Where are we at the end of these extremely volatile last few days? At first sight, the euro crisis is exactly where it stood a week ago; the bailout package still stands and the thundering threat of a Greek referendum on it has receded to a barely audible echo. Still, regardless of the outcome of the Greek political crisis, something has fundamentally changed.

Euro zone partners have started perceiving Greece as a Trojan horse that could cause the demise of the Euro. Instead of rescuing Greece in order to save the Euro, the members of the EU suddenly find themselves trying to save the Euro from Greece. For the first time, high-level politicians are openly discussing the possibility of abandoning Greece to its own fate.

As one European central banker told me, “we now know what we need to do.” Banks are reportedly starting to test how they could withstand the fallout of a Greek departure from the euro zone. A German economist, clearly flabbergasted by the decision of Greek Prime Minister George Papandreou earlier in the week to hold a referendum, described Papandreou as a man who had “clearly decided to commit suicide for fear of dying.” A colleague at a big European think tank asked: “Don’t the Greeks realize that being part of the Euro already means shared sovereignty?” He continued by asking how Papandreou could possibly think that one country alone can decide on the fate of sixteen other countries. One representative of the German Bundesbank vented his frustration by pointing out that if the Greeks hold a referendum, why not have one in Germany, or in France or Italy, or anywhere else. “Where does it stop?” he asked me, not expecting an answer.

Overall, the widespread feeling is that a breaking point has been reached, and that Greece is no longer a deserving partner in what French President Nicholas Sarkozy calls “a common journey of the Euro members.” Only some media commentators, looking for a tale of moral clarity, applauded Papandreou for what they described as his principled defense of democracy. Unfortunately, righteousness was probably the last thing on Papandreou’s mind when he announced that he wanted the Greeks to decide in a referendum on the very same bailout package he had accepted just a few days earlier.

Instead, the Greek prime minister was looking for political cover from a deal that is deeply unpopular among his citizens. Furthermore, since many details of the package still need to be worked out, it is fair to assume that Papandreou had calculated that parts of the deal could be renegotiated in order to extract more concessions.

Germany and France perceived this move as classic blackmail, and reacted accordingly. They framed the question of the referendum for Papandreou as such: the decision Greeks had to make was much larger than just deciding on the financial rescue package. “The question is whether Greece remains in the euro zone. That is what we want. But it is up to the Greek people to answer that question,” With this statement, Mr. Sarkozy broke a taboo that only last week seemed untouchable.

This is significant for a number of reasons. First of all, it questions the long held assumption that Greece is of systemic relevance to the Euro. For months the rationale for helping Greece had been that if the country failed, the whole euro zone would crumble. No more.

Secondly, the Franco-German duo, still divided on many aspects of the Euro-crisis just two weeks ago, now appears to be closing ranks. Thanks to Greece, the French have moved much closer to the German position, where the debate on Greek membership of the euro zone had effectively started many months ago. By mid-week, Sarkozy and German Chancellor Angela Merkel were a picture of harmony in the French city of Cannes. Rarely have we seen the two leaders so convincingly displaying such unity to the rest of the world. Together, Germany and France spearheaded the decision not to pay another cent to Greece as long as it refused to fully embrace the deal it had signed in Brussels at the end of October. It was a risky bet. Not having fully explored the ramifications of a sudden, disorderly Greek default, the Franco-German duo had to hope that Greece would not dare challenge them further. Athens received the message loud and clear. When there is no daylight between Paris and Berlin, it is hard for any European opponent to successfully divide and conquer. Greece ended up completely isolated.

With Greece back pedaling, Merkel sought to tighten the screws on the man who is causing her the biggest headache, Italian Prime Minister Silvio Berlusconi. If the Greek political system is dysfunctional, then Italy’s is not far behind. The difference is that Italy, as the third largest economy of the euro zone, is of systemic relevance to Europe. Isolating Greece alone will not be sufficient to convince the markets that the crisis can be contained. On the contrary, if Italy does not tackle its challenges decisively, an isolated Greece could indeed be perceived as a Trojan horse, allowing anti-euro forces to get behind the crumbling fortifications of the euro zone. To prevent that from happening, financial markets need to be convinced that Italy has recognized its challenges and has started doing what is needed − not only to address its huge debt problem, but also the more structural weaknesses that have depressed its economic growth for more than ten years. Unfortunately, the only commodity Berlusconi has offered so far is a series of promises. With a rapidly evaporating paper thin majority in parliament, and cornered by a euro-skeptic coalition partner that is against any major reforms− particularly of the pension system, Berlusconi could be the next political victim of this euro-crisis. He just needs to take a look at his colleague in Athens to know what can happen if he continues to procrastinate.

Italy, even more than Greece, is the true challenge the euro zone now faces. Berlusconi lost the trust of all his European partners a long time ago. He has now lost the markets, too. Italians have now slowly woken up to the fact that their billionaire prime minister is a liability for their country. This week the battle lines have started to shift more decisively, from Athens to Rome.

With the G20 meeting in Cannes focusing on how to boost the firepower of the International Monetary Fund (IMF) to intervene even more decisively in the European crisis, as well as on how to best monitor Rome’s progress in implementing its promises, it has become abundantly clear how worried the leading economies are about the Italian situation. Angela Merkel said that the “time for talk is running out, action is now required.” Officially, she was speaking of Greece, but the intended audience for her warning was Silvio Berlusconi.

U.S. President Barack Obama mentioned Italy’s willingness to be monitored by the IMF in his press conference in Cannes. He said that there “is more hard work ahead and difficult choices to be made.” He tried to be upbeat about the capacity of Europeans to deal with their problems. However, in Germany, a new poll out this week paints a gloomier picture. While most people think that Merkel is doing a good job trying to steer the euro zone out of the storm, they doubt it will be enough. A vast majority of Germans now think that the worst is still to come. Having experienced one of its most turbulent weeks, the struggle to save the Euro only seems to be entering a new, even more difficult phase.


Alexander Privitera is the Washington based Special Correspondent for the German news channel N24 and is a frequent contributor to AICGS publications and events.

This essay appeared in the November 4, 2011 AICGS Advisor.