Smoke and mirrors and the euro crisis

When it comes to the eurozone crisis there is often a conventional wisdom and then another world where the debate is quite different.

This week in Berlin the German Chancellor, Angela Merkel, looked back over the past year and saw "some progress". She detected a strengthening of economic and monetary union. The rules of the Stability and Growth Pact - which govern the euro - had been reinforced. Competitiveness would improve under measures already agreed. All of this, in the view of the German leader, was a "considerable step forward".

But it is not difficult to hear an entirely different analysis. In this version of events the rescue strategy for the euro has failed. All that has happened during the past 12 months is that Greece's debt has grown. So, too, with the Republic of Ireland and Portugal. The bail-out loans only add to the debt, whilst the austerity measures insisted on by the EU make the road back to growth steep and rocky.

There is negative growth in Greece and Portugal and Ireland is at best flat-lining. These countries have been given shelter from the markets, but there is no evidence they can escape the debt trap they are in.

As this version of the crisis gains credibility, the pressure is growing to change tack and to let Greece restructure its debt, with investors taking losses.

Here, too, there is an official line oft repeated by European officials: "a restructuring of Greek debt is not an option."

Only yesterday a senior official at the European Central Bank, Jose Manuel Gonzalez-Paramo, declared that any restructuring would have "extreme adverse consequences".

Their argument and, until recently, the conventional wisdom was that a restructuring would lead to significant losses for international banks - particularly in Germany and France - and that instability would flow through the entire European banking system.

But, here too, there is an alternative take on events that challenges this view.

Ferdinand Fichtner, a senior research associate at the prestigious German Institute for Economic Research in Berlin, said this week that a Greek default was both inevitable and necessary.

He revealed that recently there was a meeting in Essen of around 20 of Germany's economic think-tanks. There was a near-consensus in favour of restructuring Greece's debt.

Mr Fichtner disputes the central argument that restructuring would imperil Europe's banking system. He estimates that German banks hold around 25bn euros (£22bn) of Greek government debt and would mostly be able to absorb losses from their Greek investments. (Most analysts believe a Greek default would involve creditors only getting back 50% of their investments.)

In Mr Fichtner's view some banks might fail, but it would not put at risk the European banking system.

He and the economists believe that losses taken now would be less expensive than continuing to loan Greece tranches of money with little expectation the money would be repaid. The Greek papers speculate that on top of the 110bn euros bail-out the country received last year, they need another 50bn.

Yes, after a default it would be difficult for Greece to raise money, but it would not be saddled with a debt mountain approaching 360bn.

All of this will come to a head in a few weeks. A team from the IMF and the EU is in Greece assessing whether the Greek reform programme is on track.

The key player once again will be Germany. Until they see the EU/IMF report the German chancellor and her key officials are saying nothing. One important question is whether Greece is not living up to its commitments or were the assumptions underpinning last year's bail-out unrealistic.

Let us presume that the report concludes that the sums don't add up; that Greece will be unable to return to the markets next year to borrow money.

The German government will then face some difficult choices.

I get the impression that no decision has been taken.

Germany could decide to back the more radical option and to allow Greece to default. A softer alternative would be to lengthen the period of maturity of the current loans, lower the interest rates, and increase the rescue fund. It would be described as a refining of the original bail-out, but it would be a soft restructuring.

But a further assistance package will be fiercely debated in Germany. Increasingly German MPs are questioning the current bail-out strategy. (The Dutch finance minister has already said it would be very difficult for the Netherlands to support a bail-out Mark 2.)

The view from Brussels is that any default would spread to other countries and that it would undermine the credibility of the single currency and so the European project.

Angela Merkel is on record as saying defending the euro is a German national interest. Her instinct will be to be cautious, to play it long, to hope that long-term Greece turns a corner.

But this time round the public, opinion-makers, members of parliament are better informed and they will not just line up behind another Brussels rescue package. As one analyst told me yesterday in Berlin, there is a tension in political circles, an awareness that key decisions will have to be made before summer and "all options are now on the table".