We can't stand aside from this European crisis

The Chancellor, Gordon Brown, is clearly pleased. Jack Straw in his newly open Eurosceptic stance must be reassured. Only Tony Blair is, I suspect, not too happy about it. But the European project is in a mess, and getting messier.

By any normal political standards, France's and Germany's breach of the euro rules is an outrage, and a deeply damaging one. On any analysis the Foreign Secretary's decision to come out, just as President Jacques Chirac was visiting London, and dismiss the planned new European constitution as "not absolutely necessary" was openly provocative. As for the noises coming out of continental capitals at the moment suggesting that the member states could miss the end-of-year deadline for the Intergovernmental Conference without much harm, and that Germany and France could go it alone if necessary, this can only add to the sense of a ship floating onto the rocks in a general mood of carelessness.

Now you can argue - and the interpretation was already being put about yesterday after the shock of the decision to let Germany and France ignore the growth and stability pact - that the situation is drastic but not too serious. Europe, goes this view, has always muddled through with desperate threats leading to fudged agreements at the last minute.

Jack Straw's warnings can be seen as just one more move in this game of bluff as the negotiations reach towards their climax. So too can the suggestions from European capitals saying that agreement isn't really that necessary before next year. In practical terms the Union could still go on conducting business even if a new constitution were never agreed.

On strictly economic terms it is also perfectly possible to dismiss Tuesday's decision of the finance ministers as no more than bowing to reality. The European central bank might not like it - indeed it does not - but the markets have taken it in their stride. Most economists would sympathise with the view that the euro rules are far too tight for a period of nascent economic revival. Better to risk inflation at this stage than to knock that revival on the head.

All true, but take a few steps back and look at Europe as its citizens, and the outside world, must see it. We have an enlargement that will double the size of the Union but a proposed constitution on which there is no real agreement and no democratic support. The big boys of France and Germany want an effective system in which they can predominate. The middle ranking countries such as Spain and Poland, fear they will be squeezed out. The smaller countries know they will be marginalised, with fewer commissioners, fewer votes and a smaller voice.

To them the decision to let Paris and Berlin get away with breaching financial rules for three years in a row is not just wrong in principle, it is another example of how Europe is becoming a community of two sets of rules, one for the major players and another for the smaller ones. Portugal, Ireland and Greece all had to toe the line on deficits, why not France and Germany? And they are right. When it comes to it, most of these countries will be holding referendums next year on the constitution and most will probably reject it.

Britain's role in this is on the margins. This is not just because of our reluctance to join the euro and the continued divisions over Iraq. It's because on the stability pact, the new constitution and other major issues we tend to be with the French and Germans. Even on the questions of a common foreign and defence policy our differences tend to be more about degree than direction.

But we do have an interest in ensuring that the European Union doesn't fail. On present trends there is now at least a 50 per cent chance that the new constitution will fail, or only go through in the most emasculated form. There is also a reasonable chance that the growth and stability pact will fall for lack of commitment.

Neither of these prospects would directly hurt us. But the consequences in a Europe that would then divide down into groups, whose economic progress would falter and whose enlargement might paralyse the institutions could have a devastating impact on us. At risk would be not only the functioning of the Union as it operates now - a risk which many here might be prepared to take - but the collapse of the whole dream of an enlarged Europe, a vision which Britain does hold to.

There are two ways the Union could now go. One is to muddle along, pushing through a compromise constitution by the year's end and holding to an economic union observed more in principle than in practice. It might work in the short term. But then the whole thing could come unstuck if a substantial number of countries fail to ratify the new treaty and the markets force a crisis in the euro.

The alternative route would be to call a halt now, carry through enlargement with a minimal change in voting procedures and rethink both the constitution and the growth and stability pact. With a different sort of exercise, with the new entrants in place and with a proper consultative process, there would be a chance of agreeing a new treaty that achieved democratic legitimacy and a fair equilibrium between large states and small, old Europe and new.

a.hamilton@independent.co.uk