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European unity teeters as leaders fail to agree on measures to resolve debt crisis

British Prime Minister David Cameron, left, speaks to Italian Prime Minister Mario Monti, right, during a bilateral meeting Thursday before the start of a two-day summit of European leaders at the European Council headquarters in Brussels.

Jock Fistick/Bloomberg/Jock Fistick/Bloomberg

European Union leaders agreed on the need for tougher fiscal regulation but not on the details of how and when to achieve it, after the European Central Bank dashed market expectations it would move forcefully to stem the euro area's debt crisis.

Meeting under a pall of political and economic gloom, the assembled presidents and prime ministers also sought desperately Thursday to prevent their divisions over euro-zone regulation from leading to a potentially fatal breakup.

It was their 15th meeting in 23 months in search of a formula to convince investors they can come up with the discipline and cash to restore confidence in the euro. The two-day summit is scheduled to end Friday.

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They also faced a crisis of confidence in the durability of the EU itself, the worst in the 60 years since Europe started to build a union of collective trade and values on the ashes of centuries of war and mutual distrust.

Although the leaders appeared to be moving closer to an agreement to require deficit and debt limits, the long wrangling did not send the reassuring signals that world markets wanted.

The European Central Bank let it be known that it did not plan to substantially increase its purchase of the sovereign debt of the euro zone's most distressed countries. Combined with reports that EU leaders were still at odds over whether to create a massive bailout fund for debt-ridden countries, stocks dropped sharply across Europe and in the United States.

Loss of faith in the euro, and the deepening recession in Europe, would have worldwide ramifications. "Should the crisis deepen and spread further to the larger European economies, transmission to Canada could become more severe," Bank of Canada Governor Mark Carney said.

"An adverse outcome for Europe," he added, "would also raise the risk of a significant impairment of funding conditions for Canadian institutions."

Meeting into the pre-dawn hours Friday, EU leaders haggled over whether to accelerate a new rescue fund for euro-zone countries threatened with insolvency. A sticking point was whether it should be combined with loans into a super-fund to backstop countries buried under debt or unable to afford to borrow in the markets.

They accepted a German-French proposal that countries adopt some version of a constitutional or budget-balancing guarantee and accept penalties from the EU for incurring more debt than their economies can handle.

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The crisis has outlined in stark terms the rifts among Europeans over how much political power to assign to the EU to police its members' budgets and how much money it will get to prop up the most debt-ridden countries.

French President Nicolas Sarkozy and German Chancellor Angela Merkel triggered the anxiety with a joint proposal earlier this week that would empower the EU to impose deficit ceilings, vet national budgets and impose penalties on fiscally wayward governments.

If all EU leaders did not agree, they warned, they were prepared to hold out for a separate and self-regulated fiscal union of just the 17 countries that use the euro as their common currency.

The French-German ultimatum raised the possibility that the European Union could increasingly spin off into a collection of overlapping but separate alliances, or what some have called an "à la carte EU."

Before going into their closed-door meeting, a number of European leaders expressed alarm at the idea of a two-tiered union. Leaders of the Netherlands, Denmark and Poland called for any debt crisis package to include all EU members, whether or not they use the common currency.

"We also have to make sure that we keep the union of 27 together," said Dutch Prime Minister Mark Rutte. "It is not just a union of 17 euro countries. It is of great importance for a country such as the Netherlands, which is growth-orientated and believes in importance of jobs, that we keep countries such as the U.K., Sweden and the Baltic countries and Poland in."

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While every international summit has its share of personality and culture clashes, this one is more than ever a showdown between strong-willed leaders.

At an earlier meeting over the euro-zone debt debacle in October, Mr. Sarkozy reportedly flew into a rage against British Prime Minister David Cameron, telling him he had no business interfering since Britain had long rejected the common currency and opted out of many EU laws.

British financial institutions, though, are deeply invested in the euro and Mr. Cameron comes to the summit with the same urgency to see it rescued. But he is also under pressure at home to accept nothing that would give the EU any say in how Britain manages its finances or any powers that could jeopardize the euro holdings of the British financial industry.

"The more euro-zone counties ask for," he told parliamentarians in London this week, "the more we will ask for in return."

Another dispute with Britain involves the French and German insistence on changing existing EU treaties to cement the fiscal discipline in the euro zone.

"Words alone are not believed any more because too often we did not live up to our words," Ms. Merkel said a few hours before the summit, at a meeting with centre-right European Parliament deputies.

Mr. Cameron faces demands from within his own party to hold a referendum on any change, a sure-fire recipe for a political crisis at home.

The EU already has separate self-governing blocs. Some countries, but not all, allow free movement of workers between them. Some, but not all, participate in a single-visa zone. But the tough talk from the German and French leaders of a possible go-it-alone fiscal union is seen as a leap beyond.

"Our well-being and our ways of life … can only be preserved in a European Union that works," wrote Lluis Bassets, deputy editor of the Spanish newspaper El Pais, in a commentary published Wednesday.

The Merkel-Sarkozy plan, he added, would create "a Franco-German Europe, a federalism of two partners who are inviting those who want in to join up."

Ms. Merkel's high profile on the debt crisis has triggered an unusual wave of Germany-bashing in France and Britain, where some media and politicians have portrayed her as the embodiment of a revived Teutonic drive to dominate Europe.

If that same backlash leaks into the EU summit meetings, Ms. Merkel's ability to negotiate down from her absolute positions could be compromised.

"It's dangerous and it doesn't increase this government's room for manoeuvre," said Almot Möller, a European policy specialist with the German Council on Foreign Relations.

The political consequences of failure hang heavy over the deliberations. The ratings agency Standard & Poor's warned this week that it could downgrade the creditworthiness of 15 of the 17 countries in the euro zone.

French officials, among others, lashed out at the timing of the announcement as a bit of presummit arm-twisting engineered by the United States. Mr. Sarkozy, facing re-election in April, is desperate to maintain his country's prized AAA rating.

A downgrade could set off a politically unpalatable chain reaction, increasing borrowing costs not only for the national and local governments but also for quasi-governmental agencies such as the French national railroad.

Mr. Sarkozy has already announced three austerity plans since the summer, based mainly on tax increases and speedier pension reforms, but would face the even more politically unpalatable prospect of spending cuts and higher unemployment.

Europe's financial troubles have already toppled six governments in the past year.

Italy, the third biggest euro-zone economy after France and Germany, is drowning in debt. Spain and Ireland are deeply mired in recession dating back three years to the spectacular bust of their speculative real estate booms.

Greece was saved from default by a major bailout, but there are open debates among European economists and politicians over whether it should remain in the euro zone given its debt burden and deficit.

Until now, only Germany and Spain have written debt and deficit ceilings into their laws. The French Socialist opposition has blocked a similar proposal, as did Austrian leftist parliamentarians in a vote on Thursday.

Slovakia's parliament, on the other hand, overwhelmingly approved a constitutional amendment establishing a debt ceiling of 60 per cent of GDP, the limit set by the euro-zone rules, and goes a step further. After 2018, the cap would be lowered gradually to 50 per cent.

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Foreign Editor

Susan Sachs is a former Foreign Editor of The Globe and Mail.Ms. Sachs was previously the Afghanistan correspondent for the newspaper, and covered the Middle East and European issues based in Paris. More

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