LIKE the plague of olden days, the contagion is spreading from one country to the other and is now threatening to infect the very lungs of Europe, France and Germany. First it was Greece and Ireland, then Portugal, Italy and Spain, practically in that order. Now France and Belgium are on the verge of being downgraded. And the option of ten-year German Bunds last month shifted only US$ 4.8 billion out of US$ 8 billion worth on offer.

The collapse of the Euro zone is almost a certainty now unless the German Chancellor Angela Merkel and the European Central Bank can pull some miracle at the last minute and try to square a circle. There are signs, however, that the market is already preparing for the worst and there are also signs of what such an eventuality could entail. Industrial orders in the Euro zone fell by 6.4% in September, the steepest since December, 2008. The index of perceptions of purchase managers has been reading 47.2, well below the threshold mark of 50. The European Commission index of consumer confidence fell again in November for the fifth time in a row. All these are indicators of a creeping recession.

The situation is getting serious by the day and a single spark could ignite the entire edifice. The spark could come in the form of a bank failure leading to a run on the deposits of other banks or an imminent disorderly default by Greece or even Italy or a revolt against the austerity measures being enforced as conditionalities for bail-out packages. Or France could lose its AAA rating which could trigger a run on banks across Europe.

The results of the elections in Greece in February reflecting public anger against austerity measures coming in as part of the bail-out plan could make Greece leave the Euro zone and reinvent its own currency. The trend could then be followed by one peripheral economy after the other. That could enable these countries to write down the value of their public and private debts and cut wages and prices relative to those prevailing in the Euro zone and, in the process, improving their competitiveness. The countries left in the Euro zone would then be put at a competitive disadvantage to the new cheaper currencies just across their borders. That would mean the erstwhile members of the Euro zone imposing capital controls and possibly retreating towards autarky by raising retaliatory tariffs. The death of the Euro zone would naturally lead to the death of the European single market and the concept of the European Union itself.

A single currency without a political or at least a fiscal union was never a bright idea even to start with. A currency is not just a piece of paper. It acquires consumer and investor backing only because of the executive and the legislative force of the sovereign government issuing that currency. When the sovereignty backing the currency is itself divided, its different constituents are motivated to behave in rather irresponsible ways for short term gain vis-à-vis the other constituents of the grouping. And, when the sovereign defaults, the investors and the consumers cannot be blamed for panicking, bringing the entire edifice down. And that is exactly what has happened in the case of Europe.

The situation can still be salvaged even at this late stage if the European leaders see reason even at this at late stage. This month, the European Commission President, Jose Manuel Barroso came up with two proposals. One was an agreement on stronger monitoring of national budgets by Brussels, including the right to recommend changes before they were submitted to national parliaments and a fierce oversight of countries in severe difficulties. The second proposal was for mutualisation of debt by floating common Euro bonds backed by Euro zone as a whole and by the European Central Bank.

The proposal fiscal union is being seriously discussed at political levels. Britain has rejected it outright saying it can not countenance any compromise with its sovereignty. Sweden is not likely to agree. Some countries have sought time for internal consultations. But most have reacted favourably. There is however no movement yet on common euro bonds or joint liability for the sovereign debts. However, even steps towards a fiscal union could inspire confidence in the markets and eventually lead towards some solution to the ongoing crisis. These are tough times for Europe, though. ·