It’s a dangerous game of chicken: the fear and loathing in Europe is driving stock markets down, forcing bond yields on Italian and Spanish debt up to pre-”easy money from the ECB” levels and even President Hollande can’t get to Berlin without his plane being hit by lightning. Götterdämmerung in der Eurozone.

The chaos resembles last night’s battle on the terraces at the Bundesliga relegation play-off between Fortuna Düsseldorf and Hertha Berlin (incidentally, grabbing the headlines from the awkward Merkel-Hollande first date). Amidst it all, Greeks are taking fright at this high-stakes series of bluffs and heading for the ATMs – withdrawing €800m-plus in a foretaste of what would happen if Grexit really took place or were even about to happen.

A run on Greek and, maybe, other banks would be one consequence of a Greek pull-out/throw-out of the single currency. Bondholders of more than €400bn in Greek sovereign debt would suffer horrendous losses if Athens were forced/chose to move back to the drachma. Hans-Werner Sinn, head of the Ifo economic think tank in Munich and a proponent of Grexit, has calculated the cost to the German state at €80bn (though he thinks Greece staying in would cost it more). A team at the IESEG School of Management in Lille says it would cost Germany around €90bn and France €67bn: see Evans-Pritchard’s Telegraph blog.

What’s more likely is that Grexit, especially if it could not be contained and, instead, provoked further assaults on the currency, would cause untold damage throughout Europe and elsewhere. Greeks, who have already suffered between 25% and 40% cuts in living standards, seen national output decline by a fifth, watched their young people flee a 54% jobless rate to northern Europe, would face inflation of 50% or more, unpaid pensions and salaries… The country, one minister has warned, would be engulfed in civil war…

In the wider EZ, in the event of a general break-up, this could be the outcome as envisaged (in a report last year from UBS): Depreciations of up to 60% occur.

Weaker countries slide into slump as capital inflows cease, runs on banks spread, unemployment reaches heights last seen in the 1920s, companies collapse in the midst of a worse credit crunch than in 2008, protectionist tariff barriers are re-erected, hyper-inflation swiftly becomes stagflation, ultra-right-wing, populist, xenophobic movements/parties win wide support in arguing that the Germans are about to buy up the whole shooting match. UBS calculates that the net cost per person is €9500-11,500 or 40-50% of GDP in Y1.

Even the stronger members, desperately trying to shelter behind a new common currency, the Euro-Thaler, are submerged by the economic/financial tsunami that follows. The thaler appreciates so much (50%) Mittelstand exports are wiped out, hundreds of thousands of jobs are lost, banks thought sound are forced to admit their exposure to “southern” assets and re-capitalise, capital controls are imposed to slow down influxes; border controls are re-introduced to prevent foreigners flooding the home country, the far right wins more and more support, the scourge of ethnic cleansing returns to Europe. Germany, whose inflexible orthodoxy helped sink the ship, is forced out of the EU and loses 20-30% of its GDP or €6000-8000 per person in Y1.

Charles Dallara, who negotiates on behalf of a majority of private bondholders, told Channel 4 News this week that the threat of global recession is one reason why EU/EZ leaders will make a last-ditch effort to keep Greece in – as HoMer/Merkollande indicated in Berlin last night. Another sage set of explanations is set out in La Stampa (English translation here). Another view, tweeted incessantly by Nouriel Dr Doom Roubini in recent days, is that Alexis Tsipras and his Syriza win Greece’s June 17 re-run election, default, exit the euro, switch to the drachma, turn euro-denominated debt into drachmas and, lo, eventually, there’s growth and jobs – certainly on a shorter time horizon than the post-2020 scenario envisaged by Olli Rehn. That seems an intelligent economist’s facile dream.

The nightmare brought by Grexit is the more likely scenario – and that’s clearly the view at the Treasury/Downing Street. Tsipras and his counterparts are holding a gun to the head of EU/EZ leaders with the words: We dare you; you can’t kick us out because you’d go down with us…Merkel et al reply: On your heads be it; 78% of Greeks favour staying in the euro so they should vote in parties supporting that position. In that event, well, maybe, we’ll tweak the bailout terms…For Nucleusthe stakes in this high-risk game of bluff are plain: Greece within the euro remains the more likely option and one that the UK and Europe as a whole should strive to sustain.

The Eurozone crisis changes everything. If by the end of the year, the Eurozone is left limbless and the economy sits in deep freeze, the binary in/out argument for continuing EU membership will no longer be left just to Nigel Farage and the Tory Bufton Tufton’s out in the shires. If enough Tories don’t see that Margaret Thatcher’s continent-wide single market baby is worth protecting, which they don’t, then it won’t be long before they ask the people to foster it to the evil uncles in Brussels.

Such is the increasingly slippery slope to the final reckoning. First we had theMandelson referendum speech last Friday, then we had the Spectator’s James Forsyth suggesting the Tories would hold a post-renegotiation referendum as a ‘certainty’. Today the UK media again focus on a possible referendum. The FT, Guardian, Daily Mail and Sun all report that Shadow Chancellor Ed Balls has promised to consider holding a referendum on UK membership of the European Union, claiming that:

“Whether there could be a case for there being a referendum more widely on Britain’s relationship with Europe as a new settlement evolves…that might be an issue whose time comes, but I don’t think that that is now.”

But the time may come quicker than anyone thinks. There are three things to consider here. The first is that all parties understand that Britain’s relationship with Europe is being fundamentally changed by the eurozone crisis, since it is both destroying the pro-Europeans hope that pragmatic Brits would always vote to be in a successful single market and it is underpinning eurosceptics’ predictions that the single currency members will forge a much closer political union with the UK on the outside. The squeezed eurorealist centre ground is losing out because the chief winner from the single market – business – is too frightened to be pushed above the parapet to say the unsayable: yes, Britain must stay in Europe to finish the job we started. We must forge the biggest single market in the world and we have allies who want and need us to do this job. But fair enough. It should be the politicians who make the case. They don’t because they are utterly clueless about how to respond to the relentless incoming artillery fire of EU fraud, waste, red tape and superstate pomposity from the papers their Bufton Tufton’s read. They are not given practical ammunition by anyone – not even the EU itself which would rather talk big than fight dirty.

The second fact to consider is that neither the PM or the Labour leader want a referendum. The last thing they want is to demolish the flawed but essential structure that enables them to win friends and influence people in the places that matter. The British people are of course never told that London is far from the surly runt in the European pack. Awkward, churlish and relentlessly suspicious of big ideas (like the euro), the UK can still command the agenda and build alliances. There would be nothing that Germany would like less than for Britain to abandon Europe to Latin backsliders and nothing France would like less than for Britain to abandon France to Germany. Surrounding this troika are allies for the picking. A referendum that says no ends 56 years of British foreign policy. So, since there is no Plan B, the status quo is always best. But referendum talk may become a self-fulfilling prophesy because politics will always trump policy. The Tories see a way to dish the kippers and Labour sees a way to get back their lost white working classes. In the tussle for power in 2015, diplomacy can go hang.

The third thing to realise is that this is a genuine tragedy. Not for the Eurozone which (but for the Germans) has the solution to their problems if only they had the courage to accept the logical inevitability of the currency union – fiscal union. But for Britain. The Times today reports the view of the former US Ambassador to NATO in which he lambasts Britain’s foreign policy as incoherent…

“Prime Minister Cameron’s coalition Government has yet to develop a coherent strategic vision for the United Kingdom’s role in a changing global landscape,” it says. “His coalition has downplayed the term ‘special relationship’ with the United States at the same time his Government has weakened its ties to Europe.

“[Mr] Cameron’s handling of a decisive December 2011 European summit threatens to leave London isolated as Europe pursues further fiscal integration. Aside from pursuing a policy of ‘commercial diplomacy’ and robust development assistance, British foreign policy vision and strategy remain unclear.”

This is not what people should expect from a Cameron-Clegg duumvirate. History has a habit of punishing drift. Usually the people, demanding firm leadership, fail to get it and become beguiled by easy options. Edward Grey and Neville Chamberlain may have brought war closer in 1914 in 1939 simply because Germany was utterly unclear about how Britain would jump in the event of a crisis. We are at that stage now. Unless a clear view is pushed that Britain must lead in Europe at the very least to achieve the completion of the single market then the portmanteau for Greek euro exit might be followed by another sad word, Brexit.

It was far worse than Angela Merkel imagined: her CDU slumped to its worst post-war result in Sunday’s NorthRhine-Westphalia poll and scored just 26.3%. The social democrats (SPD) scored 39.1% and the Greens 11.3%, giving what had been a minority red-green government an absolute majority. The CDU’s top candidate, her environment minister, quit straight after the scale of the debacle became known shortly before 1800BST yesterday (Sunday).

The scale of defeat is a bitter pill for the German chancellor as she prepares to meet the new French social democrat President, Francois Hollande, tomorrow (Tuesday) just two hours after his inauguration on an anti-austerity platform. The fact that the Liberals, the FDP, her coalition partners in Berlin, defied the pollsters and won 8.6% of the vote – as thousands of CDU voters switched to it – is no consolation; it enables it to distance itself from her.

What’s more, the vote was a resounding raspberry to home-made austerity policies which have seen savage declines in living standards in regions such as the industrial Ruhr around Düsseldorf, Dortmund and Essen. The question arises: is this also a big No to European austerity policies and Merkel’s fiscal pact? Lots of Anglo-Saxon commentators believe the answer is: not necessarily or even a plain no. Germans, pointing out that the CDU campaign was primarily an attack on red-green over-spending/deficits and had at its core the demand for “debt brakes” – or constitutional barriers to deficit spending Germany is now imposing on the eurozone as a whole -, says yes.

Certainly, Merkel and her finance minister, Wolfgang Schäuble, now realize that the domestic agenda must embrace wage rises and, if necessary, above-average inflation to boost domestic demand for goods and services from southern Europe. Schäuble spells out ahead of Hollande’s visit and his own election as eurogroup chairman tonight how austerity and growth policies can be married in the French media.

Certainly, too, last night’s election result is a further boost to the pro-growth camp in Europe – as even the UK coalition government and its Labour opposition understand (see David Seymour for Nucleus today). UK bond rates may be at a record 300-year-low but – as the Greek tragedy reaches yet another messy dénouement – the country needs sustainable growth across the Channel more than ever to prevent a 1929-style slump.

Inexorably, it is dawning on a number of great British opinion-formers that if Greece falls out of the euro, the catastrophe that ensues will eclipse this country, too.

Nucleus has been warning for some time that those who have been prophesying with glee that the Greeks would bring about the collapse of the single currency should be careful what they wish for.

George Osborne – who is certainly no europhile – understands what the consequences would be for the UK, which is why he promised billions more to the IMF knowing that much of it would be used to bail out struggling eurozone countries.

Today in The Times Vince Cable is warning that a “massive” impact awaits Britain should the eurozone fail to contain the turmoil sweeping the Continent.

The Times describes this as “the bleakest prediction of the UK’s economic vulnerability to date by a senior minister”. It shows the Government has been forced to acknowledge the threat to our economy.

It isn’t only politicians who are sounding the alarm. Remarkably the Daily Mail suffered a double dose of euroreality on Saturday, not only from Simon Heffer but in its editorial, which said:

“With half our trade depending on EU markets, it’s nothing short of insane to pursue politics as usual at home, as if developments in the rest of the continent had nothing to do with us. For even if a country as small as Greece were to drop out of the euro…the knock-on effects would shake British banks and businesses. And [if there were a] more general meltdown, the shockwaves would be calamitous.”

The Mail added: “It is far from improbable that the City would be forced to seek further bailouts from taxpayers already being squeezed to suffocation.”

Heffer wrote: “Anyone who thinks Greece’s withdrawal from the eurozone would solve the problem is deluded…We cannot be complacent about what might happen if Britain was to lose a substantial chunk of [its exports to Europe] when some of our EU partners hit the economic rocks.”

After years in which there has been little if any sensible debate about Europe, at last it is possible to read balanced arguments (though the Telegraph and Express are still running hysterical nonsense today).

It is highly significant that Peter Mandelson and Ed Balls have united in today’s Guardian to explain why they are breaking the habit of a lifetime by agreeing on Europe.

They write that although they disagreed on the case for British membership of the single currency, they do agree that it needs to survive and succeed.

They explain: “The reality is that there is no bad outcome for the eurozone that is not a bad outcome for Britain.”

Balls and Mandelson go on to say that this is a perilous time for the British government to be increasingly isolated and politically disengaged, adding: “Britain should be influencing the debate on the future of Europe, not locked out of the room where the big decisions will inevitably be taken on issues that directly affect our economic interests.”

This may well be a view which has already been considered in Downing Street.

Two decades ago, in the wake of reunification, the then German defence minister, Volker Rühe, officially opened the Bendlerblock as the Berlin seat of his ministry. It was a highly symbolic ceremony: the building was the HQ of those brave if foolhardy Wehrmacht officers who led the July 20 1944 plot against Hitler at the Wolfenschanze and were summarily executed in its courtyard. In the event’s margins, this correspondent and senior German officers discussed their country’s new military role – amid considerable soul-searching on their part.

The first Gulf war had taken place, greeted by a new generation of Germans with huge demonstrations in Bonn’s Hofgarten, scene of the anti-Pershing missile protests beforehand, and banners hanging from windows everywhere: “Nie wieder Krieg” and “Kein Krieg für den Oel“. Rühe, publicly, and his senior staff, privately, had to argue very cautiously indeed for a change in outlook: specifically, for German participation in any “out of (Nato) area” military operations. Many of those officers present at the moving ceremony would have wanted to take part in the Gulf operation but acknowledged that it was politically and constitutionally impossible.

A decade later the then Chancellor, Gerhard Schröder, banned Germany from taking part in the second Gulf war and, specifically, the operation to remove Saddam Hussein. It was a watershed moment for Europe: France also refused to take part; the UK, of course, gladly joined… Yesterday, in Berlin, Philip Hammond, British defence secretary, tried to persuade Germany and Germans to overcome its “historic reluctance” to act “out of area” – not just “beyond its own borders” as this report in the Telegraph erroneously says.

The ban on such overseas operations was, in fact, lifted by the federal constitution court in 1994 so Hammond is, in a sense, knocking at an open door. But each one must now be approved in advance by a simple majority in the Bundestag – and this can be hard to achieve as we have seen with respect to the “peace-building” deployment to Afghanistan (less so, obviously, with the anti-piracy operations off the Somali coast). The politics in favour of an enlarged German military role commensurate with its economic might are, well, not easy. (Germany may well have overcome its “economic giant, political pygmy” soubriquet inside Europe, but not outside it).

Hammond’s speech in front of Thomas de Maiziere, his German counterpart and ex-chief of staff to Angela Merkel, so a key player, and subsequent briefing for Bundeswehr officers has several purposes. First, it is a gentle reminder that, proportionally, Germany spends half as much of its GDP on defence as Britain and France – 1.3% versus 2.6% and 2.3% respectively according to SIPRI. Berlin, enjoying a primary budget surplus in stark contrast to London and Paris, can simply afford to devote more cash to Europe’s defence/military missions. (Since July 2011 it has an entirely professional Bundeswehr since conscription ended then).

Second, in the run-up to the Nato summit in Chicago, it’s a blunt reminder that the US’s strategic vision is firmly directed at the Asia-Pacific, especially China; Europe is no longer a strategic theatre, or virtually not. For the Obama White House, Europe is rich enough not only to sort out its debt crisis, but to pay for its own defence. It’s a message that – so far as one can tell from a cursory reading of the German press – went unnoticed. But it’s one that Obama and his team will want to press.

Germany – the main topic of last night’s televised slugfest between Hollande and Sarkozy in a way – is learning that flexing its economic muscles brings unstoppable demands on it to commit more military as well as monetary bang for its buck…

“The crisis consists precisely in the fact that the old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear.”

So said the Italian sage, Antonio Gramsci, as he explained away Mussolini’s rise. The UK government watches on as morbid symptom number one unfolds: this week voters will reject austerity, but their democratically elected leaders will be precluded from providing growth. As Merkel faces the French and Greek people how can this logjam be broken and can the UK do anything?

Growth gurus are this week seducing politicians with another big bazooka solution. As Robert Kuttner, co-editor of The American Prospect, says,

“It is not difficult to imagine a growth agenda. Some European countries have very large deficits, mostly the consequence of the recession itself. But the Euro zone as a whole has plenty of room for fiscal expansion. The EU as a whole needs to launch a massive development program in the spirit of the Marshall Plan — the Spanish newspaper EL PAÍS writes that senior leaders in Brussels are talking of such a plan in the range of 200 billion Euros.”

So can Germany swallow another quick fix?

Worried that Hollande’s campaign has surged on this Marshall Plan growth splurge in direct contradiction to Berlin’s fiscal pact, the Germans are mobilising to counter French manoeuvring, courting Mario Monti in Italy and Mario Draghi at the ECB, united in the mantra that “there is no alternative to fiscal consolidation.” Although Monti last week warned that the austerity drive risks shrinking the euro area economy and leading to a double-dip recession, he was careful to steer away from direct criticism of the German chancellor. As David Marsh, co-chairman of the Official Monetary and Financial Institutions Forum, says,

“that was probably wise. Italy may well find itself in need of an EMU – for which read German – bail-out if the country’s bond yields continue to rise and the economy continues to contract.”

All well and good, but Berlin suddenly faces a democratic lose-lose scenario which trashes its beloved fiscal pact and leaves Europe sleepwalking. First, austerity will have the people’s thumbs down from almost all Europe soon. The longer austerity is maintained and increased without any seeming benefit in terms of growth, the wider the opposition will be. Britain’s double dip makes it the twelfth EU member state now in recession. Second, with Germany closely identified with the austerity policy, austerity fatigue will erode German influence over the euro area. This is even more likely as German politicians, frit of their own voters, refuse to do the one thing that could justify and alleviate the impact of austerity on others, namely stimulate Germany’s own economy and, crucially, re-orientate it towards greater domestic demand.

Says David Marsh: “At the moment, Germany is getting the worst of two worlds. It is imposing austerity on other countries, which among other things stops them from buying German goods. And it is making these countries adversaries, by seemingly enforcing a ‘pain but no gain’ policy. Neither can be a good idea for Germany.”

So the question is how long can Germany resist the unpleasant truth that, as it hangs onto its pennies, it loses its moral and political authority.

Is the Marshall Plan another idea to nowhere?

Possible not and nor is it new. Ian Traynor explains the growth thinking in Europe:

“The “project bonds” idea has been pushed for ages by the European Commission and its boss, Jose Manuel Barroso. He wanted to use bits of the EU budget the same way. Now this is emerging as the lowest common denominator compromise for avoiding a Franco-German clash (Hollande-Merkel) over growth and austerity.”

Currently, there are few details on the plan available but the main mechanisms for achieving the funding seems to be to increase the European Investment Bank capital by €10bn, which it is claimed would boost the lending capacity by €60bn and overall investments by €180bn and use the remaining €11.5bn in the European Financial Stability Mechanism (EFSM) as initial capital to be leveraged in the private sector.

Does George Osborne, so clear that the Eurozone crisis is the cause of the new UK recession, endorse this Keynesian scheme to mitigate the pain of austerity? Well, as high speed rail proves, he is not averse to pump-priming infrastructure projects at home. And the Marshall Plan would be an EU scheme rather than just a eurozone one with proportionate access and funding. This also means that as a contributor to the EIB and EFSM, the UK would have to be involved in the whole thing which would awaken the beast that is Bill Cash in Westminster. Worse still for Numbers 10 and 11, Parliament is yet to vote on ratifying the permanent euro bailout fund (European Stability Mechanism).

As the government tears its hair out at the prospect of another European bust-up, Nucleus sees this as an opportunity to practice and preach the growth agenda in Europe to avoid the impression of British powerlessness over the Eurozone car crash. So far, we have half the EU supporting Dave’s single market letter. Now, it must be time to put flesh on the bones of the European message by supporting Eurozone growth in order to avoid stagnation at home. Even Open Europe says:

“In principle this could be a positive idea for Europe – we like the focus of the investment and if it is conducted in the right way, it could be worth the UK participating. However, it’s hard not to be slightly sceptical about how Europe tends to go about these kinds of schemes, which could instantly undermine that case.”

Back to Gramsci: the new cannot be born unless the morbid symptom is cured. This is no time for the luxury of being ‘slightly sceptical’ when the answers are obvious.

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“A new pest has arrived from the Continent,” an expert from the RHS at Kew told worried Today Programme listeners this morning. It’s a hairy caterpillar, which can provoke asthma attacks and skin rashes in humans, but it also serves as a metaphor for the euro-bacillus afflicting these shores. Right on cue the latest UK manufacturing sector PMI (purchasing managers index) shows a further downturn. It’s all Europe’s fault, we hear the cry from besieged Downing Street 10 and 11.

Today, May Day, the Continent is on hols – or out on the streets, as in Athens, demonstrating against austerity or, as in Paris, staging huge rallies in the run-up to Sunday’s presidential elections second round. In Germany the huge engineering union, IG Metall, is limbering up for a series of stoppages (Warnstreiks) from tomorrow in pursuit of a…. 6.5% pay claim for 3.6m employees (after public servants won 6.3% in March). After years of accepting declines in living standards, a prime source of Germany’s economic recovery, the unions would like to see the fruits of growth shared more equitably.

The arguments around growth and austerity, long-term structural reforms and shorter-term monetary easing, project/infrastructure bonds and spending cuts, are moving into a higher gear. In the FT Wolfgang Schäuble, German finance minister, goes back on the offensive in favour of “fiscal consolidation” and praises the new Spanish budget (no doubt forgetting that it ensures that youth unemployment hits 60%). Schäuble, almost certain to be the next eurogroup (EZ finance ministers) chairman after Jean-Claude Juncker, says it would be a “mistake” to see talk of growth as “a change in direction”.

That’s a clear signal to the markets – and blunt warning to M Hollande – that Germany’s not for turning. Opining from his Southwark comfort zone, Gideon Rachman effectively and patronisingly sides with German “austerity ayatollahs” in ridiculing Hollande’s pro-growth agenda as “vacuous slogans” and a demand for surplus countries to go on a “consumption binge”. (The Pearson news stable – see the latest Economist cover story here – appears to have dismissed Hollande before he’s even won or set out his plans in favour of…Sarkozy whose new campaign slogan is: “Too many immigrants”). We all favour structural reforms but their short-term impact is to depress output and jobs – and even the unimpeachable markets know that some short-term stimulus is required and that includes some boost to German domestic demand…Here’s an early and rather modest proposal for a “growth compact” from the think-tank Re-define.

There’s talk now of an informal EU summit brought forward to June 1 or three weeks after Hollande – barring an extraordinary upset – enters the Elysée. The only item on the agenda should be how to get Europe out of what a Le Monde columnist is calling “death in the ruins of neo-liberalism”, and restoring hope. That, of course, will require political leadership of a kind entirely lacking in recent months and years.

Coming this week to the Eurozone bust-up: Greek and French general elections, local elections in Italy, the Irish referendum campaign, the fallout from the fall of the Dutch Government and a meeting of the European Central Bank. Little wonder that the PM in his Andrew Marr interview yesterday returned to the euro stage to warn that the eurozone was not halfway through its difficulties. To raspberries from across the Channel he hinted that the euro may not survive, expressing a frustration shared in Washington and other world capitals that a big financial “bazooka” to defend the single currency remains stillborn:

“It’s going to be a very long and painful process in the eurozone as they work out do they want a single currency with a single economic policy and all the things that go with it, or are they going to have something quite different?”

His intervention underscored the concern in No 10 over the potential for the euro emergency to torpedo a British economy struggling from a double-dip recession. And the PM should be on top of this for three reasons:

1. If Hollande wins the mood music changes

Political infighting over Germany’s insistence that euro area governments slash borrowing as rapidly as possible is growing rapidly. France’s Socialist presidential contender, François Hollande, has called for the Merkel’s ‘fiscal compact’ to be renegotiated to inject pro-growth elements. Mario Draghi, president of the European Central Bank, is promoting a “growth compact”, which has gained currency in some EU capitals. For two years the PM has endorsed both ideas. He backs Merkel’s rigour and promotes economic growth. The question is whether these two ‘compacts’ can be reconciled if Hollande wins. Bill Emmott in The Times says,

“In principle, they can indeed be reconciled. The means of reconciliation need to come quickly, probably in the form of his first phone calls and meetings with Angela Merkel, Germany’s hardline but strongly pro-euro Chancellor. What he is likely to want is a pact that Germany will find hard, but not impossible, to accept. Senior German figures, including politicians and officials surrounding Mrs Merkel, know that the eurozone’s current course is not sustainable. Fiscal austerity is unavoidable given the doubts held by investors about the solvency of Greece, Spain, Italy, Portugal, Ireland and even perhaps France, but it is bringing about a deepening recession that is also making continued austerity appear untenable. Something needs to change.”

He expects three solutions:

“The first would be a Greek default and exit from the euro, with an accompanying package of financial support from the European Union and the IMF. The second would be a eurozone-wide plan for publicly financed capital investment. The third would follow the proposal tabled in February by Mr Cameron and Italy’s Mario Monti, along with nine other European leaders, to launch a liberalisation drive to extend the continent’s single market and thus stimulate private investment.”

Will this actually happen? So far, every time the euro has come to a fork in the road, its leaders have just carried straight on. But the French election could be the moment when that changes. If he does try to pick a fight with Mrs Merkel, President Hollande simply could not afford to enter into a lengthy battle while the markets destroy what is left of France’s financial credibility. But it is not hard to see how a redrawn “fiscal and growth pact” could allow Mr Hollande and Mrs Merkel to claim victory and keep the Franco-German motor running. As David Charter says also in The Times:

“The current argument over the fiscal pact is the same as the one that took place in 1997 between a certain Dominique Strauss-Kahn, then France’s Socialist Finance Minister, and Theo Waigel, his conservative counterpart from Germany. Mr Waigel had drawn up a “stability pact” as a condition of German agreement to the single currency. Mr Strauss-Kahn argued for a “growth programme” to protect workers from what was seen as a recipe for austerity. The result was the “stability and growth pact” that saved face for both sides and set the rules for deficits and borrowing that are now being modified by Mrs Merkel’s fiscal pact.”

Britain could be positioned to act a non-playing honest broker between Paris and Berlin if anyone is the Bundeskanzlei and the Elysee would care to listen. Alas, yesterday’s pooh-poohing of Dave’s ‘I told you so’ comments would suggest they won’t. But he should insist.

2. Merkel is isolated and Germany must decide if it wants the euro to survive

Whatever happens, Germany needs to make a definitive decision to both transfer funds to the indebted economies and stimulate the demand of its own consumers and businesses for traded goods. This will be a tough decision, but the collapse of the eurozone would be a disaster for the growth prospects of Germany — and indeed of the UK. However, ‘growth’ proposals likely be aired by the “Ecofin” council of finance ministers on May 15, will bring stark divisions over fiscal strategy into the open. There is speculation that a “Latin bloc” – with allies in core Europe such as Austria – could try to force a rethink on austerity if François Hollande is elected. Ambrose Evans-Pritchard in the Telegraph says Mrs Merkel will have torelearn the forgotten art of compromise. He believes:

“This then is the birth of a Euroland growth bloc with well over 200m people and a commanding majority vote in the European Council, a defining moment in this saga. Unable to dictate terms, she may struggle to deflect the ruinous implications of monetary union onto other EMU countries for much longer.”

The Latin Bloc might politely tell Berlin: acquiesce in the new landscape, or expect Latin Europe to take matters into its own hands and bring about the fiscal, monetary, and exchange conditions needed to safeguard its societies – entailing a very nasty shock for German banks and exporters. In any event, the real question is whether Merkel can continue to withstand the hostility around her. Even her potential partners after the September 2013 election would impose Eurobonds tomorrow if they could. It must be getting lonelier in Berlin.

3. The politics are dangerous

Next Sunday’s elections in France and Greece might be about to send the eurozone countries in a turbulent, anti-Merkel direction creating a new period of panic in the financial markets that could again bring the euro to the brink of disaster, as David Cameron has warned. Whatever the economic problems, it is people – mainly the low-skilled and poorly educated, the supposed losers from globalisation—who are most openly in revolt. For them European integration is not the solution, but the problem. Greece’s election on May 6th will reveal deep resentment over the severe recession that austerity has brought as will Ireland’s May 31st referendum on the fiscal compact.

Whilst Merkel can stonewall the Keynesians, could she live with being the woman who not only destroyed the euro but also destroyed peace and solidarity in Europe? In both France and the Netherlands, between one-fifth and one-third of voters support extremist parties that oppose European integration, globalisation or both. These forces are deemed to have brought wage-sapping, job-destroying competition. The far right adds that they have also brought welfare-grabbing immigrants, above all Muslims. With European leaders expressing alarm about the rise of extremists and populists, one German daily, Handelsblatt, asked in a front-page headline: “Is Europe failing?”

Merkel may see the general election in Greece on Sunday (just as last Sunday’s in France) propel parties of the extremes to big electoral gains. If the Dutch election in September sees a surge of support for both the left and the right – which are united in their rejection of her policies, she would find it impossible to deny that the rise of political extremism in Europe is in part the consequence of stubbornness and stupidity among German political elites.

So it is time for the UK to stop cowering in its post-December 9th shadow. It is certainly time to make his message clear: the UK believes in growth and stability as the solution to the Eurozone crisis. It is also high time he rebooted his diplomacy in the face of likely political and social upheaval to come. When Mats Persson, Eurosceptic director of the Open Europe think-tank, thinks Dave’s latest euro comments are “unwise” and recommends huge scope for improvement in diplomatic relations, you know something is wrong.

If eurosceptics are calling for better British leadership in action, perhaps No 10 should listen.

Parliament’s International Development Committee today publishes its report on EU development assistance. The Committee of MPs found that over 50% of Europe’s development aid budget is going to “relatively rich” countries like Turkey and Serbia, and warned that this situation “could devalue the concept of aid”.

The UK, in addition to its own widely lauded international development and foreign aid programmes, gave £1.23 billion in aid via the EU in 2010.

International Development Secretary Andrew Mitchell recognised the criticisms, but argued that the EU is“already reforming the way it spends aid, making it more transparent, results-focused and targeted at the poorest people”.

The report adds to the criticism of the EU’s development aid approach, following the Organisation for Economic Co-operation and Development (OECD) peer review, published on Tuesday, that said European Union development co-operation is “improving, but still cumbersome”. The review warned of the strong possibility that the EU will miss its target of boosting collective aid to 0.7% of gross national income by 2015 because of financial pressures.

The OECD also called for the EU to develop a more cohesive approach to development aid and speak consistently with a unified voice or risk its influence and impact weakening, following the major assessment of its aid programme.

Greece and Portugal slashed their aid budgets by more than 30% in 2011. Obviously fearing others will follow, and with increased public scepticism and more intense scrutiny of aid budgets, the OECD has urged the European Union to better demonstrate to the public the successes of its aid programme through improved communication… not an area in which the EU excels.

Perhaps Nucleus can help. The EU is a major international player in development aid. In 2011, the EU provided €53.8bn (£43.8bn), more than half of the entire global aid total. The EU’s development programme, ‘Agenda for Change’, launched last year by the EU development commissioner, Andris Piebalgs, focusses on democracy, human rights and governance.

Some of the world’s poorest states, such as Somalia, are major beneficiaries of the European commission’s €11bn annual aid budget.

Mark Tran in the Guardian notes, “The review from the OECD’s development assistance committee (DAC) acknowledged positive steps taken by the EU since the last peer review in 2007, including major organisational restructuring, efforts to streamline financial instruments and enhancing dialogue with civil society.”

There is still progress to be made though, with the latest review stating,

“In completing the reorganisation [the EU institutions] need to be clear about responsibilities of each institution as they work together to implement the development co-operation programme. The EU institutions also need to strengthen knowledge management and lower the administrative burden on partners and EU staff to improve the impact of the programme.”

Internally, the EU is overhauling its controls to prevent waste in regional development projects – the biggest EU budget item.

Laurence Peter for the BBC, writes that “in the past auditors have found many errors in the management of “cohesion” fund projects, which are intended to develop the EU’s poorest regions.”

The EU Commission aims to address this issue by implementing formal contracts with national partners.

However, pressure on member states’ budgets means the level of cohesion spending is under fierce debate. Surprise surprise, the richer countries are pushing for cuts, whilst the poorer, mostly former-Communist member states, cry foul.

The European Commission has proposed cuts: a cohesion budget totalling €336bn (£275bn) for the 2014-2020 period, compared with €354bn for the current period (2007-2013).

The result is a clear split: Earlier this week European Affairs ministers from 13 members states urged the EU in a letter not to cut that budget any further, whilst net contributors, including the UK, Germany and the Netherlands, lobbied for even deeper savings.

The letter referred to was signed by Bulgaria, Estonia, Greece, Hungary, Latvia, Lithuania, Malta, Poland, Portugal, Romania, Slovakia and Slovenia. Croatia, which is set to join the EU in the summer of 2013, also backed the statement, reports Ana-Maria Tolbaru for EurActiv.

“Cohesion policy should have its resources concentrated on less developed regions and member states,” said the group, made up mostly by net beneficiaries of cohesion funds.

Leonard Orban, the Romanian minister for European affairs, called the step “an important achievement” and said member states could for the first time stand firm and reach common ground on the matter, despite their national differences.

The response of many in the net-contributor countries was illustrated by the likes of Open Europe’s Pawel Swidlicki, appearing on Welsh television to dangle the carrot of £1bn a year extra for the Principality, were regional policy to be devolved back entirely for richer member states such as the UK.

Vote winning stuff Pawel, and charity does begin at home, but it rather misses the bigger picture. In a globalised economy, particularly within the close-knit EU, regional development is a boon to all, not just the direct recipient. A steady stream of development aid is preferable to large emergency hand-outs.

Pushing hard for improved delivery and sensible budgeting is one thing, calling for swingeing cuts quite another.

The UK, and the EU, are rightly proud of their highly regarded aid and development programmes. Now, more than ever, that ought to be cherished.

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“The figures are terrible for everyone and terrible for the government… Spain is in a crisis of huge proportions…”

So said Spanish Foreign Minister Jose Manuel Garcia-Margallo in a radio interview this morning. He might have added: Europe is in a huge crisis. It has until the late June EU-27 summit to stop kicking the can down the road and start implementing a real plan to solve that is a triple crisis: of debt, banking and growth.

Rounding off a bad week for Europe, today’s Spanish unemployment figures are simply horrendous: 5.6m officially out of work, a rate of 24.44%, one of the highest in the world. Already, more than half the country’s youth is jobless. Now, 1.7m households are without anyone in work. The country is in a deep recession and expected to stay there all year – and, compounding it all, S&P overnight cut its sovereign rating two points because of…worries about a contracting economy.

Like our own Boy George, Mariano Rajoy, the centre-right premier, is sticking to Plan A: cutting the budget deficit come what may through more than €30bn of cuts. What is certain is, as Thomas Mirow, head of the European Bank for Reconstruction and Development, said in the City yesterday (citing the IMF): by the end of this year, Spanish GDP per head will be 48% of Germany’s – “almost wiping out the gains of a dozen years of convergence” under EMU.

Mirow, a German social democrat, told the Official Monetary and Financial Institutions Forum (OMFIF): “Convincing structural reform improves the long-term solvency of government, thus reducing borrowing costs and the austerity required to achieve a given deficit reduction path. This can lead to a virtuous cycle. But conversely, there is also a danger that austerity depresses short term growth to the point where its destroys the willingness of the population to support structural reform.”

There’s the rub: as several of his fellow panel-members pointed out, Spain and the rest of southern Europe are dangerously close to that point. Unemployment at these levels is, historically, a breeding ground for political extremism (if the French jobless rate were 20% rather than 10% what would Marine Le Pen’s score have been last Sunday?) Angela Merkel’s fiscal pact may end up being rejected by more than just two (UK/Czech Republic) in the end as Mirow concedes; Vikki Pryce says it’s dead. The urgency of constructing Mario Draghi’s proposed “growth compact” gets more vital every day.

At the same time, it’s clear that Europe and, especially, Spain has to take on the banking crisis and sort it out via a drastic clear-out and huge recapitalisation programme. The talk in the margins of the OMFIF conference was all about this – and the continued starvation of credit/capital to small business, the engines of growth. Europe’s bloated banking sector cannot be allowed any more to sit on mountainous piles of cash – and redistribute it to its top executives.

This is of elemental interest to the UK which, we were reminded, remains Germany’s third largest export market…Yet, again on the margins of an event billed as “EMU’s future: 20- years after Maastricht,” one heard an extremely senior ex-civil servant say the only politician to get it right at the Dutch market/university town and foresee troubles ahead was….John Major. And Gordon’s five tests remained on tablets of stone. When Mirow told his gasping audience that – apart from the Czechs – all ex-communist EBRD clients/EU members still wanted to join the euro (it’s a condition of joining the EU), albeit a bit later, heads rolled in disbelief: “The latest bunch of lemmings,” said one expert. Smug complacency is shared beyond No 11…