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A European Cold War?

The refusal of Greek voters to accept Brussels' austerity measures are in danger of creating two opposing blocs within the EU, led by Germany and France

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French president François Hollande and German Chancellor Angela Merkel together at their first official meeting last month.

Europe is the world's most important economy. It is the second-largest trading bloc on the planet, the largest donor of aid, and a military superpower. Its aggregated public deficit will be three percent of GDP this year. Its welfare state has been a beacon for decades. It continues to exercise enormous cultural and social influence around the planet. It is the birthplace of democracy, and is also a major international financial center. With the exception of the Turkish invasion of Cyprus, and the conflict in the Balkans, it has enjoyed peace for more than 60 years. None of which is to say that it doesn't face a range of serious, deep-rooted problems. What's more, along with the United States, it is in the midst of a slow decline in the face of Asia's unstoppable rise.

The euro crisis has already cost the EU five years of growth, which will end up being a lost decade or more if the continent doesn't start working together to find solutions to its many problems. The first of these is that its power base is now completely fragmented, robbing it of any decision-making capacity both domestically as well as internationally, particularly at the fiscal level. The second problem the EU faces is the lack of faith that the peoples of Europe have in it, something that will be very hard to overcome. And thirdly, and perhaps most importantly, is the reality that the EU is still very much a work in progress; despite its name, it is far from being a union, and remains largely an economic community. What is missing is political leadership, and that absence is leading to a new cold war between Greece and Brussels due to their seemingly irreconcilable differences.

Brussels regards Greece as the source of the current crisis throughout the euro zone; a financial, economic, social and fiscal crisis, and one that like all crises, is now above all else a political problem - one that is fast spreading what former British Prime Minister Gordon Brown has called "moral bankruptcy." In short, Greece is a time bomb: its political parties have been unable to form a government in the wake of its elections less than a month ago, and the electorate will now have to vote again this month. Some of the parties that have taken center stage in Greece following the elections are threatening to abandon the agreements signed over the last two years by the previous government with Brussels and that have seen unprecedented spending cuts, which in turn have led to a depression. Brussels says that it is not prepared to renegotiate the agreements, and is threatening to cut off the cash that is keeping the country alive - just. In short, things have narrowed down to a cold war style standoff, and a growing number of pundits now say that this will lead inexorably to the break up of the euro and mutually assured destruction.

"The two sides, Athens and Brussels, both have the nuclear bomb; if Greece pulls out of the euro, it will spark a cataclysm; if Europe cuts off funding, then chaos is assured," said Alexis Tspiras, the leader of the left-wing party that looks set to win this month's elections in Greece, and which will be key to the future of the euro single currency.

There could be a civil war; a complete breakdown in society and the economy"

A senior figure within the EU hierarchy outlines Brussels' position in the following terms: "The outcome of Greek democracy has to be respected, the wishes of an electorate that has made enormous sacrifices has to be respected. But the other 16 democracies within the single currency also have to be respected, having provided some 150 billion euros to Greece in financial aid, and who signed an agreement in return for providing that help. Greece's exit would spark chaos: that is why the talk of contingency plans are absurd, of plan Bs should Greece leave the euro. We have to trust that this won't happen, but the decision is in the hands of Greek voters."

This is now pretty much the official line, with the Greek electorate regarded as hostages to fortune. The EU summit on May 24 reinforced this view, making it clear that Brussels was not going to offer Greece any concessions. For the moment, there is no carrot, only stick, until Greece meets its commitments. Then, and only then, might there be a relaxing of the timeframe to reduce its deficit and money would be released from the European Investment Bank and the EU's restructuring funds to get Greece's crippled economy walking again. But if the Greeks vote for a party that will not do as it is told by Brussels, then that is that. The end - regardless of the consequences.

Speaking ahead of the Eurosummit, Jacques Delpla of the Paris-based Council for Economic Analysis said that if Greece exits the euro the consequences would be more than merely economic: "There could be a civil war, a complete breakdown in society and of the economy. The drachma would be devalued by up to 90 percent. This would destabilize the Balkans and create a kind of Somalia in the middle of Europe." Goldman Sachs' scenario was less apocalyptic, warning that a Greek exit from the euro zone "would be anything but easy, and the consequences impossible to foresee." Nevertheless, Brussels remains impassive, and refuses to budge. "The EU wants Greece in the euro zone as long as it respects its commitments. We hope that following the elections, Greece will take that path," said a somewhat chilly statement at the end of the summit on May 24.

Greece is increasingly dividing Europe. The EU's richer nations - Germany, Finland, Austria, and to a lesser degree the Netherlands - see themselves as bearing a greater share of the cost of keeping Greece afloat - despite the fact that all member states are contributing on the basis of the size of their respective economies. They say that Greece must respect its commitments. Then there is the grouping made up of France, under its new Socialist Party president, Francois Hollande, Italy and Spain, supported by José Manuel Barroso and Herman Van Rompuy, the respective heads of the European Commission and the European Council. This faction is prepared to take a more flexible approach with Greece, perhaps with an eye on their own jobs should their electorates follow the Greek approach.

The current crisis has already cost the Union five years of growth

Hollande insists that Europe will have to continue reducing spending, but also wants to see measures to boost growth and create jobs. "Austerity is built into the treaties through figures, goals and red lines that could even lead to countries being brought before the EU's courts; but growth, for the moment, has only been talked about - not a single figure has been mentioned, and there is no fiscal pact. It is hard to avoid the suspicion that Hollande will change his stance when he has to get on with the task of aligning his country's debts to prevent the markets from toppling France," says one senior diplomatic source within the EU.

Spain and France want the European Central Bank to take immediate action to ease the pressure from the international money markets, something that Germany and its satellites refuse to budge on. Hollande and Italian Premier Mario Monti want to use EU money to attract private investment to the most troubled economies. Germany seems prepared to allow this, but insists that such use of EU funding would only be for pilot projects, and that further, detailed discussion is necessary to avoid wasting more tax-payer's money. The European Commission, France and Spain would like to see a longer timetable for deficit reduction to help countries in recession. Germany has yet to pronounce on this.

The differences between the two blocs become more appreciable when it comes to finding long-term solutions to Europe's problems. Van Rompuy wants to set up a latter-day version of the Delors Committee - a group of wise men who can look at how to take the European project into its next phase. This would involve a joint treasury, eurobonds, banking union with mechanisms to resolve crises, and guaranteed joint deposits, as well as an EU finance minister - in effect, a European superstate, a United States of Europe. But there are serious differences of opinion over what this would mean in practice, notably on government debt.

"The euro was weak from the start, because it was missing part of the crisis-prevention tools it required, and had none of the crisis-management tools needed. The decisions taken over the last couple of years have, to some extent, corrected these shortcomings," says Jean Pisani-Ferry, director of the Breugel think tank. "But in reality, the only outcome of Europe's weak political leadership has been a slight retouching of the building's façade: the euro will continue to be a danger while the design faults continue to undermine it," he adds in his book, The Demons Awake . He says that what is now needed is full economic integration to avoid the mistakes of the past based on growth in the north and lack of competitiveness in the south. This would require a common budget based on principles of solidarity and responsibility. It would also require political union to prevent integration from simply being a kind of enlightened eurobureaucracy running the show.

The euro was weak from the start, as it was missing tools for crisis prevention"

Germany undoubtedly takes the European project seriously, and the country has debated the issue of further integration extensively: Berlin has been lambasted for dragging its heels over offering help to Greece and other countries in trouble; it has been accused of blocking solutions by being overcautious, and for hesitating when action was required to handle the crisis. The fact of the matter is that so far, Berlin has refused to commit itself, and its measures to control the crisis are not working.

Now France has its chance to take the reins. "Hollande has some new ideas, and a will to find a solution, but it is only logical that Germany will want to have its way when it comes to fiscal union: when all is said and done, it is in charge, it has the money, and it has the feeling that its partners are trying to hoodwink it. It knows it is the backstop and it will not back down on making sure its conditions are met," says Alfredo Pastor of the IESE business school.

Germany, increasingly isolated, and leading an ever-smaller bloc due to the effects of the crisis, against a France that is gaining support, in some cases from unexpected quarters, such as Spain. That is where we are now, and the world is waiting for the standoff to end and for Europe to come up with an answer. The euro project is incomplete and fast degenerating into an elite, led by Germany and the triple-A economies, against the lower orders, represented by Greece and the so-called peripheral states. Can the project that Jacques Delors once described as "a genuine federation of nation states" ever come to fruition?

"The EU is irreversible, if for no other reason than the costs of dismantling it are beyond imagining. But the euro-zone partners are paralyzed and unable to make the move toward full union," says José Ignacio Torreblanca, a lecturer in political science at UNED university and head of the European Council on Foreign Relations' office in Madrid, and a fierce critic of Germany's handling of the crisis.

The crisis requires action, otherwise the money markets end up calling the shots. Paradoxically, what the money markets want most of all is some political clarity and answers to the following questions: What does Europe want to do with the euro? And, does it want to do it through joint action?