The news from Europe over the last few weeks has done nothing to shore up confidence that the debt crisis can be solved. The Greek government announced that growth is likely to shrink faster than originally anticipated. Squabbles over the second Greek rescue package continued. The Italian
government tinkered with its austerity package. And Finland demanded collateral before it pays for its part, which has triggered a round of 'me too' demands from other eurozone states. It's starting to look like infighting among the creditors in a bankruptcy rather than a rescue. It really would be funny, if it wasn't so serious.

The wider issue is that Europe's politicians seem to think they can hoodwink the markets. Italy has refused to undertake structural reforms. Greece has promised to privatise much of the economy, but hasn't sold anything significant. France has signed up to Germany's call for balanced budgets, yet hasn't balanced its own in 35 years. Markets are appropriately cynical. Europe's debt rescue plans are turning into a train wreck.

It's time to apply some logic to the problem. France is not supposed to be like Spain, Italy, Greece and Portugal. It's supposed to be on the side of the strong and, together with Germany, the core of the euro project (Germany and France make up 48% of euro area GDP). If France is suddenly considered suspect, the future of the entire single-currency looks even more dodgy than it did. The only real answer is total fiscal union. But currency unions rarely end well. Those that try to combine hard and soft currency nations are particularly vulnerable. Northern European countries are used at least to paying lip service to the puritan virtues of fiscal discipline, balanced budgets and a hard currency. But the peripheral countries, with their culture of Catholicism and the absolution of past sin, seem to prefer currency devaluation over austerity when it comes to dealing with past excesses.

The logical disconnect always was: how can so many diverse nations, histories, economic models and even cultural mind sets share a single monetary policy, a single interest rate, a single exchange rate? They can't, unless they accept a truly common fiscal union, with transfers from the wealthy parts
to the poorer.

So, let's strike off the outcomes that can't occur, so we can see more clearly what is the most likely denouement of the European crisis.

First, the impossible. No country can be expelled from euro membership, so Greece's departure would have to be at its own behest. Does Greece have incentives to leave? Well, leaving would mean it could restructure its debts. The new drachma would presumably be valued at a substantial discount to the euro, so foreign creditors would receive only cents on the dollar. Greece would be a pariah for a while. But eventually, with a convincing strategy and a free-floating currency, it could eventually borrow money again.

The problem here is the implications for the banks, especially French ones, who are heavily exposed to Greece. If Greece devalued, anyone who had lent to Greek residents - be they in the public or private sector - would suffer substantial write-downs. This wouldn't matter if European banks were well capitalised, but they're not. This inherent weakness of the banking system makes other potential 'solutions' impossible too. When Irish banks failed, enormous pressure from the eurozone persuaded the government to make taxpayers take the hit rather than bank creditors, because had the banks been made to take their losses, there would have been a Europewide bank crisis. The fact is that the preponderance of weak bank capital precludes any 'solutions' that would trigger write-downs.

The impossibility of pursuing options that would result in significant bank losses leaves only a limited set of prescriptions that Germany and France can write. One obvious solution is to issue Eurobonds, but it is fraught with risks: If soft currency countries could issue unlimited Eurobonds they could refinance themselves, but there would be no reason for them to stop there. So along with the Eurobond we would need enforceable rules governing how much debt countries could have.

Germany will ultimately set the rules (they like rules). France will get some insider influence but any country not willing to collect the taxes (Greece, Italy) or impose the spending cuts will risk being
subject to increasing foreign provisos and demands. That's a big stick. The only carrot that would make it worthwhile would be access to a Eurobond market. In the end, therefore, a Eurobond might be the only workable way to keep the impossible euro dream alive.

But it would be by forcing all involved to choose between a bad outcome and a worse one. That might mean a series of more overt crises before a comprehensive solution, including austere policy harmonisation, can be imposed. Until it is, the risk of a breakaway triggering Europe's version of the US subprime crisis is very real.

But other than this solution, more months of dithering without getting at the roots of the crisis will cause the eurozone to break up and its national economies to weaken. But for fiscal federalism to happen, Europe needs strong institutions with popular support. In this sense, the crisis is above all political. Europe owes its postwar prosperity to unity. To change course now is to put all that at risk.

From Britain's point of view, more integration is the last thing we need. We must not allow the EU to use the crisis to grab more power. Monetary union was always likely to lead to excessive borrowing and spending by some member states, and so it has proved. Some even promoted it because they knew it would produce a crisis that could only be overcome by full fiscal and political union. This must be resisted. The wreckage of the eurozone provides Britain with a golden opportunity to abandon the process of integration. We should seize it. Because, let's face it, the EU has become a disaster.

The eurozone is merely the most conspicuous symptom of its failure. It reflects a historic policy blunder by the rich, prudent, northern nations that linked themselves in a suicidal currency pact with the non-serious countries of south. An absolute UK withdrawal from Europe seems politically implausible and extracting us from its web of treaties and organisations would take years. But the alternative is we find ourselves parked in a siding alongside the EU hulk while the Eastern economies power past in their bullet trains.

Peter Parfait www.theideasfactory.com