The eurozone is paralysed by a "game of chicken" between the European Central Bank and EMU governments in charge of fiscal policy. Both sides are trying to shift responsibility onto the other for shoring up Southern Europe and Ireland, raising the risk of widening contagion.

"The market is not going to wait until March for the EU authorities to get their act together. We could have several sovereign states and banks going under. They are being far too casual." he said. "This is a combined sovereign and banking crisis and that is a poisonous cocktail. The policy response has been woefully inadequate. There is a very small pot of money for a very big crisis," said Dr Buiter.

Dr Buiter described the EU’s rescue fund as an "insolvency machine" because it charges punitive rates of 6pc, preventing high-debt countries from clawing their way out of their trap. "I don’t know why they bothered to create it," he said.

Mark Schofield, Citigroup’s global head of interest rate strategy, said Portugal will need an EU rescue soon and that it is "highly likely that Spain will go the same way". This risks over-powering the €440bn bail-out fund. "Restructuring of some sovereign debt is inevitable. There is a chance that Spain could still make it, but the debt trajectory looks unsustainable if a broader EU-wide solution isn’t found," he said.

Bob Diamond, the next chief executive of Barclays, echoed fears of further eurozone ructions. He told Jeff Randall at Sky News that there is a "distinct possibility’ that one or more countries will be forced out of the euro, though the rest of EMU will hold together.

Moody’s warned that it may downgrade Portugal’s A1 rating by one or two notches on growth worries, but said the country’s solvency is "not in question". Europe’s leaders vowed to do "whatever it takes" to save monetary union at last week’s summit but offered no plan. They ruled out an increase in the bail-out fund, or the creation of eurobonds. Dr Buiter said the ECB has an "intangible asset" of €2 trillion to €4 trillion from its powers to create money and could intervene on much a larger scale if it wished, but this would blur the lines of monetary and fiscal policy. It is anathema to Germany.

"German politicians view the monetisation of sovereign debt as the road to Weimar. They expect the ECB to be the heir to the Bundesbank and not the Reichsbank," he said. The ECB insists that its bond purchases are "sterilised" – meaning that they do not add stimulus or constitute quantitative easing – but this is a disputed point. Dr Buiter said most of the Western world faces a fiscal crisis.

Japan’s debt dynamics are at the tipping point where debt issuance exceeds domestic savings, forcing it to turn to foreign investors for funding. "Who is going to buy the bonds of a country with debt of 220pc of GDP at risk-free rate 1¼pc," he asked. The United States is as heavily indebted as any country in Europe, leaving it highly vulnerable if the yields on US Treasuries rise further. "US public debt is already 93pc of GDP but if you include the debts of Fannie and Freddie [the mortgage giants] it is 130pc, which is exactly the same as Greece. Slam on another percentage point in yields and it will hurt," he said. "It is just a question of time before the market turns on the US as well. It will be the last of the Mohicans to be gathered up, and that will leave only Norway."

China is ready to buy 4-5 billion euros ($5.3-$6.6 billion) of Portuguese sovereign debt to help the country ward off pressure in debt markets, the Jornal de Negocios business daily reported Wednesday. The paper said, without citing any sources, that a deal reached between the two governments will lead to China buying Portuguese debt in auctions or in the secondary markets during the first quarter of 2011. China's central bank declined to comment on the report, while Portuguese government officials were not immediately available for comment. It is unclear whether China's government would be prepared to take on so much fresh exposure to Portugal in such a short space of time, given that Beijing has faced domestic political pressure to invest the country's foreign reserves more carefully. Chinese investment funds suffered some large, high-profile losses during the global financial crisis.

 

 

Our issue is not with the need for action to save the financial sector and to re-invigorate the real sector, but with what was done, how it was done, and what was left undone, specifically:

(i) the continuation of low interest rates and attempts at "resuscitating" the housing bubble,

(ii) the specifics of the financial bailouts,

(iii) the specifics of the stimulus,

(iv) inadequate safeguards for the financial industry to promote better behavior, and

(v) the inadequate reforms and legislation to reduce the likelihood of future bubbles and financial crises.

And as for the long run, we worry about

(vi) the impact that fiscal deficits and the growing national debt will have on economic growth and on social programs, the effect of low interest rates (even negative in real terms) on retirement annuities and thus on those living on fixed incomes, the continuation of "financialization" (defined as the divergence of the real and financial sectors, the growing importance and share of the financial sector in the overall economy), the rapid widening of income and wealth distribution and the resulting social issues that are developing in the US, and their repercussion on international relations.