Europe races towards a debt-day decision

Angela Merkel has declared the continent is in a race against markets to achieve political union. With Spain tilting into the bond dangerzone overnight, a landmark European determination may be fast approaching.

As the eurozone debt crisis worsened overnight, with Spanish and Italian borrowing costs continuing to rise, Paris and Berlin were able to agree on only one thing: financial markets are now the enemy.

In Berlin, German Chancellor Angela Merkel warned that Europe was now "in a race with the markets” to turn itself into a full political union. Meanwhile, in Rome, French President Franois Hollande argued that Italy had been unjustly attacked by financial markets, and pushed for tighter controls on speculators.

Appearing at a joint press conference with Italian leader Mario Monti, Hollande said that Europe "needs instruments, mechanisms to support banks, and countries, which can find themselves suddenly and unfairly in a storm, so that speculation is discouraged”.

Against a backdrop of growing market turbulence, Paris and Berlin are now hard at work preparing rival proposals for saving the eurozone that they intend to present at the summit of European leaders later this month.

But the pressure from the markets is unrelenting. Spanish 10-year bond yields hit 7 per cent overnight, their highest level since the euro was introduced. Investors are all too conscious that Greece, Ireland and Portugal were all forced to seek bailouts when their borrowing costs hit the 7 per cent level.

And Italy’s borrowing costs are also rising. At a bond action overnight, Italy’s three-year borrowing costs jumped to 5.3 per cent, sparking fears that Italy may also need a bailout.

In Rome, Hollande said that his proposal for saving the eurozone would involve boosting growth, reinforcing stability, and deepening the region’s economic and monetary union.

Hollande is arguing in favour of issuing eurobonds – which would be jointly guaranteed by all eurozone countries – in order to cut the borrowing costs of countries such as Spain and Italy. He is also in favour of introducing a tax on financial transactions.

Berlin, however, remains hostile to the idea of eurobonds. Overnight, Merkel told the German parliament that ideas that involve collectivising Europe’s debts were "unconstitutional and completely counterproductive”.

She also warned against burdening Berlin with too much of the cost of rescuing debt-laden eurozone countries, pointing out that "Germany’s strength is not infinite”.

Instead, she called on European leaders to take gradual steps towards achieving the "Herculean task” of forming a European political union that would complete the process of monetary union. "Here we are certainly in a race with the markets”, she added.

But although Paris and Berlin are at loggerheads on the details of how to save eurozone, both agree that the overall solution lies in more centralised controls over the region’s banks and budgets.

The trouble is that this push towards greater integration comes at a time when the political dream of a united Europe is largely in tatters. It is only pressure from the markets that is forcing Paris, Rome and Madrid to dust off the old dream of a federation of European states. They fear that unless Europe now takes big steps towards greater political union, the eurozone will collapse, resulting in a spate of massive bank failures and economic catastrophe.

European leaders are deeply aware that moves towards greater European integration will likely feed the growing sense of political disenfranchisement, which could see a surge of support for radical nationalistic groups on both the left and the right.

The risk is that as Europe moves towards closer integration, its will increasingly adopt populist anti-market policies. For instance, Europe could well introduce protectionist policies to support the region’s producers and encourage employment. It is also likely to introduce much tougher banking regulations and limit the activities of financial markets.

The great irony is that, after pushing Europe towards closer integration, markets may well be forced to bear the cost of the revival of the European dream.

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