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Eurozone: A new 'politburo' forms

Eurozone woes forge new informal circle of leaders, who are struggling to pull the eurozone out of crisis.

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The presence of IMF Managing Director Christine Lagarde gives the group greater credibility in the markets, as well as providing a reality check on what international lenders expect and the limits to their willingness to support the euro zone.

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It all began with a blazing row at the Old Opera House in Frankfurt on Oct. 19 that spoiled Jean-Claude Trichet's farewell party after eight years as president of the ECB.

As the fallout from Greece's debt crisis singed European banks and panicky investors dumped euro zone government bonds, French President Nicolas Sarkozy, who had snubbed the ceremony in honour of Trichet, flew in at the last minute to meet a visibly irritated Merkel.

Sarkozy himself said that day that France and Germany were at odds over how to leverage the euro zone's financial rescue fund. The French wanted to let the European Financial Stability Facility operate as a bank and borrow money from the ECB.

"In Germany, the coalition is divided on this issue. It is not just Angela Merkel whom we need to convince," Sarkozy told lawmakers, according to Charles de Courson, who was present.

At the Frankfurt meeting, described by one participant as "explosive", Merkel and Trichet firmly opposed the idea, which they said would violate the European Union's treaty prohibition on the central bank financing governments.

Germany insisted on that clause when the ECB was created because of its own history of fiscal abuse of the central bank that fuelled hyperinflation in the 1920s and funded the Nazis' massive rearmament in the run up to World War Two.

As French officials tell it, Merkel is not so hostile to the proposal as her finance minister, Wolfgang Schaeuble, and the head of the German Bundesbank, Jens Weidmann.

The French are convinced that Merkel understands the ECB will have to be more centrally involved in fighting bond market contagion, but she cannot get it through her divided coalition for now. They see the ECB as the main centre of resistance.

After hearing a chorus of Obama, Cameron and the leaders of India, Canada and Australia at the G20, Merkel acknowledged that the rest of the world found it hard to understand that the ECB was not allowed to play the role of lender of last resort.

But the crisis may have to get still worse before the Germans and the ECB relent, if they ever do.

The Frankfurt Group has already had an impact in euro zone crisis management but like all informal core groups it has begun to stir resentment among those who are excluded, and it has yet to prove its ability to craft a convincing longer-term solution.

North European creditor countries such as the Netherlands, Slovakia and Finland, where public hostility to further euro zone bailouts is fierce, are already grumbling about decisions being taken behind their backs.

In Greece and Italy, there has been strong criticism of the perceived arrogance of "Merkozy", as the Franco-German duumvirate are increasingly nicknamed, in summoning their prime ministers to receive ultimatums.

German and French officials shrug off such complaints as inevitable, noting that EU partners are even more unhappy when France and Germany do not agree, since that paralyses Europe.

"There is always a trade-off between legitimacy and efficacy," said an EU official involved in the Frankfurt Group. "The euro area institutions were not designed for crisis management so we need innovative solutions.

"In an emergency like this, we have to have a structure that works," he said, adding that the presence of the European Commission and of European Council President Herman Van Rompuy guaranteed that the interests of smaller member states would be taken into account.

EU officials had held conference calls with the 15 other euro zone states during the Cannes summit "to keep them in the loop". The head of the EFSF, Klaus Regling, was secretly flown to Cannes to brief the leaders on the state of accelerated preparations to leverage the rescue fund, one source said.

Merkel long resisted French pressure to create more of an "economic government" in the euro zone, not least because she did not want Germany to be in a minority on issues such as bailouts, free trade or the EU budget.

She also did not want to alienate German allies and neighbours such as Denmark, Poland and the Czech Republic, which are not in the euro zone.

But recent problems in smaller countries that aggravated market turmoil -- Finland's demand for collateral on loans to Greece and Slovakia's parliamentary wrangling over increasing the EFSF's powers -- convinced her of the need for stronger leadership to impose order.

Whether the Frankfurt Group will be the forum that finally convinces Germany to accept a bigger crisis-fighting role for the ECB, or the creation of jointly issued euro zone bonds, remains to be seen.