This week saw a drop in the borrowing costs for Ireland, Spain, Portugal and even Greece, as markets apparently took heart in rumours that EU leaders will soon strengthen the main bail-out fund, the EFSF, to back up eurozone countries in trouble. A German-dominated proposal for stronger economic governance of the eurozone is being discussed at the EU summit today.

The plan does not lack points of contention, i.e. a minimum retirement age across the eurozone, de-linking wages from inflation, a cast-iron rule on limits to spending deficits for all euro countries. European leaders have until the end of March (a self-imposed deadline as much as anything else)  to work out their differences and convince markets that they can agree a sustainable plan for long-term eurozone stability. Or it might all kick off again.

News of  the markets calming down are welcome, the reason underpinning them (EU leaders consider putting even more taxpayers’ cash on the line to save countries that mismanaged their finances) are not – a contradictory feeling that those of us who saw this coming will have to deal with.

But notwithstanding positive developments of late, there has been something very familair about the last couple of weeks – as Greece’s problems continue to smolder beneath the surface. We hear increasing worries about Greek debt levels and leaked rumours over a possible restructuring combined with a bailout.

It may not be as much hype, but looking at the numbers, in fact, it’s feeling alot like last Spring.

Leaked reports claim that EU leaders are now considering a restructuring plan for Greece’s debt, which would see the country buying back some of its own debt at a cheap price, using some €50 billion from the EU’s bail-out fund, in combination with a lengthening of the pay-back period of the EU loans Greece has already recieved.

As we argue in our latest briefing, Greece will find it almost impossible to make it through the next two years without some sort of additional help or restructuring. Just consider the facts and figures:

• Greece’s debt to GDP ratio is set to reach 152% this year, equal to €341 billion
• It will have to find at least a total of €53.35 billion to plug its huge funding gap (this includes debt maturing, interest payments and money needed to plug the budget deficit – and this figure is likely to prove an underestimate)
• Disbursement of EU/IMF bail-out funds this year will only amount to €46.5 billion, leaving Greece €6.85 billion short
• Greece’s cost of borrowing is still around 11% for long term debt, meaning that it cannot go to the market to raise the extra cash (as that would be wholly unaffordable).

EU leaders are therefore right to consider ways to restructure Greek debt. However, as we also argue in the briefing, the proposal contemplated isn’t in itself much of an answer. As the table below shows, even if Greece were to make it through this year, or even 2012, it would continue to face daunting re-financing targets, which, again, aren’t matched by available bail-out cash.

So even if the rumoured restructuring plan were implemented we estimate that Greece’s debt to GDP ratio would still top 145% in 2011, though if private bondholders agreed to take part in the plan (which is far from certain), this could be slashed by considerably more. For Greece to get back on the path towards sustainability its debt to GDP ratio needs to be below 100%. This, in turn, would require a write off of more than one-third of all Greek debt. A substantial jump from the 2.4%-4.2% expected with the current plan (without private bondholders included).

There is also no indication as to how Greece would deal with the €148 billion of debt maturing by 2014, nor the interest payments on its debt, which accounted for a whopping 20% of all government expenditure last year.

The scheme proposed by the eurozone leaders also fails to address some other familair problems. Greece has a massively overvalued currency, poor growth prospects and little international competitiveness. Until these issues are properly dealt with, Greece’s long term prospects look bleak.

The markets may be looking up right now – which is good news – but for Greece, alas, little has actually changed, despite some considerable austerity efforts. Even with a mild restructuring/another bailout, the Greek debt crisis is likely to rear its head again.

Maybe a third lightening strike will force eurozone leaders to try something different.

Back in October Open Europe estimated, based on leaked reports from a couple of European governments, that the EU’s mismanaged Galileo project – aimed at creating a global satellite navigation system – was way over budget (and possibly ten years behind schedule).

I don’t know where these figures come from

Tajani described the estimates as “exorbitant” and “unimaginable”, and insisted that the deployment budget (which is only part of the cost) remained at €3.4 billion.

I think Galileo is a stupid idea that primarily serves French interests.

Of course, Tajani is keen to point out that the satellite is expected to bring €90 billion to the European economy over 20 years – and the project will no doubt result in benefits if it’s ever completed. But this has been revised down radically from the Commission’s ridiculous original estimate of €275 billion per year in revenues worldwide by 2020 (in addition to the equally delusional 3 billion users and the creation of 150,000 new jobs).

Forgive us for not quite trusting Tajani on this one.

A  letter in yesterday’s FT by Annerose Tashiro of law firm Schultze & Braun in Frankfurt, argued that the eurozone should consider adapting a restructuring plan akin to the US bankruptcy code – the so-called Chapter 9 – which enables American municipalities and cities to default . She argued,

Looking into the framework that Chapter 9 provides, such a municipality would not be under the threat of any sort of liquidation or dissolution. There would also be no estate in the traditional sense and no assets – so no one is suggesting that the Greek school system should be sold off to pay its debts.

Similarly, a leader in today’s Handelsblatt makes a forceful case for  allowing and providing for organised bankruptcies within the eurozone. “Only when investors know their risks, prices can fulfill their role in the market place”, the leader argues, noting  that “neither banks nor countries should be ‘too big too fail’”. It calls for an insolvency procedure to be ready in a couple of years time, as “Greece might default after all”.

These are valid points which EU leaders would do well in taking aboard. German Finance Minister Wolfgang Schauble has consistently argued for the introduction of some sort of orderly insolvency procedure to deal with a sovereign default within the eurozone, fearing for Greece’s in a first instance.

Such a mechanism would have several appealing aspects from a German – and economic – point of view:

- Crucially, it would transfer risks from taxpayers to creditors (where the risks belong). At the moment, German taxpayers are potentially liable for some €120 billion – a crazy amount by all standards. In total, roughly €29 billion has already been dished out to Greece as part of the first rescue package, with Germany being liable for a substantial part of that sum. The rest of the bailout package is theoretical at the moment.

However, should Greece continue to tap the bailout funds, and other countries – such as Ireland, Portugal or, heaven forbid, Spain – follow suit, these bailout fantasy sums would no longer be theory but will become an absolutely massive liability on the books of Bundesministerium der Finanzen.

A chaotic default following taxpayer-backed loans would combine the worst of all worlds, and would be a disastrous blow to both the euro and the European Project as a whole. Even if the risk of a eurozone country defaulting was tiny (and it isn’t), you can see why German politicians don’t want to take this gamble.

- And close to German hearts, an insolvency procedure could encourage fiscal discipline. As a leader in the FT argued last week, “In a union so clearly unable to control the fiscal habits of its member states, the threat of default would be a powerful check on excessive borrowing and irresponsible lending.”

This is also why a permanent bail-out fund at the EU-level, as some have argued for, could be probematic, as it potentially opens up another avenue for moral hazard – in addition to being wholly undemocratic.

- It could allow for Germany to sneak in other changes to eurozone governance, including temporary suspensions of voting rights for countries breaking soon to be toughened up EU budget rules.

Whether a Chapter 9-style mechanism or something else, any concrete proposal for an orderly default procedure is bound to come up against massive political challenges. The elephant in the room is Treaty change. Germany seems inclined to push for changes at the level of all 27 member states, which would require all EU countries to agree. Alternatively, the eurozone could establish such mechanism outside the EU Treaties, which, incidentally, would circumvent Britain.

An insolvency procedure would involve a clear transfer of powers from member states to the EU, as national laws must be brought in line with whatever is established at the European level.

BUT, instead of taxpayers footing the bill for the poor decisions of governments and companies they cannot vote out of office, such an arrangment would mean that ultimate liability will rest with those who actually made the mistakes.

If a bankruptcy procedure means no more taxpayer funded or ECB-led bailouts of governments – which have no basis in the rule of law in the first place – the net effect could actually be a fairer and more democratic eurozone.

It has been called “a violent clash”, “a virile confrontation”, “a furious row”. But today’s Le Monde finally sheds some light on what Sarkozy and Barroso really said to each other during that infamous squabble at last week’s EU summit over the Roma deportations.

The paper has published a transcript of the row, under the headline: “A lunch as bitter as bile in Brussels”. Below are some of the more juicy excerpts from the confrontation (the full article is only available to subscribers of Le Monde‘s website).

One caveat: The transcript has been put together based on the accounts of several witnesses – both first and second hand – and therefore might not always reflect what was said verbatim, but the authors of the article maintain that it’s fully reliable.

With no further ado, let’s leave the stage to the protagonists:

European Council President Herman Van Rompuy: “Nicolas [Sarkozy] has asked me to give him the possibility to make some remarks on a current issue. Indeed, I leave him the floor”.

French President Nicolas Sarkozy: “I have the highest respect for the [European] Commission. I have done a lot for it. I have done a lot for the Commission and to bring France back to the heart of Europe [...] It’s normal for the Commission to investigate. But before any investigation, one of the Commission’s Vice-Presidents [Sarko obviously referring here to Justice Commissioner Viviane Reding] has used expressions like ‘disgusting’, ‘disgrace’, ‘Second World War’. These are words I can’t accept. I don’t say that the Commission is disgusting [...] I’ve come here only because she [Ms. Reding] has apologised. I had told [Commission President] Barroso that I would not come if she didn’t apologise”.

Commission President Jose Manuel Barroso: “The substance and the form [of Reding's declarations] are two separate issues. We have rules against discrimination, and it’s the role of the Commission to defend them [...] The Commission has distanced itself from Viviane’s statement. She has said that she regrets the interpretation which has been made of her declarations”.

Sarkozy (interrupting Barroso): “The interpretation?! It’s not for this that she had to apologise, but for saying that [France's Roma policy] is ‘disgusting’”.

Barroso (keeping his cool): “I understand Mr. Sarkozy’s emotion [...] Ms. Reding has said that she regretted her statement. I note that the French Secretary of State for European affairs has not done the same”.

A quick footnote: French Europe Minister Pierre Lellouche had responded to Viviane Reding’s remarks claiming that the French people, not the European Commission, were the real guardian of the EU Treaties.Italian Prime Minister Silvio Berlusconi: “We need to withdraw speaking rights for Commissioners and their staff. Only Barroso must be allowed to speak [in public]“.

German Chancellor Angela Merkel: “We need to convey an image of serenity at the end of the summit. We need to avoid using certain expressions”.

Iron Angie’s words of wisdom fail to cool tempers however.  Instead, Sarko insists that the school kids EU leaders adopt a common position on the Roma issue, specifying that the Commission has the right to ensure the respect of EU law, but member states still have the final word.

At this point, Barroso loses his patience:Barroso: “These pressures must stop [...] The Commission must be allowed to do its job. Otherwise, we will not have the kind of Europe we want. The European Court of Justice will have the final word”.

Sarkozy: “We can’t say that the Commission will refer the matter to the Court. There has to be an investigation before. By the way, I have to pay tribute to Jean-Claude Juncker [Prime Minister of Luxembourg, Ms. Reding's home country], who has urged this lady to apologise”.

Sarko avoids calling Ms. Reding by name…Luxembourgish Prime Minister Jean-Claude Juncker (trying to mediate): “Ms. Reding should not have talked the way she did. Nicolas should not exaggerate, though. It’s only by chance that she was born in Luxembourg”.

Barroso (interrupting Juncker): “But it was you who appointed her [as EU Commissioner representing Luxembourg]. Three times!”

Juncker: “Yes, but at your request…”

Sarkozy: “Let Van Rompuy speak”.

Van Rompuy reminds the EU leaders that journalists from all over Europe are waiting outside and proposes to draft some conclusions to settle the matter, at least for the moment. Barroso tries to spell out his own conditions.Barroso: “We will not target a specific Commissioner. Otherwise, we will also refer to other people”.

French Europe Minister Pierre Lellouche springs to mind…

Sarkozy: “Barroso can’t tell us what to say!”Barroso: “I’ve the right to express my opinion, because I’m a member of the European Council myself. And I even have a special statute [...] We have done everything to help you with the European Parliament, which is furious on this issue. Let’s not turn all this into an institutional quarrel. That would be excessive”. Berlusconi: “We need to silence the Commissioners!”

And the row reportedly terminates here, with Chancellor Merkel suggesting they move on to a different topic.

The European Commission yesterday announced the results from the latest Eurobarometer poll – carried out in May during the height of the crisis – with a press release carrying the headline, “EU citizens favour stronger European economic governance”. 75 percent of Europeans, we are told by the press release, are in favour of giving the EU a stronger role in the coordination of member states’ economic and budgetary policies.

EU Justice Commissioner Viviane Reding – who also is in charge of Communication – commented:

The clear majority for enhanced European economic governance shows that people see the EU as a decisive part of the solution to the crisis.

Clearly, something fishy is going on here, not least since such overwhelming support for EU action is conspicously absent from the rest of the poll  (26 percent of people say that they consider the EU best placed to deal with the financial and economic crisis, for example).

And sure enough, the Commission is trying to take us for a ride.

Respondents to the Eurobarometer survey were only asked whether or not “a stronger coordination of economic and financial policies among all EU member states” would be effective to combat the ongoing crisis (see p. 38 here). The question doesn’t even mention the role of the EU or the term “European economic governance”. Creatively, the Commission then adds up the respondents who think that stronger coordination would be “very effective” (26 percent) and those who only find it “fairly effective” (49 percent) to reach the 75 percent figure.

Seriously, how stupid do they think we are? By no stretch of the imagination is this the same as 75 percent of Europeans being in favour of giving the EU more powers to monitor national economies, which the Commission is trying to make us believe in its press release.

The Eurobarometer survey could have asked this question instead: “Do you think that the EU should be given more powers to monitor your country’s economy, including decisions on public spending and taxation?” We suspect the result would have been completely different.

What the Commission really should be focussing on is the troubling fact that only 49 percent of respondents think that EU membership is “a good thing” down from 53 percent last year. Or that the percentage of people who think that EU membership is “a bad thing” has reached its highest level in a decade – now at 18 percent (see p. 12).

What’s more, the percentage of people who think that EU membership is a good thing has decreased by 5 percent in France and the Netherlands, for example, and by a striking 10 percent in Germany (down to 50 percent) in only one year. 45 percent of Germans (and 52 percent of Austrians and 36 percent of Swedes) also associated the EU with “waste of money”. Incidentally, these countries are all net contributors to the EU budget.

Only 19 percent of Europeans associated the EU with “democracy”.

Is the Commission getting the hint? I hope so, but somehow I doubt it.

A recent Eurobarometer poll has found that the majority of Spaniards, a sizeable 54 percent, believe that “without the euro, with the peseta, we would have been able to confront the economic crisis”. Somewhat surprisingly, perhaps, this is higher than the eurozone average of 45 percent.

In an interview with Spanish daily La Vanguardia, the Head of the European Commission’s Representation in Barcelona, Manel Camós, set out a rather customary EU explanation as to why people might hold such odd views: ignorance, what else?

So says Camós:

This makes us think that the public has not understood the advantages of the euro because the experts, in general, are convinced that thanks to the euro we have had the [economic] development that we have had and that we can overcome the crisis.

He goes on, “both interest rates and the inflation rate have decreased. Before the euro in Spain the interest rate was higher than 14% and now, in spite of the crisis, it is around 4%”.

Señor Camós gives a reflexive reaction that is all too common amongst the EU establishment – whenever public opinion is unfavourable, it’s because those pesky people just don’t get it.

Problem is “the Spanish public” has given expression to a perfectly rational view. Most commentators agree that keeping up with an essentially German monetary policy has undercut Spanish competitiveness, for example, while low ECB interest rates have served to fuel the Spanish housing/private debt bubble, the effects of which we are now seeing. A currency devaluation to put this right is not an option for Spain which in turn will make the economic adjustment much more painful for ordinary people, as a squeeze on wages and unemployment takes up the slack.

In fact, as the eurozone crisis unfolded, even the political and monetary elite started to acknowledge that the euro hasn’t been all plain sailing for the Spaniards and other eurozone countries.

Take EU President Herman Van Rompuy, for example, who now admits that the euro served as a “sleeping pill” for the eurozone. Or Bundesbank President Axel Weber who points out that “the benefits of monetary union, in particular lower interest rates and the elimination of exchange rate risk, have not always been used wisely and have tempted some countries to live beyond their means” (e.g. the Spanish housing bubble).

Or EU Commissioner for Competition Joaquín Almunia, a Spaniard himself, who noted that countries like Greece, Portugal and Spain have experienced “a permanent loss of competitiveness since they are members of the Economic and Monetary Union”.

Of course, there are also benefits for Spain, but surely, any serious commentator or official should address these well-documented drawbacks before accusing people of ignorance?

Incidentally, the exact same argument was used last week by another leading Commission figure – Commissioner for Enlargement, Štefan Füle. Mr Füle took issue with an opinion poll which showed that 60 percent of Icelanders were opposed to EU membership, up from 54 percent in November. Füle lamented

the current lack of broad public support for EU membership in Iceland…This shows that there is a need for more information about the EU and its policies. The decision should be based on facts and figures not on myths and fears.

In Ireland, the Netherlands, France (after the No votes to the Lisbon Treaty/EU Constitution), Spain or Iceland, the answer is always the same: if you take a somewhat adverse view to anything EU-related, it’s because you’re ill informed or ignorant. This line was personified by Margot Wallström, the Commissioner in charge of ‘selling the EU’ to the public during the EU Constitution/Lisbon Treaty debacle (Wallström’s position has now been abolished – not exactly a ringing endorsement of her record).

This infamous clip of Wallström on Newsnight gives a hint of how hopelessly self-contradictory and untenable this approach is. In fact, you can just as well argue the opposite – that well-informed people tend to be more critical to grand and artificially constructed EU projects or to the idea of concentrating more powers in Brussels.

The Danes, who said No to Maastricht in the nineties and No to the euro in 2000, consistently rank amongst the most informed in the EU. What’s more, before the Danish referendum on Maastricht in 1992 (to which the Danes voted No), an investigation showed that a representative sample of the country’s voters was just as informed about key-EU issues as a cross-section of back-bench MPs (who were asked the exact same questions).

Likewise, studies show that the EU-wary Swiss were better informed about the EU than citizens in their neighbouring countries who were EU-members around the time of the country’s rejection of the EEA.

Opinion polls keep on indicating that the support for the EU is dropping across Europe. 6 out of the 8 last referenda on EU-related issues have delivered negative outcomes (from the perspective of the EU elite that is). Camós, Füle and Wallström are clearly missing something.

And some humility wouldn’t hurt. The eurozone crisis has landed a massive blow to the EU’s political elite, who largely got it wrong on issues such as the likelihood of convergence, the risks of an enlarged euro and the drawbacks of single interest rates (as we’ve documented here).

There are rational arguments for and against more EU powers, the Lisbon Treaty, the euro and so forth. But claiming ignorance as the only reason to people’s declining faith in the EU is just plain ridiculous. Better instead to actually try to tune in to citizens and listen to what they want the EU to do and to be – along the lines of what the original Laeken Declaration tried to set out.

And then try to actually act on it.

Open Europe hosted a debate in Brussels last week, looking at the future of the EU in the wake of the eurozone crisis. “Superstate or disintegration?” was the deliberately polemic question to be answered.

The ever-eloquent Dan Hannan, a UK Conservative MEP, warned against further harmonisation by pointing to Europe’s history. It was the competition, he argued, arising from various independent European powers co-existing that made Europe take off post-1500.

Giles Merritt, the amiable secretary-general of eurofederalist Friends of Europe, said it was just the opposite; Europe only gained its influence through the Treaty of Westphalia, which involved European powers coming together, collectively hammering out a common rule book for how relations between (from then on) sovereign states should work.

This is no doubt one of those long-standing debates, but the evidence from economic history is difficult to ignore. As David Landes sets out in his seminal work The Wealth and Poverty of Nations:

Fragmentation gave rise to competition and competition favored good care of good subjects.. . . European rulers and enterprising lords who sought to grow revenues . . . had to attract participants by the grants of franchises, freedoms and privileges—in short, by making deals. They had to persuade them to come.

The Treaty of Westphalia locked in this order, ensuring that sovereign states could continue to compete – also leaving them free to copy the advances of those that had enjoyed greater economic and social success.

In contrast, China – with its once scientific and naval superiority – chose the path of a single, unified empire; a heavily centralised regime whose autocratic rulers faced little pressure to change their ways. Ambition was not rewarded and there were few escape routes for those with a desire for economic or scientific progress. The consequences are well known: China’s economic revolution was delayed by some 500 years.

The Economist breaks it down in its Millennium issue:

China’s rulers could ban some advance, and their ban was obeyed. Europe’s regimes might try such things. Some did: Florence issued an edict in 1299 forbidding bankers to use Arabic numerals; in 1397 Cologne ordered its tailors not to use machines; after the invention of the ribbon loom in 1579, the city council of Danzig is said to have ordered the inventor to be drowned. But their efforts were in vain, indeed self-damaging: a rule that hurt the economy hurt the state that made it, as against others economically more enlightened. In Europe, rivalry among governments wore away at the interests opposed to economic growth.

(Other works emphasising the importance of “institutional competition” along the lines of Landes’ thinking, include, for example, “How the West grew rich” by Nathan Rosenberg, “Law and Revolution: The Formation of the Western Legal Tradition” by Harold J. Berman; and on the importance of institutions, Douglas C. North’s “The Rise of the Western World: A New Economic History“)

But there’s also another aspect of the Peace of Westphalia that is too often overlooked. The nation-state – the idea of territorial integrity and sovereignty – paved the way for the concept of popular sovereignty in Europe. The state became the unit around which democracy – the pre-condition for which is a demos – could be organised.

Europe’s history is of course much more complicated than this – geography is key, for example, religion is a major factor and the rise of the nation-state was coupled with wars and, at times, nasty expressions of nationalism.

Still, EU leaders would do well to glance backwards for a few minutes before deciding what do to next. The eurozone crisis is once again begging fundamental questions about Europe’s past and future.

First, if the EU continues on its path towards more and more harmonisation – on regulation, law and fiscal policies – it undercuts one of Europe’s greatest recipes for success.

Secondly, continuing to erode the link between the nation-state and democracy could prove hugely problematic. As has been stated over and over again: democracy without a demos is bound to fail.  No amount of money from the EU to various cultural projects and citizenship campaigns will be able to artificially inject a demos into the European Project. And again, this must not be considered a bad thing – Europe’s diversity harbours tremendous strength.

Alas, with a €500 + €110 billion EU bailout package on the table, and more money potentially from the IMF, the EU’s infamous democratic deficit has taken a quantum leap in the wrong direction. Taxpayers in one country are now liable for the mistakes of a government in a different country – but without the opportunity to throw the ‘rascals’ (who they are underwriting) out of office. This broken link breeds contempt amongst people. Push it too far and EU leaders could see the rise of the very forces that they’re professing to fight.

 Thirdly, do not take away the “right to exit” – free movement is what the EU does best (preferably through mutual recognition rather than harmonisation) and is in many ways the modern facilitator of the political and economic competition that produces the best result for Europe as a whole. But too much harmonisation offsets the benefits of free movement – the natural exit route will not be another European country, but probably to the US or the emerging economies to the East.

(The sharp-eyed will spot a potential contradiction between points 2 and 3, which needs to be taken seriously as well).

 At Open Europe’s debate, Dan Hannan quoted German economist Wilhelm Röpke, who once said:

to try to organise Europe centrally and to wield it into a block is nothing less than a betrayal of Europe and Europe’s patrimony, betrayal made all the worse by being carried out in Europe’s name.

Spot on.

After a semester of emergency summits, this Thursday the EU aspired to hold the most boring European Council possible: discussing no member States’ bankruptcies, agreeing no multi-billion bailouts, ending talks at 6 pm – not at 6 am of the following day – and, above all, talking as little as possible about Spain.

That is how El Mundo summarised yesterday’s summit of EU leaders. And indeed, this was the most uneventful and dull European Council summit in years. But this dullness may prove deceiving.

British Prime Minister David Cameron escaped unscathed – despite some eurosceptics and federalists secretly wishing to see some blood during the PM’s first visit to Brussels. The most exciting event appears to have been that Commission President Jose Manuel Barroso served Cameron an English breakfast – just to make the British leader feel a little bit more like home.

Cameron declared victory in his ‘battle’ to resist more powers for the EU to review national budgets, insisting that no one is allowed to see the UK’s budget before Parliament does. But this was a fight that David Cameron could win – as already the draft conclusions made clear – which is probably why the he chose to focus on it in the run-up to the summit. As ever, managing expectations is key in politics and it worked thsi time. The pre-budget report, which is published in December in the UK, offers a convenient way out for the UK government and is the item that presumably will be ‘peer reviewed’ by the Commission and other national treasuries.

The frictions between Nicolas Sarkozy and Angela Merkel defined yesterday’s EU summit in many ways. The German Chancellor remains suspicious of Sarkozy’s drive for a gouvernement économique for the 16 eurozone members, fearing the politicision of monetary policy (including further losses of independence for the ECB and inflation risks).

But following months of tensions, Sarkozy and Merkel seemed to have reached an uneasy compromise earlier in the week, saying that “The natural frame for economic governance is at 27.” They also agreed on the possible need for Treaty change to introduce tougher sanctions to underpin the stability pact.

So everyone happy then?

Not quite. The European Project has had a rocky ride during the Spring – to say the least – culminating in the “Super Weekend” back in May, when the ECB lost its independence and European taxpayers became liable for some €500 billion in eurozone bailout loans.

It suited EU leaders well to tone down this summit  but under the surface there are a number of explosive issues.

Perhaps most importantly, although leaders adopted a “don’t mention Spain” policy – the shadow of the Iberian Peninsula loomed large over the entire summit. Reports earlier in the weak claimed that the EU, the US and the IMF are preparing a €250 billion credit line for Spain amid concerns that the country is going bust. Everyone now knows that such rumours, whether well-founded or not, can be lethal.

And the fundamental tension between France and Germany remain unresolved. At his press conference yesterday you could perhaps sense that Sarkozy is keeping his dream of an economic government at 16 alive. He said:

We are only at the beginning of the concept. Only four months ago, the words ‘economic governance’ were taboo. But the idea is progressing…The idea of economic government is not only about dealing with budgetary issues. It will allow us to put into place a strategy for competitiveness in several domains, such as research, social rights and universities.

That’s not quite the language coming out of Germany. Frankfurter Allgemeine Zeitung today features four of Germany’s leading economists warning against an EU economic government and the eurozone bailout. They write:

Europe does not need an economic government, but rather political and economic mechanisms which will effectively limit public and private indebtedness of the member states.

They continue, “the emergency [bailout] packages in the current form should not be renewed”. Question is whether German taxpayers and voters will stomach more sovereignty (and potentially money) lost – chances are that they won’t.

Both the French and the German press seem to agree that Merkel now has the upper hand – and the conclusions from yesterday’s Summit bears the Chancellor’s fingerprints. But a new Franco-German bargain won’t be so easily achieved this time –  although both still have much to lose from not making up.

Then there’s Britain. How long will the Cameron-EU love-in last?

Proposals stemming from Brussels for tougher financial regulation and supervision – including three new EU supervisors with substantial powers (at least under the European Parliament’s draft proposal) – will remain thorns in the side of the UK’s coalition government. It’s unlikely that Cameron can hold his position on these proposals. The upcoming EU budget negotiations could prove another headache.

And as Open Europe sets out in a new report, despite the Franco-German tensions and a reluctant German electorate, the wheels are in motion for the next round of EU integration. Indeed, British taxpayers are already on the hook for some €8 billion in potential eurozone loans through the so-called European Stabilisation Mechanism (part of the €500 billion bail-out package) – effectively a first step towards a common EU bond.

This afternoon Commission President Barroso, speaking at the European University Institute in Florence, also reminded the UK’s Coalition Government why the game over the EU’s economic government is far from over:

The European Council’s conclusions have envisaged small steps, which sometimes are the most important. It is like a silent revolution – stronger economic governance made through small steps

, he said according to Italian media.

Talk like this scares the bejesus out of British politicians – particularly those on the right – as the EU’s entire history is seen as a long silent revolution, whose final outcome is clear: a fully-fledged federal Europe. And the actual proposals for the first step towards en EU economic government won’t be tabled until October – and much can happen before then. As Cameron said, “You’ve always got to be on your guard” in the EU.

So for the EU’s ‘Big Three’, there is much to play for still.

The biggest victory of the summit probably belonged to Italy that  managed to convince EU leaders (or so the Italian government claims today) that aggregate debt, rather than public debt, should be the main criteria for the Stability and Growth Pact. Italian Prime Minister Silvio Berlusconi explains: “The aggregate debt criterion puts Italy in second place, while public debt puts us second to last”. If this principle were to be adopted, the UK would become the most debt-laden country in Europe (due to its high levels of private debt), while Italy suddenly appears awfully virtuous, as Euractiv explains.

At least one country leaves happy.

The Franco-German axis, which for so long has defined the European Union, has taken some serious hits lately. Following the trauma of the eurozone crisis, the relationship between the two countries is heading towards a historic post-war low – to the point that Angela Merkel and Nicolas Sarkozy are almost no longer on speaking terms according to whispers in Brussels. This wasn’t helped by Sarkozy’s comments the other week that “95 percent” of the bailout package deal agreed corresponded to French demands.

Today Wirtschaftswoche takes an interesting look at the strains, quoting one “experienced” CDU source saying that “In this government one can talk anti-French without being punished…that wasn’t the case at the time of [Chancellor] Kohl”.

Quite extrordinarily, the article also suggests that relations between Sarkozy and Merkel are at such a low ebb that “Merkel likes to imitate the vain behaviour of the little Frenchman, thereby making friends in her party laugh during the late hours.” Harsh!

Apart from the huge implications for the future of the EU, Merkel’s more assertive stance – and the power vacuum left by the radical weakening of the Franco-German axis – is also proving very confusing for journalists. Particularly anglo-saxon ones. In today’s FT, Philip Stephens is so perplexed by this new order that he desperately searches for some sort of familiar point of reference and finds….Margaret Thatcher! Stephens argues:

Mrs Thatcher spoke the language of the small shopkeeper from her native Lincolnshire. Ms Merkel, as determined as was Britain’s Iron Lady that Germany should no longer pick up Europe’s bills, has her own exemplar of the virtues of provincial thrift.

He also seems very pleased with his phrase “anti-European invective”, using it twice to describe what he sees as the mood in the UK and Germany – without engaging with any of the actual arguments about the sustainability of the current model for European integration. Stephens is obviously struggling to get with the programme. If Merkel sounds like Thatcher, what exactly is that a sign of? German taxpayers are potentially liable for some €120 billion in eurozone loans and have just seen the independence of the ECB kissed goodbye – after having been promised that neither could ever happen. Whining over the fact that the Germans are not acting like this is ‘business as usual’ just isn’t serious.

In Stephens’ eyes the whole world is turning ‘anti-European’, apart from Sarkozy and a freemasonry of like-minded Eurocrats in Brussels (to steal a phrase from a thought-provoking piece by Simon Jenkins the other day). His views sound almost…provincial.

A leader in today’s IHT is also struggling to come to terms with the changing nature of Europe:

Now, at the worst possible moment, Germany is turning to nationalist illusions. Europe’s past economic successes are now viewed as German successes. Europe’s current deep problems are everyone else’s except Germany’s. That is neither realistic nor sustainable. But German politicians and commentators are callously and self-destructively feeding these ideas.

Some journalists should really get out more and see some ordinary people outside of the political bubbles in a few selected capitals. A more sensible take on the situation can be found in the Economist’s Charlemagne column today:

Anger and denial are hardly surprising. Germans were promised that the single currency would be the old Deutschmark in new clothes, backed by Teutonic discipline and a fiercely independent central bank. Arguably, that fantasy Deutschmark died early on May 10th, when a euro-zone bail-out mechanism was agreed and the European Central Bank started buying government bonds by the bucket load. Germans are now in mourning. How they recover is not just their problem, but Europe‘s.

Now, we all prefer when people get along. But the broken Franco-German engine certainly opens up the playing field for new alliances in Europe – and for a new, more sustainable and healthy European agenda. Is the UK’s Con-Lib coalition government ready to go to work?