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Battle Lines Set in Euro Zone for Next Week

Friday, 22 Jun 2012 | 4:42 PM ET

Battle lines have now been drawn in the euro zone for next week, a week in which the Italian Prime Minister, Mario Monti, said the euro zone must save itself and for which he believes there can be no room for failure.

Europe's 27 heads of state will meet on Thursday and Friday. At that summit, Angela Merkel believes that she can restore market confidence by driving euro zone leaders to sacrifice overall control of their budgets to Brussels. Years after that fiscal discipline is forever enshrined in the euro zone, Merkel said there could be joint issuance of debt.

But when the Big Four met in Rome on Friday, the France's new president, Francois Hollande, was brutally at odds. Hollande said it should not take 10 years to introduce euro bonds, and he directly challenged Merkel to give ground now on key issues in exchange for her fiscal union. Or as Hollande put it, "There can be no transfer of sovereignty if there is not an improvement in solidarity."

It would be great for market sentiment next week if Hollande could get Merkel to allow bailout funds immediately to be used automatically to buy up Spanish or Italian debt above certain yields. Or if he can get her to remove her objections to a banking union with euro-zone-wide deposit guarantees. (To that end, Hollande is meeting with European Central Bank President Mario Draghi Monday who is drawing up such plans.)

But the danger now is that Germany is deadlocked against France, Italy and Spain with euro bonds their central issue, that the leaders have painted themselves into a corner and that, having promised to deliver greater integration, they fail next week.

Without that agreement, there is no fig leaf with which Merkel can sanction more immediate measures to deal with the contagion threatening to engulf Spain and Italy.