When the historians come to write up their accounts of Europe's sovereign-debt crisis, it may well be that this coming week proves to be the one in which a resolution is reached – at least pro tem.
Clearly it's dangerous, if not plain daft, to predict such seismic events, but there seems to have been such a mood change among the Continent's political leaders over the past week that it suggests they have finally got their act together to agree a deal which solves the eurozone muddle.
At the heart of the crisis, the problem has always been a relatively simple one – Angela Merkel would not play ball and underwrite a bail-out until she was convinced that those countries struggling with mountains of debt, such as Greece and Italy, would be able to demonstrate that they would – and could – stick to their austerity plans. Merkel knew that if she were to budge on this, she would not only lose her delicate electoral support, but German taxpayers would be in uproar over the injustice of hard-working Germans supporting the supposedly less-hard-working southerners.
But I also think Merkel had intuitively picked up on a more subtle reason why Germany couldn't take the high ground earlier in the crisis: she was nervous of a historically aggressive Germany being seen once again as the aspiring leader of Europe. That's why, perhaps, Merkel needed the other countries to submit to Germany's austerity drive without her own country looking as if it were in complete command. And, if you think back over the year, it rather looks as though Merkel has won that battle; since February, there have been five new governments across those eurozone countries – one by one the old guard have fallen and there have been new leaders first in Ireland, Portugal, Spain, Greece, and now Italy. It's in Italy, perhaps the most volatile of all the debt-ridden countries, that there appears to be the biggest swing towards a serious budget. The new Prime Minister, Mario Monti, demonstrated again last week that the country would certainly aim to cut its deficit within three years.
So why did the mood change so swiftly? First, there's the little detail of a looming credit crunch affecting the entire continent. You only have to look at the inter-bank lending market to see how frozen this has become. In fact, those banks which have excess money at the end of a normal trading day prefer to put their money with the temple of safety, the ECB, rather than lend it to each other as usual. That they are prepared to do this and so earn a pittance on their money – there's an annualised interest rate of just 0.5 per cent, rather than the 1.25 per cent or so they would earn if they lent to other banks – shows how scared they are. According to the ECB's own numbers, the overnight money on deposit with the central bank has risen from virtually nothing in September to about €300bn today. If you want to know what a credit crunch looks like, then that should be enough evidence.
Remarks from the ECB's Mario Draghi, that a "fiscal pact" could help pave the way for a tougher policy from the ECB to help contain the contagion also helped the change in mood. His hints of more aggressive bond buying, and even limits on the differentials – the spreads – between German and other debt cheered up the markets. It wasn't quite the offer of eurobonds that some people are pushing for, but it was a helpful sign that the ECB will play a bigger role.
Then there was the co-ordinated central-bank action earlier in the week to help improve dollar funding for the European banks starved of dollars over the past few months, as the US money-market funds have not been lending. This was yet another sign that the central-bank authorities – the inclusion of China was another positive sign – are likely to keep pumping liquidity into the system over the next few weeks until a deal is agreed.
But the big game-changer is that Merkel will meet with Nicolas Sarkozy in Paris tomorrow – ahead of Friday's summit – to come up with plans for an EU treaty change to boost fiscal integration in the eurozone to ensure tighter control over the budgets of recalcitrant countries. In turn, Sarkozy has also promised Berlin that Paris will accept stronger control over its national budget, and he may well need to recapitalise the French banks as part of any package.
Ironically, Sarkozy has been promising to reform France's archaic public sector but hasn't done so, either because he couldn't persuade his fellow politicians or didn't try hard enough. Now getting a deal with Berlin gives him the excuse, and no doubt helps him seek re-election next spring.
If the two leaders come up with a deal, then Merkel wins too – she can tell her voters that in return for underwriting the troublesome countries, those countries promise to stick by the new rules. Treaty change is not the only solution to this crisis, but if Italy, Greece et al can stick to their fiscal plans and get on with their own internal devaluations then it will be less painful than dropping out of the euro.
And now, I'm going to stick my neck out a little further and suggest that if Merkel pulls this off, she could turn out to be the most significant politician in European post-war history. Who knows, a new Bismarck?