Sorry, there is no euro break-up plan – yet

Reports of plans for a break-up of the euro are premature

Very quickly, I have grave reservations about the Reuters story claiming that top German and French officials have had "intense consultations" on plans to reshape or "prune" the currency bloc, reducing it to a manageable core.

The Brussels press corps do not believe it. Nobody seems to know which German official is briefing behind the scenes that "you’ll still call it the euro, but there will be fewer countries."

The claims do not remotely reflect the stated position of Chancellor Merkel and President Nicolas Sarkozy. Merkozy might like to see Greece tossed to the wolves. That is a different matter.

There is a drive for a core Europe or "Avant-Garde" that pushes ahead with closer union, but that is mostly directed against the UK and other members of the awkward squad. Reuters seem to have conflated two separate issues.

The reality is that EU leaders are still unwilling to contemplate an orderly break-up of monetary union, or to deploy the system’s dwindling reserve of credibility to prepare for this traumatic moment.

To the extent that the Reuters story catches one vein of thought in EU capitals, it is about forcing weak states to leave EMU. This is the worst possible outcome. It can only set off a chain reaction, ultimately engulfing France. At that point the whole eurozone would spiral into a catastrophic depression – if it is not already. Germany itself would be ruined.

My own proposal – like that of Hans-Olaf Henkel, the former head of Germany’s BDI industry confederation – has long been for a radically different kind of break-up. Germany and its satellites should leave, bequeathing the euro, the ECB and other EMU institutions to a Latin union led by France. The euro debt contracts of the south would remain intact. (It is crucial that France stays in the southern bloc, otherwise the instant devaluation of the south would be too great, and France’s banks would blow up on Italian debt)

If conducted skilfully, the revalued Teutonic Thaler could be held by exchange and capital controls at a 30pc premium for long enough to stabilise the two systems. Ultimately each side would get what it wants: Germany could enjoy the stronger currency it needs; the south would restore labour competitiveness without having to go through a decade of grinding deflationary slump. This itself would reduce the risk of defaults. I suspect that within five years, the Latin half would prove to be the more dynamic bloc.

Obviously Germany, Holland etc would have to recapitalise banks to absorb the shock of 30pc FX losses on their Club Med bonds. The banking system might have to be nationalised. So what? This would be much cheaper than the trillions now needed to prop up EMU’s rotten edifice. It addresses the core problem of north-south currency misalignment within EMU that lies behind the whole crisis. Unfortunately, neither Berlin nor Paris seem ready to think along these lines. It would require a complete purge of the political elites in both countries.

Given this strategic fact – and given the risk that Europe will take us all hurtling into disaster – the authorities must instead step up to the plate and deploy the ECB as a lender of last resort to halt the debt spiral. (Yes, the ECB may be incapable of playing this role, since it has no sovereign indemnity. That is a risk. All possible outcomes are by now fraught with danger.)

This must be backed by a broader switch away from 1930s Laval-Bruning liquidationist and contraction policies. There is no justification for allowing real M1 deposits to contract across most of the eurozone – and to plunge in the south – as has occurred over recent months. For a monetarist central bank, the ECB is remarkably insouciant about money.

The EU must slow the pace of fiscal contraction and launch a monetary blitz to lift the south out of chronic depression. A 5pc nominal GDP growth target for euroland for as long as it takes would do the trick. I believe central banks have the capability to deliver such result.

Let me be clear, this is not my preference. It would better for greater Germany to leave EMU. But given the evidence so far that Germania has no intention of taking such a course, it must instead drop its opposition to the sort of radical reflation stimulus so obviously needed to save monetary union and avoid a savage slump.

What Germany cannot continue to do is to refuse to leave EMU, and refuse to reflate. This is not a policy. The rest of the world is entirely entitled to make its irritation known.