Nearly everything that eurozone leaders have done in response to the euro crisis has been done in the name of preventing contagion.
But guess what. It's already here. Because (nearly) everything those leaders have done, after large amounts of dithering, has ended up making the situation worse.
In the past 24 hours we have seen: Spanish and Italian bond yields head over 6%; the value of shares in three of Britain's leading banks fall by 6-7% yesterday, as a result of European stress tests which they passed; and the gold price hit an all-time record of $1600 per ounce. (British bank shares have since gone back up again).
Phew. It makes you wonder where we'd be now, if Europe's leaders had NOT been so focussed on limiting contagion.
The events of the past week have taken the eurozone crisis into (yet) another new phase - and ratcheted up the pressure on eurozone leaders as they prepare for their special summit on Thursday in Brussels.
There is now much talk about an "end game" for the euro, with serious commentators now suggesting that the break up of the single currency is a realistic possibility.
But how, exactly, would the euro break up? Until now, that is where the conversation stopped - because even if we could see the case for countries leaving the euro, it was tricky to see how they would get from here to there.
Not any more. Now we can see very clearly how it would happen, thanks to a highly illuminating disagreement between the German government and the European Central Bank (ECB).
Switching accounts
Let me explain how an exit could come about, then go back to the argument with the ECB.
Most countries suffering financial crises have one crucial weapon at their disposal: they can print money. That means, even if they have to default on their foreign currency debt, they can always print enough domestic currency to stand behind the deposits in their banks.
As we know, that is not the case for countries in the eurozone. As Roger Bootle and Ben May point out in a very useful note for Capital Economics, this means that countries in the euro are vulnerable to a particular kind of crisis which could not really happen elsewhere.
All you need is for domestic deposit holders to start worrying that their country was about to leave the euro, and start putting their money in, say German bank accounts, instead.
In fact, the signs are that they have started to do just that: Greek bank deposits have fallen by nearly 15% in the past year.
But on this scenario, it's not strictly necessary for people to go to the trouble of opening German bank accounts. If ordinary Greeks simply withdraw euros in cash and hoard it under their beds, you get the same effect.
In either case, the upshot is that you get Greek banks going to the Greek central bank to get extra euros, which the Greek central bank has then to get from the ECB.
At the limit, all of Greece's bank deposits leave the Greek banking system - and end up as liabilities on the balance sheet of the ECB.
Doomsday scenario
We're not there yet. But as I've discussed many times (see, for example,my blog of 8 December 2009), the ECB has been acting as the backstop for Greek banks, providing them with emergency cash against increasingly iffy collateral in the form of Greek government debt.
This is the lending that would stop if Jean-Claude Trichet makes good on his threat to stop accepting Greek debt as collateral in the event of a "selective default".
But you can see that a doomsday scenario for Greece - and the ECB - could develop without this. You just need everyone in Greece to start taking seriously the idea that their euros are about to turn into drachmas, and start hoarding euros or opening foreign bank accounts.
In that case, you're not just talking about the ECB sitting on a lot of Greek government debt. You'd be talking about it sitting on the entire liabilities of the Greek banking system. And no amount of collateral in the world is going to cover that.
In these circumstances, the ECB would be looking at massive potential losses in the event of a sovereign default, or a Greek exit from the euro.
And just to be clear, ECB losses will ultimately have to be borne by its shareholders - the European governments.
The amounts involved are not small, especially if you look beyond Greece. Greek total bank deposits are roughly equivalent to 80% of government debt. Portuguese bank deposits come to more than double the amount of government debt.
Add them all up, the bank deposits of the five periphery countries come to about 230% of German GDP. Is it really plausible that German - or Finnish - taxpayers would consent to taking on even a fraction of those liabilities? Implicitly, that is the question that European leaders need to consider in the run up to the summit.
Present crisis
In the event of a serious run on all Greek banks, there would be three possibilities: eurozone governments agree to guarantee all of those liabilities; or the ECB could cut off funding, forcing the collapse of the Greek financial system; or the eurozone could decide to allow or force Greece to get out of the euro.
As Bootle and May point out, all of these options are bad. But it's not clear that Greece leaving the euro would be the worst, for Greece or for the rest of the eurozone.
None of this is to say that Greece is about to leave the euro. But you can now see how an apparently technical dispute with the ECB, over the nature of default, actually runs right to the heart of the problem.
Critics say that the ECB is forcing a crisis, by insisting that it will cut off funding for Greek banks in the event of a default. But the reality is the crisis is already here. What the ECB is doing, rather, is forcing governments to decide how it is going to be resolved.
The leaders who will meet in Brussels on Thursday still have the power to decide whether this crisis is going to end with much greater integration and burden-sharing between the governments of the eurozone - or a dramatic break-up. But they are increasingly losing control of the timing.
Stephanie Flanders
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