A dog eat dog world

This placard seems to capture how a lot of Portuguese are today feeling about their economic future - Socrates is the poodle in Merkel's arms. (hat-tip FTD)

How much longer can the eurozone live an alternate reality?

This week's fun and games are over, with EU leaders concluding their Brussels summit earlier this afternoon.

Once again, this summit is unlikely to be remembered for anything EU leaders could agree on but, rather, for what eurozone leaders, in particular, were unwilling to even discuss. Namely, getting to the root of sorting out the eurozone's short-to-medium-term future.

As the BBC's Paul Mason asks on his blog:

Why, within the space of 12 days, do we get a "grand bargain" to create a Euro Stability Mechanism (11 March), which is then (a) knocked back by Finland (b) defied by Portugal (c) renegotiated at the behest of Germany's FDP coalition partner so they can do a tax giveaway in the coming elections; and (d) excludes Ireland anyway?

Chancellor Angela Merkel's, and by extension Germany's, focus on what are, in the grand scheme of things, minor details is starting to betray a worrying resemblance to an obsessive-compulsive's inability to recognise the bigger and far more important realities in life. Merkel's two 'victories' from this summit appear to be the fact that Germany will now pay in its share of capital to the permanent post-2013 eurozone bailout fund over five years rather than four and an EU commitment to "stress test" nuclear power stations. These are both pretty obvious bones thrown to the domestic German audience - the SPD and Greens are breathing down the neck of Merkel's CDU party in important regional elections - but will do little to reassure people that the eurozone is serious about tackling its problems. Not for the first time, domestic politics is pitted against eurozone imperatives.

True, the proposals on economic governance and tighter fiscal discipline were broadly endorsed, but earlier German proposals have been watered down and there's still much to play for in regards to how much of the package will be credibly enforceable. How will Italy and Greece cope with demands to get their debt-to-GDP below the 60% threshold?

Partly also due to Finnish resistance, eurozone leaders were unable to reach agreement on how to top up the existing temporary bailout fund, which, with Portugal more or less in a state of political and economic crisis seems a little complacent to say the least. We're told that all will be settled at the next summit in June - but haven't we heard this before; "It will all be sorted next time, no need to worry".

Maybe Merkel and the rest of the eurozone's leaders just prefer working under pressure. June really will be cutting it fine: Portuguese elections are expected to have been held only a week or so before and the new attempt at credible stress tests for Europe's banks are due to be published.

How much longer can the eurozone live an alternate reality?

What conclusions should we draw from Germany's abstention on no-fly zone?

Last night's UN resolution authorising the creation and enforcement of a no-fly zone over Libya, and Germany's abstention in the Security Council's vote in particular, is stirring quite a debate.

Iain Dale has been quick to denounce the German abstention as "shameful" and an act of "cowardice".

The Spectator's Alex Massie has countered that:

Having doubts is not shameful and I don't see why we are supposed to think that Germany should have supported the resolution simply because Britain, France and other countries were doing so.

Perhaps I'm missing something, but if sovereignty means anything it must permit sovereign, friendly nations to disagree on matters of major international importance. (And if the Germans are bad europeans for preventing a common EU approach doesn't that just mean they're fulfilling the traditional British role? Which in turn means they must, from the eurosceptic position, be the Good Guys in this instance.)

Germany's aloofness when it comes to matters of foreign policy and military action can be extremely frustrating. Take its unwillingness to get fully involved in Afghanistan, despite providing the third largest contingent of NATO troops, as an example. The legacy of the Second World War still looms large in the German psyche and that is somewhat understandable.

But, whatever one's views about the merits of Germany's perceived pacifism, Massie makes surely the most important point: that countries should be free to make up their own minds and, if they disagree with each other, so be it.

The real problems arise when you try to force these different views through the funnel/sausage machine that is the EU in the hope of a single common position.

At last week's summit, we should remember, it was Germany that blocked EU endorsement of a no-fly zone. This, in the words of the Independent, left France and the UK "isolated" in their call for intervention. This was, of course, nonsense because, as we have seen, it was never going to be the EU that decided on the use of force. The Franco-British defence pact, agreed last year outside the auspices of the EU, was an admission - however small - on the part of France that to get things done militarily, the EU is just too slow, indecisive and unwieldy.

And it was the Frankfurter Allgemeine Zeitung that today noted "the tensions in foreign policy between France and Germany are remarkable," adding that the lack of Franco-German consensus was "paralysing the EU".

The Franco-German relationship will always be the most important in the EU (they share a border, a turbulent history and the same currency), but on more and more issues, be it defence or the future of the euro, as France and Germany get up close and personal, the more they start to grate with each other. The FAZ article started by noting that newly appointed French Foreign Minister Alain Juppe's first visit to Berlin was cancelled, albeit with the "plausible excuse" that he had to fly to the UN in New York.

Alright, it's only in one area, and hopefully it won't come to the use of force, but if France begins to see the benefits of a flexible approach to European cooperation, sometimes outside the EU, this could prove to be important in breaking down the EU's monolithic approach to many other issues.

German Parliament flexes its muscles

As we've highlighted before, a bust-up in Germany over the fate of the eurozone's bail-out schemes could be imminent, both on the EFSF and its permanent successor.

As if Merkel didn't have enough on her hands, the Bundestag yesterday approved a motion that explicitly demands that the German government bans the EFSF from buying government bonds from troubled eurozone countries. In effect, the Bundestag is asking Merkel to backtrack on last weekend's agreement between eurozone leaders which would have given the EFSF the mandate to buy bonds directly. That's a pretty big set-back for the Chancellor.

The motion isn't binding for the government, but still hugely problematic since the Bundestag needs to approve any deal to increase the scope and size of the EFSF.

The vote illustrates the growing gaps between Angela Merkel and parliamentarians belonging to all three coalition parties (CDU, CSU and the FDP). If this happend in the UK it would be labelled an outright "rebellion" against the government.

According to Märkische Allgemeine, the Bundestag gave its consent to a permanent eurozone bail-out fund, a European Stability Mechanism (ESM), which would take over from the EFSF in 2013. However, it attached a number of strings, including:

- strengthened stability and growth pact
- guarantees for the independence of the ECB
- safeguards that the ESM would only be activated in emergency cases
- a mechanism which would involve private creditors in the rescue fund (unclear how this would work)
- a restructuring procedure which would include private creditors
- a guarantee that the eurozone would not turn into a transfer union.

If you think about it, those are not small thing to ask for in the current climate. This one could be interesting.

Will this make countries keener on joining the euro?

Negotiations on the shape and form of the eurozone's permanent bailout scheme - the "European Stability Mechanism (ESM)" - are entering a crucial phase. The fund is meant to be up and running by mid-2013 and is likely to have €500bn available. Of this amount, between €80bn and €100bn will be up-front cash from member states - the rest will come in the form of guarantees.

People are naturally getting nervous about this arrangement, particularly in Germany. Sueddeutsche suggested the other day that German taxpayers will need to contribute between €18bn to €25bn to the scheme in paid up cash (in addition to the guarantees).

Chancellor Angela Merkel isn't too keen on discussing how much Germany might have to contribute in the end. "She doesn't want to talk about this now", a diplomat reportedly said.

We can see why. A direct €25bn liability on Germany's books could increase the country's borrowing costs and hamper efforts to consolidate its budget.

To avoid this, the German government is pushing only for countries without a triple A rating to contribute paid-up cash, as triple A countries - so says Merkel - are lending their good name to the cause, and that's quite enough. But this, in turn, would increase the cash contributions from weaker eurozone members. This has raised alarm bells amongst weaker euro economies as well as a range of non-eurozone members.

Reuters yesterday quoted EU sources saying that eurozone members Estonia and Slovakia as well as Latvia, Lithuania, Bulgaria and the Czech Republic have all criticised the plans. They argue that basing cash contributions to the ESM on a country's proportion of the ECB's paid-up capital is unfair. The countries have even threatened to block proposals for tougher EU-wide budget rules unless changes are made to the suggested ESM arrangement. One representative said,

"Unless there is a change to the ESM capital key we will block the agreement on the governance package once it returns from parliament and EU finance ministers have to approve it by unanimity."

Also non-euro member Sweden has objected to the proposed capital key for the ESM.

Why do these countries feel so strongly about this issue. They're not in the eurozone after all? Well, probably because they understand that, were they one day to join, they could be forced to cough up actual cash to save a Greece, Ireland or Portugal. Paid up cash is a far more serious liability than loan guarantees. Slovakia's refusal to take part in the Greek bail-out gives a hint as to why these countries aren't thrilled by the prospect of a permanent bail-out arrangement linked to the ECB's capital key and credit status. In such an arrangement, smaller economies that haven't really done anything wrong could end up with a pretty hefty bill.

On a related note, where is the UK in all of this? So far, the UK appears to have taken little interest in the structure and pay-in arrangement of the permanent bail-out mechanism. If this is because it doesn't intend to ever join the euro, that's one thing.

But if it's because Britain thinks it has no stake in making sure that the new eurozone rules are fair and make economic sense - rather than facilitating even greater meltdowns down the road (a very real risk) - then the UK government is sadly mistaken.

The euro pact and Germany: Triumph or a coming bust-up?

The Telegraph's Ambrose Evans-Pritchard describes the weekend deal at the EU summit as a "total German triumph". He paraphrases Chancellor Angela Merkel saying that "whoever wants credit must fulfil our conditions".

Regular readers of this blog will know that we rate Ambrose very highly (at a time when most other journalists, including the FT gang, couldn't spot a currency-related credit crisis from a yard's distance, he warned against what we've seen in the eurozone over the last year).

On this one, however, we think that his assessment might be a bit premature.

Perceptions matter tremendously in markets as well as in politics. And the perception in Germany is certainly not one of triumph.

Die Welt quotes a top EU diplomat describing Merkel's "pact for the euro" as an "empty shell", predicting that "in the coming weeks the spreads of troubled countries could further increase". An analysis in the newspaper notes that the pact "remains far beneath the original expectations of the German government", given the large room for manoeuvre that member states are given in its implementation. The headline in the paper reads: "Merkel's secret euro capitulation".

And Merkel might even face a fight within her own coalition about the terms and crucial details of the euro pact.

Although FDP leader and Foreign Minister Westerwelle called the deal an acceptable compromise, liberal MP Frank Schaeffler said that "the result contradicts the position of the FDP group in parliament”. Volker Wissing, finance spokesman of the liberal faction in the Bundestag stressed that an earlier agreement on this among majority parties in the Bundestag "had excluded what has now been decided at government level", as he expected "very difficult talks", which could endanger the German Parliament's approval of the deal.

"It is surely close to a transfer union," Michael Meister, deputy parliamentary leader of the Christian Democrat (CDU) party added (and it was not meant as a positive remark). CSU MP Thomas Silberhorn bluntly said that "the government has stepped over a red line that the parliamentary groups had clearly defined."

Just ahead of the summit, another top Christian Democrat politician, Bundestag Speaker Norbert Lammert, had voiced concern about the whole thing, lamenting that "many representatives still don't feel sufficiently informed".

It is not clear whether these (prominent) backbenchers will in the end vote down the agreement. Bloomberg claimed this afternoon that several backbenchers have signalled their willingness to vote for the deal when it reaches the Bundestag.

But the strong talk is a reminder of the nervousness about all of this in Germany, especially in the run-up to the key regional elections in two weeks time in Baden-Württemberg - a stronghold for Merkel's CDU where the party could now suffer defeat.

It doesn't help that outgoing Bundestag President Axel Weber has stepped up his criticism of current eurozone policies. In a hearing at a Bundestag committee this week, he will warn European governments against making any bond purchases as a means of bailing out weak Eurozone countries, saying

"the result would be that private creditors and national financial policymakers would be relieved even further of their responsibility, and taxpayers of the countries doing the financing would be burdened with further, possibly substantial risks."

Chances are that Merkel will manage to push through this deal in the short term - though the German Parliament may demand some red meat in return for giving its approval.

But, as the EU correspondent for the Frankfurter Allgemeine Zeitung, Werner Mussler, warns: “the consistent loyalty of Germans to Europe is facing a test.” And Europe's biggest tabloid Bild today carries the headline, "saving the euro gets increasingly expensive!".

Some members of the German establishment have already started questionning the very premise on which Merkel has based her bail-out concessions (saving the euro, even with the risk of more bail-outs and a move away from traditional Bundesbank policy is cheaper than refusing to pay). For example, the former boss of the German industry federation BDI, Hans-Olaf Henkel. Although a former euro enthusiast, he now argues in favour of splitting up the eurozone, writing that it has become “a transfer union, a community of redistribution in which a new competitive discipline will emerge: who can tap the others for the greatest amount."

Berlin's biggest fear is that Mr. Henkel is finding it increasingly easier to recruit more allies.

A blueprint for doing nothing?

‘Enhanced economic co-ordination in the euro area’ is the long winded title for the new watered down version of the Franco-German ‘pact for competitiveness’ - the blueprint for saving the eurozone (well...).

Following the massive hostility towards the initial proposals the pact was pawned off onto Herman Van Rompuy, the European Council president, in an attempt to find a compromise. The result is a four page document that outlines some nice ideas but, scratch the surface, and it has very little substance.

The pact focuses on: fostering competitiveness, fostering employment and enhancing the sustainability of public finances. It feels as if we've heard this before, i.e. the Lisbon Agenda (or the new Europe 2020 strategy, same difference) with a pinch of the original Stability & Growth Pact.

All admirable aims and definitely issues which need to be tackled, especially if the eurozone is to avoid a similar crisis in the near future.

In most areas the actual policy specifics (specifics being pretty much every aspect of the policy other than the general overarching aim) will be left to member states, bringing into question the actual need for this document at all. Between the new macroeconomic monitoring and the increasing acceptance in member states for the need to enhance competitiveness on the national scale, what value is this pact supposed to add in real life? The lukewarm reception it received seems to support this, and casts further doubts over the chances of an agreement which contains something new and convincing being produced at the March summits.

An interesting question is how the German Bundestag and Bundesrat will respond to a proposal which quite clearly give national government quite a bit of discretion in defining their own caps on debt levels and wage setting arrangements.

At best the new pact looks to be a set of guidelines for member states to follow and to show a unified approach. That is fair enough, but it should not be treated as more.

ECB Presidency: Now what?

Axel Weber's elevation to President of the European Central Bank was long seen as a mere formality - a natural step towards the realisation of a"German-speaking euro". So reports in today took plenty of people by surprise, including Chancellor Merkel and the markets. Apparently, the Governor of the German Bundesbank has decided to pull out of the race because, in the words of a European official quoted by the WSJ, he has "other plans". Some papers suggest that these plans could involve a top job at Deutsche Bank.

The situation is somewhat confused. According to Bundesbank sources, Weber might still want to run for ECB-President. Weber himself has said he will not make any comments until he discusses the issue with Merkel. But our guess is that Weber has thrown in the towel.

First, Weber doesn't have lots of friends in the eurozone's "periphery" countries. He's a fierce (and vocal) opponent of the ECB's purchases of junk bonds from Greece, Ireland & Co. And he's probably keen on raising interest rates to curb inflation, because, at the end of the day, this is what the ECB is there for. But such a policy would be poison for vulnerable economies in the eurozone, that are trying bounce back from the economic downturn.

Germany may also have decided that sacrificing Weber's ECB Presidency was a price worth paying in return for France's backing for the "pact for competitiveness".

So now what? Merkel is said to be lacking a "plan B". The only viable alternative would be Klaus Regling, the chairman of the European Financial Stability Facility, but he has no intention of quitting his current post.

Sarkozy would presumably be quite keen to replace Trichet with Christian Noyer, the Governor of the French Central Bank. Or maybe with IMF Director Dominique Strauss-Kahn (simultaneously neutralising a possible rival in next year's French Presidential elections). But nationality matters, and it's very unlikely that another Frenchman is appointed in place of Trichet.

Italy's Mario Draghi has therefore emerged as the strongest contender. He has been doing a decent job in protecting Italian banks from the crisis, and his international reputation as Chairman of the Financial Stability Board is up to scratch. He's also considered more diplomatic than the hawkish Weber.

However, his previous position at Goldman Sachs could prove to be an obstacle. In addition, as ECB President Draghi would also chair the European Systemic Risk Board, the new EU watchdog in charge of macro-prudential supervision. But Italy has already secured the chairmanship of the European Banking Authority (Andrea Enria). There are four new financial supervisors in the EU, and giving two of the chairman positions to Italy might prove too much, especially as the UK, Germany and France got none.

The situation remains fluid, in other words. Trichet is leaving the Eurotower in October and what's clear is that the eurozone can hardly afford a row over his successor.

Saying 'Nein' To Angie - Part II

We've already looked at the reaction from some of the European press to the Franco-German "pact for competitiveness". But what about European leaders? Well, as has been widely reported, Paris and Berlin may find it a bit more difficult than usual to get their way.

Possibly the toughest reaction came from non-euro member Poland, whose PM Donald Tusk "personally attacked" German Chancellor Angela Merkel and expressed “fundamental doubts” about her plans, according to Spiegel. Going all out, he added:

Why do you have to demonstrate a division? Are the rest of us standing in your way?

Belgian Prime Minister Yves Leterme said on his arrival at Friday's summit that he was "absolutely not in agreement" with the idea of scrapping the link between pay rises and inflation, and warned,

We will not allow our social model to be undone.

Luxembourg's Prime Minister Jean-Claude Juncker concurred,

I can't really find a reason why abolishing the indexation of wages should improve the competitiveness of my country or the euro area.

Austrian Chancellor Werner Faymann, a known supporter of German-style fiscal discipline, bluntly stated,

I don't even think it's possible that the EU sets the retirement age.

Predictably, Greece also voiced its disapproval, not quite appreciating the idea of a constitutional limit to government borrowing - the already infamous "debt brake". In an interview with Ta Nea, Greek Deputy Prime Minister Theodoros Pangalos said,

I categorically reject the thought of an EU decision to intervene in national constitutions. The idea that this would be a precondition for being a part of the German rescue plan is not attractive to me.

European Council President Herman Van Rompuy will now try to find a compromise, suitable to all eurozone leaders. An extra eurozone summit is planned, possibly for March 11, then the aim is to have a deal ready at the EU summit by the end of March.

Bonne Chance.

Saying 'Nein' To Angie

Last week's EU summit, saw the Franco-German "pact for competitiveness" - a raft of proposed rules on wages, pensions, spending and taxation to strenghten discipline in the eurozone - run into some serious opposition. Not surprising given that the plan effectively demanded that permanent, cast-iron rules, rather than votes in democratically elected national parliaments, determine key policies on spending, taxation and pensions across the eurozone.

Mariano Rajoy, leader of the Spanish opposition Partido Popular, summarised the underlying problem: “As a Spaniard, I don’t like to be told what I have to do by outsiders”.

Both the content (such as breaking the link between wages and inflation) and the process (France and Germany hammering out a deal behind closed doors with little input from anyone else) caused plenty of mutters from the other EU leaders.

The Merkel-dominated plan would lay down the new economic rules in exchange for injecting more money into the eurozone's rescue fund, but is now unlikely to be adopted in full.

Here is a round-up of what the press in the so-called 'peripheral' eurozone countries - the politically correct epithet for PIIGS - said last week about Iron Angie's ultimatim.

An article in Greek left-liberal newspaper To Ethnos argued,

The way in which decisions are being forced through in the states of the Eurozone and EU nowadays is nothing short of a coup d' état. One may or may not agree with Merkel's proposals [...] But what is absolutely unacceptable is this method of foisting these measures on the states.

In Spain, an editorial in El País criticised plans to keep salary increases below the level of inflation and argued,

The Spanish economy needs to change its growth pattern; save more and increase productivity. To achieve this, many changes are needed, and one can also discuss what Merkel proposes. But in the end, each country must choose its own formula to boost productivity.

Another Spanish daily, La Vanguardia, simply stated,

[A common] European economic policy is running. Angela Merkel is driving it.

An article in Italy's top financial newspaper Il Sole 24 Ore noted,

If all goes well, the Franco-German pact for growth and competitiveness will not make any mention of imbalance corrections for countries running excessive trade surpluses: no mention of the fact that Germany might be forced to boost its internal demand to favour growth in the rest of Europe. However, a blueprint will be provided for the gradual Germanisation of Europe [...] In other words, the European economic government always invoked by France, but all in German sauce [...] Will other eurozone countries follow? Bets are open, but if they want to stay in the euro area they will not have much choice.

In Le Figaro, Chief International Economy reporter Alexandrine Bouilhet described the Franco-German proposal as the “tree hiding the forest” , arguing,

The markets listen to it with only half an ear, not to say that they are indifferent. They are only waiting for one thing: fresh money on the table to avoid a Spanish collapse. The rest is nothing but political window-dressing made of promises that only bind those who made them…”

Chapeau!

Je T'Aime... Moi Non Plus

Lofty plans for aligning France's and Germany's economic policies are nothing new. French President Nicolas Sarkozy is particularly excited about the idea.

But what do people in both countries think of the prospect of becoming more like eachother? Today's Le Monde features a new survey carried out by French Institute IFOP on behalf of a German and a French think-tank.

It gives an answer that Sarko - and a big chunk of the EU elite - probably don't want to hear. According to the poll, only 18% of Germans think that their country should consider France its "privileged partner". On their part, only 31% of French think Germany should be considered the same.

And there's more. Only 44% of Germans agree that their country should coordinate more of its economic policies with other eurozone countries, compared to 65% of the French. Unsurprisingly, French and Germans aren't exactly on the same wavelength when it comes to the role of the ECB. 69% of Germans say that the ECB should focus its efforts on "combating inflation and price increases", while 51% of French think that it should act to "spur economic growth". That discrepancy goes to the very heart of the eurozone's problems (one-size-doesn't-fit-all).

In other words, not a good place to start for two countries which are trying to show the eurozone that greater harmonisation of economic policies is both achievable and desirable...

We can't help but to recall what French Economy Minister Christine Lagarde recently said on BBC Newsnight. When asked whether people had ever voted in favour of greater harmonisation of economic policies in the eurozone, she replied:

The European project has been around for over fifty years and it was built on the back of a situation where people were at war […] The European project is something we all believe in because we want peace to be maintained.

Eh, was that really the question?

Instead of reverting back to their default Kum-bay-ya mode when faced with economic and democratic reality, Lagarde and the others would do well in pondering these poll results. After all, reality will catch up with them sooner or later.

Merkel's last chance, to save the hard euro

Another great comment piece from Die Welt editor Dorothea Siems - under the headline "Merkel's last chance, to save the hard euro":

The German negotiating position is weak because both [German Chancellor Angela] Merkel and [German Finance Minister Wolfgang] Schäuble categorically reject every alternative to the unconditional defence of the common currency, and even brand those thinking about it as traitors of the European idea.

The Chancellor must use her chance to make it clear to her European friends that she is not ready to ask the Germans – for whom orderly state finances are an invaluable quality – to make way for a 'soft-currency union'. If the EU partners do not accept this last warning signal, then they are the ones who are not showing solidarity. The question for alternatives will then be inevitable.

Don't Touch My Eurobonds

A couple of weeks ago, Eurogroup Chairman Jean-Claude Juncker politely suggested that "in Germany, the federal and local authorities are slowly losing sight of the European common good." But after Berlin mercilessly slammed his beloved idea for a common eurozone bond, Juncker has decided to step up his rethoric another notch.

In an interview with German weekly Die Zeit, published today, he says that Germany's thinking on Eurobonds is "a bit simplistic", and argues:

They [the Germans] are rejecting an idea before studying it [...] This way of creating taboo areas in Europe and not dealing with others' ideas is a very un-European way of dealing with European matters.

A sharp reaction to Juncker's comments arrives from FAZ, the solid German conservative daily. A leader in today's paper argues:

Apparently, it is un-European to raise taboos. Is it, however, European to bend EU treaties and break the ban on bail-outs? When a Eurobond is issued [...] countries with a bad name can enjoy lower interest rates, countries with better solvency are paying the price for that. These mathematical financial facts are real, whatever else Juncker may state.

An article in Der Spiegel further unpicks Juncker's silly definition of what constitutes a good European. According to a German government official, eurobonds would increase interest by one percent for Germany - which would add an extra €480m for every €48bn the country borrowed. Luxembourg would not have that problem, since it doesn't really have to borrow.

As the government official said, "Is this what being a good European means?"

Prepare for departure

In a comment piece for Die Welt, Jörg Eigendorf has some well chosen words for Chancellor Angela Merkel.

With regards to the “What happens now?” question being thrown around the Euro countries, Eigendorf deems both the idea of an enlarged rescue package and common Euro-bonds as “madness”. He argues that Germany would then be responsible for other European countries in the eyes of the law, “thus undermining both the Maastricht Treaty and the German Federal Constitutional Court”.

Eigendorf notes that possible moves would also “collectivise responsibility for wrongdoings, and probably only postpone the bitter end and worsen the final fiscal fiasco.” He adds that

German politicians must be aware that the solvency of their own state is finite. At the latest, if Spain is rescued, the imbalances in Italy, and probably also France, will be calculated.

These, he argues, are burdens already borne by the German taxpayer, and

the more the federal government gets involved in the collective liability, the larger and more transparent the costs to the general public are. From a political point of view, it won’t be endured for long.

Finally, he comments:

The Merkel government can hope that the current crisis management works, that the markets calm down and countries see reason on fiscal policy. That is possible but it is not probable. Instead, there is the alternative of deeper political union, which doesn't look realistic, or an orderly unwinding of the euro zone to fewer, relatively economically solid countries. Even if a government leader should not speak loudly about it, that is exactly what Chancellor Merkel should now prepare for.

Strong stuff...

"Everything is at stake"

Chancellor Angela Merkel has been speaking at her party's congress and, given the events in Ireland, the euro was a key theme of her speech.

It's fairly stirring stuff:

"Everything is at stake -- if the euro fails, then Europe will fail. The idea of European values and unity will have failed, an idea that gave our continent strength and prosperity after the last century with its wars and destruction. It's up to us. It's our task to create a new anchor for a culture of stability in Europe."

She went on to criticise the decision to admit Greece into the euro:

"In 2000 Schroeder and Eichel couldn't let Greece join the euro fast enough and they ignored all the warnings. It was a political decision...political decisions are important but those which ignore the facts are irresponsible."

Merkel also made a point of defending Germany's export-led model, which many say has contributed to the euro's problems, adding:

"We will not allow ourselves to be punished for something that we do well. We'll not allow ourselves to be whipped because we export good products, made in Germany, all around the world."

From never-never land to reality; Angela Merkel takes care of business

Before yesterday’s European Council meeting, the European press were predicting that the Franco-German agreement made in Deauville might as well have been made in “never-never land”. Member states will resist and President Sarkozy and Chancellor Merkel will stand “isolated”, they said.

And even as late as this week, UK-based EU observers were in the news repeating that a new EU treaty is virtually impossible, only a year after the Lisbon Tretay entered into force.

Open Europe has argued for months that Merkel means business in her drive for Treaty change - and that she could achieve it if she puts down her foot (the exposure of German taxpayers to sub-prime eurozone loans is one clue, the need to address potential challenges in the German Federal Court is another).

And sure enough, today the German press is buzzing. FT Deutschland’s headline reads, “Merkel wins at Euro-Poker”. Die Welt writes, “Merkel asserts her will in Brussels”. Spiegel chimes in with, “Europe comes up against the Iron Chancellor”.

In a commentary in Handelsblatt Thomas Ludwig writes that, “Merkel and the German government held their nerve at summit negotiations and ultimately had the better argument on their side”. He also congratulates the German Chancellor for “being hardheaded” and said it will “pay off for the eurozone in the long-term”.

Handelsblatt also reports that Merkel advocated the suspension of voting rights for members who flout budget rules purely “for tactical reasons”. In reality, her primary aim was to push for a permanent crisis mechanism for the eurozone, which most member states have agreed is the best way forward. In other words, she established an outlier for member states to reject, pavign way for a deal on what she really wanted.

Merkel just gave her EU colleagues a lesson in how to get things done in Europe - is Whitehall taking note?

Has Cameron underplayed the UK's hand in Europe?

Over at Conservative Home, we examine how David Cameron is getting on in Brussels - the performance so far is a mixed bag, but there's a clear risk that he has underplayed the UK's hand in the negotiations.

Meanwhile, German media praises Angela Merkel's "poker skills". She has now achieved backing from EU leaders, in principle at least, for changing the Treaty in order to introduce a permanent crisis mechanism for the eurozone.

Cameron gives way on new treaty for 2.9% budget increase?

Die Welt is reporting that Cameron has done a deal with Merkel on treaty change.

The article notes that Merkel signed a letter penned by Cameron stating that the Council would not accept a budget increase higher than 2.9% in negotiations with the European Parliament. In return, Cameron will back Merkel's demand for a treaty change, reportedly assuring Merkel that he will secure the passage of a new treaty through the UK Parliament without a referendum.

As we argued earlier today, even if Cameron were to achieve a freeze to the EU budget, there’s nothing stopping MEPs and other member states from pushing through a substantial increase in 2012 or 2013 to make up for it.

If the reports are true, Cameron may well have severely underplayed the UK's hand, missing the opportunity to get real concessions in return for treaty change. A one-year 2.9% budget increase certainly doesn't cut it.

If true, Cameron has just given away the greatest leverage the UK has had in EU negotiations in a very, very long time...

How Cameron should play his cards in Europe

Over at the Spectator's Coffee House blog, we take a look at how David Cameron should approach today and tomorrow's EU summit - and how he should play his cards in negotiations in Europe moving forward.

We argue,

The British media woke up this week, realising that Europe still exists. As David Cameron travels to Brussels, questions loom over what, exactly, he can achieve in Europe – at this summit, and more importantly, moving forward.

Much of the commentary surrounding the summit has focussed on the increase to the EU’s 2011 budget, which Cameron is fighting. And for good reason. It’s insane that Britain – or any other net contributing state – should be forced to accept any increase to the EU budget, at a time of tough austerity at home.

Cameron has spent considerable time talking up the negotiations on the budget increase, so he may have an ace up his sleeve to achieve a cash freeze tomorrow or in the coming weeks. But a 2.9% hike is not unlikely, meaning that an extra £430 million would be added to UK taxpayers EU bill – or even more once the European Parliament has had its greedy hands on it.

However, as outrageous as it is, the annual budget increase is only a side show in a far bigger act.

Even if he were to achieve a freeze to the EU budget, there’s nothing stopping MEPs and other member states from pushing through a substantial increase in 2012 or 2013 to make up for it. The EU budget is negotiated in seven-year periods (though that can vary), with minor adjustments being made on an annual basis. Sadly, negotiations over this budget period have already been lost – courtesy of Tony Blair in 2005.

So the bigger prize – which may or may not be discussed in corridors at the summit – is clearly a reduction in the size of the budget from 2014 onwards. Cameron has rightly stated that this is his priority moving forward.

But here Cameron could be committing a strategic mistake. The temptation is to try to ask for concessions on the post-21014 EU budget, in return for supporting Merkel’s repeated calls for a Treaty change to fix the eurozone.

Thing is, the UK already has a veto over the negotiations on the post-2014 budget. If the UK refuses to agree, an effective cash freeze will be achieved anyway as the previous budget will be carried over. Secondly, member states are desperate to get rid of the UK’s rebate from the EU budget – in itself a powerful bargaining chip.

So if Cameron trades budget concessions for Treaty change, he will effectively be giving his EU partners two for the price of one.

A better way forward for Cameron is to horse trade on the EU budget and possible Treaty change separately.

Despite strong opposition from EU leaders, German Chancellor Angela Merkel continues to push for a Treaty change to fix the eurozone. And she won’t cave in easily.

As we’ve argued before, Cameron should back Merkel’s calls for Treaty change in return for repatriating powers to Britain. It Treaty change actually materialises, the whole package can then be put to a public vote in a genuine referendum on EU reform. Many Tory backbenchers are now picking up on this idea as well.

Cameron and Merkel will meet on Saturday night over dinner to discuss the way forward for the EU. The Prime Minister must think carefully about how to use the unusually fluid European situation to put Britain’s relationship with the EU on a more sustainable path.

The scope for a new Anglo-German grand bargain is greater than in a long-time. But for Cameron to give away his hand this early would be a serious mistake.

Merkel refuses to fold

German Chancellor Angela Merkel is a tough cookie.

Sandwiched between Deauville and tomorrow's EU Summit, Dr. Merkel took to the podium today to defend the controversial pact with President Sarkozy on economic governance in the eurozone that has left both German politicans and EU leaders incensed (but in different ways).

Addressing the Bundestag this afternoon, a firm Merkel said both President Sarkozy and herself will relentlessly insist on a "culture of stability" at tomorrow's European Council summit. She stressed the necessity of taking "precautions today for dealing with future crises" in the eurozone.

Such precautions, she said, will simply have to include a Treaty change. Merkel stated that the measures taken earlier in the year to bail out Greece were "unavoidable" but did not provide long-term solutions. She insisted on a new, robust and legally unassailable "crisis management framework" anchored firmly in a new EU treaty; a move that she admitted is "ambitious". But she confidently asserted that, for the EU

success will only come with a change to the treaty...improvement is always possible, even if the road is rocky.

Presumably responding to Luxembourgish Foreign Minister Asselborn's and others' sneer that Europe does not work with only a "two-stroke engine", the German chancellor said, "the Franco-German union is not everything in the EU, but, without a German and French union, it is not much."

Tomorrow's summit could be really interesting...