John Lichfield: Cameron has played a poor hand badly

Britain's future? Proud isolation: like the Cayman Islands, but without the weather

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Britain is not leaving the European Union, just yet. But the EU may already have abandoned Britain. The fog of the Battle of Brussels, 8-9 December 2011, is still clearing. But psychologically and politically a Rubicon has been crossed, both in Brussels and in London.

The Prime Minister has played a poor hand very badly. He has put Britain into a position of deep isolation within the EU which even Mrs Thatcher in her "money-back" days skilfully avoided. He has given the circling sharks of the Eurosceptic backbenchers and press a taste of blood which could rapidly turn into a feeding frenzy.

Months of difficult negotiations lie ahead in which Britain will find itself willingly cast as the villain by our anxious European partners as they struggle to avoid the collapse of the euro. In such a febrile mood, in Britain and on the Continent, the possibility of a de facto, or even actual, UK departure from the EU is no longer unthinkable.

Past EU-UK battles have been about important but fundamentally secondary issues, such as farm policy or budget contributions or "mad-cow" beef exports. Mr Cameron has managed to manoeuvre himself into a position of Britain vs the Rest on the most fundamental issues of all: the survival of the euro and the EU itself.

The Prime Minister was presented in the European media yesterday as a kind of wicked fairy. He did not want to go to the proposed, new euro-27 treaty ball. That was his right. But to please his party's Eurosceptics, he refused to allow the others to hold the ball unless they gave Britain, or rather the City of London, an "unwedding" present.

He wanted Britain to become a kind of Cayman Islands within the EU: enjoying the benefits of being part of a European single market for financial services but not subject to EU oversight or regulation. The other leaders could not accept that. Mr Cameron knew they could never accept that.

Most of the Rest went ahead instead with plans for a separate, looser inter-governmental treaty on budgetary discipline and not-quite-fiscal-union for the 17 eurozone countries. Other non-euro-countries can sign up if they wish. At least six have said that they will do so, leaving Britain in a minority of at most four (with, conceivably, one or more of Hungary, the Czech Republic and Sweden) and most likely in a minority of one. The 23 – or maybe more – countries which join the new machinery will hold monthly meetings and, while the crisis lasts, monthly summits. They will be able, in some cases, to agree on common positions affecting UK economic interests and then impose them on the full EU by majority vote.

If Mr Cameron had not played the bulldog for the domestic gallery, a looser "treaty of the 17-plus" might well have been the outcome in any case. By making maximalist demands for the City (and the Eurosceptic right), the Prime Minister allowed several countries – France included – to avoid the pitfalls of a new EU treaty and to shelter from the new-found, federalising zeal of Chancellor Angela Merkel. There is, however, a psychological gulf between a consensus EU decision to go for this "second-best" intergovernmental treaty and a decision forced by, and blamed on, Britain. Arcane and nasty battles lie ahead on how the new "fiscal compact" can be run and policed.

Will David Cameron continue to demand Cayman Islands status for the City as the price of UK agreement that the EU institutions should police the new intergovernmental rules for euroland? If he refuses, the "fiscal compact" could be threatened, tipping the euro, and the European and British economies, over a cliff. If he gives way, the Eurosceptic lobby – hysterically immune to the argument of overriding European and British interest – will try to destroy him. It remains to be seen whether the "fiscal compact", to be finalised by March, will impress the markets and persuade global investors to start buying once again the sovereign debt of euroland countries. The first signs yesterday were not encouraging.

Markets are still looking stubbornly for a sign that the European Central Bank will be prepared to print cash to guarantee sovereign debt (as the Bank of England and US Federal Reserve have done). Both Germany and the ECB are still refusing, at least publicly. The euro could yet collapse, threatening to bring down the EU. A "stronger" treaty of the 27 might (or might not) have been more plausible for the markets. If investors do turn up their noses, Mr Cameron will become a convenient scapegoat for France and Germany and others.

The true national interests of the UK demand that we should remain a central and respected part of the EU to defend common European political and economic values in an increasingly menacing world. A treaty of 27 would not have forced new fiscal discipline on non-euro members like Britain. It would have allowed the Government to continue to shape EU policy – including financial regulation – from a position of influence within the Union.

What we now face is not a two-speed or two-tier Europe but a Europe of Britain vs the Rest.

Britons, in their new isolation, will doubtless stand proud. Like the Cayman Islands, minus the weather.

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