Margareta Pagano: How to save the euro... or not

Well, it would help if Europe's leaders jetted back from their holidays to set the markets straight – pronto

If Europe's political leaders want to stop the markets from further meltdown, they must fight them at their own game; the politicians should come back from the beaches, or walking the Alps, to hold an emergency meeting – pronto. There's only one way to stop the investors from panic selling and that's with brute force. And the only language the markets understand is certainty. One Asian trader put his finger on the button last week when he said: "Why should we buy Italy's bonds if the European Central Bank doesn't want to buy them?"

It's a good question. And the only way Europe's leadership can demonstrate that Italy's bonds are worth buying is if Angela Merkel, Nicolas Sarkozy, even Italy's ridiculed Silvio Berlusconi, meet somewhere – even at one of their beach homes – to speak with one voice. They should declare to the world that they are taking hold of this crisis once and for all; Spain's José Luis Rodriguez Zapatero has already seen sense and returned to Madrid, so he's on red alert.

Then, they must state that a meeting of all 17 eurozone members will be called for September, if not sooner, at which the most recent Greek bailout will be ratified. In the spirit of camaraderie, they should ask David Cameron or George Osborne to join them as an honorary guest, as our support is crucial.

It is in our interests that the UK work closely with our neighbours on stopping this bloodbath – not just because so much of our trade is with the eurozone but because, more dangerously, so many of our banks have huge exposure to the Continent; Royal Bank of Scotland took a hit of £733m on its Greek bond exposures, and there will be more to come – the UK has lent £200bn to the eurozone. Member states should also put other measures in place to deal with the short-term – and they are short-term – problems facing Spain and Italy.

Although the global markets have been bubbling away for weeks, one of the reasons shares went into free fall so suddenly is that, with the US deficit package in place, investors turned their attention back to Europe and remembered that nothing has yet been agreed on resolving the crisis.

If the politicians don't come up with a plan, we could be heading for the next phase of the financial crash. If the last crisis was caused by the build up of US sub-prime mortgages, then this one will be triggered by sovereign debt. Here are some numbers that will have the hairs on the back of your neck standing on end: German banks have lent $238bn to Spain, while French banks have lent the country $220bn. Italy has borrowed $511bn from French banks – about 20 per cent of France's GDP.

Strangely, Europe's politicians should look across the Atlantic for inspiration to tackle this crisis. After weeks of what seemed at times foolish antics, President Obama has been able to break bread with the Tea Party and has at least come up with a transparent package which will be approved. And there's a reason for that – Obama took the lead and his Treasury Secretary, Tim Geithner, made sure that he kept the markets informed throughout of what was going on.

That's the absolute reverse of what's happening in Europe. Most of the politicians are running around like headless chickens; making promises they either can't or don't wish to keep. Meanwhile, it's the unelected technocrats at the ECB such as Jean-Claude Trichet, and European Commission president José Manuel Barroso, who have been trying hard to patch up the crisis behind the scenes; trouble is, they've been putting sticking plaster on open wounds, not sewing them up.

One minute Trichet seemed to suggest that the ECB would help Spain and Italy, but then, at last week's meeting, Europe's central bankers resumed their buying of bonds, but only for Portugal and Ireland. Then Barroso made his howler by admitting the crisis was spreading to Spain and Italy, and, more ominously, conceded that investors need to be convinced that the EU is taking appropriate action.

That was a red rag to the bulls, which turned them into bears again. Instead of messing around, Barroso should be behaving like a proper consigliere – telling his politically elected masters the unthinkable – that either they solve this crisis and keep the one-currency-fits-all alive, or it will crack up.

For Europe's leaders have two choices. They meet, agree that the German paymaster will guarantee the debt of the most troubled eurozone countries and then, most probably, they will have to consider seriously for the first time issuing long-term eurobonds. If this is to work, it needs political unification, one central bank and long-term subsidies from the successful northern economies to the smaller, troubled ones in the south which need to be put in fiscal straitjackets and forced to put into effect their own internal devaluations if their economies are to grow.

And the banks – particularly Deutsche Bank – will have to accept fierce haircuts, possibly a No 1. If this is unpalatable then Merkel and Sarkozy, for it is for them to decide, must accept that Europe is dysfunctional and that the only way for countries such as Greece, Ireland and Portugal – and possibly Italy and Spain – is to opt out of the euro.

One central banker I spoke to on Friday said this would have to be carried out in utmost secrecy as any whiff of a break-up to the markets or the public would cause a run on the banks. It would have to be done over a week-end and announced first thing on a Monday morning – promising that people's wealth would be protected. It's unlikely to happen, but I do know that the Bank of England has its own contingency plans for a euro break-up, and there have been rumours for months that Germany's big printers have designs ready in case of a new German mark.

The irony of this latest meltdown is that really nothing has changed in the underlying economies of Europe; there's been trouble brewing for months. But August is a funny month – a dangerous one, when wars break out, coups d'état are launched, and markets often go into tailspins. It's partly so febrile because so many people are away on holiday, which is why trading volumes are low so stock market and bond movements are exaggerated. But it's also proved to be a moment of truth; the seeds of the last financial crash were first spotted in August 2007, and then in August 2008 the credit crunch hit home.

Once again Nouriel Roubini, aka Dr Doom, is looking more prescient by the day. He has been warning for the past two years that the eurozone must put its house in order fast, or risk default. As Roubini put it last week, there's a beauty parade going on right now for the least ugly. Not a pretty sight.