Dominic Lawson: Can Europe survive its cavaliers?

Without devaluation, the only way the Greeks can restore competitiveness is to impose real wage cuts

(James Benn)

According to the historical satire 1066 And All That, the English Civil War was fought between "Right but Repulsive" Roundheads and "Wrong but Wromantic" Cavaliers. A modern satire on the European financial crisis could well use the same terminology, with Germany as the right but repulsive advocates of roundhead "austerity", and those calling for still more cavalier "borrowing for growth" as wrong but wromantic.

With the election of the Socialist François Hollande to the French Presidency, and the collapse in support for the Greek parties which had agreed to cut the budget in accordance with the German-inspired euro stability pact, the past couple of days have been an undoubted boost for the Continent's Cavaliers. The trouble for them is that the only rational solution to the ills of the eurozone, if it is to remain a single currency area, demands full political union with fiscal transfers on a pan-European basis, in exactly the way that, for example, the taxpayers of England fund Wales and Northern Ireland.

If this were to happen, then Germany would become even more the paymaster of Europe, to an extent that would make its recent financial guarantees of over 200bn euros to shore up the single currency look piddling. There is no sign that the German electorate is willing to do that; but even if it did, it would only be in return for watertight political control over how their money was spent and allocated. And there lies the problem: most Greeks already regard as intolerable and degrading the fact that Germany has attached demands for tax increases, labour law reforms and the sale of Greek state assets as part of the price for its financial assistance.

Though this was in any case the price of support from the IMF, the Greeks have a particular historical sensitivity to Germany's role, manifested by outrageous cartoons in their newspapers portraying the German Chancellor Angela Merkel in Nazi uniform.

In Italy and Spain, there has been a similar resurgence of references to the Nazis' plans for European domination, as if it were analogous to the current state of play on the Continent. As Gideon Rachman observes in the current issue of The National Interest there is also a German counterblast, coloured by its citizens' increasing fury at the prospect of having to subsidise the bankrupt economies of southern Europe: "Semiracist stereotypes about lazy Greeks and law-breaking Italians are now common currency in the German press."

It is a bitter irony that so much of this is precisely a consequence of the creation and widespread adoption of the euro, the currency created by France and Germany in the belief that only this would entrench such political harmony in Europe that conflict would be permanently prevented. Remarkably, this is still their view. Last year, Merkel warned that "nobody should believe that another half century of peace in Europe is a given – it's not: if the euro collapses, Europe collapses. That can't happen."

Yet it was the fact that Greece became a member of the euro that allowed it access to vast borrowings, which in turn wrecked its economy. Of course, the banks were foolish to work on the apparent assumption that they were lending in a currency that had a country behind it which would act as guarantor: it doesn't. As Der Spiegel observed, "The euro can be truly dangerous as a result of a unique feature that distinguishes it from the dollar, the yuan and all other currencies: the euro is a house without keepers, a currency without political protection, without a uniform fiscal policy... Normally a country depreciates its currency when its economy falters, allowing it to increase exports and therefore reduce its deficits. But this doesn't work in a monetary union. If one country doesn't manage its economy effectively, the common currency acts as a manacle."

Absent a devaluation, the only way that the Greeks (and others in a similar position) can restore a degree of competitiveness within the eurozone is to impose real cuts in wages and pension entitlements; this is exactly what the Germans had done themselves over the past decade and a half, which is another reason why their citizens are so unwilling to pay more to allow their southern neighbours to carry on lounging in the sun (as they see it).

Doubtless German irritation, at the highest level, is also based on the vivid memory that it had always argued, within the councils of Europe, that the Greek economy was insufficiently sound and competitive to be part of the eurozone in the first place. John Major, the British prime minister at the time of these fraught discussions, recently recalled how, nevertheless, "France insisted: you cannot say no to the country of Plato."

The question now is: can Plato retreat? That is, can a plan be devised to allow Greece – if it can't construct a government to fall in with the Euro stability plan – to leave the single currency without the whole system breaking down? Admittedly, the majority of Greeks still want to remain part of the euro, even if they don't want to pay the membership fees; but that is not a sustainable position.

As a friend who has been involved in these European matters financial put it to me last week: "We should be having discussions about this, but not only is the break-up of the euro not being publicly debated; it is not even being discussed in private when we meet. It is, in the literal sense, unspeakable."

Yet it is already happening in reality. A crucial point in favour of the euro was that companies could trade across the Continent without worrying about matching assets and liabilities on a country-by-country basis. That has stopped. Because multinational firms want to be protected against the possibility of the currency breaking up and suffering massive balance sheet mismatches, they are now trading within Europe exactly as they would if every country had its own currency. Banks are beginning to match their national assets and liabilities within Europe in the same way, and are actually being encouraged to do so by the European Central Bank.

So Jacques Attali, the former adviser to France's last elected Socialist President, François Mitterrand, was right to tell the BBC yesterday that the euro will "not last five more years... unless there is a single European state". He is wrong, however, to imagine that the voters of Europe would support such a construction at the ballot box (assuming they were consulted). On that, I suspect, the Greek and German peoples would agree.

d.lawson@independent.co.uk