mr Sarkozy pressed ahead with his promise to impose a tax on financial transactions unilaterally.

Perhaps the most interesting dynamic was between France and Germany ahead of the French presidential elections in April and May. Mrs Merkel said that she would campaign for the re-election of Mr Sarkozy, saying he had done the same for her in the past. But she said she would not be worried if his opponent, François Hollande, who is leading opinion polls, were to win—even though he wants to renegotiate the fiscal compact and has blocked Mr Sarkozy’s attempt to enshrine a golden rule in the constitution.

Asked if she could envisage having to take France to court for failure to adopt a balanced-budget rule, as provided for by the compact, Mrs Merkel said: “I cannot imagine taking legal action against France because I cannot imagine that France will not institute a golden rule.”

THIS grotesque map of the world, depicting Europe as a bloated balloon, caught my eye this week, and powerfully illustrates one of the factors in Europe's debt crisis. It depicts the countries of the world sized according to the amount of government spending*. that they spend on social protection, from pensions to health, education and unemployment benefits.

In the words of the World Bank, which published it in a report issued this week ("Golden Growth: Restoring the lustre of the European Economic model", here), Europe is the world's “lifestyle superpower”. As opposed to America, which spends almost as much as the rest of the world put together on defence, Europe spends more than the rest of the globe combined on social policies.

In many ways this is an admirable aspect of Europe's economic model, which combines high living standards with high standards of social welfare. The trouble is, such spending is helping to bankrupt governments—not least because those very same caring policies ensure that Europeans live longer, requiring more expenditure on health care and the payment of pensions for more years.

Anybody who wants to understand the strengths and weaknesses of European economies in this time of crisis would do well to read the report (the overview is here).

First the strengths. Europe, say the authors, invented a unique “convergence machine” by admitting successive waves of poorer countries and quickly raising their standards of living. Convergence has been accelerated by the free flow of trade and capital within the European Union. As the report puts it:

Between 1950 and 1973, Western European incomes converged quickly towards those in the United States. Then, until the early 1990s, the incomes of more than 100 million people in the poorer southern periphery—Greece, southern Italy, Portugal, and Spain—grew closer to those in advanced Europe. With the first association agreements with Hungary and Poland in 1994, another 100 million people in Central and Eastern Europe were absorbed into the European Union, and their incomes increased quickly. Another 100 million in the candidate countries in Southeastern Europe are already benefiting from the same aspirations and similar institutions that have helped almost half a billion people achieve the highest standards of living on the planet. If European integration continues, the 75 million people in the eastern partnership will profit in ways that are similar in scope and speed.

Yet this convergence machine is spluttering, and deep reforms are needed. Much effort has been expended on explaining the nature of the financial crisis of the past two years. The sharpest and most concise analysis I know of is a recent policy brief by Jean Pisani-Ferry, director of the Bruegel think-tank in Brussels ("The euro crisis and the new impossible trinity", here). This argues that the problems are deeper than a lack of fiscal discipline: there is a flaw in the way the euro zone was designed, without a lender of last resort, without joint bonds and with a vicious feedback loop that weakens both sovereigns and their banks. There is a tendency in Brussels to think that, if only the euro zone were to make the leap to federalism, all would be solved. Far from it.

The World Bank report shows that Europe has deep structural flaws to contend with. Perhaps most worrying is the slowdown in labour productivity, the underlying driver of economic growth over the long term. This chart (right) shows how Western Europe had almost closed the productivity gap with America by 1995. But thereafter it started to lag ever farther behind the United States (and kept losing its lead over Japan).

The effect is most alarming on the Mediterranean rim. These next two charts show that, as expected, in 2002 northern Europe was more productive than southern Europe, which in turn led the new member states of eastern Europe. But between 2002 and 2008 something strange happened. The convergence machine went into reverse for southern Europe. While the easterners were roaring ahead to catch up with the northerners, prroductivity in Mediterranean countries actually fell.

Part of the reason is contained in this chart (right). It shows how foreign direct investment was abruptly redirected from southern countries to the new member states in the east. Mediterranean members faced a triple challenge: they were hit hard by globalisation and the loss of low-tech industries such as textiles; they faced competition from cheaper labour in ex-communist members; and the adoption of the euro made it harder for them to adjust through devaluation. Yet Club Med has only itself to blame. 

A premature adoption of the euro by southern economies is sometimes blamed for this reversal of fortune. Others say that letting the formerly communist countries into the European Union so soon did not give the south enough time to become competitive. But perhaps the most likely explanation is that of all the economies in Europe, the entrepreneurial structures of Greece, Italy, Portugal, and Spain were least suited for the wider European economy. For one thing, a sizable part of net output in southern economies is generated in small firms—almost a third of it in tiny enterprises (with fewer than 10 workers). This is not an entrepreneurial profile suited for a big market. Unsurprisingly, with the expansion of the single market in the 2000s, foreign capital from the richer economies of Continental Europe quickly changed direction, going east instead of south as it had done in the 1990s.

Did the south need more time to adjust, or did it squander opportunities? The latter seems more plausible. Ireland has shown that EU institutions and resources can be translated quickly into competitiveness. The Baltic economies are now doing the same. The chief culprits for the south’s poor performance were high taxes and too many regulations, often poorly administered. While these mattered less when its eastern neighbors were communist and China and India suffered the least business-friendly systems in the world, they are now crippling southern enterprise.

All is not lost. Northern European states, especially Nordic countries, show it is possible to innovate, raise productivity and maintain generous social welfare at the same time. This is the World Bank's explanation for their success:

What has the north done to encourage enterprise and innovation? Much of its success has come from creating a good climate for doing business. All the northern economies are in the top 15 countries of 183 in the World Bank’s Doing Business rankings; at 14th, Sweden is the lowest ranked among them. They have given their enterprises considerable economic freedom. Their governments are doing a lot more. They have speeded up innovation by downloading the “killer applications” that have made the United States the global leader in technology: better incentives for enterprise-sponsored research and development (R&D), public funding mechanisms and intellectual property regimes to foster profitable relations between universities and firms, and a steady supply of workers with tertiary education. Tellingly, Europe’s innovation leaders perform especially well in areas where Europe as a whole lags the United States the most. These features make them global leaders; combining them with generous government spending on R&D and public education systems makes their innovation systems distinctively European.

Even so, there are reasons to worry, even in northern Europe. For instance:

What has been more perplexing is Europe’s generally poor performance in the most technology-intensive sectors—the Internet, biotechnology, computer software, health care equipment, and semiconductors. Put another way, the United States, the Republic of Korea, and Taiwan, China, have been doing well in sectors that are huge now but barely existed in 1975. Europe has been doing better in the more established sectors, especially industrial machinery, electrical equipment, telecommunications, aerospace, automobiles, and personal goods. The United States has young firms like Amazon, Amgen, Apple, Google, Intel, and Microsoft; Europe has Airbus, Mercedes, Nokia, and Volkswagen.

The productivity gap is especially important in Europe, given that Europeans tend to work less than Americans, while spending more on social protection.

The hallmark of the European economic model is perhaps the balance between work and life. With prosperity, Americans buy more goods and services, Europeans more leisure. In the 1950s, Western Europeans worked the equivalent of almost a month more than Americans. By the 1970s, they worked about the same amount. Today, Americans work a month a year more than Dutch, French, Germans, and Swedes, and work notably longer than the less well-off Greeks, Hungarians, Poles, and Spaniards..

And on top of fewer working hours in the day, and taking longer holidays, Europeans have tended to retire earlier—even as they lived longer. By 2007, the French could expect to draw pensions for 15 years longer than they did in 1965. On current trends for immigration and participation in the workforce, says the World Bank, the 45 European countries in its study will lose 50m workers over the next 50 years. Which brings us to that spending bulge.

Europe’s states are not big spenders on either health or education. The variation among countries stems from a difference in spending on pensions and social assistance. Europe’s countries also differ how they tax these benefits; Northern European countries tax the social security benefits of people with high incomes more than others in Europe. After taxes are considered, the southern periphery is the biggest social spender in Western Europe. But the reason why Europe spends more than its peer on public pensions is the same in the north, center and south. This is not because Europe has the oldest population (Japan’s is much older) nor because of higher pension benefits (annual subsidies per pensioner are about the same in Greece as in Japan). It spends more because of easier and earlier eligibility for pensions.

So the outlook is gloomy. Even with greater productivity, even if governments can reduce unemployment and bring more women into the workforce, Europeans will have to stay in work for many more years. Even so, the workforce will decrease. So Europeans will have to rethink migration policies too.

* A correction to my post last night: the World Bank's map is sized according to all government spending, not just spending on social policies. The World Bank tells me the map would be even more distorted were it to focus only on public spending on health, education and welfare benefits.

My piece this week on the British row argues that the bust-up could yet go either way: towards a progressive deterioration in relations that might ultimately see Britain leave the union, or towards a reconciliation that sets aside the rancour of the night of December 8th-9th. The past few days have seen evidence of both possibilities. 

First there was the war of words started by French leaders as they openly incited markets and credit-rating agencies against Britain, arguing that perfidious Albion was more deserving of a downgrade than France. For two countries with similar debt levels, Britain has a higher budget deficit and is running higher inflation. The difference is that the Bank of England, unlike the European Central Bank, acts as the lender of last resort to the sovereign, so investors are less worried about losing the face value of their bond.

The French charge was led by the central-bank governor, Christian Noyer, and quickly followed up by François Fillon, the prime minister, and François Baroin, the finance minister. Even the daily Le Monde seemed surprised by the vehemence of the attack, asking "what has bitten the French government?" The answer, it seems, is the need to prepare the country for the imminent loss of its AAA rating. 

On the reconciliation side of the ledger is the news that Herman Van Rompuy, who, as president of the European Council, chairs summits, has invited Britain to join the treaty-drafting sessions as an "observer". British officials say that they will even have the right to speak (although not to vote). The readiness to take up the olive branch suggests that Britain recognises it made a mistake in casting a veto. At the same time, several of the countries that had abandoned Britain are now having qualms about the treaty.

The EU bureaucracy has already produced a working draft of the new treaty. The aim is to have a version ready for a European summit at the end of January or early February, and to complete it in time for signature in March. 

The arrangement is inelegant: the treaty involves all, or nearly all, of the EU's members, but is separate from the EU's current treaties. Still, this is not the first time such an intergovernmental treaty has been grafted on to the EU. The creation of the Schengen open-border region was originally set up through an intergovernmental treaty. But Schengen was something entirely new. The new euro-zone treaty must somehow amend a substantial body of existing legislation, without formally amending it. "It's a dog's dinner," says one diplomat. 

The agreement will test the ingenuity of Hubert Legal, the aptly named legal adviser to the Council of Ministers. The French lawyer has already displayed a considerable degree of flexibility that has not been to the liking of all. 

On the eve of the summit he had told a meeting of sherpas, the envoys of national leaders who were preparing the meeting, that an intergovernmental treaty would be nigh-on impossible. Any change would have to be done with the agreement of all 27 EU members. This oral opinion did much to convince British officials that they had a strong hand with which to demand concessions. 

But the following night Mr Cameron's fellow leaders decided that they would not grant him a special protocol giving Britain a veto over key aspects of financial regulation. If Britain decided to block a change to the EU treaties, the euro zone would draft a new one, along with anybody else who wanted to participate. Mr Cameron asked Mr Legal to offer a view. To the surprise of many, Mr Legal said that such a roundabout arrangement would be possible after all. The second surprise for Mr Cameron was the alacrity with which all non-euro members announced their readiness to participate. 

Later on, Mr Legal's close associates defended him from the charge that he had changed his opinion. Not at all, they claim; he had merely told the sherpas that a treaty at 27 was preferable. When the second-best option became the only avenue, he made it clear that there were options to try to make it work. 

EU treaty negotiations are notoriously arduous, given the need to secure agreement among all member states, and the near-certainty that somebody will refuse to ratify. Ireland, which may be obliged to hold a referendum on the new arrangements, is among those countries arguing that it needs concessions if it is to win ratification.

So Mr Legal and his team have come up with an innovation: under his draft, the treaty would come into force once nine members of the euro zone (ie, a simple majority) have ratified it. Euro-zone countries that do not ratify it will not be bound by its terms. But like Greece last month after it announced (then cancelled) a plan to hold a referendum, refuseniks would no doubt come under severe political pressure to choose whether they want to stay in or out of the euro. Countries outside the euro zone could voluntarily agree to be bound by the budget strictures of the new treaty. 

A separate intergovernmental treaty introduces two complications, in particular. 

First, the aim is to make it harder for politicians to meddle with proposals by the European Commission to place countries under the "excessive deficit procedure", under which they can face sanctions if they run annual deficits higher than 3% of GDP. Under current rules, this requires approval by a qualified (weighted) majority vote (QMV) of member states. The treaty seeks to change this vote to a "reverse QMV" procedure, whereby the proposals are accepted unless a qualified majority of ministers vote against it. How to change this without changing the existing EU treaty? Well, under the terms of the intergovernmental treaty, the minister would agree to behave as if the reverse QMV rule existed. In other words, it is a gentleman's agreement without real enforcement provisions. 

Another difficulty is the role of the European Court of Justice. Germany wanted profligate states to be forced to account for themselves before the ECJ. Now the court will only have oversight of whether countries have correctly adopted EU-mandated rules on balanced budgets into their constitutions or other legal instruments. Moreover, because the new treaty is only intergovernmental, the European Commission will not be able to sue countries; instead, it will be up to member states to take each other to court, something that does not happen often. 

The new draft treaty includes a paragraph in the preamble mentioning a separate treaty, on establishing a permanent euro-zone bail-out fund, known as the European Stability Mechanism (ESM). There is no link made in the operative paragraphs. Yet it is a reminder of the bargain that Germany demands of its euro-zone partners: it will stand ready to rescue countries in trouble (up to a point); in exchange, countries must accept far greater budgetary rigour. 

The ESM treaty, still to be completed after multiple changes (see my post on how it undid last year's Franco-German deal at Deauville), has an interesting peculiarity: it too will enter into force with less than unanimity. But in this case it requires ratification by countries representing 90% of its capital (shared according to the ECB capital key). Moreover, in urgent cases decisions within the ESM can be taken by a majority of 85%. 

All this sets up not just a two-tier EU (with Britain in the outer edge), but perhaps also a two-tier euro zone. On the current draft, Ireland will not be able to veto the new intergovernmental treaty. But wealthy Germany alone can block the ESM treaty, and can block decisions to grant aid to any country. 

When in doubt, EU governments and Brussels officials love nothing more than wrangling over the texts of treaties. The question, as ever, is whether it impresses the markets. The answer so far is: no.  

We should expect 2012 to be even more difficult than 2011. Italy and Spain have large piles of debt to refinance in January; the most creditworthy states of the euro zone could soon start to be downgraded, weakening their already underpowered temporary rescue fund (the European Financial Stabiility Facility); the plan to leverage this fund is deflating like a botched soufflé; and so is the idea of boosting the IMF's resources to help the euro zone.  

For the euro zone to survive, a long list of things needs to go right—at a time when so much can go wrong. So enjoy the holidays while they last. 

WE JOURNALISTS are probably too bleary-eyed after a sleepless night to understand the full significance of what has just happened in Brussels. What is clear is that after a long, hard and rancorous negotiation, 

In an effort to stabilise the euro zone, France, Germany and 21 other countries have decided to draft their own treaty to impose more central control over national budgets. Britain and three others have decided to stay out. In the coming weeks, Britain may find itself even more isolated. Sweden, the Czech Republic and Hungary want time to consult their parliaments and political parties before deciding on whether to join the new union-within-the-union.

So two decades to the day after the Maastricht Treaty was concluded, launching the process towards the single European currency, the EU's tectonic plates have slipped momentously along same the fault line that has always divided it—the English Channel.

Confronted by the financial crisis, the euro zone is having to integrate more deeply, with a consequent loss of national sovereignty to the EU (or some other central co-ordinating body); Britain, which had secured a formal opt-out from the euro, has decided to let them go their way.

Whether the agreement does anything to stabilise the euro is moot. The agreement is heavily tilted towards budget discipline and austerity. It does little to generate money in the short term to arrest the run on sovereigns, nor does it provide a longer-term perspective of jointly-issued bonds. Much will depend on how the European Central Bank responds in the coming days and weeks.

Some doubt remains over whether and how the "euro-plus" zone will have access to EU institutions—such as the European Commission, which conducts economic assessments and recommends action, and the European Court of Justice, which Germany hopes will ensure countries adopt proper balanced-budget rules—over Britain's objections.

But especially for France, on the brink of losing its AAA credit rating and now the junior partner to Germany, this is a famous political victory. President Nicolas Sarkozy had long favoured the creation of a smaller, "core" euro zone, without the awkward British, Scandinavians and eastern Europeans that generally pursue more liberal, market-oriented policies. And he has wanted the core run on an inter-governmental basis, ie by leaders rather than by supranational European institutions. This would allow France, and Mr Sarkozy in particular, to maximise its impact.

Mr Sarkozy made substantial progress on both fronts. The president tried not to gloat when he emerged at 5am to explain that an agreement endorsed by all 27 members of the EU had proved impossible because of British obstruction. “You cannot have an opt-out and then ask to participate in all the discussion about the euro that you did not want to have, and which you also criticised,” declared the French president.

With the entry next year of Croatia, which will sign its accession treaty today, the EU is still growing, said Mr Sarkozy. “The bigger Europe is, the less integrated it can be. That is an obvious truth.”

For Britain the benefit of the bargain in Brussels is far from clear. It took a good half-hour after the end of Mr Sarkozy's appearance for Mr Cameron to emerge and explain his action. The prime minister claimed he had taken a “tough decision but the right one” for British interests—particularly for its financial-services industry. In return for his agreement to change the EU treaties, Mr Cameron had wanted a number of safeguards for Britain. When he did not get them, he used his veto.

After much studied vagueness on his part about Britain's objectives, Mr Cameron's demand came down to a protocol that would ensure Britain would be given a veto on financial-services regulation (see PDF copy here). The British government has become convinced that the European Commission, usually a bastion of liberalism in Europe, has been issuing regulations hostile to the City of London under the influence of its French single-market commissioner, Michel Barnier. And yet strangely, given the accusation that Brussels was taking aim at the heart of the British economy, almost all of the new rules issued so far have been passed with British approval (albeit after much bitter backroom fighting). Tactically, too, it seemed odd to make a stand in defence of the financiers that politicians, both in Britain and across the rest of European, prefer to denounce.

Mr Cameron said he is “relaxed” about the separation. The EU has always been about multiple speeds; he was glad Britain had stayed out of the euro and out of the passport-free Schengen area. He said that life in the EU, particularly the single market, will continue as normal. “We wish them well as we want the euro zone to sort out its problems, to achieve stability and growth that all of Europe needs.” The drawn faces of senior officials seemed to say otherwise.

The 23 members of the new pact, if they act as a block, can outvote Britain. They are divided among themselves, of course. But their habit of working together and cutting deals will, inevitably, begin to weigh against Britain over time.

Mr Sarkozy and Angela Merkel, the German chancellor, have given notice of their desire for the euro zone to act in all the domains that would normally be the remit of all 27 members—for example, labour-market regulations and the corporate-tax base.

Britain may assume it will benefit from extra business for the City, should the euro zone ever pass a financial-transaction tax. But what if the new club starts imposing financial regulations among the 17 euro-zone members, or the 23 members of the euro-plus pact? That could begin to force euro-denominated transactions into the euro zone, say Paris or Frankfurt. Britain would, surely, have had more influence had the countries of the euro zone remained under an EU-wide system.

It says much about the dire state of the debate on Europe within Britain's Conservative party that, as Mr Cameron set out to Brussels, another Tory MP portentously invoked the memory of Neville Chamberlain, who infamously came back from Munich with empty assurances from Adolf Hitler. Mr Cameron may have made a grievous mistake with regard to Britain's long-term interest. But at least nobody can accuse him of returning from Brussels with a piece of paper in his hand.

(Picture credit: AFP)

Read more: Bagehot's take on Britain falling out of the EU

AT LEAST there is hope. Grim-faced European leaders gathered in Brussels on December 8th for their summit to save the euro with the news that Pope Benedict XVI was praying to the Virgin Mary for the sake of Italy and Europe. He should also spare a prayer for Mario Draghi, the president of the European Central Bank.

As the dinnertime negotiations stretched into the wee hours of Friday morning, leaked drafts of a communiqué indicate that the summiteers intend to agree to a “fiscal compact” to ensure the stability of the euro zone. These words matter: they are the same ones that Mr Draghi had used a few days earlier in a Delphic judgment that many interpreted to mean that he would intervene more heavily in the bond markets, once the politicians had delivered a more credible system to impose budget discipline.

The leaders seemed to be appealing directly to Mr Draghi to deploy the “big bazooka”, which only he controls, to protect big and vulnerable sovereigns like Italy and Spain. So is salvation at hand? Not quite.

Even before the summit had started, Mr Draghi punctured the bubble of optimism that his words had created. He had been misinterpreted, he said. Mr Draghi "was surprised by the implicit meaning that was given” to what he had said.

He also popped what had been another emerging reason for hope: that the ECB, or individual central banks, might lend money directly to the IMF so it could lend back to European states. “It's legally complex. The spirit of the treaty is that one cannot channel money in a way to circumvent the treaty provisions. If the IMF were to use this money exclusively to buy bonds in the euro area, we think it's not compatible with the treaty.” Markets quickly deflated.

Senior European officials suggest that Mr Draghi was just playing coy—perhaps because he is still new, or perhaps because he is Italian, or perhaps because he wants to hold the leaders’ feet to the fire.

To judge from the latest draft—parts of which are likely to be rewritten—the compact being negotiated broadly follows the lines agreed by President Nicolas Sarkozy of France and Angela Merkel, the German chancellor.

— Governments should adopt a fiscal rule to balance their budgets over an economic cycle, though they could incur deficits “in the event of exceptional circumstances”.

— Specifically, the structural deficit should not exceed 0.5% of nominal GDP. Countries with debt “significantly lower” than 60% of GDP could run higher deficits.

— Such a “golden rule” should be enshrined in national constitutions or other legislation. The European Court of Justice will have the power to verify whether the rule is properly transposed.

— Countries breaching the 3% deficit limit imposed under the existing Stability and Growth Pact will face “automatic consequences” unless ministers block action by a qualified or weighted majority (this is known to Brusselistas as “reverse QMV”). That said, “exceptional circumstances will be taken into account”.

Where the draft communiqué pulls away from the “Merkozy” script is in its attempt to open the door to Eurobonds:

 …the possibility of moving towards common debt issuance in the longer term and in a staged and criteria-based process should be considered, once significant progress has been made in reinforcing fiscal rules and discipline. Any steps towards that end will have to be commensurate with a robust framework for budgetary discipline and economic competitiveness to avoid moral hazard and foster responsibility and compliance.

Another point that upsets the Germans is the idea that the European Stability Mechanism, the permanent euro-zone bailout fund that will replace the European Financial Stability Facility, should “have the possibility to directly recapitalise banking institutions and to have itself the necessary features of a credit institution”. In other words, it should become a bank, which would allow it to borrow from the ECB. This would be an indirect means of using the “big bazooka”.

These points are likely to be excised, or heavily rewritten, by the end of the summit. Moreover the paperwork leaked so far says nothing about the biggest underlying issue. Will the required changes to the euro zone's treaties be brought about with the agreement of all the EU's 27 members, or will the euro zone set off on a path of separation, by drawing up its own treaty? My column this week looks at the role that Britain, in particular, will play in determining the outcome. The word last night was that Mr Cameron was being "very tough". But when have his officials ever described their prime minister as a wimp?

In the short term the markets will not really care what legal instruments are used, or what diplomatic phrases are negotiated. The crucial thing will be whether the leaders have produced what Mr Draghi needs to act.

So leaders are performing a peculiar ritual to win the favour of the ECB president. If countries mortify themselves sufficiently, then perhaps Mr Draghi will smile upon them. Word has it that Mrs Merkel would not mind a greater role for the ECB, but it should not be funding governments too overtly, and it should not be told by their leaders what to do. This all to preserve the hallowed independence of the ECB.

France and Germany disagree bitterly about the ECB's involvement in the crisis. They have now agreed to keep silent; the less said about it, the better. If Mr Draghi were indeed to intervene, he should be seen to do so independently, not under duress.

And yet there is something incongruous about this idea that Mr Draghi should be kept pure and unsullied by worldly politics, concerned only with the celestial mysticism of monetary policy. If that were so, then why is he, like his predecessor Jean-Claude Trichet, attending a European summit where the grubbiest of political intercourse takes place? It is like having the pope come round to preach in a brothel.

(Picture credit: AFP)

That deal envisaged tougher monitoring of countries’ budgets and economic policies, and a rapid amendment to the European Union's treaties. Many thought treaty change was unnecessary but went along for Mrs Merkel's sake.

Sounds familiar, no? That is because, a year on, “Merkozy”, as the Germano-French duo are now known, are once again pushing for a toughening-up of controls on national budgets and yet another revision to the treaties.

At a summit in Paris today the two leaders announced they would “force-march” the euro zone towards stricter rules to ensure that a debt crisis could never happen again. They will submit proposals for a new treaty on Wednesday and, if they cannot secure agreement from all 27 EU members, they declared they were ready to push ahead with a separate agreement among the 17 members of the euro zone. That risks isolating Britain, as well as the nine other non-euro states.

Treaty change is no more popular than it was in Deauville, not even among euro-zone members. But at a summit of European leaders in Brussels starting on Thursday the chances are that some form of treaty revision will grudgingly be agreed, because Mrs Merkel wants it so badly.

But in many ways, the new proposals undo the bargain at Deauville, which, many think, helped worsen the crisis. Since then Ireland and Portugal have been bailed out; Greece has sought a second rescue programme; contagion has spread to Italy and Spain; and the prime ministers of Italy and Greece have been replaced by technocrats.

A year ago, the Deauville bargain saw Germany agree to water down proposals to impose more “automatic” sanctions on countries that breach rules on public debt and budget deficits. France insisted on maintaining greater discretion for governments (though it later had to give some ground to the European Parliament).

In exchange, France agreed to a limited treaty change to turn the temporary bail-out fund, the European Financial Stability Facility (EFSF), into a permanent mechanism known as the European Stability Mechanism (ESM).

One provision, that the most persistent offenders should lose their voting rights, was soon abandoned. But a second one, seeking the “adequate participation” of private bondholders, survived. At first haircuts were supposed to apply only to new debt issued from 2013, when the ESM was due to come into force. But this year the euro zone twice demanded that private creditors take losses on existing Greek debt.

For many critics—notably Jean-Claude Trichet, the recently departed president of the European Central Bank—this private-sector involvement (PSI, in Euro-jargon) badly spooked the markets about the value of the European debt they were holding.

France and Germany will not accept that they made a mistake in Deauville. But look at their latest deal and it is clear that they have had second thoughts: France has agreed with German demands for even greater "automaticity" in the process leading to sanctions; and Germany, in return, has agreed to weaken the articles on restructuring the debt held by private creditors.

The PSI provisions had been written into the treaty to create the ESM, which has yet to be ratified. Mrs Merkel said the text should henceforth make clear that the euro zone will act in accordance with IMF practice in judging whether a country is bust, and so in need of debt restructuring.

This is intended to make clear that euro-zone debt is no riskier than the debt of other countries. One reason for the concession is that the euro zone wants to bring forward the ESM. In contrast with the EFSF, which is based on national guarantees, the ESM will have paid-in capital that should make it a more effective firewall against market contagion. At a time of acute nervousness in the market, the provisions for PSI were unlikely to help restore calm.

Having done away with much of their Deauville pact, Mrs Merkel and Mr Sarkozy made a number of new bargains. Germany more or less gave up its long-standing demand that countries in breach of fiscal rules should be taken to the European Court of Justice (ECJ).

Under the new Germano-French deal, the task of imposing legal restraints on governments will be given to national courts, through budgetary golden rules that all euro-zone countries will be expected to adopt. Instead of examining an individual country’s budget, the ECJ would be entitled to examine only whether the golden rules are in conformity with European demands.

In return, Mr Sarkozy has abandoned his fight for joint Eurobonds. The French president gladdened Mrs Merkel’s ears when he declared: “It would be a funny idea to mutualise the debt so that France and Germany would have to pay for the debt of others without having control over it.”

It is unclear whether even the Franco-German compromise deal can be secured outside the EU's treaties. Without the European Commission, who would be in charge of monitoring budgets? But the intention is clear: it is a warning to Britain, Poland and other euro “outs” not to make too much of a fuss or risk finding themselves isolated.

In any case, Mr Sarkozy has notched up another victory in his quest for a more exclusive hard core of euro-zone countries: he secured Mrs Merkel’s agreement to monthly meetings of the 17. Just a few weeks ago, the talk was of two euro-zone summits a year, not 12.

Expect a stormy summit.

THE two speeches in two days by Nicolas Sarkozy and Angela Merkel reveal the many differences between them ahead of next week's European summit. I give a brief analysis in my earlier post. What follows is a more detailed exegesis (a link to Sarkozy's speech in French is here and a PDF Merkel's address in German is here):

Sarkonomics and the origin of the crisis

The French president offers a strange bit of Sarkonomics to explain that the crisis was caused by external forces – the unregulated globalisation of trade and finance – of which France is essentially a victim.

Financial globalisation established itself to compensate artificially the ravages that [trade] liberalisation without rules caused in the economies of developed countries. It was necessary so that the surplus of some could finance the deficits of others. It was necessary so that debt could compensate for the unacceptable fall in living standards of households in developed countries. It was necessary to finance a social model that was crumbling beneath deficits. It was ineluctable so that financial capital could seek elsewhere the profits that it could no longer hope to gain in developed countries. Thus was established a gigantic machine to create debt.

Mr Sarkozy says France cannot be blamed for the troubles it faces because other rich countries are in trouble too; yet he does not explain why some developed countries (Germany and several Nordic states, for example) have survived the crisis better than France despite the infernal debt machine. Later on, Mr Sarkozy says France has to cut back on state expenditure to preserve its destiny (this was tricky for him, as he had vowed three years earlier in Toulon not to conduct a policy of auterity)

Mrs Merkel, for her part, does not speak much of great uncontrollable forces unleashed by laissez-faire capitalism. Instead she emphasises the responsibility of individual states. The problem, in her view, is that countries have broken fiscal rules, and there has been nobody to enforce the limits on deficits and debt.

Early victims

There is an interesting contrast in how Mr Sarkozy and Mrs Merkel speak of the countries that have already succumbed to the markets: Greece, Ireland, Portugal, Italy and Spain. For Mr Sarkozy, their fate is a warning of what might happen if France does not act in time.

Let's take a moment to look around ourselves at the situation of other European countries that have not taken the measure of the crisis in a timely manner, that did not make the necessary efforts. They have been forced to lower salaries and pensions, and massively increase taxes.

Mr Merkel, aware of criticism that Germany is wantonly pushing vulnerable countries into recession, even depression, praises those that are undergoing the pain of adjustment:

I think we often have no idea of the contribution that people in the countries are making to ensure that the euro will be a permanent and stable currency. So I want today to express my absolute respect for these efforts. Because this is a contribution to a sustainable Europe.

She also makes a point of praising eastern European EU members outside the euro zone – the Baltic States, Romania and Bulgaria – that have also tightened their belts, sometimes brutally. Germany, moreover, does not seek to impose its will, only to promote a "stability culture".

Rushing and waiting

Both agree the euro zone and the wider European Union face their gravest crisis. Mr Sarkozy is in a hurry, not least because France's AAA-rating is in danger. Europe, he says, could be “swept away” unless it acts.

There is urgency. The world will not wait for Europe. If Europe does not change fast enough, History will be written without Her.

Mrs Merkel, though, is in no rush.

There is no possibility for a quick fix. There is not one last shot, as some say before every summit. This is not my language nor my thinking. There are no easy and fast decisions.The debt crisis is a process. It will take years.

Even senior Americans officials come away from Berlin perplexed by the way Germany seems oddly unperturbed by a crisis that is alarming the rest of the world. Perhaps Germany feels less exposed to the crisis. Or perhaps it thinks that only by dangling countries over the abyss will they understand the need to reform. In any case, Germany is reluctant to risk more of its taxpayers' money.

Discipline or solidarity?

Both Mr Sarkozy and Mrs Merkel speak of a crisis of confidence” in the markets. But they mean very different things by this phrase.

For Mrs Merkel, markets have lost confidence that the rules of the Stability and Growth Pact (which limits deficits to 3% of GDP and total debt to 60% of GDP) will be kept. Now there must be legally-enforcable rules – including legal debt brakes in each country and intrusive monitoring at the European leavel - with real sanctions for breaches.

This crisis is a chance to make a turn for the better, to repent. The lesson are quite simple: rules must be adhered to; compliance must be monitored and non-complicance should have consequences. National responsibility and European solidarity are mutually dependent.

Mrs Merkel does not speak much of “solidarity”, except to say that it must go hand in hand with discipline. She specifically rules out joint Eurobonds, of the kind being examined by the European Commission. These would breach the German constitution.

However her officials are now signalling that they may be willing to consider a partial, and probably temporary, mutualisation of debt. The best-know scheme, promoted by the Bruegel think-tank, would see joint Eurobonds issued for good debt (blue bonds) under 60% of GDP. Anything above that (red bonds) would be issued nationally and would incur higher yields. But Germany is floating the idea, inspired by a panel of wise men, of mutualising the bad debt above 60% of GDP to try to restore some order.

For Mr Sarkozy, the crisis of confidence is driven by the worries in the markets about the prospect of a succession of defaults or debt-restructurings, and the doubts about the survival of the euro. The answer is, first and foremost, cast-iron solidarity. He does not say Eurobonds, but he hints at them strongly. And he wants to stop all talk of imposing losses on private bond-holders – a prospect that many in Germany want to maintain so that markets can impose discipline on governments. The French president says:

If we want the euro to survive, we don't have any choice: we must establish solidarity without weakness against all those who doubt the viability of the euro and speculate on its break-up. It must be absolutely clear that all the countries of the euro zone will be in solidarity with each other. It must be clear that what was done for Greece, in a very particular context, will not happen again, that no state in the euro zone will be pushed into default. It must be absolutely clear that in future no saver will lose a cent in the reimbursement of a loan granted to a country of the euro zone [ie, a bond-holder]

Like Mrs Merkel, Mr Sarkozy says solidarity must go hand in hand with discipline. On this, at least, there is some agreement.

Let us examine our budgets together. Let us more rapid, automatic and severe sanctions on those that do not respect their commitments.

The EU and its treaties

All this, say both leaders, requires the treaties to be changed. For Mrs Merkel, this is a matter of completing the economic and monetary union, and establishing a “fiscal union” (though she does not define the term). For Mr Sarkozy, “Europe must be re-thought; it must be refounded”.

So far so good. But Mrs Merkel and Mr Sarkozy disagree deeply on the nature of a reformed union. Who, for intance, should be responsible for monitoring budgets and economic policies, and imposing sanctions?

Mrs Merkel is clear: independent institutions, free from political interference, are essential for credibility. Preserving the independence of, for example, the courts and the ECB, is “for the highest good of our democracy”. On the question of budgetary rules and sanctions, she says:

There must be no political leeway when it comes to determining whether the limits are violated or not. There must be real automaticity.

Mr Sarkozy sees it completely differently: the decisions must be taken by leaders. Political involvement is the essence of democratic legitimacy, in his view. This passage is telling, even though Mr Sarkozy begins by casting the argument in terms of his opposition to economic liberalism.

Europe without politics, Europe on automatic pilot that blindly applies rules of competition and free trade, is a Europe that cannot confront crises...A more democratic Europe is one where responsible politicians decide. The foundation of Europe is not the march towards more supranationalism...The crisis has pushed heads of state and government to assume growing responsibilities because, in the end, only they have the democratic legitimacy to be able to decide. Thus European integration will pass through intergovernmentalism because Europe must make strategic choices, political choices.

Intergovernmentalism may well ensure that decisions have greater legitimacy, but it also has drawbacks. National vetoes make it much harder to reach decisions and implement them, as seen throughout the debt crisis. Mr Sarkozy tries to address this by suggesting that decisions be taken by “qualified” majority (ie, a weighted majority).

There are other problems. Leaders that need each other to make political deals have too often turned a blind eye to each others' flaws, as happened with Greece. Without institutions to guard the common interest, smaller countries tend to feel bullied by bigger states: just see the growing rancour over the involvement of Merkozy in unseating George Papandreou and Silvio Berlusconi, the leaders of Greece and Italy respectively.

Europe at 17 or 27?

Mr Sarkozy has recently spoken bluntly about the need to create a core eurozone more or less separate from the ten non-euro states, including Britain (see my last post here). In his Toulon speech Mr Sarkozy toned down his latent separatism, though he still speaks of a “euro-zone government” and is filled with rancour about “social and fiscal dumping” and “disloyal competition" within the EU (ie, by low-tax Ireland and low-cost eastern European members).

Mr Merkel, by contrast, has been careful to sound inclusive. Under presure from Mr Sarkozy, she has agreed to hold more summits of the 17 member-states. But when it comes to reforming the treaties, her stated preference is to do it with all 27 members of the EU “to avoid splits within euro members and non-euro states”. She knows that treaty change at 27 is the best way – perhaps the only way - to ensure that the European Commission and the ECJ are involved.

Whether it is feasible will depend, in large part, on the price that Britain seeks to extract for its agreement to changing the EU's treaty. Though he did not express a preference, a separate new treaty at 17 is probably Mr Sarkozy's preference. This would help create a harder, more exclusive core; ensure that it it becomes as intergovernmental as possible; and exclude the more liberal British, Scandinavians and easterners. Mrs Merkel says this would be “second-best” and, even she is forced down this route, she will seek to ensure that the euro “outs” are able to join its budget strictures and remain free to join the euro in future.

The ECB's bazooka

The independence of institutions is essential for Germany, and none is more sacrosanct than the ECB. Mrs Merkel bristles at the demands, from Europe, America and elsewhere, that the ECB use its big bazooka and take decisive action to stop investors' run on sovereign debt. But the ECB's statutes prevent it from lending directly to euro-zone members. Instead, it has provided liquidity to banks – this week the ECB and other world central banks acted to reduce the cost of obtaining dollars. It has also been buying government bonds intermittently, and in a limited manner, in the secondary markets to improve “the transmsision of montary policy”. Even this has caused divisions within the ECB. In America and Britain, by contrast, the central banks have no compunction about acting as the government's lender of last resort. Mrs Merkel say:

I will make no comment on what national and European courts, and the European Central Bank, should do or not do in future. It is obviously important to point out once again: the task of the European Central Bank is different from that of the Fed in the United States of America, for example, the Bank of England. This is enshrined in the treaties. The task is to ensure monetary stability.

Mr Sarkozy, for his part, pays lip service to the independence of the central bank but is less shy about telling it to act.

There are debates on what the statutes authorise it [the ECB] to do. I don't want to enter these debates. The ECB is independent and will remain so. I am sure that, faced with the risk of deflation that threatens Europe, the central bank will act. It is up to it to decide when and with what means. That is its responsibility. None must doubt that it will assume it and, moreover, I am glad it has already started to do it.

The speech that matters

Any treaty change will take time, whether it is limited to imposing more discipline or includes a path to Eurobonds in future; whether the integration is intergovernmental or relies on supranational European institutions; whether it reopens the treaties of the 27 EU members or is done through negotiation at 17 (or even fewer).

The nature of the treaty will affect the well-being of the euro zone in decades to come, so it is worth doing right by turning the euro zone into a coherent economic unit. This is something that long-term investors care about, and giving the right signals now helps.

But what panicking investors really want to know is whether the euro will survive the coming weeks and months. Tougher fiscal rules adopted within the current treaties have so far had no effect on confidence. The impact of new governments in Greece, Italy and Spain is still uncertain. The euro zone's rescue fund, known as the European Financial Stability Facility, is inadequate. No amount of financial engineering will make it big enough to save Italy and Spain (let along France) if investors dump their bonds entirely.

For the immediate future - and possibly for as long as it takes to change the treaties - only the ECB can avert a collapse by dint of its ability to print money. Nobody should expect the ECB to declare unequivocally that it stands ready to deploy its unlimited power behind all sovereigns. But it can do more.

The word in Brussels is that Mrs Merkel is ready to let the ECB act more intensely, though she could never say so. And Mario Draghi, the ECB president, could never be seen to ask for political guidance. That said, he will probably need to have confidence that, firstly, enough discipline is being restored so the ECB will not be left holding junk bonds and that, secondly, Germany's Bundesbank will hold its tongue if he prescribes a bigger dose of unorthodox medicine.

The real question is whether European leaders will give Mr Draghi enough a wink to act. Speaking in the European Parliament on December 1^st, he sent them his own wink, implying he was ready to move if leaders adopted a new "fiscal compact". His was the speech that probably matters most, so it is worth reading carefully (full version here):

Fundamental questions are being raised and they call for an answer. At the heart of these questions are not only the credibility of governments’ policies and the actual delivery of the promised reforms, but also the overall design of our common fiscal governance.

I am confident the new surveillance framework will restore confidence over time. I am also quite sure that countries overall are on the right track. But a credible signal is needed to give ultimate assurance over the short term.

What I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.

Just as we effectively have a compact that describes the essence of monetary policy – an independent central bank with a single objective of maintaining price stability – so a fiscal compact would enshrine the essence of fiscal rules and the government commitments taken so far, and ensure that the latter become fully credible, individually and collectively.

We might be asked whether a new fiscal compact would be enough to stabilise markets and how a credible longer-term vision can be helpful in the short term. Our answer is that it is definitely the most important element to start restoring credibility.

Other elements might follow, but the sequencing matters. And it is first and foremost important to get a commonly shared fiscal compact right. Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term. After all, investors are themselves often taking decisions with a long time horizon, especially with regard to government bonds.

A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration. It would also present a clear trajectory for the future evolution of the euro area, thus framing expectations.

On the precise legal process that brings about a move towards a genuine economic union, we should keep our options open. Far-reaching Treaty changes should not be discarded, but faster processes are also conceivable.

Whatever the approach, companies, markets and the citizens of Europe expect policy-makers to act decisively to resolve the crisis. It is time to adapt the euro area design with a set of institutions, rules and processes that is commensurate with the requirements of monetary union.

IT SEEMS odd, at first sight, to see the markets taking so much hope from two speeches in two days - one by France's President Nicolas Sarkozy and the other by Germany's Chancellor Angela Merkel - that revealed more differences than agreement on how to resolve the euro zone's debt crisis.

Perhaps it is the fact that both say the European Union's treaties should be changed, and any agreement on any subject is good news. Or perhaps it is the hope that, whatever they say in their opening bids, they will come up with enough of a deal at the next European summit on December 8th-9th to allow the European Central Bank to deploy its “big bazooka”.

Then again, markets have often rallied ahead of summits in the expectation of an agreement, only to be disappointed within days, or even hours, of the latest half-step being announced.

Neither Mr Sarkozy nor Mrs Merkel offered any real detail of what should be included in a revision of the treaties. But even their vague outlines reveal contrasting philosophies. I give a fuller analysis of the speeches in the next post (here). In summary:

- Mr Sarkozy places the emphasis on “solidarity” among European states (ie, joint Eurobonds, and no defaults or debt-restructuring after Greece), while Mrs Merkel gives priority to budgetary discipline and rules.

- Mr Sarkozy urges the European Central Bank to act; Mrs Merkel is jealous of guarding its independence

- Mr Sarkozy wants to create a hard core of euro-zone countries within the European Union; Mr Merkel wants to include as many non-euro states as possible 

- Mr Sarkozy wants to Europe to integrate through the action of leaders (reproducing France's presidential system, with lots of discretion for the executive); Mrs Merkel favours more independent institutions like the European Commission and the European Court of Justice (more akin to Germany's federal structure, which retricts politicians' leeway)

These differences should come as little surprise. It has been ever thus in the EU. The Franco-German motor is not made for harmonious co-operation, but rather to manage and contain the many disagreements between Paris and Berlin.

Still, something has changed recently. In the past year, Mrs Merkel and Mr Sarkozy (“Merkozy”, as they are known) have tried to resolve their differences behind closed doors, and then issued a joint declaration setting out their position ahead of European gatherings.

This happened at the Franco-German summit in Deauville in October last year, when they agreed that private creditors should share the pain of rescuing collapsed economies. A year later, the two leaders claimed to have found “total accord” when it was patently untrue: they soon had to postpone the EU summit in October, and then held a second one days later, in order to overcome their differences over a second Greek package and how to boost the euro zone's rescue fund.

So now, just a week before a key summit of European leaders, Merkozy chose to set out their stalls separately, before meeting at a Franco-German summit on December 5^th, that may find some kind of compromise.

Mr Sarkozy's appearance was, in effect, a campaign speech, with many barbs aimed at the opposition Socialist party as well as exhortations to fellow Europeans. He spoke at a party rally in Toulon, where in 2008 he had vowed to reform capitalism. Now he says it is time to reform the European Union. Mrs Merkel, by contrast, gave a matter-of-fact speech in the Bundestag to outline her negotiating position at the forthcoming summit.

In a sense, neither of these speeches really matters. Any new treaty, even a limited one, will take month to negotiate and, probably, years to ratify. What is important, in the short term, is whether European leaders come up a sufficiently credible promise to reform, and rein in those who break budgetary rules, to allow the European Central Bank to use its “big bazooka” more freely without fear of moral hazard.

Earlier this week, the ECB president, Mario Draghi, hinted that he might be willing to do so, if euro-zone countries reached a new "fiscal compact". He did not define it, and did not say treaty change was needed. Another hopeful sign is that Germany, while rejecting permanent Eurobonds, is now floating a proposal to mutualise, probably temporarily, all excesive debt above 60% of GDP.

This is not quite joint Eurobonds, but may set a precedent for them. In any case, for the first time Germany may be saying ja to something after months of nein. That would be something to cheer.

Read more: One problem, two visions (part II)

You cannot make a single currency without economic convergence and economic integration. It's impossible. But on the contrary, one cannot plead for federalism and at the same time for the enlargement of Europe. It's impossible. There's a contradiction. We are 27. We will obviously have to open up to the Balkans. We will be 32, 33 or 34. I imagine that nobody thinks that federalism—total integration—is possible at 33, 34, 35 countries.

So what one we do? To begin with, frankly, the single currency is a wonderful idea, but it was strange to create it without asking oneself the question of its governance, and without asking oneself about economic convergence. Honestly, it's nice to have a vision, but there are details that are missing: we made a currency, but we kept fiscal systems and economic systems that not only were not converging, but were diverging. And not only did we make a single currency without convergence, but we tried to undo the rules of the pact. It cannot work.

There will not be a single currency without greater economic integration and convergence. That is certain. And that is where we are going. Must one have the same rules for the 27? No. Absolutely not [...] In the end, clearly, there will be two European gears: one gear towards more integration in the euro zone and a gear that is more confederal in the European Union.

At first blush this is statement of the blindingly obvious. The euro zone must integrate to save itself; even the British say so. And among the ten non-euro states of the EU there are countries such as Britain and Denmark that have no intention of joining the single currency.

The European Union is, in a sense, made up not of two but of multiple speeds. Think only of the 25 members of the Schengen passport-free travel zone (excluding Britain but including some non-EU members), or of the 25 states seeking to create a common patent (including Britain, but excluding Italy and Spain).

But Mr Sarkozy’s comments are more worrying because, one suspects, he wants to create an exclusivist, protectionist euro zone that seeks to detach itself from the rest of the European Union. Elsewhere in the debate in Strasbourg, for instance, Mr Sarkozy seems to suggest that Europe’s troubles—debt and high unemployment—are all the fault of social, environmental and monetary “dumping” by developing countries that pursue “aggressive” trade policies.

For another insight into Mr Sarkozy’s thinking about Europe, one should listen to an interview he gave a few days earlier, at the end of the marathon-summitry in Brussels at the end of October (video here, starting at about 54:30):

I don't think there is enough economic integration in the euro zone, the 17, and too much integration in the European Union at 27.

In other words, France, or Mr Sarkozy at any rate, does not appear to have got over its resentment of the EU’s enlargement. At 27 nations-strong, the European Union is too big for France to lord it over the rest and is too liberal in economic terms for France’s protectionist leanings. Hence Mr Sarkozy’s yearning for a smaller, cosier, “federalist” euro zone.

This chimes with the idea of a Kerneuropa ("core Europe") promoted in 1994 by Karl Lamers and Wolfgang Schäuble, who happens to be Germany's current finance minister. Intriguingly, it is the first time that Mr Sarkozy, once something of a sceptic of European integration, has spoken publicly about “federalism”, although he had made a similar comment in private to European leaders in March (see my column). It echoes the views of Mr Sarkozy's Socialist predecessor, François Mitterrand.

Such ideas appeared to have been killed off by the large eastward enlargement of the EU in 2004, and by the French voters’ rejection of the EU's new constitution in 2005. But the euro zone’s debt crisis is reviving these old dreams.

But what sort of federalism? Mr Sarkozy probably wants to create a euro zone in France’s image, with power (and much discretion) concentrated in the hands of leaders, where the “Merkozy” duo (Angela Merkel and Nicolas Sarkozy) will dominate. Germany will no doubt want a replica of its own federal system, with strong rules and powerful independent institutions to constrain politicians. Le Monde carries a series of articles (in French) on what a two-speed Europe may mean.

If the euro zone survives the crisis—and the meltdown of Italy’s bonds in the markets suggests that is becoming ever more difficult—it will plainly require deep reform of the EU’s treaties. Done properly, by keeping the euro open to countries that want to join (like Poland) and deepening the single market for those that do not (like Britain), the creation of a more flexible EU of variable geometry could ease many of the existing tensions. Further enlargement need no longer be so neuralgic; further integration need no longer be imposed on those who do not want it.

But done wrongly, as one fears Mr Sarkozy would have it, this will be a recipe for breaking up Europe. Not two-speed Europe but two separate Europes.

The first steps toward integration, the idea of holding regular summits of leaders of the 17 euro-zone countries, has already caused early friction with Britain (see my earlier post here). This week there were further cracks when, during a meeting of the euro zone’s finance ministers in Brussels, their colleagues from the ten non-euro states held their own separate dinner in a hotel nearby.

All this is alarming the European Commission, the EU’s civil service and the guardian of its treaties. Speaking in Berlin on November 9th, its president, José Manuel Barroso, delivered what amounted to a direct rebuke to Mr Sarkozy.

The Commission welcomes, and urges—in fact we have been asking for a long time—a deeper integration of policies and governance within the euro area. Such integration and convergence is the only way to enhance discipline and stability and to secure the future sustainability of the euro. In other words, we have to finish the unfinished business of Maastricht—to complete the monetary union with a truly economic union.

But stability and discipline must also go together with growth. And the single market is our greatest asset to foster growth.

Let me be clear—a split union will not work. This is true for a union with different parts engaged in contradictory objectives; a union with an integrated core but a disengaged periphery; a union dominated by an unhealthy balance of power or indeed any kind of directorium. All these are unsustainable and will not work in the long term because they will put in question a fundamental, I would say a sacred, principle—the principle of justice, the principle of the respect of equality, the principle of the respect of the rule of law. And we are a union based on the respect of the rule of law and not on any power or forces.

It would be absurd if the very core of our project—and economic and monetary union as embodied in the euro area is the core of our project—so I say it would be absurd if this core were treated as a kind of "opt out" from the European Union as a whole.

Mr Sarkozy’s words seem to have caught the attention of Joschka Fischer, elder statesman of Germany's Green party and a former foreign minister, who said that the EU at 27 had become too unwieldy. “Let’s just forget about the EU with 27 members—unfortunately,” he told Die Zeit, a German weekly newspaper. “I just don’t see how these 27 states will ever come up with any meaningful reforms.” Indeed, some think the euro zone itself might be smaller than the 17 members (Greece may soon default and leave the euro).

The speech that everybody is waiting for now is Mrs Merkel’s. The chancellor wants to change the treaties, and on November 9th she called for “a breakthrough to a new Europe”. But what sort of Europe that should be was left mostly unsaid.

"THE IMF will never be big enough to save the euro zone.” That is how one IMF official dismissed the idea that the fund would help put up a firewall to protect the euro zone. It could help, obviously, but in the end salvation was for the euro zone to figure out for itself.

With Greece potentially facing a default and exit from the euro in the coming weeks, euro-zone countries have been working to build up their rescue fund, known as the European Financial Stability Facility, though financial engineering that might expand it to about €1 trillion. But without the full power of the European Central Bank, which is not allowed to lend to states, this is not enough to save a country like Italy, should it collapse in the bond markets (see my previous post)

So the Europeans had been hoping to winkle out some more tens of billions of euros from, or through, the IMF. Three options were under discussion:

• Increase contributions to the IMF, particularly from the bigger emerging countries, such as China. Europe might then be able to draw on a larger pool of funds.
•  Get the IMF to generate more of its reserve asset known as Special Drawing Rights, a sort of virtual gold, that Europeans could pool, turn into real currency and pump into the EFSF
• Ask the IMF to establish and supervise a trust fund for the euro zone, into which countries could contribute.

These matters remained contentious until the end of the summit. José Manuel Barroso and Herman Van Rompuy, presidents of the European Commission (the EU’s civil service) and European Council (representing leaders) rashly came out before the end of the meeting to declare that one or all of these measures would almost certainly be approved.

But next door, Angela Merkel, the German chancellor, had stopped pretending. There was no deal on the IMF, she said, and hardly any country was prepared to put money to boost the euro-zone's bailout fund. The final communique made only a generic promise to provide the IMF with more resources, in a manner to be discussed by finance ministers in February. The key passage said:

We will ensure the IMF continues to have resources to play its systemic role to the benefit of its whole membership, building on the substantial resources we have already mobilized since London in 2009. We stand ready to ensure additional resources could be mobilised in a timely manner and ask our finance ministers by their next meeting to work on deploying a range of various options including bilateral contributions to the IMF, SDRs, and voluntary contributions to an IMF special structure such as an administered account.

Christine Lagarde, the IMF boss who has argued for a bigger coffer to confront economic turbulence, claimed to see this as a victory: “I go away from Cannes with an unlimited [commitment] - no cap, no floor, no ceiling on resources. The members are saying we will do whatever it takes in terms of resources so that the IMF is fully equipped in case of crisis."

But in the view of Sony Kapoor, managing director of Re-Define, an economic think-tank in Brussels, "The EU's failure to get tangible commitments from the IMF or indeed any of the emerging economies reinforces the fact that the ECB and only the ECB can act to resolve the Euro crisis."

Barack Obama, who had joined European leaders in discussion on how best to strengthen the fund, expressed confidence that "Europe has the capacity to meet this challenge". He urged Europeans to do more to "send a signal to the markets that they stand behind the euro". But he also commiserated with European leaders for the sheer complexity of the problem they were grappling with, quipping quipped that, over the past two days, he had had a "crash course" in European politics.

Now, let's recognize how difficult this is.  I have sympathy for my European counterparts.  We saw how difficult it was for us to save the financial system back in the United States.  It did not do wonders for anybody's political standing, because people's general attitude is: 'You know what? If the financial sector is behaving recklessly or not making good decisions, other folks shouldn't have to suffer for it.'

You layer on top of that the fact that you're negotiating with multiple parliaments, a European parliament, a European Commission -- I mean, there are just a lot of institutions here in Europe [...] There are a lot of meetings here in Europe as well.  So trying to coordinate all those different interests is laborious, it's time consuming, but I think they're going to get there.

Expect lots more of those laborious, time-consuming meetings.

Though yields on its bonds have soared alarmingly, Italy has not had to seek a bail-out (not yet anyway). And in an attempt to ensure it does not succumb, bringing down the euro with it, it has been placed under a special preventive regime—placed on probation to ensure it implements the many promises it made to carry out reforms designed to promote growth and balance the budget by 2013.

The polite fiction is that Italy has "invited" this monitoring, but nobody makes any secret of the fact that the government of Silvio Berlusconi has a problem with “credibility”. Nicolas Sarkozy, the French president, says Italy’s case is “completely different” to that of Greece, which has galvanised the attention of the G20 summit, given the prospect that it may soon default on its debt (see my recent post here and my last column here)

By the same token, Italy’s position is now markedly worse than that of Spain, which until this summer had been seen as the country most likely to succumb after Greece, Ireland and Portugal. But Spain's outlook is now less dire as a result of a succession of reforms, and the decision by the prime minister, José Luis Rodríguez Zapatero, to step down at the next election later this month.

So Mr Berlusconi, in the dying days of his government, has been put in remedial class—a humiliation for the third-biggest economy in the euro zone, and a founding member of the European Union. “He is fully aware of the seriousness of the situation. And if he wasn’t, he is aware of it now,” says one senior EU source.

Little more than a fortnight ago, such treatment would have been unthinkable. Officials in Brussels recount how Mr Van Rompuy had sent Mr Berlusconi an early draft of the last European summit’s conclusions, making passing reference to “specific commitments made by Italy and Spain”.

Mr Berlusconi telephoned him, saying being singled out in such a manner was “a scandal”. Italy’s fiscal position, with a primary budget surplus (before interest) and low private debt, was healthier than that of most other euro-zone members, insisted Mr Berlusconi. Italy’s high debt was the product of the past, accumulated by previous Christian Democrat and Socialist governments for which he could not be held accountable. “I have always wanted to carry out reforms,” Mr Berlusconi told Mr Van Rompuy. To which the European Council president replied: “Silvio, it's time to make your dreams come true.”

At the first of two pairs of European summits last month, Mr Berlusconi was summoned by Angela Merkel, Germany’s chancellor, and Nicolas Sarkozy, the French president, to be told to come up with a credible reform plan within three days (see my column here), in time for the second round of summits on October 26th.

Euro-zone leaders welcomed Italy's promises but, as with cold-war nuclear pacts, decided to “trust but verify”. The summit declared:

We invite the Commission to provide a detailed assessment of the measures and to monitor their implementation, and the Italian authorities to provide in a timely way all the information necessary for such an assessment.

A week later, the IMF was also “invited” to join the monitoring process. As well as humbling Mr Berlusconi, the decision was also a sign of mistrust in the ability of the commission to act with sufficient rigour.

Mr Berlusconi shrugged it all off as nothing more that an audit, of the sort that a company might seek from an accountancy firm. Some audit. Christine Lagarde, the IMF's boss, said she would be reporting quarterly, in public documents, on Italy’s progress. This is what she had to say:

We will be checking the implementation of the commitments that have been made by Italy under the 15-page commitment that it has made to the members of the euro zone a couple of weeks ago. So it’s verification and certification, if you will, and implementation of a programme that Italy has committed to. As far as I’m concerned, I might be laborious I might be demanding, I might be rigorous but I will be looking at the commitments that have been made to confirm the implementation.

The problem that is at stake, and that is what was clearly identified both by the Italian authorities and by its partners, is a lack of credibility of the measures that are announced. Therefore, to attest the credibility of those measures, in other words their implementation, the typical instrument that we would use is a precautionary credit line. Italy does not need the funding that is associated with such instruments. The next best instrument is fiscal monitoring.

The question of precautionary credit lines led to a strange little incident that highlights Mr Berlusconi’s problem with credibility. The Italian prime minister claimed that the IMF had offered him such a line of credit. But Ms Lagarde said no such offer was made. Who to believe? Most will take Mrs Lagarde’s word over Mr Berlusconi’s.

(Photo credit: AFP)

The Frankfurt Group, or GdF for short, is the latest addition to the proliferation of international political groups, the G7, G8 and the G20, among many. Consisting of the leaders of Germany, France, the Eurogroup of finance ministers, the European Central Bank, the European Commission and the International Monetary Fund, the F-team has quickly established itself as the cluster managing the euro’s crisis. It has no legal structure or secretariat, but it is now the core within Europe’s core.

It was born by unhappy coincidence at Frankfurt’s old opera house on October 19th, on the occasion of a farewell party for Jean-Claude Trichet, the former president of the European Central Bank (ECB). This was meant to be a grand sending-off, with a farewell concert, drinks reception and laudatory speeches from Europe’s political elite. Angela Merkel, the German chancellor, was among those in the front row.

But soon the atmosphere soured. Wheeled on to the stage, Helmut Schmidt, the former West German chancellor, indignantly told the audience that the failure of the current generation of politicians was a far greater threat to the future of Europe “than the indebtedness of individual states.” Then came news that Nicolas Sarkozy, the French president, would fly in even as his wife was in hospital, about to give birth to their daughter, Giulia.

While the orchestra conducted by Claudio Abbado struck up its performance of Mozart, the leaders gathered in a backroom of the opera house to prepare for the upcoming European summit on October 23rd that was meant to resolve the crisis once and for all. But the debate soon turned rancorous. Mrs Merkel rejected Mr Sarkozy’s push to boost the euro zone’s bail-out fund by allowing it to borrow money from the ECB. Mr Trichet was, if anything, even more vehemently opposed to the idea. By treaty, the ECB is forbidden from lending money to governments. The ECB president, it is said, abandoned his customary English for his native French, the better to argue with Mr Sarkozy.

The incoming ECB president, Mario Draghi, quickly returned to the main event to listen to the concert. Two hours later, Mrs Merkel slipped out of a side door. Mr Sarkozy stormed out the front, with key aides running to keep up with him. “I was surprised by the depth of disagreement," said one participant.

Plainly the summit would be unable to reach a deal. But instead of cancelling it, euro-zone leaders decided instead to call a second one three days later. Each summit, moreover, was split into two gatherings: one for the EU’s 27 leaders, followed by a smaller meeting of the 17 euro-zone members. If only multiplying the power of the EFSF were as easy as multiplying meetings—and political acronyms.

But somehow, around 4am on October 27th, European leaders finally announced a “comprehensive set of additional measures reflecting our strong determination to do whatever is required to overcome the present difficulties”.

The deal, however, was full of holes that must now be filled quickly, given the political chaos in Greece (see my earlier post and column) and the prospect that it might default in the coming weeks.

The Frankfurt Group is steering the effort to complete the new firewall “at an accelerated pace”. It is not as unwieldy as the 17-strong Eurogroup of finance minister, but more legitimate the duumvirate of Germany and France. Sometimes the F-team summons others for a dressing down, as happened with the Greek prime minister, George Papndreou, on November 2^nd. Sometimes outsiders are invited to assist, such as the American president, Barack Obama, who joined discussions the following evening. That stamp of approval will ensure that GdF is here to stay.

One can almost hear the scraping of shovels as European leaders rushed to fill the sandbags in the hope of surviving the impending explosion in Greece, perhaps followed by Italy (see earlier post).

What they need is bags and bags of money to strengthen the existing rescue fund, the European Financial Stability Facility (EFSF). But there is no more cash to be had, so it must be conjured up through financial engineering.

European leaders claimed at their last summit that the EFSF would be expanded to €1 trillion, but this never seemed adequate, while legal and political problems are hampering progress. “There are some creative solutions,” is all one person close to the discussions would say, expressing doubt that it could be concluded by the end of November. This is uncomfortably close to the mid-December moment when Greece runs out of money and, unless it receives more money, must default.

One source of extra money might be the IMF, which helps to explain why Barack Obama joined European leaders for crisis talks last night. The fund can only lend to states, rather than buy bonds on the markets, as the revamped EFSF is intended to do.

But perhaps, say European leaders, richer emerging economies could contribute more money to the IMF. Another option, likely to be approved, is for the IMF to make available new lines of credit for well-managed countries suffering from “exogenous shocks”, though it is unclear whether this would apply to Italy. More esoterically, the IMF could, through its ability to produce liquidity known as Special Drawing Rights, make more resources indirectly available for European states to pump into the EFSF.

One thing the IMF can certainly do is to monitoring countries’ finances. It already works with the European Commission and the European Central Bank (ECB) in bailing out Greece, Ireland and Portugal, and in assessing their reforms. The last troika report (here and here) on Greece, much gloomier than previous ones, seems to be partly the result of IMF demands for a more “realistic” appraisal of Greece’s prospects.

Even though Italy is not being formally bailed out, senior sources say it is likely that the IMF will be brought in to help monitor its implementation of a raft of promises to promote growth and bring down its vast debt.

But without the firepower of the ECB, nobody really believes any of these measures can really withstand the blast if Italy blows up after Greece. The one bit of good news was the first move by Mario Draghi, the newly-installed ECB president to cut interest rates. Even amid the gloom over Greece, markets rallied. But nobody should stop digging for cash.

Forget the financial-transaction tax. Forget the regulation of commodity prices. Forget the call to ensure that the world’s poorest do not suffer twice, once because of their wretchedness and twice because rich-world aid budgets are cut. These things and more will be mentioned in the final communiqué. The most burning issue is the fate of the euro.

Just days after European leaders unveiled their latest "comprehensive solution" to the euro's woes, the Greek prime minister, George Papandreou, threw everything back into chaos by announcing this week that he would hold a referendum to approve the deal. As one senior source put it: "You don't call a referendum on austerity and expect people to vote for cuts."

Depending on the bewildering politics of Greece, the plebiscite may or may not take place. Mr Papandreou faces a vote of confidence tonight (November 4th) that he may well lose.

But for the first time, European leaders have been forced to confront directly and publicly the possibility of an explosion that they promised could never happen: a chaotic default by Greece and its departure from the euro. And next to the barrel of gunpowder labelled “Greece”, there is a whole dump of high explosive called “Italy”. Indeed, Silvio Berlusconi, the Italian prime minister, is causing almost as much concern as his Greek counterpart.

For other G20 leaders, the euro's crisis poses the biggest threat to the stability of the global economy. One senior European official recounts how he was told by a fellow participant: “Even in the smallest village in Australia they are discussing the Greek referendum”.

European leaders met and met again; after dinner on November 3^rd, they were even joined by the American president, Barack Obama. Yet none is really in control of events. With one eye they studied ways of building greater protection against the impending blast; with another they watched the television screens to follow the gyrations of Greek politics.

Mr Papandreou was at first reported to have dropped the idea of the referendum, but then spent much of a rambling speech to parliament justifying it. Leaks from a cabinet meeting suggested he would resign, but then the prime minister claimed victory for his negotiation strategy and urged parliament to give him a vote of confidence.

On Wednesday night in Cannes, where he was summed to explain himself, Mr Papandreou said the referendum's question would be whether Greece should be in or out of the euro. The next day in Athens he said this was never the intention; the question should be about the terms of the proposed second bail-out of Greece.

Others Greek politicians seemed no more consistent.  Earlier in the week the finance minister, Evangelos Venizelos, said he supported the plebiscite (even though he had not been informed about it). Now he told parliament he opposed it. Rumour has it that he is positioning himself to take over from Mr Papandreou.

Antonis Samaras, leader of the opposition New Democracy party, also changed his tune. He still demands the resignation of Mr Papandreou, but having long opposed EU-inspired austerity measures, he now wants the second bail-out to be approved by the current parliament. Mr Papandreou claims Mr Samaras has come to his senses because of the referendum.

All this muddling may yet provide a political opening: Mr Samaras agrees to join a government of national unity, and Mr Papandreou drops the referendum, perhaps stepping down to make way for another prime minister. But nobody can be certain of the outcome.

Rarely has Nicolas Sarkozy, the French president, sounded so grim about the prospect for “Europe” (by which he means the European Union):

We cannot accept the explosion of the euro, which would mean the explosion of Europe. The problem must be posed in this fashion, and not otherwise. If the euro is the core of Europe, the explosion of the euro would blow up Europe. And Europe is the guarantee of peace on the continent where people have behaved in the most brutal and violent manner of all continents of the world - not in the 15^th Century, but in the 20^th Century. It is perfectly normal that two founding countries of Europe [France and Germany], and the two largest European economies, should take up the front line to defend a European heritage that has been bequeathed to us by our predecessors. The crisis of the euro is one of the most important crises that Europe has known since its creation.

“I HAVE never failed to make the grade,” says Silvio Berlusconi after being summoned before headmasters of the euro zone for a beating. “I was convincing.”

But Angela Merkel of Germany and Nicolas Sarkozy of France thought differently. When asked whether Italy's prime minister had reassured them about doing his homework to draw up a plan to bring down Italy's vast debt and implement structural reforms, Mrs Merkel and Mr Sarkozy first hesitated, then looked at each other and, finally, smirked knowingly. (video clip here, in French)

“How to put it?” started Mr Sarkozy, “We have confidence in the sense of responsibility of all of Italy's political, financial and economic authorities.” Mrs Merkel chipped in: “It was a meeting among friends.”

It was anything but friendly. Rarely has a member of the euro zone—and a founding member of the European integration project, no less—been chastised so publicly. But in many ways, the euro-zone debt crisis is now all about Italy.

In discussions all weekend, including at two European summits, leaders worked on drawing up a package deal to save the euro that should be concluded in another round of summits on Wednesday.

All three of the main issues—the fate of Greece, the “firewall" to prevent contagion and the recapitalisation of Europe' banks—revolved in some ways around Italy: if Greece's debt is restructured, will the markets then turn on Italy, the next most-indebted state in the euro zone? If so, is the new firewall big enough to protect Italy? And does the plan to strengthen banks with fresh capital, so that they can withstand the loss of value of their bond holdings, not place an unfair burden on Italy, whose banks hold vast amounts of depreciated Italian debt?

Earlier this summer, when Italian bonds started to collapse, the European Central Bank (ECB) had quietly told Mr Berlusconi to push through reforms in exchange for the ECB' intervention to buy Italian bonds, so holding down Italy's borrowing costs. But once the most acute market pressure was relieved, Mr Berlusconi began to backtrack on his austerity measures, to the fury of Germany.

At the summit, Mr Berlusconi was told bluntly to go away and come back in three days' time with a credible plan to reform his country. “There is no question of appealing for solidarity from partners if those whom we assist do not themselves make the efforts necessary” declared Mr Sarkozy.

Herman Van Rompuy, president of the European Council (who presided over the summits), later repeated the point, saying “certain countries” had to make “commitments” about future reform. Or else, what? asked journalists. “They WILL make commitments,” replied Mr Van Rompuy, curtly.

The Italian prime minister, through, is unrepentant. Like every practiced school miscreant, he has an excuse for everything.

No structural reforms? His partners in the Northern League prevented a reform of pensions. Now he would urge the league's boss, Umberto Bossi, to abide by proposals to have a uniform retirement age of 67 across the euro zone.

Was Mr Sarkozy not furious with Italy? Well, the French president's attitude to Italy was coloured by his understandable annoyance about the allocation of seats at the ECB. Having supported an Italian, Mario Draghi, to succeed Jean-Claude Trichet as the bank's president, France had demanded that the Italian member of the ECB's six-man executive board, Lorenzo Bini-Smaghi, should step down early to make way for a Frenchman. But Mr Bini-Smaghi had declined to listen to pleas to avoid a casus belli between Italy and France, despite the offer of prestigious jobs back home (though not the job he wanted, ie, to become governor of the Bank of Italy).

“Sarkozy was annoyed,” admitted Mr Berlusconi. “There has been a clash on this question of Bini-Smaghi, for which I bear no responsibility. At a certain point I told him [Sarkozy]: 'What can I do? Shall I kill him? I don't think so.'”

Mr Berlusconi is always great with the one-liners. But his buffoonery is wearing thin on the rest of the euro zone.

IN A decade’s time, perhaps, the twin European summits on October 23^rd may come to be seen as the moment when the 17 countries of the euro zone started to break away from the 10 non-euro states.

It is always hard to define the precise moment when an big and complex process has started. But today would be a good candidate. This is not just because the summit of the 27 members of the European Union is being followed by a separate meeting of the 17. This has happened before, after all.

But the long and bad-tempered lunch that separated the two summits in Brussels - with France's Nicolas Sarkozy and Britaoin's David Cameron as the main protagonists of the acrimony, even though they have just won a war in Libya - indicates that both the euro's “ins” and its “outs” are aware that their relationship is changing in a fundamental way.

I explore several of the issues of a two-speed, two belief Europe in my column this week (Wake up, euro zone). Several factors combine to bring all this to a head.

1. The markets are testing to destruction the ambiguity of a monetary union with disparate national fiscal and economic policies. In aggregate terms the EU’s deficit and debt rations are in better shape than, say, those of the United States. But the EU is not a federal state, and the markets sense that the euro zone is reluctant to stand fully behind its weakest members.

2. Nicolas Sarkozy has secured Germany’s support to hold regular meetings of euro-zone leaders. They will be presided over by Herman Van Rompuy, president of the European Council (who chairs summits at 27),  but the euro-zone leaders reserved the right to choose someone else where Mr Van Rompuy’s term expires. Even if integration goes no further, the habit of the 17 working together will be felt across the EU.

3. Angela Merkel, the German chancellor, is pushing hard for re-opening the EU’s treaties. The EU has already done this once to create a permanent bail-out system (it has not yet been ratified). Now it wants to do so again to impose greater fiscal and economic discipline on states that use the euro. The euro zone has adopted several new tools to monitor and co-ordinate economic policies. But having bailed out three peripheral states, and with the prospect of big economies like Italy collapsing, Germany and the other creditor states want even stronger treaty-based powers – for example the ability of taking a profligate state to the European Court of Justice.

4. David Cameron faces an increasingly emotive domestic debate on Europe. He is resisting demands from eurosceptics for a referendum on Britain’s membership of the European Union. But the prospect of opening the treaties makes it harder to ignore pressure to seize the moment to redraw Britain’s relationship with the EU or, indeed, to withdraw from the union altogether. Having encouraged the euro zone to integrate to save itself, Britain is now looking for “safeguards” to ensure it does not stray too far.

All these issues mean that European leaders spent the best part of two hours over lunch debating the interplay between the 17 and the 27. Should the ins meet first, followed by the outs? Or should it be the other way around?

On Wednesday 26^th, when the euro zone holds the second session of its two-part summit, the EU’s 27 leaders will make a point of gathering beforehand. The meeting will last just an hour, and will sign off on the plan to recapitalise Europe’s banks. But because the financial sector is part of the single market, which is an issue for all EU states, and Mr Cameron wanted to make sure that the 27 were seen to take the decision, not the 17.

For now, Mr Cameron does not appear to have a very strong hand. Most of the other euro-outs are committed, legally and politically, eventually to joining the single currency. Mr Sarkozy’s harsh words to Mr Cameron were strikingly spiteful: “We are sick of you criticising us and telling us what to do. You say that you hate the euro and now you want to interfere in our meetings.”

British officials shrug off Mr Sarkozy’s legendary rudeness as a personality flaw. “He never pursues it. He is not interested in texts,” says one diplomat.

This is not quite true. In the final conclusions, Britain was unable to secure strong language to safeguard the interests of non-euro states. Britain had proposed a reference to the need to develop “concrete and effective mechanisms to ensure that the integrity of the internal market at 27 is fully preserved and that the interests, including essential economic interests, of the non participating member states is fully protected”. Instead, the task of safeguarding the interests of the outs was left to the European Commission, the EU's civil service

Despite the resistance of most European leaders, Mrs Merkel secured a specific commitment to “exploring the possibility of limited treaty changes”, to be discussed in December following a report by Mr Van Rompuy.

Later on, Mr Van Rompuy explained:

It is normal that those who share a common currency must take some common decisions relating to that currency. In fact, one of the origins of the current crisis is that almost everybody has underestimated the extent to which the economies of the eurozone are linked; and we are now remediating that. However, it is vitally important to safeguard the integrity of the single market among the 27. It gives the union cohesion and is the very basis of our prosperity. So we must keep the links between the two types of decision-making as close as possible, in a spirit of trust. And that's why we decided today that the 27 leaders will also meet before Wednesday's follow-up euro summit.

Mr Cameron said the last treaty revision, to create the permanent European Stability Mechanism, had allowed Britain to extricate itself from contributing to the bail-out of Greece and others.

Those countries in the eurozone that see the need for greater integration recognise that it may be necessary to have treaty change as well as other measures to integrate their economies. Treaty change in the future may well present a good opportunity for Britain. The last treaty change which was to create the European Stability Mechanism gave us in Britain the opportunity to get out of the bailout funds for the eurozone. So we exacted a good price for that treaty change [...] We shouldn’t get ahead of ourselves, the idea of the possibility of treaty change has to go back to the European Council, then you have to have a convention, then you’ve got to consult the European parliament, then, then, then… This process can take years.

Turning to his backbenchers, he said a referendum would be a distraction – not just from the need to deal with the crisis, but from the opportunity to exploit a chance to renegotiate Britain’s status.

I don’t think this is the right time to legislate for an in/out referendum. This is the right time to sort out the eurozone’s problems, defend your national interest and look to the opportunities there may be in the future to repatriate powers back to Britain. Obviously the idea of some limited treaty change in the future might give us that opportunity….We must not get overexcited about this but any treaty change in the future does give you the opportunity to advance your interests which of course I would want to do.

Amid the self-congratulatory verbiage about how the euro zone had taken “unprecedented steps to combat the effects of the worldwide financial crisis”, the document was silent on all the most important elements of the much-promised “comprehensive solution” to the euro's debt crisis: how to strengthen monitoring of Greece's derailing adjustment programme; how much of a haircut to impose on private holders of Greek debt; how to boost the power of the bail-out fund to protect Spain and Italy; and how to recapitalise Europe's most fragile banks.

These voids were due to be filled in a weekend marathon of meetings in Brussels. Finance ministers would gather on October 21st and 22nd. Then the leaders would hold twin summits on October 23rd, first of all the European Union's 27 members, followed by a gathering of the 17 leaders of the euro zone. At the end of it all there would be, as Nicolas Sarkozy and Angela Merkel promised in Berlin a fortnight earlier, a “global package” that would prove to the world that the euro zone could deal with its problems.

“You should know that France and Germany have perfectly common positions on all the issues,” Mr Sarkozy had declared at the time, comically refusing to give any detail of what that the accord consisted of. (Transcript here, in French)

The disagreement between the French president and the German chancellor became ever more apparent as the days went by. Mrs Merkel started to play down the prospect of a comprehensive resolution of the crisis, saying there would be no magic wand. A rushed visit by Mr Sarkozy to Frankfurt to meet Mrs Merkel and other key figures, apparently leaving his wife, Carla Bruni, to give birth to their baby daughter on her own, does not seem to have unblocked the positions.

On October 20th, the climate of discord seemed to grip even the troika of technical experts assessing the Greek programme. Reports emerged of disagreement between the IMF and the European Commission over their estimates of Greece's ability to bring down its debt; the IMF thinks the commission is being too optimistic. A draft of the troika's report (PDF is here) spoke of the country's debt dynamics being “extremely worrying”. But the key section in the report setting out the figures was left blank.

Reports started circulating of the Franco-German disagreement being so bad that the summit might have to be delayed. This was quickly denied. But asked whether there might have to be an additional summit next week, a senior EU official said vaguely: “Is there life after death?”

Yes there is, at least when it comes to euro-zone summits. As the summit of October 23rd gives up the ghost, another one is already being born. A statement (Word file is here), from the Elysée Palace said the French and German leaders were determined to draw up “a global and ambitious solution” to the crisis. After a “deep examination” of the issues on the 23rd, the statement said, there would be a new summit to be held by October 26th, at the latest.

The charitable view of the mess is that Mrs Merkel needs time to consult the Bundestag on changes to the bail-out fund. Moreover, given the poor state of Greece's reform programme, more time is needed to negotiate with Greece's private sector a greater reduction of its debt than agreed in July. The cynical view is that there is a perfect disagreement between Paris and Berlin. Details of the latest state of play are summed up here. In short, the summit to resolve the crisis is, itself, in crisis.

^{Correction: This blog post briefly, and mistakenly, referred to "London" rather than "Berlin" in the last paragraph.}

NICOLAS Sarkozy attended two births today. The first, in Paris, concluded happily when his wife, Carla Bruni, brought into the world a baby girl. She is the French president's fourth child, and the second for his spouse. The infant's name has not been confirmed.

Mr Sarkozy then flew to Frankfurt to attend another parturition. The mother is called Europa, nicknamed euro. And we already know the name of her bundle: Comprehensive Solution. It is the third such offspring this year, and the latest labour promises to be the hardest. There is every sign that the babe, if it is not still-born, will be a disappointing runt.

While baby Sarkozy's arrival happened discreetly, there were lots of relatives on hand to wait for Comprehensive Solution. Europa's labour coincided with the retirement ceremony of a favourite uncle, Jean-Claude Trichet, who does something in banking and offered a few cautionary words about necessity being the mother of procreation. Given the risky birth, everybody left the party in silence. But the relatives will gather again in Brussels tomorrow, and the day after tomorrow and the day after that for a great family Council.

The godmother, Angela Merkel, has already told the world to expect a sickly, cursed child: “All of the sins of omission and commission of the past cannot be undone by waving a magic wand.... This is going to be a long and arduous road.”

The birth of Comprehensive Solution involves a delicate operation to remove a putrid boil in Europa's nether regions. The condition is called “Greek debt” and the euphemism for the medical procedure to excise it is “applying a haircut”. It is more like amputation. And not even the financial doctors know if it will stop the infection, or cause it to spread throughout Europa's body.

It was only a few days ago that Nicolas and Angela had promised the world the birth of a Saviour, who would protect Europa from the wild bond-raiders come from the forests.

But the more the experts have studied foetus, the more it seemed to be not quite right. It was supposed to develop two strong legs, with €2 trillion worth of muscle, to hold up Europa. But now it looks like it will have no more than €1 trillion, ie, one leg.

And Comprehensive Solution was supposed to have two strong hands (to hold the purses of Europa's bankers). These were reckoned to weigh in at €200 billion. But further inspection puts them at less than €100 billion, ie, barely one hand. Having indulged in fiscal promiscuousness well into adulthood, old Europa lacks the strength to bring forth a healthy child.

Nicolas still hopes for a miracle. He is back in Paris with Carla and the baby girl. But he knows his family's fate depends on the survival of Comprehensive Solution.

Come the family Council in Brussels on Sunday, everybody will sing the praises of Comprehensive Solution. But word of its horrible condition is spreading through the souks, where traders see it as a bad omen. And through the gloom of the forest, one can already catch the glint of the bond-raiders sharpening their swords.

But just days before the EU’s summit on October 23^rd , the permanent representatives of the EU’s 27 member-states in Brussels are devoting an almost obscene amount of time to their old pastime: theological disputes over the balance of power within the EU.

The latest version of this game is the question of how and by whom the European Union is represented in international bodies: what are the roles and prerogatives of EU bodies and national governments in all manner of international discussions.

Welcome to the parallel universe of planet Brussels.

So far 85 joint statements have been blocked at the United Nations, the Organisation for Security and Co-operation in Europe and the Council of Europe. The myriad subjects range from nuclear disarmament to the rights of the child, the rights of indigenous people, financial reform of the UN, the status of the Roma, economic development in Africa, resistance of germs to antimicrobial drugs and much more besides.

At issue is a disagreement over who should speak on a particular subject – the member-states, the European External Action Service (EEAS, the EU’s newish “foreign ministry”) or the European Commission (the EU’s civil service)? And on whose behalf should they claim to speak – the member states collectively, the EU as a whole, or just as a particular body, eg, the Commission?

These matters were supposed to have been settled in the 2009 Lisbon treaty, which created the EEAS. But there are many grey areas of shared competence. These are being contested by the Commission on the one hand, and by the British on the other. The problem dates back to the Lisbon treaty, but has become acute since May, when Britain’s Foreign Office publicly gave warning that it would resist any attempt by EU bodies to encroach on British rights in foreign policy. More often than not in the long discussions at COREPER, the committee of permanent representatives, the British have been outnumbered 26:1.

Pierre Vimont, one of the most senior EEAS officials, has expressed his frustration at such pedantry. As he told the annual dinner earlier this month for the Friends of Europe, a Brussels-based think-tank, the burning issue has been whether “we should pronounce statements on behalf of’ ‘the EU’, or ‘the EU and its member-states’."

Old hands in the EU will note that, in a system where power only ever seems to flow towards Brussels, the frontier between national and shared competence will inevitably be guarded vigilantly. Britain's Tories, in particular, never liked the idea of giving the EU an enhanced role in foreign policy; most others would dearly like the EU to speak with greater authority, so want to see it taking more of the stage. As one (non-British) national envoy notes despairingly: “Other countries laugh at us. They can’t believe the Europeans have gone back to institutional bickering.”

All this should act as a warning for the current discussions on reforming euro-zone governance. France would like to create new inter-governmental institutions to run the euro zone. Germany wants to re-open the treaties to give Brussels more authority over national budgets. But as the foreign policy dispute shows, any change to the balance of power is bound to be challenged, could cause paralysis - and may worsen the problem you are trying to solve.

Later today (Thursday) Britain's foreign secretary, William Hague, will take questions from the public via Twitter on the London conference on cyberspace that he is organising for next month. As a journalist, I cannot help but feel that this a bit of a stunt: communicating in 140 remotely typed characters, the questioner has little chance of putting a politician on the spot. Still, I suppose one should not criticise ministers for trying to communicate with the public.

The subject is serious, however. More and more people and devices are being hooked up to the internet. One debate concerns the future governance of the internet: should it be directed by governments, or should it be left to the private sector to develop inventively (and somewhat anarchically)? The Economist recently ran an account of the debate (here) and expressed its view in a leader (here). To judge from Mr Hague's tweets, he agrees with us.

Inevitably, given the pervasiveness of information technology, cyberspace is also becoming a question of security. After land, sea, air and space, cyberspace is now the fifth dimension of warfare. Could a country launch a crippling attack from cyberspace, say to knock out the electricity grid of a rival state, or snarl up the logistical chain of its armed forces? The answer is: maybe.

For those that want to get up to speed, a good place to start is my Economist cover story on cyberwar last year (here), and the accompanying leader (here).

In America, especially, cyberspace is rising up the scale of national-security threats. Britain, too, is tooling up for defence (and offence) in and through cyberspace. In the rest of Europe the debate perhaps centres more on questions of data privacy. On all sides of the Atlantic, however, cybercrime is endemic.

A Google News search for “cyber attack” throws up recent news of a threat by hackers to knock out the New York Stock Exchange on October 10^th, a report on a new centre to defend America's critical infrastructure, speculation about the cause of the failure of Bank of America's online banking service, and demands by Congress for America to respond firmly to “predatory” cyberespionage by China.

Ahead of the London conference, the Ditchley Foundation in Britain gathered senior officials, industry experts and NGOs at its Oxfordshire retreat to discuss how best to balance the benefits of an open internet with the need for action to protect the electronic commons. I was asked to sum up the debate. These were my thoughts, tidied up and edited where necessary for clarity and discretion:

THE words of one senior participant still resonate: "It's so big it does my head in." At every turn this weekend, we have run into the problem of definitions: what is it that we are dealing with? It is not because cyberspace it is distant or foreign, but because it is all around us and we are part of it.

As with the Supreme Being, we can only talk about it in metaphors. Some have invoked the language of nuclear deterrence, others of biological weapons, others have spoken of crime, others of public health. Some talk of the Law of the Sea. One breakout group reports: "We are in a swamp where we need to make polders."

Some of the questions that came up:

- Is this millennial change, or perhaps just decennial?

- We don't know how big the problem is

- We don't know what to protect

- The discussion on critical infrastructure is a bit like a Monty Python scene: "So, apart from e-mail, Skype, Facebook, iPads, iPhones, drains, water, electricity and air-traffic control, what has cyberspace ever done for us?" We don't know what is critical, and what is critically critical. What depends on cyber (eg, the financial sector). And how does cyber depend on non-cyber (eg, the grid)?

- We cannot count the cost of cybersecurity. We cannot insure against losses. And we cannot sue for negligence

Everybody here seemed to quote their children. So are we the right people to be discussing this? What is cyberspace? “It's stuff,” says one participant, quoting his kids

Why is it so hard to understand?....

Because this stuff is all mashed up.

The interconnectedness of cyberspace breaks down borders and distinctions around which societies and states are organised.

It mashes up people and geography. It has created the global village, but it has the anonymity of the megalopolis. Everybody is anonymous. There are no cops. And we like to keep it that way. The internet merges friend and foe, business and criminality, the City of London with the spammers of Lviv and the scammers of Lagos. The enemy is not on the other side of the world, but maybe just behind this screen.

We have spoken of freedom of the seas. But this sea is infested with pirates, with no territorial waters, no system to identify ships, and no coast guard. The sea is in front of every door. Put Venice off the coast of Somalia, and you start to get the idea.

Cyber mashes up functions. Things that used to take lots of people can be done by far fewer. I thought of Michael Caine's movie “The Italian Job”: the gang of robbers needs the mafia to give them the plans, they have to blow up the power transformer in Turin, break in to a computer centre to switch the reel tape so that they can scramble the traffic lights, make the heist and escape with a fleet of Minis driving through the back yards of houses. Today all this can be done from the comfort of your living room.

Cyber mashes up the trivial and the critical. My kids on Facebook, my local hospital and military command-and-control are all going over the same network. It mashes up the numbers. Billions of people and billions of devices are being hooked up. That means you can have 7 billion victims, or maybe 7 billion attackers.

It mashes up weapons. With physical violence you can more or less distinguish between threats and who should deal with them: you might try to deal with a drunken fist yourself, rely on police to deal with with gun in the hand of a robber and call on the army to take out a howitzer. In cyberspace any computer can be any of these kinds of weapons. The distinction may be just a few keystrokes, even a few nanoseconds.

Finally, the internet mashes up state and private: a lot of this stuff is increasingly critical to the state, but it is made and operated almost entirely by the private sector, to maximise convenience and profit. Security may be incidental. The private sector may be the first target of attack, and its infrastructure may be the launch-point of attack.

The experts say any computer or network connected to the internet can be penetrated, given time, effort and resources. So why are the lights still on, the wi-fi still working? Maybe it's harder to mount this kind of attack than we think. The hacker can break in, but you need intelligence systems to reconnoiter and engineering knowledge to understand how to modify a system. So maybe those that can do it do not want to, and those that want to have not yet thought of it. Maybe for the jihadist cyberattack lacks the gore of suicide bombing.

So who should do what to improve security? First of all we need more facts. We need to map our infrastructure and understand the single points of failure. We need better measures of how much data is being lost, from both industry and government. But this creates more headaches: how do we share info on attacks? One participant said: “Officially there has been no data loss in France, because the legislation requiring disclosure is only just being put in place.” Another participant says governments can only disclose so much, for fear of giving away targeting information to enemies.

We can distinguish a spectrum of actions that we recognise from the non-cyber world, ranging from nuisance, to crime, fraud, espionage and acts of war. But a world organised in nation-states is ill equipped to deal with most of these problems in cyberspace.

One participant spoke of the invention of the motorcar leading to the creation of the FBI in America to investigate crimes across state lines. We are not going to create a global FBI.

By definition we need international co-operation. But given the difficulty that we at Ditchley are having even in defining the problems, treaties are going to be very difficult. So we should start with something small and build out. I see it as a quilt, a patchwork: treaties on specific aspects, but then norms, co-operation among the like-minded such as the proliferation security initiative, co-operation within industry and with government, codes of conduct, exhortation to best practice, even Facebook groups on cybersecurity. The role of NGOs, think-tank and private experts in sensitising governments, without it seeming a form of electronic imperialism, is important.

The discussion becomes easier when we discuss specific examples. So we need to break up the problems into their components, and then try to address each part of the problem. Another useful segmentation is to think of the physical integrity of the internet as separate from what is carried on it.

The integrity of the internet strikes me as something everybody might be able to agree upon. Could we get a treaty on this? It might ban a generalised attack on the internet, and commit states to prompt co-operation in the repair of natural or man-made damage. We have banned all manner of weapons because of the perceived horror; we have accepted the free navigation in space and agreed not to shoot down each others' satellites. Agreement on the integrity of cyberspace would be a useful step forward, not least in planting the idea that this is a global commons.

As with terrorism, where the world has not agreed a general definition, can we agree to outlaw certain forms of behaviour? For example, could countries agree to co-operate in stopping Distributed Denial of Service (DDOS) attacks [NB: these seek to bring down computers by flooding them with bogus requests for information], regardless of who the victim might be or the cause? This might raise the price of using such tactics.

Then it seems to me you can have more co-operation on crime: get countries to sing up to existing conventions. Child protection was mentioned as a good starting point.

Whatever the threat, it seems to me that the private sector will be involved in almost all responses. One working group made the point that “knowledge implies more responsibility”.

We have said we want to preserve innovation and the gains of brought by cyberpace. I agree. Government-directed IT doesn't work. Remember the disappearance of France's Minitel network.

But can we have minimum standards of security? Perhaps governments and service-providers could impose some standards of internet hygiene by tracking infected computers, pulling down bots and so on. Can we do more on spam?

Some have spoken of the need for an public-health campaign in cyberspace. So does the government need to get involved with inoculation campaigns, as in real life, to ensure herd immunity? Or can we draw lessons from car-safety standards, where a vehicle is not allowed on the road unless it is certified as roadworthy?

On fraud and espionage, especially, we probably need minimum standards of security for the private sector. Where and how are sensitive data kept? How do you incentivise the private sector to take security seriously? How do you calculate value?

Also, can we incentivise software companies to write better code? Can I sue somebody for the dodgy BIOS on my laptop? Is there a minimum standard against which software could be certified? Should there be a software and hardware MOT?

Planning and exercises are even more important as we go up the scale closer to war. If parts of the internet go down in a crisis, for example, can government ration bandwidth?

It is tempting to look at the lessons of arms control, but there are some big differences with cyberweapons.

Detection problems: the weapon is skills rather than technology or systems. They are hard to spot, and hard to count.

Maybe we are in the realm of deterrence. But this too is different from the nuclear sort.

Strategic balance: is cyberwar destabilising the nuclear equilibrium? Does it give you a first-strike option?

Speed. How does one take decisions in nanoseconds? Pre-authorisation? Automation of war?

We also have to think of the NATO alliance. Here, as elsewhere, there is an asymmetry in capabilities: does it matter that only a few countries are competent in cybersecurity? Perhaps a weakness in one country does not make much of difference in terms of collective cybersecurity. But can an ally in NATO be intimidated, blackmailed and neutralised politically because he is less defended in cyberspace?

In any case, it is hard to translate rules and practices of war. Two examples:

- Is private industry ready to be the warfighter?

- How do you put red crosses on hospitals and orphanages? Do we have to put them on separate networks, ie, create a "dot.humanitarian" domain?

Here we start to move into polders. Should we create "dot.secure" areas? People are willing to give up a lot of privacy in social networking. It seems to me that they would be wiling to do it for security. People could give up anonymity to do banking, but maybe not for online dating sites.

Then there is the cloud. We have to think of what is in the cloud. And we have to think: where is the cloud? Is it in my sovereign space? Can I get at my critical data in a crisis?

Plainly, there are great opportunities by hooking up to the internet. But there are also great vulnerabilities. So do we have to think of what needs to be unplugged; are there things that should never have an IP address?

Germany and France want somebody else to start paying. And who better to punish than the reckless bankers and speculators who, in their view, caused the trouble in the first place?

The idea of imposing a financial transaction tax (FTT) has been around since the start of the crisis, indeed for several decades since it was mooted by the late Nobel laureate, James Tobin. But has faced a seemingly insurmountable problem: in a globalised connected financial world, a financial tax has to be global if markets are not simply to shift their operations to where they will not be taxed.

As Timothy Geithner, America’s Treasury Secretary, repeated to European finance ministers in a less-than-cordial encounter (see previous posting) in the Polish city of Wroclaw this week, the United States opposes the FTT on the grounds that it would raise the cost of capital and weaken the already-fragile economic recovery.

Undeterred, Germany and France last week called for the tax to be imposed by the European Union alone (see joint letter from the German and French finance ministers here). The European Commission is also supporting the idea, and will unveil proposals in the coming weeks. Michel Barnier, commissioner for the single market, said his proposals would be “technically simple, economically bearable by the financial sector, financially productive and politically just”. He gave no figures for how much money could be raised. 

Supporters of a more localised FTT would argue that this is an opportunity for Europe to show the way in taking action that is both moral and remunerative. As with emissions-trading to curb climate change, others will follow. Indeed, European officials are already arguing over who should take the proceeds of an FTT: national exchequers, the European Union or a special-purpose European fund to deal with future banking collapses?

Even so, the idea is running into the firm objections of, among others, Britain. Jacek Rostowski, the Polish finance minister who holds the rotating presidency, said the EU was “very, very divided” on the issue when it was discussed in Wroclaw. In any case, he said, “nobody expects this element to be crucial in our attempt to stabilise the situation, both fiscally and financially.” In other words, the FTT is not worth the trouble it would cause.

Thus the idea that gathered strength yesterday: a financial transaction tax within the 17 countries of euro zone. “I’m sure that if it’s impossible at the worldwide level, we’ll need to organise that in the European Union, or at least in the euro zone.” To reduce the risk of avoidance, he said, an FTT in the euro zone would have to be imposed at a lower rate than a global tax. In an interview, his German counterpart, Wolfgang Schäuble, supported the idea.

One might question whether an FTT in an ever-smaller geographical area makes sense, particularly given that it excludes London, Europe’s main financial centre. The pony-tailed Swedish finance minister, Anders Borg had some words of caution:

We have substantial experience in Sweden. Basically most of our derivative and bond trading went to London during the years we had a financial transaction tax. So if you don’t get a solution that is universal it is very likely to be detrimental for European financial markets. And from the Swedish perspective, we cannot foresee that we would introduce such a tax in our system again.

The idea of an FTT at 17 raises another intriguing question: might it become the first fracture in the EU from the move to integrate the euro zone to confront its debt crisis? An FTT is no longer a question of monitoring budgets and maintaining fiscal discipline, but a move to integrate taxation, which in turn influences the EU’s single market.

Britain may consider a FTT at anything other than the global level to be self-defeating. But what of a common base for corporate tax in the euro zone? Even if British tax rates are lower, a simplified and uniform system for calculating and paying corporate tax in the much of the European market may prove attractive to some companies.

Such issues worry British officials. But for now the greater alarm is over a collapse of the euro, so the British have become among the loudest cheerleaders for euro-zone integration. “Time is running out,” said George Osbone, Britain’s Chancellor of the Exchequer. “They have got to get a grip and deliver a solution to the uncertainty in the markets.”

If the ordinary citizen has to pay tax on a daily financial transaction, like buying a toothbrush, there can be little moral argument against taxing financial transactions. But at a time of crisis, the question is an FTT might actually worsen the crisis. Might a euro-area FTT not weaken the euro area’s banks? After all, the IMF is urging governments urgently to recapitalise their banks - not to draw money out off them - to halt the spread of contagion from their exposure to the sovereign debt of vulnerable European countries. Two French banks were downgraded this week due to their exposure to Greek debt

It would not be the first time that Germany and others, in taking aim at the bankers, shoot themselves in the foot. The demand that the financial sector pay for a share of the second bail-out of Greece (which has not yet been approved) caused delay, destabilised the markets and had to be buttressed by offers of government cash to protect the European Central Bank and Greek institutions. It raised comparatively little money. If the euro zone believed the creditors should take the hit, it should have allowed a proper restructuring of Greece’s unsustainable debt. Instead it came up with a fudge that did more harm than good.

The resentment of bankers, and the desire to protect the taxpayer is understandable. But the grudging and erratic response of the euro zone’s governments has been as much part of the problem as of the solution. The citizen will be placed at ever greater risk unless the crisis is tamed quickly. To do that, two destabilising feedback loops have to be broken. The first is between collapsing banks and collapsing treasuries; the other is between panicking markets and hesitating governments. An EU or euro-area FTT helps with neither. For now, it is a distraction - and could make things worse.

THERE has been much talk of late that the euro’s debt crisis would force its 17 members into greater fiscal integration, perhaps even towards the United States of Europe (see my column here and here) But its finance ministers are certainly not going to take advice from the United States of America, in the form of Timothy Geithner, the Treasury Secretary, on how to go about pulling themselves together and taming the “catastrophic risks” facing the euro zone

The difference between European pretension and American reality was apparent on the tarmac of Wroclaw airport: the man in charge of the public finances of the dollar zone came in a big jet; those running the treasuries of the euro zone turned up in countless smaller planes. The euro currency may be unified currency, but its budgets and treasuries are national. Every European minister wants to limit his of her nation’s liability for propping up the euro. So the beast is being confronted with a European shotgun with multiple pellets, not a big American bazooka.

Mr Geithner made two appearances before the ministers to tell Europeans to start thinking and acting big: once before those of the 17 members of the euro zone, and then later, more emphatically, before the larger gather of ministers from the 27 members of the European Union. In short, his advice was that Europeans had to act more like America: the more solvent needed to co-ordinate fiscal stimulus. And their rescue fund, known as the European Financial Stability Facility (EFSF) needed to increase its firepower by being able to borrow, so it could defend even a big country like Italy.

One model Mr Geithner suggested is the Term Asset-Backed Securities Loan (TALF) programme that he created in 2008, when still president of the New York Federal Reserve, to re-liquefy frozen credit markets for households and small businesses. Another model, to turn the EFSF into a bank, was proposed by CEPS, a think-tank in Brussels. Both rely on allowing the EFSF to seek financing from the European Central Bank.

Mr Geithner spoke behind closed doors but, officials say, his comments were fairly similar to the ones he made semi-publicly at a meeting of officials and bankers at a separate conference in Wroclaw. “Of course your financial challenges in Europe are within your capacity to manage financially, you just have to choose to do it,” he declared.

For Mr Geithner, the euro zone’s crisis is not just a matter of financial stability, but of geopolitics. “One of the starkest ways to emphasize the importance of Europe getting on top of this is that you don't want the future of Europe to rest in the hands of those who provide financing to the IMF.”

Governments and central banks, he said, “have to take out the catastrophic risk from markets, they have to definitively remove the threat of…cascading defaults [and avoid] loose talk about dismantling the institutions of the euro.”

His exhortations may not be that different from his comments during a meeting of G7 finance ministers in Marseille last week. But this time in Wroclaw he was guest, not a participant. He was allowed to join the hallowed Eurogroup, which excludes even the current holder of the rotating presidency of European Union's finance ministers, Poland’s Jacek Rostowski, because his country does not use the euro.

Jean-Claude Juncker, Luxembroug’s prime minister who presides over the Eurogroup, declaring sniffily: “We are not discussing the increase or expansion of the EFSF with a non-member of the euro area.” Didier Reynders, the finance minister in Belgium’s year-old caretaker government, haughtily demanded to know what the US intended to do about its debt and deficit, which is worse than the euro zone’s aggregate numbers.

The Austrian finance minister, Maria Fekter, was even more dismissive about “this Mr Geithner”. By her account, the German finance minister, Wolfgang Schäuble, had told the American visitor that taxpayers in AAA-rated European countries would not accept the commitment of much more money to salvage weaker euro members, which is why Germany and others were pressing for a tax on financial transactions – something that Mr Geithner rejects. She went on:

I found it peculiar that even though the Americans have significantly worse fundamental data than the euro zone that they tell us what we should do and when we make a suggestion ... that they say no straight away. I would have expected that if he explains the world to us, he'd listen to what we have to say to the Americans.

Ms Fekter has a reputation for blunt talking, but one of those present say she did not utter such words to Mr Geithner’s face. Instead, my source tells me, she spoke in the hall only after the Treasury Secretary had gone.

From the German camp, the word is that Mr Schäuble objects to increasing the EFSF through public guarantees, but he is not opposed in principle of leveraging the EFSF; the resistance to that idea comes mainly from the European Central Bank.

One small ray of hope is that the ministers agreed to a compromise with the European Parliament on new rules to monitor the deficits, debt and economic imbalances of euro-area members. This might help prevent a future debt crisis, but will do little to resolve the current one, except by showing that the euro zone can, eventually, take action.

But such meagre confidence will be obliterated by any hint of a transatlantic spat. It was Mr Juncker, after all, who had spoken of the need for “a concerted effort at a global level”. More comically, he declared that Europeans had to show more “verbal discipline” and avoid their usual cacophony. “I insisted with my colleagues to be as disciplined as possible when expressing our views.” Nobody listened to him. Remember: Loose Lips Sink Ships

One reason is that the politicians cannot keep up with the markets. The euro zone has yet to implement the decisions of July’s summit, but the next shock wave has already struck. Another is that the performance of Greece under the EU-IMF programme has been so poor that every quarterly assessment to approve the next tranche of loans becomes a cliff-hanger.

So each episode of market panic is worse than the previous one, the weapons in hand look inadequate, contagion spreads, while governments and institutions lose their nerve.

The proposed increase in the firepower of the main bail-out fund, the EFSF, will not be enough to protect Italy should it go under, as it has threatened to do in recent weeks. As one German official put it to me: "Italy will have to deal with its problems on its own." The ructions at the European Central Bank exposed by the resignation of its German chief economist, Jürgen Stark, raises concern about how much longer the ECB can keep buying up the bonds of vulnerable euro-zone states. The German constitutional court has not blocked the temporary bail-out system, but appears to have all but killed off the idea for now of issuing joint Eurobonds, the one idea that might have arrested the crisis in the short term (though lots of people think they might make the long-term problems worse).

German politicians now talk openly of cutting off Greece’s lifeline and letting it fall out of the euro, causing another seizure in the markets, where French banks have now come into the firing line.

Greece's departure from the euro, if it happens, will be painful for both Greece and the rest of the euro zone, as Jean Pisani-Ferry, director of the Bruegel think-tank, points out. And there is the question nobody can answer: will Greece's exit remove the source of contagion, or ensure it spreads? Until now, nobody has dared test the proposition.

It is not impossible that the euro zone will be able to muddle along a bit longer: Greece may have done just enough in its latest plan to cut spending and raise revenues to receive the next tranche; the German parliament may be coaxed into approving the July decisions; the revamped EFSF may then be able to take up the bond-buying task from the ECB and a problem may be found to the problem of Finland’s demand for collateral. Then what?

The situation is so dire that any bit of bad news would easily cause another collapse in the markets. So at the same time as Germany is talking of giving up on Greece, it is also talking about redesigning the euro zone. Done right, a new European architecture may ensure that such a crisis does not recur.

But as Barry Eichengreen points out, the problem is now, not tomorrow. It will take years to renegotiate and ratify new treaties, even assuming there is no blockage of the sort that beset the Constitutional Treaty. But the euro zone faces critical days and weeks.

This contradictory effect is apparent from our charts showing the direction of yields on sovereign bonds, which move inversely to the price.

The “spread” over 10-year German bunds is the standard measure of perceived risk. It is the premium, or additional interest, that markets demand for holding the debt of a euro-zone country compared with the bonds isued by Germany, deemed the safest.

Until last month's summit, the worry was focused on whether Greece would be able to repay its debts, and whether its sickness would infect bigger countries. Leaders of the euro area decided greatly to extend maturities on Greece's rescue loans and to cut the interest rate it pays. Ireland and Portugal got the same prescription.

In addition, Greece got a bit of local surgery, in the form of a slight “voluntary” haircut on private creditors. Many think wholesale amputation is what is really needed to save Greece. But for now the aspirin and antibiotics have brought down the fever somewhat, as is apparent in the left-hand chart, Ireland and Portugal are faring better too.

By contrast, the spreads of Italy and Spain (right-hand chart), already sickly, have continued to rise, reaching the highest level since the adoption of the euro. Why is the cure not working? One reason is that these two countries have not asked for, and have not been given, the medicine of emergency loans, so they are still struggling on their own. Another is that the measures promised to contain the spread of the disease – giving the euro area's main bail-out fund, the European Financial Stability Facility (EFSF) greater powers to intervene early in a crisis (see my earlier posting here) – have yet to be approved by national parliaments, which are on holiday. Finally, even if the EFSF's drugs are made available, there are not enough supplies in stock to deal with an economy as large and indebted as that of Italy. It may not even be enough for Spain.

The lending power of the EFSF is being increased to its full headline figure of €440 billion. But many think it needs to be bigger still – five times larger, says one leading financial analyst (see here). The bigger the crisis, it seems, the bigger the dose of cash required. But the question is this: as more countries fall ill and are unable to support the EFSF, who will be left to bail out the euro zone? Already questions are being asked about the creditworthiness of France, the AAA-rated country with the highest debt ratio in the EU.

The measures taken by the euro zone might have had a chance of working had they been adopted six, or even three months ago. But now the infection has got out, and it is fast developing resistance to the standard drugs.

To help you keep track of the state of the epidemic, we hope regularly to update these charts. Watch this space, and our dedicated page on the euro-zone crisis. Readers might also want to keep tabs on our debate on the future of the euro, which is just ending.