Crisis escalates as Germany's control of Europe breaks

The political dam has broken in Europe. German Chancellor Angela Merkel no longer has enough allies in the club of EU prime ministers to impose her hair-shirt agenda. Her methodical plans are disintegrating on every front.

The immediate fate of Greece and the euro is in the hands of a boyish motorcycle Marxist.

Syriza leader Alexis Tsipras has vowed to tear up the hated Memorandum, as the EU-IMF "troika" loan package is known.

He showed no sign of backing off as he met his country's president and began talks on the formation of an implausible Left front. "The popular verdict clearly renders the bailout null and void," he said.

To those who warn that such defiance means an unstoppable lurch towards full default, a banking crash, and EMU expulsion, he retorts that Greece has the "ultimate weapon". It can bring down the whole European system if EU leaders refuse to soften the terms.

This bluff may be called. "Patience among the creditor countries is running out," said Blanka Kolenikova from IHS Global Insight.

Germany's media says finance minister Wolfgang Schauble is itching to force Greece out of the euro as a salutary example, sure that Europe is strong enough to withstand the shock. This in turn is an illusion waiting to be punctured.

Arnaud Mares, of Morgan Stanley, said a Greek exit would set off "massive deposit flight" from all the vulnerable EMU states: "It could unravel the single currency altogether."

It is a dangerous moment for European and global markets. Greece has no functioning government. It must decide on a series of bond repayments, starting this week. Tough choices will not wait until fresh elections in June, should they occur.

The new bonds issued after private investors suffered a 75% haircut in March are already trading at levels of extreme distress, with 21% yields on 10-year debt. The EU deal to end all deals has collapsed after just two months.

The disastrous chain of events has essentially discredited the entire crisis policy imposed on Europe by Germany. Combined fiscal and monetary contraction has pushed much of southern Europe into a deflation "death spiral", pulling the rest of Europe down with a delay. Even The Netherlands is now in deep recession.

Revolt was inevitable. It has finally occurred. The European Commission called on Tuesday for an immediate investment blitz to stop the downward slide. This follows hard on the heels of a call by European Central Bank chief Mario Draghi for a "growth compact". The EU institutions are slipping out of Germany's control.

The election of Francois Hollande in France has radically altered Europe's balance of power, and popular fury across a string of democracies has done the rest.

There are signs that Italy may start to tuck in behind France, picking away at the EU Fiscal Compact. Silvio Berlusconi's People of Liberty party said it would not back treaty ratification unless it includes eurobonds and turns the ECB into a lender of last resort. The party rebuked Italy's premier Mario Monti for behaving as "Germany's representative".

The party's abrupt shift follows an electoral rout over the weekend in north Italy, where anti-euro maverick Beppe Grillo won 20% of the vote in Parma and 15% in Genoa.

Monti cannot push the treaty through without Berlusconi's blessing. The carefully-crafted plans for ratification in Berlin and Rome on the same day are in tatters.

Merkel said she would embrace Hollande with open arms but on policy substance she has carried on as if the insurrection never happened. "The fiscal pact is not negotiable", she said, insisting that EU treaties could not be reopened once parliaments had begun to ratify. This is not true. The European Constitution was abandoned after France and The Netherlands voted "No" in referendums in 2005.

Berlin hopes to assuage Paris with a beefed-up role for the European Investment Bank and a growth compact, perhaps tacked on as an annexe to the fiscal treaty. Officials at the Kanzleramt think Hollande's rhetoric was hot air, and that he will switch tack once in office, like Gerhard Schroder, the German Social Democrat, did a decade ago.

This may be a misjudgment, failing to catch the mood of fury in Europe. Hollande was emphatic in his victory speech. "My mission is now to give Europe growth, jobs, prosperity and a future. We are not doomed to austerity," he said. They may call him "Flanby" in France after a brand of caramel pudding but his mildness disguises a steely side, and his Socialist base is not to be trifled with.

For Germany it is a moment of truth. Berlin has put off hard choices since the crisis began. It has refused eurobonds or budget transfers, stepping back from the Rubicon of fiscal union.

Merkel has insisted on austerity and reforms alone, imposing the full burden of adjustment on the weaker states. She has brushed aside arguments that the EMU's crisis is in essence a North-South imbalance in trade and capital flows that cannot be corrected in this fashion within a currency union.

Her government has ignored warnings that simultaneous contraction in the whole of southern Europe, without offsetting monetary stimulus or expansion in northern Europe, can only lead to a replay of the Gold Standard errors of the early Thirties. This phase of the crisis over. Now Germany itself will have to adjust.