June's EU summit was the first to agree measures that address the core of the crisis: inflated government borrowing costs that weaken public finances and ultimately make sovereign insolvency self-fulfilling; and a vicious cycle in which worries about bank and sovereign solvency feed on and amplify each other. Unfortunately, the agreed measures were modest and have already prompted a backlash in various countries, not least in Germany and the Netherlands. Indeed, much of what was agreed at the summit is unlikely to come into effect. All this suggests that the limits of the politically possible may already have been reached.
Many commentators have raised the possibility of a grand bargain under which the Germans sign up to debt mutualisation and the French agree to cede sovereignty over budgetary policy. Germany has not ruled out debt mutualisation and a banking union, but argues that there must be a political union first. The problem with Germany's position is that the French have never ruled-out a loss of budgetary sovereignty in return for a proper fiscal union. Nor have the Spanish or the Italians. They are not opposed to political union, but argue that there must be crisis management first.
This French-Italian-Spanish argument makes sense; there is not time to create a political union before acting. Also, countries cannot cede sovereignty without getting something immediate in return. For example, if Mario Monti signed up to whatever the Germans mean by political union without extracting a concrete commitment to mutualise debt, he would be out of power very quickly. If the Germans offered some form of risk mutualisation in return for much closer political integration, the French, Italians and Spanish would no doubt readily sign up. The Germans know that. The problem is not how to strike a grand bargain; the question is whether the Germans want it or are able to deliver on their part of it.
The necessary institutional reform can hardly be pushed through under the radar, but must win democratic approval. This will clearly not be easy to secure. Of course, while Germany is running a big trade surplus with the rest of the eurozone which Germany's private sector is no longer willing to finance, transfers of one sort or another are inevitable. But no-one should be under any illusions about how difficult this is for politicians to explain to their electorates, even if they understand themselves. In the public's eyes and in the minds of many politicians, a trade surplus just shows that their country is more competitive. What could be wrong with that?
And the Germans and others do have legitimate concerns about the sustainability of a fiscal union. It will require a high degree of solidarity between its component parts. We see that solidarity within Germany, or in the UK or US, but it is less clear that it exists in the eurozone. Even if they could win democratic approval for such measures, German politicians understandably fear that a fiscal union would be difficult to sustain politically. This would especially be the case if the performance of eurozone's southern members failed to improve, creating a kind of giant Mezzogiorno. German politicians fear that this could give rise to populism and anti-EU feeling. There are similar concerns in the Netherlands and elsewhere.