It took two nocturnes to chart the next steps, starting with an accord by finance ministers at 4:30 a.m. yesterday to make the European Central Bank the hub of bank supervision by March 2014 for the 17 countries using the euro. By noon, a deal was forged to release 49.1 billion euros ($64.3 billion) for Greece, followed by the leaders' future-of-Europe deliberations until 2 a.m. today.

The euro traded at $1.3075 at 2:15 p.m. Brussels time, barely changed from $1.2960 at the start of 2012. During the year it never fell below its January 1999 debut rate of $1.1668, a sign that for all the turmoil, investors felt the currency's survival was never in jeopardy.

Financial-market tensions have abated, thanks mainly to a pledge by the ECB, first made in late July and yet to be acted on, to put a floor under the bond markets of vulnerable countries such as Spain or Italy.

“It is still possible that an accident will precipitate the collapse of the euro zone,” the Washington-based Brookings Institution said in a report this week. “What this narrative misses, however, is the other important part of the story — how European leaders, at the same time as they are battling difficult economic conditions, are slowly building more solid foundations for the euro zone.”

Euro Road Map

Accords on bank supervision and Greece's next disbursement left the leaders to focus on a “road map” for turning the euro zone into a “genuine” economic union over the next 5 to 10 years, with models such as the federal systems in the U.S. and Switzerland.

With Germany heading for elections in September 2013, Merkel, Europe's dominant policy maker, ruled out adding to the burden on her voters, the main underwriters of 486 billion euros in rescue loans granted since 2010.

A strategy under discussion to handle failing banks “may not be at the cost of the taxpayers but has to be structured so that those responsible for the failure of the banks carry the burden,” Merkel said.

A half year of brainstorming over the euro's future tilted further in Germany's direction, with any thought of the joint issuance of new debts or redemption of old ones banished from the road map put together by EU President Herman Van Rompuy.

Luxembourg Prime Minister Jean-Claude Juncker, who contributed to the road map, said he was “quite dissatisfied” that its bolder recommendations were dropped.

Even a less ambitious proposal for euro countries to pay into a common fund to offset economic shocks was too much for Germany. Only a “limited” pool of “around 10 or 15 or 20 billion euros” will be made available for countries that sign economic-reform contracts, Merkel said.

That would be equal to at most 0.2 percent of euro-area gross domestic product, less than the 2 percent that Bruegel, a Brussels research institute, estimates would be needed for a shock-absorber budget to cushion disruptions such as a jolt to energy prices.

In the opposite corner was Hollande, who took office in May on an anti-austerity platform and, in a break with the Berlin-Paris tandem that guided the early stages of the crisis response, sought allies in Spain and Italy to offset German dominance.

Merkel blocked Hollande's bid to have “future-oriented investments” bracketed out of budget-deficit calculations. Hollande took solace in the prospect of even a bare-bones financing package for growth-boosting reforms. “I'll take it,” he said. “I'll take everything.”

Next Steps

The conflict will carry over into next year's debate on the path toward a banking union, with the goal of giving central authorities the power, and the financing, to deal with failing banks. At stake is when the 500 billion-euro European Stability Mechanism rescue fund would get the power to recapitalize banks directly, essentially using European money to clean up mistakes made at the national level.

The fate of Greece — pummeled by 17 consecutive quarters of recession and 25.4 percent unemployment — hangs over the the deliberations. Yesterday's agreement to release the first aid tranche in six months came with a pledge by European governments to take “additional measures” in case Greek debt reduction veers off track.

While another cut in Greece's bailout-loan rates and an increase in infrastructure funding would help fill in any remaining gaps, the policy makers hinted that outright debt forgiveness — still a taboo topic for Germany and its top-rated creditor allies — would be on the table as well.

International Monetary Fund Managing Director Christine Lagarde, less constrained by European political sensitivities, was more explicit, saying the euro governments made “assurances to provide additional debt relief if necessary.”

Bloomberg News

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