China is ready to get more deeply involved in participating in solving the European debt issue. -- Chinese Premier Wen Jiabao

Wen made these very positive statements at a joint press conference in Beijing on Feb. 14 with EU President Herman Van Rompuy and European Commission President Jose Manuel Barroso.

Unsurprisingly, Van Rompuy said at the same press conference that he welcomed the interest China has shown in investing in European sovereign bonds and the region's rescue fund.

Wen ended the EU-China summit by confirming that China is considering more involvement in the two euro area rescue funds: the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). This would be music to the European leader's ears. Plus, Vice Premier Li Keqiang, mooted to be the next Premier, also said that China wants to support EU during its debt crisis when he met with Van Rompuy and Barroso.

So far, so good. But when and in what form might this help come? In terms of timing, Wen says that China expects "those highly indebted [European] countries to strengthen fiscal consolidation, cut deficits and reduce debt risks in light of their national conditions." He added: "We hope the EU will soon reach internal consensus, make the political decision and send to the international community a clearer and a stronger message of policy responses." Waiting for that may take a while.

Wen made clear that gaining access to European markets and enhancing trade is the most urgent issue. There may be a difference in views here in terms of what's most pressing. As for what form the aid make take, Lou Jiwei, the head of China Investment Corp. (CIC), the country's giant sovereign wealth fund, said that the German Chancellor Angela Merkel asked China to buy German and French government debt when she visited there in the first week of February. Sovereign wealth funds typically invest in real assets or buy equity shares, so that's not too likely. But, the People's Bank of China (PBOC) or SAFE (China's foreign exchange management body) could buy government debt as part of their reserve accumulation.

Indeed, PBOC Governor Zhou Xiaochuan said, "China will always adhere to the principle of holding assets of EU sovereign debt." The governor outlined the three avenues that could offer help: the central bank, the CIC and the banks that are arms of the state: China Development Bank, Export-Import Bank and others.

The latter, though, are more likely to invest than to buy government debt. In fact, China has repeatedly emphasized the benefits of being a source of investment at a time when Europe is facing tight credit conditions, especially for utilities, where returns are stable and thus attractive to the Chinese. (For instance, CIC invested in Thames Water.) Europe could indeed use more investment, including in infrastructure, as its economy registered the first negative quarter since 2009 when fourth-quarter 2011 GDP contracted by 0.3%. This could help, but may not be quite what the euro leaders were hoping for.

The key unanswered question is whether China could invest in the EFSF or ESM, perhaps helping to "leverage" these funds as the current cap of €500 billion is considered to be too small to serve as an effective firewall for the euro crisis. Plus, China made no indication as to whether it would increase its contributions to the IMF - that was an aim of Van Rompuy during the visit- since the IMF could serve that role.

Nevertheless, Zhou said that China has "expressed clearly" through the G-20 that it will not reduce the proportion of its investment in euro assets during the global financial crisis and European debt crisis. Maintaining the euro's status as the second reserve currency in the world must count for something, especially as that implies purchases of euro sovereign debt, while they await possible Chinese investment in the rescue funds.

One deciding factor may be the idea proposed by Germany's Chancellor Angela Merkel and France's President Nicolas Sarkozy last week in Paris: that the bailout funds are paid into an escrow, or separate, account to guarantee that lenders are repaid.

Jacob Funk Kirkegaard of the Peterson Institute for International Economics in Washington says the proposal could be a game changer for the Greek debt restructuring deal and for Greece's relationships with the European Commission, the International Monetary Fund and the European Central Bank, known as the Troika.

In this clip, I talk about how setting up an escrow account changes the game:

Under the debt restructuring now being negotiated, holders of Greek debt are being asked to voluntarily swap their existing obligations for new bonds worth about 70 percent less.

Kirkegaard speculates that bailout funds paid into the escrow account would only be available to make interest payments on the new bonds, not the old ones, therefore providing "a powerful incentive to secure a higher participation rate among creditors" in the bond-swap program.

If sufficient money is held in the account, the bond holders would then be assured by the euro area of getting their interest payments, removing the threat of default on the new bonds.

That would change the dynamic between Greece and the Troika. Until now, Greek governments have bet that the Troika has no choice but to pay the next loan tranche, knowing that the risk of contagion from an unstructured Greek default would devastate the entire euro region.

But with an escrow account, if there were Greek resistance to reform, the Troika would be able to use the account to keep holders of Greek bonds happy while keeping back new funds from the Greek government.

The question is, will the Greeks agree to this arrangement? I suspect they have little choice.

Meanwhile, even with an escrow account in place, some analysts say the ECB must erect an even higher firewall to contain the ill effects of Greece's financial woes. Here's Kevin Doran, senior fund manager at private bank Brown Shipley & Co. discussing his take on the magnitude of the challenge:

Fink says concern over Greek politicians squabbling about the conditions needing to be met to unlock a second bailout are just "noise" and that a deal "will be worked out."

That's pretty much the view of Bob Parker, a senior adviser to Credit Suisse Asset Management (CS), who predicts a two-year equity market rally starting in the second half of this year. "It's dangerous to be short global equity markets," he told Linzie Janis and Owen Thomas on Feb. 8. "Are equity markets going to be higher at the end of the year? The answer is: decisively yes."

Parker is optimistic for three reasons: the risk of U.S. recession is "gone," he says; China's economy is headed for moderate slowdown and nothing more severe; and the risk of a euro zone breakup has been reduced thanks to the European Central Bank's infusion of liquidity into the banks via its three-year loans.

Guy Spier, chief executive of Aquamarine Capital Management, also sees equities rising as corporate earnings growth accelerates and European policy makers make slow but steady progress resolving the debt crisis.

"I don't think the debt crisis has been handled with the greatest of efficiency, but Europe is muddling through," Spier says. "I think that many actors, including myself, are recognizing that the powers that be will hold the euro together."

Both Spier and Parker forecast a mild euro zone recession this year, with Parker looking for a contraction of 0.2% to 0.3%.

That view tallies with some economists. Greg Fuzesi at JPMorgan (JPM) last month raised his first-quarter euro zone forecast to zero from an annualized contraction of 1.5%, after January's improvement to the Purchasing Managers' Indexes for services and manufacturing.

Sure, there are plenty of people like Jamie Dannhauser at Lombard Street Research who say getting excited about the PMIs seems a little premature, but my sense is that we are at a turning point as others like Erik Nielsen at UniCredit (UCG:IM) predict forecasts for the euro zone to be revised higher on the back of better data, including three improvements in German business confidence in a row and improving Italian PMIs.

Carsten Brzeski at ING is another optimist. Check out his report, "Swan song for the recession? Four reasons for a quick rebound of the German economy."

And one more voice: James Nixon, chief European economist at Societe Generale: "People have not really anticipated the scale of the ECB's actions. We've seen the ECB expanding its balance sheet by 730 billion euros since the second week of August last year and that's a display of unbridled central bank authority and yes that is a form of QE and a lot of that will end up in the equity markets."

See that interview on Bloomberg TV today.

Photograph by Hannelore Foerster/Bloomberg

Successive Federal Reserve Chairmen from Alan Greenspan to Ben Bernanke have been associated with what financiers call a "put" option. The Greenspan put and the Bernanke put refer to the notion that the central bank supports the economy--and thus the markets--with low interest rates and liquidity. Although central banks officially deny doing it, the perception is that they effectively put a floor under asset prices, like a put option on a stock.

The ECB has seemingly had a similar effect on European markets. Will the unlimited loans to banks at the record low interest rate of 1 percent offered since Mario Draghi took office end up creating a Draghi put?

The benchmark European Stoxx 600 index ended the month of January just 2 percentage points shy of a bull market, up 18 percent since its September low. That's the biggest gain for the equity market for the start of a year since 1998. Even the VStoxx, a measure of implied volatility for stocks, has fallen to its lowest level since July.

What's driving it? According to BNP Paribas (BNP:FP), the ECB's provision of unlimited cash to banks is the cause. Christian Dargnat, BNP's chief investment officer, told Bloomberg News: "A wall of money was put into place. We've started to become more positive. The ECB's operation was the impetus." Indeed, BNP Paribas has reduced its cash position in favor of European stocks.

Richard Iley, BNP's chief economist for Asia, echoed the sentiment in an interview this morning with Bloomberg TV, in which he calls the ECB's liquidity boost a "game changer" for the European debt crisis.

The ECB effect goes further. Morgan Stanley (MS) upgraded one of Italy's biggest banks, Intesa Sanpaolo (ISP:IM), to overweight on Feb. 7 despite Fitch downgrading the bank's credit rating by one notch on Monday night to A- from A. The reason is that the ECB has reduced systemic risk and narrowed sovereign spreads, especially in Italy, and thus driven the earnings upgrade for Italian banks.

The ECB's actions aren't just boosting stocks. The CEO of Intesa says that ECB funds it borrowed are being used to buy sovereign debt. "We will use part of ECB funds to buy Italian government bonds, considering that there are significant amounts expiring this year," Enrico Tommaso Cucchiani said at a Milan conference. Intesa also plans to access more ECB funds at the next auction at the end of the month.

It appears that the Draghi put is supporting the government bond market. Since the ECB began offering unlimited bank loans on Dec. 8, Italian and Spanish bonds have rallied. The yield or borrowing cost on 10-year Italian bonds is down to almost 5.5 percent, the lowest since October, having dropped by nearly 2 percentage points from its euro-era record high hit in November, at 7.48 percent. Spanish bond yields have even fallen below 5 percent, down nearly 2 percentage points from their record high of 6.78 percent in November.

And it's not only countries on the European periphery that are benefitting: French bonds also have felt the Draghi effect. The "Sarkozy trade" has seen French bonds outperform German bunds as yields on 10-year debt fell from 3.8 percent in November to less than 3 percent.

Without undertaking a program of quantitative easing, or QE, whereby the ECB would buy government bonds and inject cash like the Fed, Draghi's actions have similarly supported a wide range of asset classes. Even corporate bond yields are near record lows and the euro has hit an 8-week high against the dollar at $1.3237 on Feb 7, despite the Greek debt swap talks dragging on. And there's more to come. The ECB may cut rates on Thursday or later this year, but it will offer another round of unlimited cash to banks at the end of the month. If markets continue to respond in this manner, it won't be surprising to be hearing more about the Draghi put alongside the Bernanke put.

(Photograph by Fabio Muzzi/AFP/Getty Images)

That's the view of the Bank of England's Adam Posen, who sits on the rate-setting MPC. Posen says that ECB's loans to big European banks are a "game changer," and that this lending means that banks should be "okay for a year or two."

So that's one less immediate threat to the U.K. economy. But Posen thinks there's another significant problem hampering growth: the lack of lending to SMEs.

Touching on this issue, Posen said at a Trade Union Congress forum yesterday that "it wouldn't be the end of the world" if the BOE bought assets other than gilts. However, as Posen pointed out in a Bloomberg Television interview afterwards, there is one possible problem with the BOE extending its purchases beyond government bonds to company debt: the U.K. corporate bond market looks too small for the BOE to effectively intervene. So, Posen says, Bank purchases are secondary to the bigger issue of the U.K.'s corporate bond market, which is under-developed compared with countries such as the U.S. or France.

The lack of credit is a key reason why recoveries from recessions are so slow and uneven—the U.K. economy's 0.2 percent contraction in the fourth quarter may be a sign of this. Business lending is a core problem that, Posen said, may require legislation.

Posen believes that QE works and may push for another 75 billion pounds of cash injections next week. But, even if the rest of the MPC agrees with him and goes for a third round of QE as large as the second, it won't be enough to secure the U.K. recovery on its own.

Photograph by Michele Tantussi/Bloomberg

Poor Portugal. The country's bonds have borne the brunt of investor frustration over Greece's failure to reach an accord with private bondholders on writing down the value of their debt.

The yield on Portugal's 10-year bond soared yesterday with investors concerned that it too would impose losses on holders of Portuguese debt in a restructuring.

I asked Prime Minister Pedro Passos Coelho last night after the European Union summit if Portugal would ever impose losses on its bondholders. He said it wouldn't for a couple of reasons, citing first the EU's statement last night that Greek situation is "exceptional and unique" and insisting that Portugal's debt is sustainable.

It's certainly lower than Greece's. In its autumn economic forecast the European Commission projected that Portugal's total debt will rise to 111% of GDP this year, compared to 198.3% for Greece, not taking into account bondholder write offs now being negotiated.

Allowing Portugal to impose bondholder losses would be sending a disastrous message to the market. As one Portuguese official put to me last night:

If bondholder losses are extended to a country that is successfully carrying out its program and meeting its commitments then the message to the market is that private sector involvement is a normal way of dealing with the crisis and that's not the case.

The European Central Bank was right--forcing private-sector losses in Greece was a mistake because it has left investors jittery that such losses will be imposed elsewhere.

Passos Coelho also seemed frustrated that investors aren't taking into account Portugal's record in implementing the commitments made under its €78 billion rescue package. After all, the International Monetary Fund's board approved a €2.9 billion disbursement from the aid program in December.

Portugal's problem is that there are no natural buyers for its debt, apart from domestic players. Padhraic Garvey, head of developed markets debt at ING in Amsterdam, says emerging-market investors would prefer to buy elsewhere, turned off by the complexities of euro zone politics. Recent price action was amid thin volume and was probably excessive, according to Garvey. ING is a primary dealer in Portugal's debt.

It doesn't help that Standard & Poor's cut Portugal's credit rating to below investment grade on Jan. 13 when it downgraded nine European nations.

All of this is not to say that that Portugal won't seek a second dip at the trough. Passos Coelho says that if external factors stop the country from doing so, then both the IMF and the EU will continue to "support our program."

If bond yields stay this high, it will soon be a question of how much and when?

(Photograph by Sean Gallup/Getty Images)

As EU leaders gather for a summit this afternoon in Brussels, people are asking if Europe is stepping back from the precipice and moving into a more chronic phase of the debt crisis.

My response is not yet, but we may be getting close.

First we need the private holders of Greek debt to sign an agreement to write down the value of their holdings that doesn't trigger a messy default that Josef Ackermann of Deutsche Bank (DB) told my colleague Caroline Connan in Davos would have dire consequences:

The signals coming from Athens are positive that private creditors will accept a deal that meets with the guidelines set out last week by Jean-Claude Juncker, who speaks for the euro zone finance ministers.

Analyst Han de Jong of ABN Amro wrote today:

Greece remains the wildcard. A breakdown of the PSI negotiations, and, or the failure to secure a second bail-out has the potential to lead to a re-escalation of tensions. We expect a deal to be reached because the consequences of failure will sharply focus minds.

After that Greece should get its next allotment of European Union and International Monetary Fund cash so that it can make its €14.5 billion bond repayment scheduled for March 20. Whether Greece's remaining debt load is sustainable is likely to haunt us into the second quarter.

By then, Angela Merkel's fiscal compact imposing budgetary and fiscal discipline on euro zone countries should be signed, opening the way for an agreement to beef up the firewall against contagion by increasing the size of the rescue fund.

Problem is that may be too late to convince the members of the Group of 20 nations meeting in Mexico at the end of February to increase their contributions to the IMF as part of an international effort to make sure adequate funds are in place to ensure European fiscal stability. U.K. Chancellor George Osborne says he'd only approve of more British cash if he sees a bigger EU commitment to its rescue funds.

I suspect by then Germany may give into pressure from Italy, France and Spain and signal it is willing to beef up the rescue fun--or at least end its opposition to allowing the temporary fund run alongside the permanent fund.

This week will provide another signpost on whether we are entering a new phase in the crisis: €22 billion ($29 billion) in bonds sales are scheduled for euro zone countries. The results may be the best indicator of whether the crisis has turned the corner.

(Photograph by Jock Fistick/Bloomberg)

European Central Bank President Mario Draghi suggested after the bank's January meeting that it would be "highly welcome" for European leaders to quit dithering and get the proposed fiscal-compact treaty on fiscal discipline and balanced budgets signed by the end of January.

A couple of days later Germany's new ECB representative Jörg Asmussen, after catching sight of a treaty draft, warned against moves afoot to water it down. If the pact was to be a basis for a fundamental shift toward fiscal union, then it needed credible rules, with limited opt-outs.

Lo and behold, last week a new, stricter treaty surfaced, one with rules that will automatically fine countries breaching their budget-deficit targets, except in the direst of circumstances.

So momentum is gathering. But even if the compact gets a political blessing this month, will that be enough to put an end to the European sovereign debt crisis?

"Probably not," said Michala Marcussen, head of global economics for Société Générale (GLE:FP). "The really big issue is getting more money on the table."

Enough money to convince investors that the EU can and will come to the aid of an economy the size of Italy if necessary. And keep Greece out of the bond market until it can generate a budget surplus, which could take years.

Which brings us to the other Mario, Italian Prime Minister Mario Monti, who has called on Germany to cut Italy some slack and bring down its borrowing costs.

How? With the ECB averse to becoming the ultimate lender to distressed governments, Germany's Chancellor Angela Merkel may be forced to increase the size of the permanent rescue fund from the proposed €500 billion and create a credible firewall—with all the political risk that entails.

For today, as well as the fiscal compact, finance ministers also must prepare a response to Greece's efforts to convince private bond holders to take losses and assess its second financing package ahead of the Jan 30 leaders' summit.

One step at a time. As Merkel is wont to say: this crisis won't be solved with one big bang.

Photograph by John Thys/AFP/Getty Images

The IMF has asked for as much as $500 billion, including approximately $200 billion from euro countries, to address an estimated $1 trillion funding need in the next few years. So the IMF, intent on protecting economic growth, may provide the firewall that the euro-zone rescue fund, the European Financial Stability Facility, is struggling to create. This may be more timely than ever after S&P's rating cut threw the EFSF's borrowing costs into doubt. But would the IMF fund be enough to stem the euro crisis?

The IMF won't discuss the options for funding until it has completed full consultations with all of its member countries. Still, based on its funding increase in 2009, when its resources were tripled in response to the global financial crisis, the possible avenues are clear. Then, the G-20 met in London and agreed to add $500 billion to the IMF'S lending capacity, raising it to $750 billion. This was funded in two ways: $500 billion via bilateral loans from member countries and $250 billion in so-called special drawing rights. SDRs are essentially a basket of currencies comprising the U.S. dollar, euro, sterling and yen. Increasing SDRs is like a form of global QE or cash injection. In theory, boosting SDRs could ensure the IMF has enough funds, but in practise, amounts over $250 billion face political opposition in the U.S., which effectively has a veto in the IMF.

In 2009, the rest of the IMF's funding increase came via bilateral loans, including from European national central banks. The European Union contributed $178 billion, the U.S. and Japan $100 billion each, China as much as $50 billion, with a number of other countries chipping in $10 billion or less. Countries tend not to count these loans as adding to their fiscal deficits—they are generally viewed as shifting foreign reserves to the IMF. This is also why a G-20 official told Bloomberg they were pushing for China, India, Brazil, Russia, Japan and oil-exporting countries to be the top contributors.

Even so, there may be a price to pay.The last time developing countries were asked to increase their contributions, their voting rights also rose as they asked for a bigger say in the running of the IMF in return. More than 6 percent of the quotas shifted to developing countries, making the BRIC countries among the top 10 shareholders in the Fund at the cost of European nations trimming their stakes. China's share will more than double to 6.4% following the reforms. If they pitch in this time, what will be the cost? This is especially relevant as the U.S. has said that it won't contribute. The U.K. and Japan have said they won't either, unless the G-20 reaches an agreement at its meeting in Mexico on Feb. 24-25.

The IMF may have the potential to stem any liquidity crisis, but politics and concern the euro zone faces solvency problems may mean the fund won't be big enough to be an effective firewall.

Photograph by David Ramos/Getty Images

Spanish Prime Minister Mariano Rajoy's month-long tenure has been characterized by quiet. He has avoided making public pronouncements about his plans to cut the country's deficit and for structural and labor reform, delegating all that to his ministers. This strategy of saying as little as possible appears to have served Rajoy well—indeed, his deafening silence may have saved the country a tidy sum of money: The yield on Spanish bonds has declined to the lowest since the November election when Rajoy's Popular Party swept the governing Socialists from power. In comparison, the yield on Italy's 10-year bond is almost flat over the same period.

Those expecting Rajoy to break his silence and give the media and the markets more details of his intentions today, when he held his first press conference since taking office on Dec. 21, were disappointed. Rajoy appeared along with French President Nicolas Sarkozy, who is visiting Madrid, and they held the floor for 45 minutes. In that time Rajoy gave away nothing further about his strategies.

He said tax rises already announced are "enough." He urged European Union members to do their "duty." He said Spain will reduce government spending and implement the labor reform "soon." He noted that bond spreads "haven't reacted much" to Standard & Poor's decision to cut the country's debt rating by two notches on Jan. 13.

That's right. Well, they did move today: The yield on both the 10-year and the 2-year bonds fell below their closing level on Friday. One of Rajoy's most worthwhile policies may be not to say much about his policies.

Photographer: Eric Feferberg/AFP/Getty Images

Markets will be digesting yesterday's news from the European Central Bank, which offered a great deal of detail on its unprecedented three-year loans to banks and the outlook for the euro zone.

ECB President Mario Draghi said that the record 489 billion euros of three-year loans to euro-zone banks has prevented a credit contraction from worsening. The cash has, after all, flowed into the real economy, even as deposits of cash at the ECB reached a record high of 489.9 billion euros overnight today. Amidst criticism that the money loaned out to banks was just being hoarded at the ECB, Draghi revealed that the banks that borrowed the cash are different from the ones that made the deposits.

"We really see evidence, signs that this money doesn't just stay in the deposit facility... We have other signs that this money is actually flowing in the economy... by and large, the banks that have borrowed the money from the ECB are not the same as the ones that are depositing the money at the ECB."

The loans reduced liquidity risk for the banks and gave time to those that needed to sort out their balance sheets. And, Draghi said it was "comforting to see some opening in unsecured bank-bond markets," referring to the concern that smaller banks had been shut out of markets and the larger ones had been issuing record amounts of more costly covered bonds to raise funding. Nevertheless, he expects demand to be high when the ECB offers three-year loans again at the end of February.

Still, the risk of a credit crunch has implications for the real economy. To counter this, and in view of what Draghi calls "substantial downside risks" to growth and "balanced risks" to inflation, monetary policy could be loosened. This is the why the 1% interest rate may not be a floor. In fact, Citigroup, JPMorgan and Morgan Stanley expect rates to fall to a new record low of 0.5% by mid-year, though the median forecast is for rates to stay at 1% through mid-2013.

The alternative to rate cuts would be to undertake quantitative easing like the Fed and Bank of England. Draghi avoided answering whether former ECB Council Member Lorenzo Bini-Smaghi was right in saying that QE was possible should there be deflation and that QE could be "tailor-made" for the euro zone. So, for now, that leaves further interest-rate cuts.

One obstacle in this course is that the euro zone, unlike three years ago, faces substantial deleveraging. The International Monetary Fund estimates that total private and public debt was 440 percent of GDP in the euro area in 2011, higher than the 376 percent of GDP in the U.S. Deleveraging could lead to deflation—this is what led the Fed to do QE once rates couldn't be lowered further than 0 percent. The euro zone experienced deflation in 2009, when prices fell as much as 0.7 percent. If this happens again with recession looming and rates close to zero, then a tailor-made QE programme may not sound like such a bad idea.

(Corrects to say deflation in sixth paragraph.)

Photograph by Daniel Roland/AFP/Getty Images

Romney used the opportunity of his speech (seen here on PBS via YouTube) to besmirch the Old World—and tie President Obama to its woes. Of course, some of this is standard Republican rhetoric: The GOP has played the patriotic and nativist cards for decades, appealing to the sense of American exceptionalism and love of the free market.

Thus, it was hardly out of character among right-wing politicians when Romney declared 6 minutes and 35 seconds into his speech:

He [Obama] wants to turn America into a European-style social-welfare state. We want to ensure that we remain a free and prosperous land of opportunity.

Nor when, 13 seconds later, he declared:

This president takes his inspiration from the capitals of Europe. We look to the cities and towns across America for our inspiration.

Being an admirer of anything European is anathema to red-blooded Americans, smelling as it does of effeteness and elitism. Truth is, Obama does not plan to turn the U.S. into a European-style social welfare state. And while the President might enjoy a nice dinner out in Paris with Michelle, he doesn't appear to be taking his lead from Nicolas Sarkozy or Angela Merkel or David Cameron.

In any case, these oratorical flourishes from Romney—who served as a Mormon missionary in France as a youth—reflect the old view of Europe. The new one, courtesy of the sovereign debt crisis, crept in near the end of the speech when Romney urged his listeners,

I want you to remember when our White House reflected the best of who we are, not the worst of what Europe has become.

Ouch.

No question, the U.S. carries a huge burden of sovereign debt, equal to more than 94 percent of GDP, according to the IMF. Which occupant of the White House is responsible for getting America to that point is open to some debate, but the Republican one before Obama clearly bears part of the blame. As for what Europe "has become," it's worth noting that among the troubled peripheral nations (aka the "PIIGS") only Greece and Italy have government debt burdens significantly higher than that of the U.S., while those of Ireland and Portugal are roughly comparable and Spain's is far lower, at 60 percent.

A Jan. 11 Bloomberg View column by Clive Crook suggests a more nuanced mutual understanding. In "Europe Learns From U.S., So Why Not Vice Versa?," Crook spells out some of the differences between the U.S. and Europe economic systems and asserts that Democrats "do want to move the U.S. in a European direction." But, he adds, that's not necessarily such a bad thing. "Europe has things to teach the U.S.—and the U.S. has plenty to teach Europe. Looking abroad for guidance is no cause for shame."

Americans might not want to seize upon Greece as a model of fiscal rectitude or look to Spain for labor laws. But last summer's near-disaster in Congress over extending the U.S. debt ceiling (a game of "political brinkmanship" in the words of Standard & Poor's, as it cut the country's AAA credit rating for the first time) demonstrates that neither Europe nor the U.S. has mastered the complex intersection between politics and budgets. Were Romney to be the next U.S. president, he'd no doubt find managing America's fiscal problems as challenging as Obama has. In that regard, there's nothing unique about America.

Photograph by Justin Sullivan/Getty Images

Italian Prime Minister Mario Monti told Germany's Die Welt newspaper there will be protests against Germany and the European Central Bank in Italy unless its citizens can see concrete advantages to the spending cuts and reforms his government is implementing. In other words, time is running out in Rome and the euro summit at the end of January must offer benefits to those touched by austerity measures.

This statement, made before a meeting with Germany's Angela Merkel in Berlin, is one of Monti's few remaining cards, and it may be a surprisingly strong one. The implications of public opinion in Italy turning against the European Union and its institutions, and Italians coming to see the EU as a German undertaking rather than one that is shared, would be immense.

Italy is as much part of the EU and the euro zone as France or Germany are. Were a majority of Italians to turn against the euro, the sovereign debt crisis would get much more complicated. For all the tags applied to Italy when it's been bundled with the so-called peripheral euro members, Italy is, if anything, a core member of the bloc. Monti intends to avoid public opinion turning against the euro and the EU, and will expect France and Germany to help deliver some good news for Italians at the end-of-month meeting, whether this is a relaxation of the demands for fiscal or labor reform, or measures that will moderate the country's financing costs. Monti is counting on Merkel's and Sarkozy's understanding that Greeks rioting against the EU is one thing, but Italians doing so is another matter.

Cuts and reforms aimed at reducing Italy's government deficit can only be pushed through, even by a technocratic government such as Monti's, so long as a majority of Italians acquiesce. So, Monti is also trying to make all the right noises to ensure Italians remain positive on Europe.

After meeting Merkel today Monti spelled out what Italy will do:

Growth must come from a healthy economic structure and it's up to each country to achieve that healthy economic structure.

Then he said what he expects from Europe and its institutions:

An improved efficiency in the mechanism that facilitates the transformation of good policy into more reasonable interest rates.

This is as close as Monti got to plain talking at the news conference he held with Merkel—and is another way of saying the ECB needs to play a role. The ECB can help lower government financing costs by backing government bonds, a move Germany has resisted so far. Monti also extolled the merits of the European Union and described Europe as "the most beautiful construction humanity has ever made." An odd contrast with his warning about possible riots.

Photographer: Markus Schreiber/AP

So much for having a currency outside the euro. Hungary sold just three quarters of the one-year Treasury bills it planned to today and the average yield rose to 9.96 percent. That's an increase of more than 200 basis points from the country's last sale on Dec. 22. The particularities of Hungary, where a new law has raised questions about the independence of its central bank, are undoubtedly a major factor in this result—still, the sale does raise the question of whether euro-zone members would have any assurance of a smoother ride if they left the common currency.

The case of a country leaving the euro may never arise. Just in case, the EU's negotiators are taking no rest. Italy's Prime Minister Mario Monti is meeting with France's Nicolas Sarkozy in Paris tomorrow, after a fleeting (and unscheduled) trip to Brussels today. Sarkozy then meets Germany's Angela Merkel on Monday, and Monti makes the trip to Berlin on Wednesday. The next summit meeting of euro-zone leaders, officially scheduled for Jan. 30, effectively begins now.

And a look at what's being placed on the table suggests the tone may be different this time. The European Financial Stability Facility is too small, Monti said in an interview with France's Le Figaro today, indicating this is a theme he may seek to reopen. He also called for a greater opening of markets in the European Union— although Italy itself may have to lead the way in selling off government-owned businesses, given the country's need to cut its deficit. Sarkozy and Merkel will be discussing economic convergence and a new treaty when they meet on Jan. 9, according to France's Budget Minister and government spokeswoman Valerie Pecresse. In addition, the proposal for a European financial transaction tax will be brought back to the fore, after Pecresse said Paris will proceed with its plans for such a tax.

So, the major difference between the upcoming summit and the meetings that marked last year is that now the discussion is over longer-term plans, and longer-term differences, rather than how to respond to the latest emergency—euro-zone leaders will be thankful Hungary and its conflagration are safely outside their immediate remit.

Okay, admittedly not many people think so. But, one might be forgiven for thinking that a corner has been turned with the significant falls in borrowing costs over the past few weeks. Today, Portugal's auction of 105-day bills registered a yield of 4.3 percent, the lowest since the country's EU-led rescue in May. It follows a pattern started last month. Spain's borrowing costs halved when it sold six-month bills in December as compared with November. Perhaps most notably, Italy sold three year benchmark bonds last week at a yield that was more than 200 basis points lower than in November. Indeed, European bonds had a record rally in December, the best performance since the adoption of the euro 13 years ago.

Other EU countries fared even better in the New Year. Sweden, Denmark and the
Netherlands all sold debt at very low yields. Germany had no problem (this time) in shifting more than 4 billion euros of 10 year notes today and even saw borrowing costs fall to 1.93 percent as compared with the so-called failed auction in November, when the country sold only 65 percent of its offering. Even Belgium's borrowing cost hit an 18-month low when it sold T-bills yesterday, and France similarly saw yields fall at its auction, paying 0.1 percent or less to borrow for up to 1 year.

However, when we interviewed Steen Jakobsen, chief economist of Saxo Bank, he
said he doubted 2012 will be better than 2011.

Plus, two very worrying developments came to light today. Overnight deposits at the ECB hit a record high of 453.2 billion euros. This reflects the unwillingness of banks to lend as they would rather park it at the European Central Bank. Perhaps even more worrying is that euro-zone banks borrowed a hefty 15 billion euros at the marginal lending rate. In other words, banks are borrowing at the penal rate of 1.75 percent from the ECB, an action taken usually when they are facing funding difficulties and reminiscent of the period when Lehman Brothers collapsed. This, if anything, indicates the euro crisis is probably not over yet.