In short, there is a far from negligible risk that the Germans and their allies are not going to move far enough to save the euro, or that they fail to get the necessary political buy-in for whatever they do agree to. Under such a scenario the euro really could unravel. If - and it is hard to see how they can avoid it under the current policies - Spain and Italy get caught in a vicious cycle of slump and rising debt, Spanish and Italian borrowing costs will continue to rise, shutting them out of the market. The ESM is too small to bail-out them out, and there is no chance of it being granted a bank license so as to borrow unlimited sums from the ECB. The ECB itself could enter the market itself and buy large volumes of Spanish and Italian debt, but the central bank may not be able to do this in the face of staunch opposition from Germany and a number of others. Could Germany and its allies be outvoted on the ECB? This is possible. But if they were, this would put paid to the possibility of the Germans, Dutch and other sceptical countries making concessions on the institutional questions, so it could prove a pyrrhic victory.
At this point the politics would start to look decidedly dicey in the struggling economies, and between them and the core of the eurozone. Politicians may start to feel trapped. Italy could prove pivotal. With Monti gone and replaced by a more populist leader, at the head of a coalition including the new anti-euro movement led by Beppe Grillo, the Italians could threaten to quit the euro unless the costs of sharing the currency are pooled. This would be a credible threat. Italy has a primary budget surplus (that is, a surplus before the payment of interest). The Italians would be loath to play such a card, but Italy could come to perceive departure as the lesser of two evils. If Italy withdrew, so would Spain. France would then come under massive pressure. The Germans would probably offer France a debt union, but would the latter go for it? They would have a hugely overvalued currency and would be a very junior partner.
To many this scenario will sound far-fetched - how could something that will have such far-reaching implications for the European economy, the region's political stability and its security, be allowed to happen? Because the solution to the crisis requires governments to do things for which they have no mandate. And the longer the crisis festers, the more difficult it will be to win such a mandate. This is the tragedy of the eurozone's handling of the crisis. Had the ECB been allowed to intervene in the markets and dispel fears for the solvency of the Spain and Italy, and had the region's creditor countries refrained from imposing self-defeating fiscal austerity on the struggling economies, the eurozone would have had much more time to prepare the ground for the necessary institutional reforms, which could have been implemented incrementally. But the crisis has now deepened to such a point that only big institutional steps will restore the credibility of the eurozone. This puts politicians in the eurozone's creditor countries in an invidious position: save the euro and be voted out of office, or open the way for an unravelling of the single currency with all the resulting economic and political fall-out.
