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Europe's Leadership Still Deeply Divided

German Chancellor Angela Merkel speaks next to France's president Nicolas Sarkozy at the Elysee presidential palace in Paris on August 16, 2011 after a meeting between the two leaders on debt crisis.
Patrick Kovarik | AFP | Getty Images
German Chancellor Angela Merkel speaks next to France's president Nicolas Sarkozy at the Elysee presidential palace in Paris on August 16, 2011 after a meeting between the two leaders on debt crisis.

The market has been driven higher by hopes for a solution to European woes. I think this is probably just a set up for a dramatic crash once it is revealed that the signals of solidarity coming from Germany's Angela Merkel and France's Nicolas Sarkozy have been false signs.

The Economist's Charlemagne column explains that the apparent similarities in recent remarks about strengthening European institutions from Sarkozy and Merkel mask much deeper conflicts.

From the Economist:

- Mr Sarkozy places the emphasis on “solidarity” among European states (ie, joint Eurobonds, and no defaults or debt-restructuring after Greece), while Mrs Merkel gives priority to budgetary discipline and rules.

- Mr Sarkozy urges the European Central Bank to act; Mrs Merkel is jealous of guarding its independence

- Mr Sarkozy wants to create a hard core of euro-zone countries within the European Union; Mr Merkel wants to include as many non-euro states as possible

- Mr Sarkozy wants to Europe to integrate through the action of leaders (reproducing France's presidential system, with lots of discretion for the executive); Mrs Merkel favours more independent institutions like the European Commission and the European Court of Justice (more akin to Germany's federal structure, which retricts politicians' leeway)

This is something I've mentioned before. Fiscal union means one thing to the Germans, and quite another to almost everyone else. It's not going to work.

Which means there is a huge downside risk in this equities rally.

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