Sean O’Grady: The paradox that could strangle Europe

There used to be joke about the old Soviet Union that its workers pretended to work and the state pretended to pay them. Something of the same is happening in the almost equally looking-glass world of the European Union. The peripheral nations, Greece, Ireland, Spain Portugal, are pretending they will be able to pay back the money the Germans are lending, and the Germans are pretending to take them seriously.

It is as if an indulgent parent "lends" the money for their spoilt offspring to buy a flat in one of the more fashionable districts of London. The loan is agreed in the full but the unspoken understanding of both parties is that it is non-recoverable. The money is made available precisely because no commercial lender would offer it. It is, in other words, a gift, though pride and propriety on both sides requires that it be termed a "loan", agreed only after intensive "negotiations".

So the Greeks pretend that they have every intention of honouring their impossible debts. Greece's credit rating is, bluntly, developing world for a reason. It cannot collect taxes without outside help. And, short of a re-run of 1941, there are limits to what the Germans can demand in the way of on-the-ground fiscal supervision. Even if the Greeks eliminate corruption with German thoroughness, their public debts will still peak at 160 per cent of GDP, and their debt repayments will eat up an unfeasible proportion of their national income. Most economists put a theoretical limit of 90 or 100 per cent on debt to GDP ratios before a nation enters a debt death spiral – and that's in an economy that has otherwise normal growth prospects. Greece cannot grow its way out of trouble, as, maybe, Ireland will, Spain just might, and poor old Portugal probably can't. In all cases the risks of default are there.

So what happens next? One of two things must. It is often said that the sheer scale of Spain's public and banking debts would overwhelm even Germany's resources, or at least her patience. That is certainly possible, in which case we will have an economic cataclysm on our hands sooner rather than later. We can only pray that the Treasury and the Bank of England are making contingency plans for what we do in the event of the house next door subsiding. And if not Spain, then others, or a combination of them could conceivably exhaust Germany. The Belgians are scarcely more solvent than the "PIIGS", and are minus a government. Others – Italy, France even – have their own issues, not limited to hopelessly ageing populations, and markets are starting to "price in" those negative trends now. Hungary and Romania aren't in the euro, but are obvious candidates for further aid. All these strays could end up on Germany's doorstep, and at any point she might decide enough is enough.

A superficially more attractive possibility is that the problems are not as bad as we fear, and the Germans, devoted Europeans, are happy to carry on paying the bills. There is an interesting, and for the EU, a strangulating paradox here. For the very industrial success that makes Germany able to afford to carry her less successful EU partners is also the engine for their continued impoverishment. Partly that's because Germany makes a living from selling exports to less productive nations nearby. Berlin then loans them the cash back to keep them alive. Nice. In that sense Germany can just keep throwing money at the others' problems as if it were the "price of being European", or, more mercenarily, the cost of maintaining export markets.

Arguably, it is analogous to theunification tax that paid for the restoration of East Germany. But such a policy leaves the rest of the EU dangerously dependent. Greece and the others will become pauperised wards of Berlin. How long, one wonders, will they be prepared to settle for a pretence of independence?

A season of little cheer for Cable

Soon, the political air will be filled again with recrimination – and I'm not talking about England's failed World Cup bid. Next February and March, when the poorest are preparing for housing benefit cuts, VAT is hiked to 20 per cent, local authority workers are being sacked, public services are slashed and tuition fees soon to treble, the investment banks of the City of London will be indulging in their usual orgy of excess. An estimated £7bn in bonuses will be shared among a few hundred lucky financiers. For them, it will be like a guaranteed lottery syndicate win. 'Cept bigger. For the rest of the nation it will be a source of deep resentment.

For a Government keen on proving its "progressive" credentials the bank bonus season is nothing to look forward to. Vince Cable, the Business Secretary, maintains that taxing them remains a "last resort", as he told this newspaper, and he wants individual bankers and their bonuses to be named, if not shamed.

The Chancellor, George Osborne, has rowed back even from publishing the bankers' rewards anonymously. He prefers a European agreement that wouldn't be effective before 2012. Part of this apparent split may just be tactics; the Treasury may prefer to do its arm twisting in private, hoping the ultimate threat will persuade the banks to behave themselves. If they do not, and Mr Cable and Mr Osborne lose their nerve, then the Coalition will be labelled the "friends of the bankers", and Tories seen to revert to type.

Mr Cable made his political reputation in opposition by harnessing (some say fomenting) public anger at the bankers. Can he, now he's in power, sit and watch them give us – and him – the finger? Say it won't be so, Vince.