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In a devastating release of diplomatic cables today we have learned that governments spy on each other, arm each other's adversaries, mess with the internet, obsessively collect chatroom handles of hapless diplomats while missing rather more obvious facts like one guy allegedly being able to download most of their intelligence.

And that central bankers in certain countries have a low opinion of politicians.

The world, in other words, is full of not very nice people, many of whom run countries, and it is blinking dangerous! Therefore most countries take it upon themselves to run intelligence operations; and behind diplomacy there is always the threat of naked force.

I think we will need a long time to sift through what the Wikileaks story tells us about the world we live in. There will new revelations on Newsnight tonight - but beyond the detail it's a slimy, sleazy, alpha-dog eat hound-dog world out there.

It reminds me of the 1860s in a not-very-reassuring way: I am glad I studied at O-level. Certainly the veneer of a serene, rules-based multilateralism is showing thin.

Oh yes, we must begin with Modigliani and Miller; M&M sound like a postmodernist jewellery company but they are in fact the .

Capital structure is, as we are about to find out, highly relevant this week - because it decides the order in which bloke A pays blokes B, C and D to whom he owes money, and whether they get all, some or none of it back.

M&M decided that in a perfect market capital structure is irrelevant: there is no theoretical advantage to writing one kind of IOU compared to another. However, we live in an imperfect market and so must move beyond this startling insight.

Let me give you the layman's explanation of capital structure as it applies to banks. All firms raise money. But banks have, uniquely, three sources: the deposits of savers; money raised by issuing shares (equity); and loans from other companies, and indeed other banks. And also, in a highly imperfect market such as the one we now live in, the state - but we will come to that later.

OK, a bank is a (Diamond and Rajan, 2001) for mediating the claims of these three sets of people - together with the obligations to its actual customers: borrowers - be they consumers, businesses or, again, the state.

The theory of why banks choose a particular mix of capital raising is disputed. What is not disputed is the order in which the queue forms: last in line are shareholders. They can lose everything. Also near the back of the queue are unsecured junior debt holders - people who have lent the bank money on high interest, high risk terms with no security backing it up - ie no claim on the bank's property.

In most countries next to last in line are the depositors - whose money is guaranteed to X amount but then face unlimited losses above that.

Standing next to the unsecured part of the deposits are unsecured senior debt holders.

And then at the front of the queue, secured senior debt.

Senior debt is a form of credit where it is recognised in law that the lender must be paid back before anybody else.

The theory of who a bank pays back first was all well and dandy, and the subject of many a PhD thesis, until 9 August 2007, when BNP Paribas informed investors they could not get their money out of one if its funds because of "the complete evaporation of liquidity".

Nobody knew the value of anything anymore, and therefore an orderly queue must form at the door of the banking system until the value could be worked out. This is what we call the credit crunch.

Fast forward to now. Bank of Ireland plc is the second largest bank in Ireland and 30% nationalised at time of writing (Saturday afternoon). Its shares were worth €18 each three years ago - but are now worth 26 cents. So the company's is worth about 1% of what it was in 2007. If it is totally nationalised this weekend, the shareholders can expect to lose everything, as per the theory, which comes to about €270m.

Its depositors are safe, as are all Irish depositors.

Against that equity base, BoI's debt structure looks like this. It owes €28.5bn - or more than 100x its equity... as you can see each year it has to repay or re-borrow between 3bn and 6bn:

Bank of Ireland plc debt rollover

In the chart above, the dark red bit represents debts guaranteed by the government. But the bright purple bit - senior secured - has also been given an irrevocable guarantee by the Irish government. This is why the Irish government itself is going bust, because those debts now go on its budget deficit. There's not much junior debt, but quite a bit of "senior subordinated" (just above that) and most of it matures late in the decade.

So it's the light purple bit - the senior unsecured - that is going to take the initial hit in the bailout. The implied interest rate (yield) on that debt is currently 14% - up from about 4% three months ago. The price of that debt on the bond market - though the market right now has, a little bit like in August 07, evaporated - reflects the view that investors will get back about 85c per Euro, max.

With the other big Irish banks it could be considerably worse.

According to the Bank for International Settlements, UK banks have about €132bn exposure to Irish debt; German banks a bit more (€139bn) and European banks as a whole €423bn. Now this is not all debt of the banks alone: it is Irish government debt, bank debt and consumer and business debt. Clearly it's not all going to be paid back.

Even if you were to lose 10c in the Euro on all that it would be a hit of €42bn to the European banking system.

Now it is clear that, compared to market theory, reality is all messed up here. Instead of an orderly queue, you have one of those queues you sometimes get when you are on holiday in Italy where the "front" consists of many people and the back of it is one poor sap in a pair of khaki shorts.

Since the government has guaranteed these debts, much of which have gone bad, the "senior unsecured" have to be forced to take a discount, or "haircut". And since the senior secured cannot be forced, they may have to be persuaded. That is what is going on in the hair salon that is the Merrion Hotel in Dublin right now.

But the hard part comes legally in hitting the "senior unsecured" creditors without forcing the depositors to lose money. Because legally they have the same rights. And not only that - in October 2008 the Irish government famously issued a total guarantee on all deposits, removing the liability cap that exists in most jurisdictions.

One way to do it would be to create a separate bank and place just two columns in its spreadsheet: all the depositors money; and a guarantee by the Irish Republic to pay it all back. This would then be guaranteed by the EU. What would be left in the other half of the bank would be just the debts and a promise by the Irish government to pay some of it back. It is not so much good bank/bad bank but a case of corpse versus zombie.

The whole thing would depend on trust of course: and trust is in short supply for the Irish government right now - not just because of its performance but because the people might eject it and elect a new one that does not honour either of the above pledges.

How to get around this?

Well interestingly enough, on 17 September 2009 a company was incorporated called Bank of Ireland (UK) plc, regulated by the Financial Services Authority in London. This was to take over the UK customer accounts of Bank of Ireland, mainly the Post Office savings account.

If you look at the structure of how the deposit guarantee scheme works you can see that the queue has slightly been re-ordered: the British government now stands behind the first 50k of deposits and - under certain conditions - the Irish government stands behind the rest.

On 23 July this year Brian Lenihan issued an edict bringing BoI(UK) under jurisdiction of the , meaning that he took powers to:

"make regulations to do anything that appears necessary or expedient for bringing this Act into operation".

So the mechanism for creating corpse bank/zombie bank exists, as does the precendent for a kind of shared sovereignty over people's accounts.

Going back to the old M&M theory, of capital structure in a perfect market, we can see that we are a long way from it.

The capital structures turned out to be important not because of the risk of a bank run, or of the credit risks embodied in the carefully constructed contracts - but of sheer political risk.

The Irish government took several actions: it guaranteed all savings - but could not afford to. Then it guaranteed the majority of banking debts - but could not afford to.

Basically if you have no government guarantee as a depositor or lender in Ireland you are now, in the parlance, stuffed. The credit queue no longer exists: or rather it's order is being determined by what is politically acceptable.

In its place is a new credit queue consisting of one person: the Irish Finance Minister, queuing on behalf of all the others, at two doors: the EC and the IMF. Luckily they do have money, but their interest rate and lending conditions are onerous.

It is bad enough that Ireland will emerge from this weekend with most of its banks nationalized; and bank deposits effectively guaranteed in Brussels and London - not Dublin.

But the worst thing is this: there is one final political risk - that the incoming government cannot make Fianna Fial's budget plan work; that it does not produce export-led growth; or that even before we get there, the resistance is so great that Ireland's part of the IMF deal cannot be implemented. Then instead of a controlled default (a queue) you get a disorderly exit (a rush to the exit).

I've covered such events before: the Argentine default of 2001; Bolivia's descent into "technocratic government" before the rise of socialist-indigenist president Evo Morales in 2005 (in a country ruled for decades by a closed elite very similar to Ireland's, which thought its political system inviolable).

After this is all over the theory of capital structure will have to be rewritten. We will have many examples of what happens when the market not only becomes imperfect, but is effectively abolished by the state. The insights of M&M will seem far distant.

This morning's leak to the Irish Times that the EU/IMF are, indeed, preparing to force those who have lent the Irish banks money to take a loss on their investment is being regarded as a big event in the world of finance.

Here's why.

I quote EU finance commissioner Olli Rehn in Brussels:

"I welcomed the clarification in Seoul that any potential private sector involvement in a future permanent crisis resolution mechanism after 2013 does not apply to any outstanding debt, nor to any EU IMF programme under the current arrangements. This is also the Commission's position."

And here's Jean-Claude Juncker :

"With regard to this permanent mechanism, in particular we need to look at the implication of the private sector. The private sector's involvement obviously could not apply to Greece Portugal or Ireland, if you take the ones that are currently being examined. Private sector involvement would only apply from the second half of 2013."

Now for the details in :

"Officials in the EU-IMF mission to Dublin are examining how senior bondholders could be compelled to pay some of the cost of rescuing Ireland's banks....

At present attention centres on two similar schemes. In the first, bank debt would be converted into equity shares. In the second, bond investors would be given the choice of injecting fresh capital into banks or face a cut in their investment. (my emphasis)

The source said there was a "common understanding" between delegations from the EU Commission, the European Central Bank and the IMF that senior and junior bondholders should each pay a share of the rescue costs.

The first step would be to seek to "persuade" senior bondholders to participate in the bailout, said the source. "If that doesn't succeed, the question is how can you force them in a legally-sound way."

I invited the UK Treasury to confirm or deny this story but they said no comment. They said the declaration made in Seoul stood...However.

If the Irish Times story is true - and it's being given credence in the City - some actual investors look set to share the burden of an EU bank/sovereign debt bailout - to cries of pain from then and delight from that now ubiquitous rostrum in the Deutsche Bundestag, from which Euro policy is now dictated.

OK. Some problems here.

First - under whose legal system do you do this? I am told the Irish legal system contains no provisions for such action so it is being partially discussed under the British legal system. This may be why Britain has to stump up - to create a legal umbrella to do any kind of deal at all.

But under anybody's law the problem is this: junior debt will get wiped out. But senior unsecured debt is, legally, I am told ranked alongside the money of depositors. So how if you cannot persuade the senior unsecured creditors to take a hit (and it's a big hit) you then face legal action where the negative outcome of the court case is, potentially, the loss of some depositors' money?

If we assume the European banks are persuaded to take a stake in the Irish banks, in return for, say a 15% loss on their outstanding debts, then that loss could amount to several tens of billions of Euros, says one investor.

I am told there will be no developments on this before we go on air this evening, but I will keep you posted.

(c) Paul Mason 2010

In the original Alien movie (1979) there is a that illustrates the problem we've been facing since September 2008, and which is coming to a head now (I've produced a handy graphic opposite).

Somebody stabs the alien: but its blood is acid. It burns through the floor of one deck and one character realises: "that cr*p's gonna burn through the hull!"

They run to the next floor, but it's already burning through to the next deck. Finally it stops: the acidic properties neutralised through interaction with the metal decks, the air, the demands of Hollywood storytelling.

In the global financial crisis the acid is toxic debt. The first thing it hits is the real economy: output, trade and the stock markets, which tank in the last two months of 2008 at the same rate as during the post-1929 crash. The acid quickly burns through here.

But then it hits a much stronger barrier: the state. From the April 2009 London G20 to the Pittsburgh G20 six months later the state holds. Fiscal stimulus, monetary stimulus, stealth bank nationalisations - and above all global solidarity all work to stop the destructive power of this toxic liquid. The world economy stabilises and even begins to recover.

But the state is not uniformly resilient: everything that is not well constructed begins to get burned again. Bipartisan politics in the USA does not survive; nor does British social democracy; and the Euro begins to disintegrate. The weakest parts of the state could not take the strain and begin to fragment.

The next floor down is globalisation: and in the trade and currency wars of mid-2010 you begin to see the first deadly drips of acid begin to smoulder there as well, testing the multi-lateral defence mechanisms of the WTO, IMF, Asian dollar pegs.

One problem with this analogy is, going back to the movie, we never know why the alien's blood stops burning. Is it the strength of the final floor or the burnout of the blood's acidic properties? (Acids after all work by giving off protons to the materials they dissolve, and each molecule has only so much burn.)

But with toxic debt you have a substance more volatile than alien acid blood - because toxic debt can get more toxic during the burning process, because by destroying growth and promoting deflation it can make bad debts worse.

So Ireland's banks realised in 2008 they were sitting on massive toxic debts; but the toxicity got worse because a) deflation and austerity collapsed the value of the property that had been bought with the loans and b) the banks standing behind the loans began to go bust. Now the state (Eire) standing behind both the loans and the real economy has begun to crack under the strain. And finally the superstate that is supposed to stand behind Eire (the ECB and IMF backed EFSF) is so weakened that it has to call on its members to double its resources in the face of the crisis - which it is reportedly doing this afternoon (see WSJ ticker).

Bad debts and toxic debts are, really, stored up stupidity: dead decisions that can never be revisited but must now be paid for. Once the toxicity is unleashed it may be an unsolveable problem: we're not used to these in the modern world, shaped as our thinking has become by the plotlines of Hollywood movies, where there is always a solution, a hero (or heroine) and the baddie gets blasted out into space during Act V.

Or, worse still, it may be a problem that you could have solved if you had acted earlier. That is, if they had let Greece go out of the Eurozone in May, or decisively bailed it out in late February.

Right now, with interest rates rising on the sovereign debts of Spain, Portugal and Belgium, and on the eve of a more or less total nationalisation of the Irish banking system, it is becoming possible to believe that the Euro governments' failure to decisively stem the 2008 banking crisis - to rely on temporary liquidity in the hope that returning growth would sort the problem out, to carry out "stress tests" which failed to test for the one thing they are now facing - that all this may have put the unity of the Eurozone in jeopardy.

The fact that we are not in the middle of a rapid contagion event, but rather a slow one, with critical moments ahead for Ireland, Portugal and the ECB, makes this crisis different to the week of chaos after Lehman, or the days of panic in May 2010 over Greece.

One mitigating factor is the German recovery, which is real; and the launch of US QE2, which has already begun to depress the cost of borrowing in the USA; also the strength of the Asian economic rebound. What people in the markets are waiting for is a decisive act of leadership from Germany.

When I explored the issue of a potential two-tier Eurozone on Newsnight, Tuesday, it was in the knowledge that, by the end of the week it would be the "de nos jours" idea going round the City.

It is certainly being contemplated in Berlin. Contemplated and dismissed: you can never break the Eurozone, Bundesbank boss Alex Weber warned the bond vigilantes last night. But on credit ratings, bond spreads, CDS and many other measures the Eurozone is already two completely different blocs, with different dynamics.

Angela Merkel as Sigourney Weaver? We'll see.

Ireland's will look familiar to anybody who has studied all the others generated off the back of the banking crisis. Higher VAT, pension cuts, minimum wage cuts, tax rises for the lower paid, benefit cuts - and cuts in public services.

And it has the same hit-and-hope element as many: that growth will mean the cuts eventually balance the budget. And that growth will be driven by exports.

Ireland's two big export markets are the USA and the UK (at about 18% of total exports each). This month the USA has voluntarily tanked the value of its own currency, and the UK's central bank is revelling in its own past achievements in that regard. Indeed the UK has adopted the view that its own deficit reduction plans will be driven by export led growth. Yet Ireland cannot devalue its own currency to achieve the export-led growth.

So it is dependent on a) a more general recovery across the Eurozone and/or b) successfully competing for high value inward investment by, for example, speculative finance industries or high tech, high value global operations.

The scale of the austerity is massive: on average, each Irish family will pay an extra €3,000 in tax, while wages and benefits will fall.

Yet Ireland is predicting growth will bounce back to an average 2.75% from next year to 2014.

To be clear - if it does not, then even this draconian budget will not put Ireland back on track to meeting the Maastricht rules. And the markets clearly believe there is little chance of the growth story coming true.

Since 2pm the cost of borrowing for Ireland has crept upwards.

But slashing your budget it is something you can control. What we need to know now is the answer to the bigger question: can they save the Irish banks and does the EU/IMF bailout staunch the contagion that is driving borrowing costs up for all governments in peripheral Europe. This depends on factors they cannot control.

Commentators are now noting loudly - as they did on Newsnight last night - that there is now effectively a two-tier Eurozone: on bond yields, on credit ratings, on deficit reduction plans, on banking stability. The authorities, above all in Germany, have begun to speak regularly about the Euro being "under threat".

What is missing is an idea of a vision of what a post-crisis Eurozone might look like. As they focus on the near-horizon crisis, Europe's leaders (as opposed to national governments) are struggling to communicate what the desired end-state is.

My report on Germany's role in the Euro crisis goes out in a few minutes on Newsnight. However there will be no big interview with Germany's finance minister German Wolfgang Schäuble off the back of it. Herr Schäuble blew us out, after much setting up, and did the same to at least one other major news organisation, because of urgent cabinet business.

There is tonight the beginnings of evidence of real contagion from Ireland. I won't grace this with over-emphasis in a TV report but it's worth pointing to (hat-tip to FT ):

-> Spreads on Spanish and Portugese debt rose
-> A rapid sell-off of the Euro followed Schäuble's remarks in the Bundestag
-> Mohamed El Erian went on Bloomberg to warn that Irish banks were "leaking deposits"
-> Plus a whole number of esoteric secondary indicators are reminding bondmarket insiders (eg on the Alphaville blog) of the pre-May 2010 situation.

We've heard tonight that the Irish government will take a major stake in Bank of Ireland (it already owns 36%); that must mean AIB as well as Anglo-Irish to be nationalised. We've heard from RTE the figure of E85bn as the size of the total bailout.

Market insiders are clear that whatever happens tomorrow (today if it's Wednesday already) has to be big, convincing and effective.

Angela Merkel today there was a serious risk of "serial bailouts".

Logically what has to happen is that cross-party agreement is reached on accepting the terms of the Irish bailout (I do not mean I necessarily want it to happen, just this is how it would work for the situation to stabilise). Then we have to see spreads fall back on Portugese and Spanish debt - which closes the doors for the various speculative attacks on sovereign debt we're reading about. And any "bleeding" of retail deposits from Irish banks has to be staunched.

Those are the concrete tasks for Euroland, Irish and IMF officials on the Eurozone's Big Wednesday - otherwise they're gonna need one heck of a big wave board to ride the pipeline of contagion.

France has had five - republics, I mean. But a man wandered up to me on Merrion Street tonight and announced to me: "this is the start of Ireland's Second Republic - as fundamental a transition as between British rule and independence".

My own personal rule in journalism is: if the same astonishing proposition comes up twice in a bar-room conversation within a few days, start thinking about reporting on it. So it is with Ireland's "Second Republic" because it has already, indeed, come up in casual conversations today, and more than once.

The essential proposition is: the IMF/EC bailout is such a profound indictment of Ireland's political class that "the whole thing will have to go". The whole system of patronage that urban/modern Irish people were slightly embarrassed about during the boom but which seemed harmless/tolerable.

The people pushing the Second Republic idea are uniformly involved in the digital economy, international in view, young, modern. I've met a property guy, an IT company guy and a blogger who all spontaneously talked to me about the Second Republic.

On the internet I've managed to trace it back to , and - but it may be older, so feel free to update me in the comments as to its origin.

UPDATE 23/11/10: I've found a set up on 18 November called 2nd-republic.ie. That seems to be where the discussion started during this phase of the crisis.

CONTINUES: However the limits to the French parallel are this: there was only one peaceful transition from republique to republique - in 1958, and it was not pretty. The others were as a result of republican government being reborn after a period of monarchism (1830, 1848, 1870) or fascism (1944).

I get the drift though. I have spent the past 24 hours listening to Irish people saying they just don't trust the political class or the political system, and they would prefer the IMF because "at least you don't have to vote for them": they usually have no overwhelming social issue, apart from the obvious austerity which many see as inevitable - there is instead a political disillusionment, a disillusionment with institutional arrangements which I can report extends also to the media.

Please pile into the comments and let me know what you think.

There's a Reuters wire this afternoon which says:

"Ireland's coalition government is rapidly imploding and there is a risk a European/IMF bailout package would have to be postponed if a snap general election is called, re-igniting concerns about the stability of the euro zone."

I'm in Dublin right now and I want to put that into context. The Fianna Fail-led coalition is collapsing in two ways: the Greens, who are being reputationally devastated by the performance of the government, have said they want an election in January - that is a controlled withdrawal of support. The two independents whose votes are crucial to the government's majority have gone further, saying they can't support the budget that is set to be put through the Dail on 7 December, with details announced this week.

The bigger problem is that the ruling coalition is claiming that any deal with the IMF will be binding on the incoming government. Labour and Fine Gael, who look like winning the election, are saying they want direct talks with the IMF now.

I don't think any of this is going to scupper the deal on its own. But there is also the matter of Fianna Fail's own backbenchers. Many of them - like the rebel independents - are essentially local politicians from rural areas. While younger, Dublin urbanites are tending to poo-pooh the press references to a betrayal of Irish sovereignty, invocations of Pearse and Connolly etc, that is not so among Fianna Fail's base.

So there is a chance that the new austerity budget will not go through - either because the government falls, or because they just cannot agree on the scale of tax rises and spending cuts to be implemented.

In this regard Ireland's 12.5% corporation tax is being seen as sacrosanct; while the Germans and French want it lifted, for the British banks and for American and Asian multinationals it's the key sweetener for inward investment and money re-cycling that goes on in Dublin.

The outcome of the war over 12.5% will show who is dictating Ireland's terms - certainly Chancellor George Osborne was explicit:

"By considering a bi-lateral loan we are recognising these deep connections between our two countries and crucially it has helped us to be at the centre of the discussions that have shaped the conditions of an international assistance package that is of huge importance to our economy."

For now I don't see protest as the main driver of opposition. My taxi-driver laughed off the scuffles outside the TD's office as "normal". But unions are calling for civil disobedience and there is a severe dislocate between many people and the whole political class, who they accuse of lying - for the past week over the bailout, for the past decade over sources of Ireland's economic growth.

Dublin, 2300 ish: I'm listening to Irish politicians shouting at each other on RTE's The Week In Politics Show. But there is not much left to shout about.

Shortly before 9pm Taoiseach Brian Cowen held a press conference at which he announced Ireland would seek a bail out from the IMF, Eurozone and ECB, with some bilateral money thrown in by Britain and maybe others.

It will go for the full monty: the EFSF, the EFSM (which Britain could contribute £6bn to) and the IMF (Britain is exposed to the tune of 5%). All Mr Cowen failed to tell us, and the Irish people listening in to the impromptu press conference, was the two main facts: how much will Ireland borrow and what will be the conditions imposed.

Ludicrously, giving the whole thing a Passport to Pimlico atmosphere, the IMF team that will dictate the terms is actually billeted in Dublin's most expensive hotel, right opposite the taoiseach's office, and right above the glaring arc lights of the news crews, which will now probably go into 24-hour rolling mode.

The news websites are reporting that Ireland may now ask for €70bn, with up to €20bn coming from bilateral and other sources.

The press conference felt to me like a holding exercise - as if the Irish government does have detail on both size of loan and extent of austerity. As if, as one person outside the gates suggested to me, the IMF guys in the hotel had looked at what Cowen was about to say and vetoed half of it. We may get more detail tomorrow.

What I don't think most people have realised is that the moment has just happened where Ireland's "shared sovereignty" with Brussels has tipped into very scant economic sovereignty.

The IMF will be on their case in real time: probably quarterly reviews where the EC or IMF can just come in and tell them to intensify austerity.

The Irish politicans on the TV are still talking about shared sovereignty as if nothing's happened.

But, as they say, "Earth to Ireland's political class and media": getting your country's budget controlled from outside is not a normal part of the shared sovereignty arrangement. It is abnormal. Likewise Anglo-Irish and Allied Irish banks look like they will soon be sold at knockdown prices to bigger, more solvent EU banks. Losing nationally owned banks is not normal either.

Actually despite all the angst in the Irish Times last week, all the invocations of Easter 1916, those we've spoken too today are quite sanguine about the IMF/EC involvement: the subtext of a lot of the vox pops we've done is - our politicians are useless and corrupt, can the IMF be any worse?

The wider picture is, in the space of a week a country of 4 million people has seen its government slide from absolute denial of bailout to absolute acceptance.

Now the issue is, did Brian Cowen do enough tonight to prevent contagion in the Eurozone?

Let me explain where the contagion comes from: the ordinary bondholders - pension fund managers - are most worried about "restructuring" - ie controlled debt default overseen by the EU. That's what they 've been worried about all along and tonight's moves should placate them. I don't see a bond-market driven attack on the Euro as long as assurances stay in place that the investors won't lose money. But when they get "contagion" nothing stops it. They are probably the most powerful force in the world after the US Navy and the Chinese Communist Party. But I don't see them moving yet.

But then there are the speculators: have some of them placed long-odds bets on the breakup of the Euro, and its substantial depreciation? Yes. Do they use this phase of the crisis to try and push a country out of the Euro? That's the question.

They have to weigh the fact that, compared to the Irish political class, which has dilly-dallied, the actual Euro leadership has stood up to this crisis - operating as always at half the optimal speed and with near zero communications to the outside world. But it has forced a member state to take the bailout to save the system, just as eventually it created a bailout mechanism for Greece.

There are, therefore, two down and two to go. Greece and Ireland have been substantially saved, at massive economic cost to their populations. Spain and Portugal, in their different ways, will be put through the fire.

If I had to call it tonight I would bet against a speculative attack on a troubled country forcing it out of the Euro in the short term. I would also expect the core bond markets to stabilise for now.

There is a sense that if you can force two sovereign countries to more or less destroy their own public sectors in order to stay in the Euro, and gain bipartisan support from left and right in both countries (Fine Gael has just said it will vote for any budget proposed by Fianna Fail here) actually you are on the way to finally reforming the Eurozone's fiscal governance.

The demonstration outside the government offices tonight was tiny: about 50 people from Sinn Fein plus gas privatisation protesters; even though it ended with some banging on the roofs of cars it was not an expression of mass anger.

There is resignation here. If that continues, and one set of interchangeable politicians replaces another - and various people who owe the government money quietly fade into obscurity in their overseas bolt-holes: eventually, we might look back at tonight as the point at which the Euro crisis reached its nadir.

It's a heterodox view and could change by the morning!

The Bank of England will soon be in charge not only of the UK's monetary policy but also its financial stability and its banking system, both of which involve macro-prudential regulation.

Tonight the bank's financial stability chief Andrew Haldane has given a speech at Columbia University, NYC outlining the Bank's latest work on modelling the credit cycle (with Aikman D and Nelson B). See Bank of England .

Haldane et al argue: self-regulation is not enough to curb the credit cycle; therefore the state needs to intervene to depress lending during a boom: monetary policy is not enough to achieve this, and indeed may be counter-productive, because if the credit boom is an excrescence on a fairly modestly growing real economy, monetary intervention can needlessly flatten growth.

Therefore:

"systematic, across-the-system actions are needed to curtail effectively credit booms and busts"

Two things follow from this: there needs to be internationally co-ordinated macro-prudential action (as signalled at Pittsburgh) and the "regulatory boundary" has to be moved so that the so-called shadow banking system, which is now as big as the official system, is brought under macro-prudential regulation.

This has massive implications. It means the Bank of England is going to, quite soon, set about trying to flatten out the credit cycle, with tools that are untested and on a system whose genetic predisposition to regulation is flight, escape, denial, resistance.

And then try and block the escape mechanism.

To get a sense of the complexity of the escape mechanism - aka shadow banking - have a look at (hat tip to Gillian Tettfor this). It looks like the wire-diagram of the Star Ship Enterprise's matter/anti-matter assembly.

I would like to know not just how the Bank proposes to bring the shadow banking system into macro regulation.

I would also like to know Haldane et al's prediction as to what will happen to the credit cycle should this prove impossible to do. One logical conclusion would be that the credit cycle is uncontrollable. Indeed a graph in the Haldane et al paper (top of this page) shows it to be relatively immune to policy since financial capital emerged in the 1870s.

Haldane concludes:

"The state of macro-prudential policy today has many similarities with the state of monetary policy just after the second world war. Data is incomplete, theory patchy, policy experience negligible. Monetary policy then was conducted by trial and error. The same will be true of macro- prudential policy now. Mistakes will be made. But as experience with the other arms of macroeconomic policy has taught us, the biggest mistake would be not to try."

Haldane's intervention follows Mervyn King's Buttonwood, New York speech where he thought aloud, loudly, about a Glass Steagall solution for British banking. Like the 19th century master of Oundle School, FW Sanderson, Britain's central bankers have decided to "think in a spacious way; think on a grand scale".

The problem is spacious thinking - given the scale of the challenge - leaves open a lot more questions than it answers. Newsnight stands ready to ask those questions should Britain's central bankers decide one day to start giving press interviews as well as lectures in New York.

Sometimes one press article sums it all up - and one chart. Today the article that sums things up is the FT's editorial. (If you can get past the firewall read it ). Since you're not supposed to quote direct anymore I will summarise:

Ireland's banks need to be recapitalised quickly or the huge exposure of other European Union (EU) banks will mean another euro-wide banking crisis. But saving the system does not mean saving every institution: big banks should get ready (all over Europe) to take over the operations of little ones.

What the FT is intimating here is that we may be at a similar moment to March 1933 when FDR imposed an enforced four day bank holiday, during which about a third of the banks were shut down. (There is a briliant free history book about it from the Fed , schoolteachers please note).

Though there is no run on the Irish banks from savers (and no need for one, since there is an EU-backed guarantee on deposits up to E100,000) the FT - and market participants I am talking to - notes the potential for a wholesale funding run, and for it spreading to the rest of the EU.

Where next? Sometime between tonight and Monday Ireland will agree on the size of a bailout and there will be haggling with the Germans and Dutch etc about how tough the conditions are.

But the long term issue is the funding requirements of the banking system - and this IS a UK problem and IS impacted by Ireland. See the chart a the top of this page.

According to the Bank of England 2011 the crucial year for UK banks rolling over their debts. About 250bn falls due next year. (Financial Stability Report June 2010 p51/52):

"The UK authorities are working with the UK banks to assess the individual and collective credibility of their strategies for meeting the refinancing challenge."

The risk is that they collectively assume there will be a rise in retail deposits. If this does not happen then, as the Bank explains:

"If, in aggregate, banks' assumptions about retail deposit growth and asset disposals were to prove optimistic, larger amounts of wholesale funding would be needed, potentially at a higher cost."

In addition, the whole process if vulnerable to shocks. Re-funding ground to a standstill in May when there was a Euro crisis.

UK Chancellor George Osborne has insisted that the UK's involvement in any Irish bailout has nothing to do with the challenges facing UK banking, pointing out that the UK banking system is well capitalised at present and has passed the EU stress tests:

"Our engagement in this is because we are good neighbours of Ireland, not because we have particular concerns about any particular UK bank."

This brought some sharp commentary this morning. City economist Graham Turner issued the following note to clients:

"In truth, the rumoured £6-7bn of support for Ireland is effectively QE2 by the backdoor. Despite the UK chancellor's denials, the bi-lateral aid for Ireland is absolutely an attempt to pre-empt further difficulties for UK banks. The huge increase in wholesale liabilities of UK banks due to roll over in 2011 shows that perhaps the UK had more than any other country to lose from an outright default of Irish bank and sovereign debt."

The Manchester Guardian led on the docks strike; weirdly, so did Dagens Nyheter; ditto Svenska Dagbladet.

Of the newspaper front pages displayed here on the walls of the Press Room in Brussels, only Il Messaggero led on the story history would remember: the signing of the Treaty of Rome. Even there, however, and in the other coverage on 26 March 1957, the foundation of the EEC was seen as a junior economic counterpart to the creation of Euroatom: this was after all the Cold War, when nuclear power seemed more important that trade.

It's a reminder of how hard it is to get your head around European stories. They are the height of tedium: men - it is nearly always men - of grey suit, grey hair, grey visage who could not have achieved anything but middling office in their own countries, stumble through press conferences in which their entire plan is to reveal nothing, excite nobody.

When something does happen, what passes for journalism for many of the correspondents stationed here seems to be to get hold of a white piece of paper with an EU pronouncement on it, pick up a phone and read it to a copy desk somewhere on the other side of the world.

Despite this, there is a humdinger of a story going on in the Justus Lipsius building here in Brussels. The EU's major powers are struggling to force Ireland to take a bailout - in order to stave off the second major crisis of the eurozone this year.

The stakes are high: Greece has been bailed out but at the price of economic penury; now Ireland must accept the same, and Portugal - because after that the EU runs out of stricken countries small enough to bail out. The next domino is Spain, and the combined resources of the International Monetary Fund (IMF) and European Financial Stability Facility (EFSF) could not save it if the bond markets turned against it. Hence the contagion has to be stemmed at Ireland.

We are learning this morning of the scale of the proposed bailout: 100bn euros reports the , which seems to have the best inside track at these talks. Though the rescue was spun last night as being "aimed at the banks" - it has to cauterise Ireland's sovereign debt credibility.

Let's be clear what happens if Ireland does not accept a bailout, or if it doesn't work. Sooner or later the bond markets decide the economic governance of Europe is not credible and they "enforce truth" - they refuse to lend to southern Europe and they call the bluff of Northern Europe which has said it stands behind their debts.

To sell the bailouts to their populations, north European countries such as Germany and the Netherlands are insisting on quid pro quo: IMF involvement, therefore strict conditions, and after that a revised Lisbon Treaty with penalties and enforcement mechanisms for those who break the fiscal rules, or let their banking systems overborrow.

The result of this will be a scale of economic centralisation, and loss of national sovereignty, not dreamed of by the discreet nabobs who signed the Treaty of Rome.

If this story were happening in Washington - an economy of 300m people on the verge of major constitutional change and institutional crisis - there would be incessant rolling news, interviews, drama and trauma. Here there is only cold coffee and grey bureaucracy and calm.

This is the EU's secret of success so far: its deliberations are opaque, nobody quite seems responsible for anything, and the accountability mechanisms are one stage removed from the people.

I think they originally put these newspapers on the Press Room wall as a joke on the journalists: look how you missed the story. But the joke's on everybody now: the euro is creaking, teetering. It will survive but at the cost of a major power shift in Europe. But the sheer greynesss and dispiriting atmosphere of Brussels blankets the story in a quality of - if not irrelevance then opaqueness.

I've often wondered what it would have been like to be a court reporter in the Forbidden City during the Qing Dynasty. I think I'm beginning to find out.

I'm in Brussels at the Ecofin meeting. Here's a few thoughts about what's being briefed to the press and what I think it means.

There are clearly talks going on to stage a bailout of Ireland, rumoured to be around 80bn euros. Ireland wants this to be a complex mixture of sovereign debt bailout and banking bailout.

But I've just spoken to the Dutch FinMin, Jan Kees de Jager who was insisting that, if Ireland asked for an European Union (EU)/International Monetary Fund (IMF) bailout, Dutch voters would only support it if there were strict rules attached. He listed them and I interrupted: "It's that or nothing?" "That or nothing," he replied.

And that's the problem. Ireland doesn't want an EU bailout because it knows it's going to get the scale and timing of its national budget taken over by the EU. Despite that I expect maybe in the next two hours the basics of a deal to be hammered out.

But here's the problem: here, amid the bureaucratic steel and glass of the EU quarter, is the bit they can control. The horsetrading between countries.

Out there, there is the uncontrollable bit - and that's the bond market. It was the bond market that staged a run on south European debt in May; and which has staged one on Ireland's debt this week. The reason is always the same - the fear that they are about to lose some of their money.

Europe's leaders have bent over backwards to avoid investors losing money; they have inflicted pain on taxpayers and service users, and humiliation on national governments in order to stave off the idea of investors losing money.

But everybody knows this is going to happen. That's why a resolution of the Irish crisis needs to happen. As one bondmarket participant told me:

"No-one in the markets thinks that a new treaty is a goer, with the ink not yet dry on Lisbon and a growing number of malcontents in the eurozone making the possibility of such a thing passing in the next few years appear dim."

Absent a new Treaty, the bond markets know the eurozone authorities are going to get pushed from pillar to post as they try to defend one bad debt casualty after another.

Incidentally I don't think this is "speculation": though there are speculators in the sovereign debt market, the market's violent reactions seem to be driven by non-speculative investors suddenly realising how poor their understanding of sovereign risk is. They realise they are actually going to lose money: but they are frantically trying to project incremental judgments and valuations into a space that has become (a) black and white and (b) where there is no real market, only political decisions.

Ireland matters because, (i) once it is sorted, attention turns to Portugal - the last of the small, saveable countries. After that, Spain - and there are even murmurings about France. Never mind if these are rational: once the murmurings start in the bondmarket it's a case of "all that is real is rational" - you just have to deal with it.

(ii) The stress tests for the European banks were organised to exclude the possibility of sovereign debt default - or a controlled default known as restructuring. But as one bond source told me: that went out of the window when Chancellor Angela Merkel started talking about imposing restructuring - ie losses on investors - through a new version of the Lisbon treaty.

A third issue is the perceived failure of the Irish anti-crisis strategy: swift bank bailouts in 2008; swift austerity in 2009. This was the model others were urged to emulate, especially because Ireland had not cooked the books like Greece. With the rest of the world (except America and China) now looking at some form of turn to austerity, they will look at the plight of the Fianna Fail government and mutter: this is how they were treated, what happens to us?

Whatever happens tonight the fundamental crisis of the eurozone is not solved. Only today Austria is reported to have suspended its bailout payment to Greece because it alleged Greece had not met the stringent conditions - which takes me back to the Dutch FinMin and my previous blogs: it's about north Europe imposing fiscal controls on Ireland and southern Europe.

And it's not over.

The Irish debt crisis that looks set to reach a denouement in the next 48 hours is being splashed as a contagion story that poses a threat to the euro.

I think it is about something bigger: the Lisbon Treaty itself and the terms of Franco-German dominance in the pact.

Let's step back and ask how we got here.

In May the eurozone ripped up its no-bailout rules and cobbled together a mechanism to solve the Greek debt crisis. Then there really was a contagion threat, which could even have sunk Britain and Spain.

But as a result of a lot of table banging late at night they agreed a 440bn euro (£374bn) fund to bail out countries who could not raise money on the international markets. With a further 60bn European Union (EU) fund and 250bn from the International Monetary Fund (IMF) that put a 750bn backstop on the debt crisis, which has lasted until now.

So why the danger?

As I wrote then, the essence of the European Financial Stability Facility (EFSF) deal is that northern Europe took control of southern Europe. South Europe was supposed to be meeting Maastricht targets on debt and deficit, but could not: so the price of a north-European funded bailout was to be fiscal control from the centre.

The eurozone had always been a monetary pact without enforceable fiscal rules and now the French and Germans would enforce fiscal sovereignty.

But it was easier said than done.

The EFSF mechanism technically breaches the eurozone's rules. It is temporary and runs out in 2013. The original idea for a more permanent mechanism was based on imposing fines on countries that broke the rules. That is, if you are going to have a law, breaking it should mean an automatic penalty.

As it became clear the indebted countries might be reliant on Franco-German funding a lot longer than 2013, Chancellor Angela Merkel and President Nicolas Sarkozy met in Deauville last month to stitch up a new deal. Instead of fines for countries there would be penalties for investors. And the future governance of Europe would not be enforced like a law - it would be more like the relationship of perpetrators and policemen in certain parts of southern Europe: enforced by negotiation.

In any new arrangement after 2013, "wholesale restructuring of debts" would follow a euro-led bailout of a country. That means investors losing their money - as they did with for example the Argentine debt default. This is what spooked the markets - as they began to believe the "haircut" would be imposed during the current bailout as well.

But there is one other detail of Deauville to remember: Merkel and Sarkozy concluded they would have to enshrine the new arrangement in a change to the Lisbon Treaty. Lisbon II would create an enforceable fiscal government for Europe and impose that quaint old fashioned north European concept on the rest: namely that if you lend money idiotically you can lose some of it. Sarkozy agreed to reopen the treaty in return for Merkel's agreement to withdraw the idea of automatic fines.

What the current euro crisis does is throw into question this whole process. The bond markets are yet again signalling they will respond to any threat of "haircut", i.e. losses by selling the debts of the stricken countries, forcing yet more EU bailouts.

The truth is Angela Merkel cannot sell any further German bailouts of southern Europe to her voters without some significant seizure of economic sovereignty by Germany over the rest. It is not clear if Nicolas Sarkozy can sell anything at all to the French. No government in Europe could currently sell a referendum on Lisbon II to its voters. That's why there is stasis.

Up to now David Cameron has said he will not stand in the way of a treaty change that only affected eurozone members, citing Britain's interest in stabilising the eurozone as a market. Conservative views are divided between those who would use the crisis for a new Lisbon referendum and those who would use the crisis to extract maximum realpolitic advantage on other issues: budget, trade, treaty opt-outs etc.

But the problem is now that Europe's stability has to be founded on a new bargain: southern Europe has to endure austerity for half a decade; northern Europe will get effective sovereignty and the power of sanction over the rest. It is hard to see this new arrangement falling into place except at the other side of a crisis.

And in the process European populations will ask themselves: is this what we originally signed up to?

Here's a brief backgrounder to the developing Irish debt crisis:

Ireland's banks lent billions in soft loans during the property and credit boom last decade, much of which they will never get back. So they had to be part nationalised and bailed out to the tune of 70bn euros (£59.6bn) by the Irish government earlier this year.

The Irish government was already facing a budget deficit crisis, because of collapsing growth, deflation, capital flight etc. It had already agreed a 7bn austerity drive over the next four years. But the bad loans it is underwriting total half the size of Ireland's GDP.

Because it bailed out the banks, it will now have to double its austerity programme to 15bn. Even if that is achievable it may tank the Irish economy so badly that they go into a death spiral of deflation, slump and eventually the government defaults on its debts.

But if they do, the eurozone stands behind them in the form of the European Financial Stability Facility (EFSF), a 440bn bailout fund, backed by another 250bn from the International Monetary Fund (IMF) and a further 60bn from the 27 member European Union (EU). Greece is already reliant on that fund, and it has enough money to bail out Ireland and Portugal if it has to (but not Spain).

So when the risk of an Irish default rose, there was no panic - as investors assumed the euro bailout funds would be used if necessary. It will probably cost 90bn euros in total to sort Ireland out.

But then, because the whole EFSF bailout fund is highly irregular and the brunt of it borne by Germany and France, last month these two countries signalled the bailout fund would in 2013 be replaced by a different mechanism that would force those who lent Ireland the money to take a "haircut" or discount on their debt - the investors would not get all their money back.

This sent shockwaves through the bond market. Why do you care? Because the bond market is your pension fund and the fund managers are suddenly faced the prospect of having to write to you and tell you they have lost some of your pension money - or quite a lot if it turns out Portugal and Greece go under. Or a massive amount if it spreads to Spain.

In addition, Ireland is being kept afloat by about 130bn of ready cash, short term lending from the European Central Bank (ECB), about 1/3 of all the liquidity provided in the entire continent, and the ECB wants to stop doing this.

The more Ireland's government resisted a bailout, the more investors began to pull money out of the Irish banks themselves, beginning what one city analyst called a wholesale funding run on Thursday last week.

OK, so what's happening today?

Fears that this will end in disorder have driven the cost of borrowing up for Portugal and Greece, despite the implicit backing of the ECB. The rest of Europe is trying to force Ireland to take a bailout, with the resulting loss of economic sovereignty as its budget gets dictated by Brussels and Berlin.

The Irish government is resisting this - while it tries to design an austerity budget to be presented on 7 December, and because it does not need to raise any new money until next year.

It is arguing in the back-channels that it should be allowed to take EFSF money for the banks, since it is the banks that are insolvent not the government.

This is tantamount to asking the ECB to act as the sovereign authority, bypassing the Irish national government and bailing out the banks direct. You would then be in a position where the euro, based on a no-bailout rule, had seen its monetary authority bail out private businesses and keep them afloat with no penalty to the national authorities that had allowed the catastrophe to happen.

As several economists have already commented: it is a giant game of pass the parcel, solving nothing.

Some are now arguing that, for once in this two year farrago of crisis and stop-gap measures, somebody other than taxpayers should feel some real economic pain: possibly savers, certainly bondholders.

The failure to impose losses on bondholders is being seen as yet another example of the problem that has plagued the policy elite: moral hazard. If you can't lose money from lending Ireland money, you will just go and lend it to another semi-busted economy.

Who will feel the pain if bondholders take direct losses? Well Ireland's debt is 29bn: 12bn of it is owned by German banks, 5bn by UK banks and 5bn by the Irish banks themselves, this latter the ultimate financial tautology.

So by bailing out Ireland, or its banks, the German government is effectively, once again, bailing out its own banks. Some may argue at the "price" of imposing economic sovereignty on Dublin from Berlin.

If it were an episode of Father Ted, you could almost hear Ted Crilly saying to Dougal: "but that money was only resting in my account..."

There's more on this from Robert Peston here.

A few months before he killed himself, the Austrian novelist Stefan Zweig wrote this, about the 1930s:

"All the pale horses of the apocalypse have stormed through my life: revolution and famine, currency depreciation and terror, epidemics and emigration; I have seen great mass ideologies grow before my eyes and spread, fascism in Italy, national socialism in Germany, Bolshevism in Russia and above all the ultimate pestilence that has poisoned the flower of our European culture, nationalism in general."*

The 1930s, which began with a financial crisis, would see the worst depression in capitalism's 200 year history, and then a combined trade and currency war which solidified the world into competing economic blocs. By the time some of those blocs ran out of natural resources, towards the end of the decade, the pathetic military machines they had possessed in 1929 had become capable of conquering countries where those resources lay, wiping out whole parts of their populations in the process.

The great cosmopolitan cities, like Zweig's Vienna, would be scoured of all that was cosmopolitan: their Jewish communities, their academic freedom, their modern art, their gay nightclubs, their labour movements.

This is why you do not voluntarily want to re-enact the 1930s. But it is the shadow of the 1930s that has fallen across the G20 summit in Seoul. The leaders emerged, as we knew they would, without what David Cameron called "a glistening headline" - only 12 months after they had signed up to one glistening paragraph after another in Pittsburgh.

The sticking point, we are told, is "the global imbalances". Once arcane, today everybody who can read a newspaper, or Wikipedia, knows basically what they are: China produces, the west consumes; China saves, the west borrows; China exports, the west imports. This arrangement, which was once vaunted as a kind of yin-yang harmony pictogram for the world economy is now seen, rightly, as dysfunctional.

However, another way of putting it is that globalisation itself has become dysfunctional - or at least the form in which it has developed for 20 years.

To solve the imbalances you have to understand their causes - and there is a wide literature on this, which I will summarise.

The two main theories are called "savings glut" versus "over-borrowing". The says: China's workers and businesses save too much and spend too little, the surplus capital in the world depresses the rate of interest and that cheap money flows into the western financial system creating boom and bust cycles.

The "over-borrowing" thesis says: America's population has become addicted to cheap credit, credit has replaced rising real wages, de-industrialisation pursued for a fast buck by firms offshoring their operations to China means the USA cannot restore its trade balance.

There is a third theory, advanced by among others, known as "the investment strike": because (for the reasons outlined above) general rates of return are low, non-financial companies under-invest to keep headline rates of profit high. This too ensures the major part of capital remains in the financial system, depressing returns and creating bubbles. Martin Wolf's book "Fixing Global Finance" contains a of all this than I can give here.

It should come as no surprise that the proponents of blaming China are US economists, including Fed chief Ben Bernanke, and that supporters of the over-borrowing explanation are mainly sympathetic to the emerging markets.

But the trade, production and consumption imbalances are only one part of the story. The other is the labour market. Looked at from a labour market economics point of view, the problem is this: in the USA real wages have stagnated on some measures since 1973; in China, though they are rising, the labour market barely functions: large parts of wage costs are borne in the form of dormitory accommodation and three meals a day in the works canteen; anecdotally when western companies try to pay their workers more they are prevented by the CCP or its union, the ACFTU. In both sides of the world economy, the sustainable sources of consumer demand are depressed.

So one answer to "the imbalances" would be for real wages to rise both in China and in the West - however, put like that, "correcting the imbalances" looks more like "rolling back the Thatcher, Reagan, Deng Xiaopoing revolution in labour flexibility".

So how could the imbalances be resolved? On paper it is obvious: China has to stimulate domestic demand - not just for railways and bridges but for consumer goods and services - by raising wages and bringing in a welfare state. I have met farmers in China using 60% of their disposable income to send one child through university. Meanwhile the west has to become more industrial, its consumers have to save more and become less obsessed with buying cheap tat at large supermarkets.

America, above all, has to get its productive capacity back. If you wanted to be really controversial you could say that everywhere has to become a bit more like Sweden and Germany. I say controversial of course because, outside of these two countries, the "social model" they represent is widely despised.

So here is the challenge: you either rebalance through collaboration or you do it through competition.

America could easily plot a course to re-industrialise, upskill, raise wages and raise savings (and eradicate debt) as follows: trade controls against China and Latin America, massive money printing to stimulate inflation and shrink the national debt, aggressively devalue the dollar. The problem is it is half doing this without really trying: its QE2 policy does stimulate inflation and depress the value of the dollar. This is what Alan Greenspan meant when he :

"America is also pursuing a policy of currency weakening. The suppression of the renminbi and the recent weakening of the dollar are, of necessity, producing firming exchange rates in the rest of the world to, as they see it, the rest of the world's competitive disadvantage."

Tim Geithner hit back that he had no such intention, but in China, they do not care about the ideas inside Timothy Geithner's head, they care about the actions he is taking.

When it gets to this point what you need is a grand bargain; a spectacular (glistening if you like) gesture to which all sides sign up. That is what Keynes in 1933:

"Our plan must be spectacular, so as to change the grey complexion of men's minds. It must apply to all countries and to all simultaneously. Each at the same time must feel able to remove barriers to trade and to purchase freely. If we all begin purchasing again, we shall all have the means to do so."

At that point the world's leaders were three years into the post-crash reality and . On 21 September 1931 Britain's new coalition government had left the gold standard, after pay cuts in the Royal Navy led to the Invergordon Mutiny, and a resulting run on sterling. Though they did not have the theoretical means to understand it, Britain had inadvertently saved itself from the worst of the Depression by devaluing sterling ("We didn't know you could do that," one hapless former Labour minister famously said). It had "beggared thy neighbour".

America, meanwhile, stuck to the old orthodoxy: though it was to begin Quantitative Easing in April 1932, it would stick to gold until 1933 - forcing itself to adopt deflationary monetary policy even as it tried to escape recession.

The lesson of the early 1930s has been drawn for us by one of the modern world's greatest economists:

"If monetary contraction propagated by the gold standard was the source of the worldwide deflation and depression, then countries abandoning the gold standard (or never adopting it) should have avoided much of the deflationary pressure. This seems to have been the case...There is a strong link between adherence to the gold standard and the severity of both deflation and depression"

That is a quote from Ben Bernanke's 1991 , The Gold Standard, Deflation and Financial Crisis in the Great Depression (with Harold James). Bernanke shows that countries that devalued their currencies first, recovered first. Those that refused to do so were driven by the orthodoxy of the time, shared by capitalist and communist alike, that strong currencies linked to metal were the only guarantee of economic stability.

Right now, countries are beginning to draw conclusions from Bernanke's insight: nobody wants to be the last person to devalue. Right now the USA is inflicting currency pain on all its supplier countries except China; China is inflicting pain on the USA through its dollar peg; Germany and Sweden are inflicting pain on the rest of Europe by using their competitive advantage within a mini-Gold Standard known as the Euro to outproduce the so-called PIGS, which are close to penury.

If the currency war continues, sooner or later trade war will follow.

What politicians are learning is that you can't stop trade wars by meaningless declarations: you can only do so by co-ordinated policy and by a massive shift in assumptions and accepted wisdom. By massive, heroic gestures like the ones Keynes urged. Geithner himself has put his finger on what such a gesture might entail: a one-time voluntary cap on trade surpluses by China, Germany and the other exporting countries in return for a reduction in budget deficits and debt. This is what never got close to happening at Seoul.

They are also learning that democracy and recession are great drivers of trade and currency war: though the central bankers form an unelected global club, the politicians they technically serve have to get elected every five years or so. There is a chance, sooner or later, that a party will come to power in a western democracy committed to overt trade and currency competition with other countries, whether it's the Greek KKE with its desire to leave the Euro or the Teaparty wing of the Republicans with their desire to declare trade war on China.

In addition, as my colleague Stephanie Flanders has pointed out, this was the summit where global consensus slightly fractured: the world view of the global south and emerging Asia was for the first time equally represented. Gordon Brown may have declared the Washington Consensus is dead, at London in April 2009, but it was in Seoul that the non-consensus emerged. The Washington Consensus, it is clear, will not be replaced with a new unity, but a new agreement to disagree.

This is where it becomes problematic - because unlike the 1930s, the world economy is massively more interlocked: in fact it is fused rather than interlocked; it is networked together by global financial flows, derivatives, multi-country production lines, massive raw material trade dependency.

Just take a look at the objects in front of you, and on your person, as you are reading this and make a list of where they come from; and then take your wallet out and ask how much credit would be available on your plastic were the source of it to be only the savers of your own country. Any return to competing trade blocs would shatter the modern world just as completely as 1914 shattered the world of coffee, cake and coloratura that nurtured Stefan Zweig.

Of course, what we now rely on is the various bilateral and multilateral bodies - the IMF, WTO, EU etc - to try and patch things up. They may have missed their chance for a spectacular circuit breaker but they could still patch things together. Even if patching things together is not as good as doing a deal on trade, climate change and currencies it is what they have to do.

Because there is one more reason why we do not want to re-run the 1930s if we can avoid it.

When the "pale horsemen of the apocalypse" visited Zweig's generation, it came as a total shock to them that they brought genocide, war, bombing of civilians, forced migration, disregard for the Geneva Conventions in war, and the overt attack on rationality by mobs devoted to medieval ideologies.

Unhappily, these phenomena are familiar to us already.

My twitter feed @paulmasonnews has made it to list produced by Oxford Economics. I am there at #7 behind Roubini, Krugman, Sachs, Tim Harford etc with 5,015 followers.

I must say however, that the list demonstrates the First Law of Twitter: everything is exponential. Krugman (at 457,000) is going to take some catching.

In an , it has been revealed that Idle Scrawl is to be listed at #8 in the top ten UK economics blogs by Wikio, behind two other ³ÉÈË¿ìÊÖ blogs (Robert #2 and Stephanie #5).

As Wikio's rankings depend on incoming links from other blogs it is clear evidence of the ³ÉÈË¿ìÊÖ's monopolistic, crowding-out behaviour, which has clearly cramped the space of such free-market, private-sector blogs as The Economist - Democracy In America (#1), The Economist - Free Exchange (#3) the Adam Smith Institute (#4) and the FT's BeyondBrics blog (#7).

Joking apart, it's interesting that the two non-MSM blogs in the top ten are Richard Murphy's (influential on the April 2009 G20 crackdown on tax havens) and the expertly-knowledgeable - which is about pan-EU policy, economics and diplomacy.

It reminds me I should produce my own alternative economics blog listing every once in a while - the ³ÉÈË¿ìÊÖ system is so geared to social media that it does not allow me to create a blogroll. There is loads of good stuff out there and I for one cannot survive long without the two FT blogs: Martin Wolf's exchange and Alphaville. And the Spectator's Coffee House is pretty indispensable where it touches on economics, and Knowing and Making which is #17, should really be higher.

Anyway I am enjoying my moment of world domination: it hasn't been this good since I lost the Orwell Prize to Night Jack, who was so good that he promptly gave up blogging and became a novelist. Right now Idle Scrawl is the of the economics blogging Premiere League and revelling in its scrappy, northern, brutalist success.

I love the commentariat: like Dougal in that famous episode of Father Ted, no matter how often you tell them not to press the red button that says do not press, their eyes are drawn to it, mesmerically and they have to press it.

In this case the red button is "the political playbook". And my thought for the day, in the immediate aftermath of the Republican victories in the US elections last night, is that the political playbook of the past 20 years is irrelevant.

Most of the instant reaction from British and transatlantic liberalism goes like this: OK, that was bad for Obama, but now he can consult the Clinton political playbook and use the GOP majority as "a lightning rod" (© Jonathan Freedland); or "move to the center" and become more bi-partisan (© Mark Penn); get a better communications strategy (© virtually everybody). Others look to the deeper issues. Create more jobs says Arianna Huffington.

I remember that afternoon, two days after Lehman went bust in September 2008, when I was in Washington DC and overhearing political insiders obsessing manically about Sarah Palin. But it was already clear Sarah Palin was yesterday's story: the politicos just couldn't understand that the world had changed.

Lehman and AIG would exert a bigger impact on politics than hockey moms. This is because many political insiders see economics as an unfortunately complex and arcane area of "policy", rather than an uncontrollable tectonic platform for everything else.

It's the same today. What's happening to Obama goes deeper than what happened to Bill Clinton, because Clinton was essentially an economic continuity with what came before, while the economics of the US are now in a state of disruption.

Though Clinton faced a guerrilla war on Capitol Hill, and Obama now will, today's GOP majority does not need to look for issues like infidelity or property speculation: they have the fundamental issue of Obama's economic stewardship. This will now probed mercilessly, like the flailing defence of an NFL team in the last two minutes of a game, in stop-start detail under blinding floodlights.

Right after Obama speaks to the nation tonight, a bunch of unelected officials known as the FOMC (Federal Open Market Committee) will launch a second round of massive monetary stimulus: they will add more to the US economy, and to the government's technical liabilities, than the combined fiscal stimuli of Bush and Obama.

They will do it because they can see not only the "known unknown" of deflation haunting America, but the unk-unk of another potential banking crisis, as losses from mortgage foreclosures pile up. They will do it in the knowledge that the rest of the world will interpret it as a mildly hostile act.

America is facing a challenge to its economically dominant position in the world: not an overt, intentional challenge or a plot, but an objective tectonic shift. Having built an economy on bad debt, low wages and trade dominance for the best part of 20 years, it is at the mercy of the process of unwinding that position. One side of this is the banking crisis; the flipside is spiralling government debt and the strong dollar.

As America unleashes QE2 it adds momentum to the trade, currency and capital-controls war that is building between the producing and consuming countries.

Trapped between a stated strong-dollar policy and a domestic monetary policy that weakens the dollar, it will struggle to escape stagnation unless it finds a way to re-start its domestic credit system.

It falls to economist Doug McWilliams of the Centre for Economics and Business Research (CEBR) to make the most acute, and the starkest comment I've read this morning about the US situation. Comparing the Tea Party to the Greek rioters and French strikers, McWilliams writes, in a note:

"All are driven by the strains placed on Western society by the economic rise of the emerging economies combined with their currency manipulation."

The world is engaged in a long, slow, painful re-balancing in which the idea that Western countries could voluntarily become "high-skill, high-wage" - and foist the economic pain of downturn onto other less successful countries using free trade or currency policy - is crumbling to dust. This is not something you put right by consulting the annals of Congressional tactics.

Having spent two weeks in the middle of it all, I think the power of the "end-of-times" rhetoric is that for so many people it rings true: whether they see the overweening state and the deficit as the problem, or the untrammelled power of Wall Street, or two military quagmires, or the offshoring of millions of jobs - Americans are looking at their way of life and asking: How does it all come back the way it was? What is to play for? A coherent economic policy that delivers growth.

Though the administration holds most of the cards - the Treasury, an eastern-elite led Fed - it does not hold them all: a credible presidential candidate for the GOP, with a viable economic alternative based on tax cuts and able to corral the Tea Party into a "social truce", could ride into office on the back of continued stagnation.

But the injection of extra billions of printed money that begins this afternoon only creates the platform for recovery. Further big steps and critical moments lie ahead - and at some point America will be forced to do things that look like it is putting its own recovery ahead of the rhetoric of international collaboration.

However, even if growth returns, there are the social and moral issues that are driving the American right. I look at the electoral map of Indiana this morning, and see the two "gain" congressional districts for the GOP - the 8th and 9th in the south of the state - and I see more than just a swing.

The rural south of Indiana is home to conservative Democrats who, since the Civil War, have combined social conservatism with support for the Dems: indeed a social conservatism held by the local media to be stronger than that of the Republican Party.

If, as seems likely, some of that group has switched decisively to the Republicans, breaking a long party allegiance, it is just one small moment of the re-drawing of political loyalties into the "two nations" that I have written about before.

2012, as was 2008, will be about who mobilises their supporters and who swings a shrunken centre-ground.

Barring the outbreak of some new international conflict or terrorist atrocity it will probably be won or lost on what happens to the economy between today and then. The Clinton-era playbook - for both sides - will be secondary.

The US Federal Reserve is set to launch a second round of quantitative easing, known as QE2, on 3 November 2010. It is probably the US policy community's last shot at averting a double-dip recession and it may work. But there is an argument raging among economists over the dangers. Here is a brief outline of what they are doing and why, and the arguments for and against. If you can improve on it, fire away and suggest changes; ditto if you disagree. I've talked to a number of financial sector economists to try to get this right, but it's still a think-piece rather than definitive.

Oh, and the whole future of the world economy depends on who's right.

1. What is QE?
QE involves the central bank creating money and using it to buy up pieces of paper known as bonds. These are IOUs issued by government, companies or banks, so it is effectively the central bank printing money and lending it to the government or others, with the aim of boosting spending power in the economy. First tried by the Fed in April 1932, it was also deployed by Japan in 2001. Both Britain and the USA adopted the policy in March 2009.

2. How much have they done already?
In the USA, $1.75 trillion dollars; in the UK, £200bn (this latter representing an input equivalent of 12% of GDP).

3. Why are they doing it?
To stimulate growth in a severe recession, you have two macro tools: monetary and fiscal. Fiscal is where you either cut taxes or raise public spending (or both). Monetary is where you cut interest rates in the hope of boosting demand, and in the process, the money supply. Early in 2009 both central banks reached close to zero interest rates, and were forced to consider unconventional measures to stimulate the money supply. QE is the key unconventional measure available.

4. How does it work?
We don't know.

4a. Come again?
The advocates of QE - the so-called monetary Keynesians who see April 1932 as the key turnaround moment in the 1930s -- thought it should work like this: you pump money into the banking system until the risk of the banks lending falls. Your first effect is to reduce the cost of borrowing for the government - the so-called risk-free rate; the second effect is to reduce the difference between that and the real cost of borrowing.

However this did not happen. Or rather it only happened for big business - not for small businesses and consumers.

The money got locked inside the banking system. It raised prices on the stock market, and for banks. And it also probably kept house prices from falling further. This is the so called "wealth effect". Also it allowed big companies to "become their own banks" - issuing their own bonds as a way of borrowing, rather than using the commercial banking sector. However the money never flowed through into final demand - small business loans, higher credit card limits, mortgages, cash in the high street. Or not in large quantities anyway.

There is even a flow-diagram produced by the Bank of England to show how it thought it might work: but the flow is stuck somewhere between the wealth effect and the boost to final demand. The money supply is only growing at 0.9% Q-on-Q - compared to 9% average for the 10 years to 2008. The Bank was insistent that QE would boost the money supply - it currently has no public explanation as to when the 12% of GDP pumped in flows through into 12% extra demand. Or as the Bank puts it: "it remains difficult to judge with any precision the ultimate impact of asset purchases on nominal demand." (May 2010 Inflation Report)

5. What did the Americans do differently?
Bernanke had already intervened to start buying up $600bn of distressed debts of the state-owned mortgage companies with central bank money, and he always argued QE should be done in this targeted way. He even travelled to the London School of Economics to warn against doing classic QE in January 2009. But the recession turned out worse than expected and he had to do full-blown QE anyway. However the US version of QE always had a much bigger targeted aspect - ie tactical buying of bad debt as well as strategic buying of safe debt, and therefore probably had a more benign impact on the mortgage market.

6. So what's gone wrong?
In neither the UK nor the US has QE led to a concomitant boost in demand, or a rapid growth in the money supply. It did lead to cuts in the real interest rate (between 30 and 100 basis points in the USA, around 100 basis points in the UK according to the resepective central banks). In fact the short-term inflation protected interest rate is now negative in both countries.

But credit conditions did not improve for consumers and small businesses.

In both countries there is a key symptom: the banking system is hampered by bad debt, while the private sector - consumers and companies - are trying to pay down debt, using any boost to credit conditions to effectively shrink the money supply "from below" just as the governent tries to boost it from above.

The USA has an additional problem: a much bigger overhang of mortgage debt: 1.5m repossessed properties, a rising foreclosure rate, etc. The UK took micro measures to guard against a wave of repossessions; the US took one big micro-measure - a fund to compensate mortgage lenders against foreclosure - that has now run out.

In short, the pro-QE critics say its failure is due to the unwillingness to nationalise the banks, inflict one-off losses on savers and investors, write off housing and commercial property debts etc. Such critics thing the Fed and BoE should have set a target interest rate - rather than a target volume of QE - ie specified the output not the input. And then printed money and manipulated the banking system until that target rate was reached. For the pro-QE crititics, the Fed needs to do a lot more QE fast. They point out that in the 1930s it was only when the Fed doubled or trebled its initial QE purchases that it had a dramatic impact on real interest rates.

The anti-QE critics say it did not work because it could not work.

6a. Do they get it?
Economists at both central banks have produced learned papers on the subject. The Bank of England (Joyce et al) :

"Our analysis suggests that the purchases have had a significant impact on
financial markets and particularly gilt yields, but there is clearly more to learn about the transmission of those effects to the wider economy."

Which kind of confirms what I've been saying.

The Fed economists (Gagnon et al) :

"Based on this evidence, we conclude that the Federal Reserve's LSAP programs were successful at lowering longer-term private borrowing rates and stimulating economic activity. While the effects are especially noticeable in the mortgage market, they appear to be widespread, including in the markets for Treasury securities, corporate bonds, and interest-rate swaps."

So the Fed can claim to a greater extent than the BoE that their particular type of QE worked better in the mortgage market. But they do not demonstrate any lasting positive impact on money supply and final demand.

7. Has it caused inflation?
The UK is certainly seeing persistent above-target inflation, and the anti-QE critics predicted this. However the pro-QE people see this as entirely due to the VAT increases. The Bank of England is in a bit of a bind because of the conceit that it has to construct all its policies around is the inflation target. It has to say QE is just an extension of interest rate policy, with the aim of getting inflation within 1% either side of 2%. It has no target for growth, demand, money supply - only inflation. So this justification is wearing a bit thin - as inflation is on the high side of target. Much was made of the undershoot to inflation when QE was launched, .

7a. However, in the USA there are warning signs of deflation. That's the qualitative difference between here and there. A certain double dip in the housing market, falling real incomes and inflation at around 1% - which is too low to sustain demand.

8. What's the objection to doing more?
This is where we hit the global macro-economics of QE - obvious to people in the market, completely opaque to the ordinary punter. I will take you through it step by step:
a) QE depresses the value of the currency of those printing the money, and forces the value of other currencies upwards.
b) It also depresses the returns savers get on long-term investments.
c) Therefore, in anticipation of more QE, massive amounts of capital have begun to flow out of the USA to the emerging markets. This is known as the Wall of Money or the "global search for yield"
d) Bad outcome #1: emerging markets accept their own currencies have to rise versus the dollar/sterling: but prices of goods coming from the emerging markets now rise. Companies in the west have two choices: pass this on in the form of cost-inflation or take a hit to profits. We get stagflation. This is the critique favoured by a some people in the UK investment community, and sees the West finally and painfully pay the price for allowing so much of its manufacturing industry to move south and east.
e) Bad outcome #2: currency war, already under way, intensifies as emerging markets resist appreciation of their currencies and this this spills over into trade war. The rebalancing of the globe takes place not within a single global market but a fragmented market of regional trade and currency blocs.

9. Is there a danger of monetisation?

When QE was first mooted, some tabloid newspapers predicted it would bring Zimbabwe style inflation because the central bank would use the money printed not just to buy and hold the national debt but to pay it off. That is known as monetisation.

Generally it leads to high inflation because in monetary theory, if a larger amount of money suddenly starts chasing the same amount of goods, the price of the goods will rise. Some commentators think that the Fed has already begun tactically monetising the debt; others believe it's a matter of quantity - that as long as the amount of Treasury debt is smaller than the amount of money in circulation it does not lead to monetisation. So anything between an extra $500bn to a trillion - even if signalled rather than purchased - could be read as an a signal that the US is about to monetise its debt.

FT commentator Martin Wolf has even to advocate a form of monetisation. What is clear is that, if you believe you face deflation, then monetisation makes sense: but it is the ultimate form of beggar thy neighbour - because it signals that holding dollars is a bad thing it is an overt signal to devalue the dollar and an overt act of currency competition.

10. What needs to happen to unblock the logjam?

QE1 stabilised the banking system and global trade; it has also filled big companies' coffers full of cash. But they are not yet prepared to invest it; meanwhile small businesses and consumers still face a credit crunch.

There needs to be a defibrillating moment where - in addition to QE2 - large amounts of bad debt are written off in the private sector - above all in the housing market. Then consumers suddenly get access to credit again and then the big cash mountains of the private sector get thrown into the economy in the form of investment.

But for that to happen somebody has to take losses who has not already taken them. That means the banks: they have to take the big hit on mortgages and commercial property they have refused to take; that in turn hits the government, which in the US and UK has "guaranteed the losses" on hundreds of billions of bad debt for the cost of a few tens of billions.

In other words, the final destructive power of the bad debt in the system has to be allowed to work itself out.

On top of that, once the final cathartic moment is over, the central banks then have to get out of money printing in an orderly way, allowing quite a bit of inflation to avoid choking off the recovery. One way to do this would be to temporarily abandon inflation targeting - to say: we will keep printing money whatever happens to inflation, until growth reaches a set target and stays there. Bernanke has toyed with this, and it will be interesting to see if he keeps the idea alive.

It's quite tricky, basically - and it involves dragging the politicians back into monetary policy making, ending the fiction that it is somehow "apolitical".

QE2 will buy time. But in that time the governments have to act at micro-level to restructure the finance system so that it starts working again.

11. Could we see another "cathartic moment"?
Some bank analysts believe the second downturn in the US housing market, with the threat of deflation, poor numbers in general etc has created a new pool of undeclared bad debts in the US banking system, totalling around $500bn. In addition, the long-postponed accounting for bad debt in the commercial property market has to happen at some point.

Both politically and economically there could never be a "second bail out" in the USA - the restructuring would have to look more like what happened when Yamaichi Securities went bust in 1997 - a state-controlled insolvency process for one or more banks. Or, of course, the Mother Of All Cathartic Moments, the enforced bank holiday of 6-9 March 1933 when Franklin Delano Roosevelt - one year into the Fed's quantitative easing spree - forced 2,000 US banks to close for good, followed by a massive injection of taxpayers' money into the surviving institutions (and of course their breakup using Glass-Steagall).

What we know from the 1930s is that QE was not enough: it had to be accompanied by massive restructuring of the finance system and in any case led to a beggar-thy-neighbour exit strategy, rival currency and trade blocs and an extended Depression for the countries that lost the exit battle because they clung to their old orthodoxies.

Addendum: Another theme you should be aware of is the danger that QE causes a "bond bubble" that then collapses, above all in corporate debt. An amusing, if slightly Newsnight circa 1982-style, video from the FT explaining this .

"Hillary is sharpening her knife," the source told me - and, believe me, that source was somebody in a position to know.

The comment, made last week, was not elaborated and did not need to be. If, as expected, the Democratic Party loses control of the House on Tuesday night, the stage will be set for a battle over the second phase of the presidency, what is becoming known as "Obama 2.0".

Today's media reports speak of the momentum running out in the Presidential-led fightback, of a lack of fervour and connection: .

On Wednesday morning the problems will be different.

The President's team is currently in transition. A new chief of staff, Phil Rouse, will begin a reshuffle that will see a new economics adviser, budget director, and national security adviser. Meanwhile many more junior aides will look at the prospect of a 2-year long fight with the newly-elected "Mama Grizzlies" of the GOP and wonder if their time could be better spent in academia. And other key members of the current administration will move out to prepare Obama's election bid for 2012.

Peter Baker's , based on a face-to-face with Obama and access to insiders, provides some startling insights into the administration's lack of preparedness to meet what's coming at it.

The most telling scene is when Obama calls a group of "presidential scholars" into the White House to discuss, among other things, the Tea Party:

"Were there precedents for this sort of backlash against the establishment? What sparked them and how did they shape American politics? The historians recalled the Know-Nothings in the 1850s, the Populists in the 1890s and Father Charles Coughlin in the 1930s. 'He listened,' the historian H. W. Brands told me. 'What he concluded, I don't know'."

You have to hope this is not the only exercise in trying to understand the backlash Obama is engaged in, because a fireside chat with a bunch of coastal-elite Washington insiders may not be as accurate as interfacing with the facts, the people, the reality.

It is one of the privileges of journalism that you get to do this. The more you do it, the more you realise - as I have reported before - that the two sides live in separate bubbles. In addition the President inhabits a bubble similar to the one that Gordon Brown got trapped in: "we saved the world from Depression, we were dealt a bad hand, the opposition is based on rhetoric not serious economic management" etc. Baker's feature is replete with evidence that this kind of attitude pervades the administration.

What's going on in US politics is that the Democrats appear to have lost the narrative: they are not connecting with their own base, meanwhile the visceral, plebeian movement that's driving Republicanism to the right is trading on that commodity, fatal to politicians who seem out of touch: common sense. It looks like the only winners from two years of the presidency are Wall Street; it looks like the stimulus has failed - even if you accept things would have been worse without it. Plus they have strong media battalions behind them.

And the Tea Party is not directly parallel to Father Coughlin or the Know-nothings. The former was a mercurial figure who veered between leftism and rightism, exploiting the airwaves as cleverly as Glenn Beck does today, but acting as a pressure-point on Roosevelt. The Know-Nothings were an anti-immigrant mass movement that was strong in the North as well as the South, and which split over slavery in the mid-1850s. That is, they did not represent the fundamental issue that was about to split the Union.

This is something more: as I have written before, the Tea Party represents the emergence of an incipient "separate consciousness" for that section of America which believes its religion, human rights and morality are being trampled on by state intervention. Implicit from the start - and in the imagery - is that it has the right to resist, not simply to campaign or pressure. On Capitol Hill, from January onwards, it will use all kinds of constitutional tactics to throw a spanner into the heart of the works of the administration, and it will back that up with mass mobilisation.

Obama's problem is that, on his own side, one half of the Democrats - that very demographic coalition that put him into power - wants him to be more radical but has no stomach for the ideological war the right has declared.

The impressive turnout for Saturday's Jon Stewart march could not mask that: the placards, sometimes , generally spoke to the theme of "let's cool it, let's be reasonable".

The other half of the Dems, the traditional insiders, party bosses, governors etc are beginning to rue the radicalism of speech but hesitancy in action the administration has shown - and bemoan the President's inability to communicate the narrative.

This is where the comment, "Hilary is sharpening her knife" - from somebody who has done a fair amount of knife sharpening for the Clintons in the past - becomes relevant.

The knife, should it be wielded, could be used to reshape the administration team at its moment of weakness and transition, placing the Presidency back under the control of the party and its machine politicians. Even Howard Dean, once the doyen of leftism, has begun to pinpoint where the knife might be wielded:

"I think the people around the president have really misjudged what goes on elsewhere in the country other than Washington, D.C.," Dean told CNN in August: "I don't think this is true of the president, but I do think his people, his political people ought to go out and spend some time outside Washington once in a while."

It will be fascinating to watch what comes out of this: will it be "Obama 2.0" or "Hilary v0.9 (beta)"?