Euro crisis: “The crisis of the eurozone has only just begun.”

I hope it wasn’t something I said… At the Guardian’s Comment is Free, Timothy Garton Ash feels “more depressed about the state of the European project than [he has] for decades.”

The crisis of the eurozone has only just begun. The bond markets have not been convinced even by last week’s giant “shock and awe” bailout of Greece. The one thing that moved them was the European Central Bank’s readiness to start buying eurozone government bonds, but it still costs multiples more for the Greek or Portuguese government to borrow than it does for the German government. A leading bond strategist tells me he now sees two alternatives: either the eurozone moves towards a fiscal union, with a further loss of sovereignty by member states and drastic deficit reduction imposed by this external constraint, or some of the weaker member states default, either inside the eurozone or by leaving it altogether. At which point capital flees, even more than it has already, from the weak to the strong: that is, from the eurozone to elsewhere and, within today’s eurozone, to Germany.

The domestic and international politics of both these paths are bloody. (In Greece, already literally so.) The tensions within European societies will rise, but so will those between European states. In particular, resentments within and towards Germany, the continent’s central power, are bound to increase either way: if Germany imposes tough terms for a fiscal union while at the same time underwriting other governments’ risk, or if it lets a Greece or Portugal go to the wall, resulting in further capital flight to Germany. In the very best case, if the old “challenge and response” pattern of integration through crisis works once again, Europe will be preoccupied with resolving its internal economic and financial problems for years to come.

And don’t get too hung up on the political leader he chose as an example, the issue of leadership has been identified elsewhere.

Meanwhile, the German Chancellor Angela Merkel continues her domestic political agenda – as explained by the BBC’s Stephanie Flanders.

Be in no doubt: in return for signing-off on this rescue package, Germany will want the new rules of the road to be written in Germany’s own image.

Chancellor Merkel has just alluded to this in her speech here – Germany wants tough fiscal controls for every eurozone country to come out of this. And, as one official said to me, at times like this, what Germany wants, Germany tends to get.

But outside Germany, the worry is that the big losers in all this won’t be speculators – but ordinary citizens in countries like Spain and Portugal who find they cannot combine massive budget cuts with decent economic growth.

Make no mistake, the UK and the rest of the world will suffer as well, if the conclusion of this crisis is a eurozone based on the same export-led growth model as Germany.

The rest of the world needs domestic demand in the eurozone to grow, not shrink even further, in the next few years. But right now it is very difficult to see how that will happen.

Indeed, if Germany has its way, the eurozone is going to make an even smaller contribution to future global growth than we thought.

Pete Baker