“The global financial system will become more multipolar,” ventured Peer Steinbrück, the German Finance Minister, as he surveyed the epic disarray in the US banking system. His hopeful prediction, offered a fortnight ago, is only the most recent unforeseen victim of the credit crisis. European leaders have underestimated the extent to which the Continent's banking system is tethered to the wreckage of the US sub-prime lending market. Their response has evinced a serious failure of leadership. That failure has implications for Europe's role in the international financial system and Europe's single currency.

European statesmen have denied the need for a Paulson-type plan to support the banking sector, preferring to work case by case. President Sarkozy presided over a European summit at the weekend that produced little but pantomime.

Responding to specific bank weaknesses has its attractions, as rescues can be mounted speedily. Those cases have included, in the past week, the cross-border rescues of Fortis and Dexia; the nationalisation of Bradford & Bingley in the UK; and the bailout of Hypo Real Estate in Germany.

But there is a drawback to this type of firefighting. Without a co-ordinated scheme, national governments may take actions that increase rather than mitigate systemic risk. This is what the Irish Government did last week by extending a guarantee for two years to deposits in six banks. Greece, Denmark, Portugal and Iceland have likewise issued deposit guarantees. On Sunday, Angela Merkel, the German Chancellor, made an ambiguous statement that seemed to point towards a guarantee of all private deposits.

This type of unilateral action is potentially destabilising. Depositors in countries that have not extended guarantees will inevitably seek to transfer funds towards banking systems that promise greater protection. Guaranteeing private deposits in one country thus risks aggravating the crisis in other countries, by further depleting the capital of banks. It may also put severe pressure on the fiscal positions of the countries that guarantee the deposits. It will not even deal with the fundamental problem of the credit crisis, as it does not cover corporate deposits.

The risk will be greatest in the euro area, precisely because of what monetary union was designed to bring about - a reduction in the costs of conducting financial transactions by creating a Continent-wide currency. What started as a crisis in Wall Street has thus spread to the European banking system, and European governance is proving itself inadequate to the task of stablising the financial system. The European Central Bank operates a single monetary policy for the euro area, but it does not operate as a Continent-wide lender of last resort. Advocates and critics of a single currency have long accepted that monetary union implies harmonising fiscal policies. It is clear from the seismic shifts in the global financial system that, if it is to work at all, it also requires centralisation of financial supervision.

Mr Sarkozy has spoken of the need to “rebuild the entire global financial and monetary system”. His Paris summit, however, was not a promising start. It was a fiasco. If there is to be a new international financial architecture on the model of the postwar Bretton Woods arrangement, there must be greater realism among European governments and institutions. Citizens of the eurozone will have to consider handing further powers to a shared authority if they want to take co-ordinated action. Countries outside the single currency will have to think once again about the price of economic union. For now, the priority should be to co-operate with US policymakers in stabilising the international banking system. Declaiming on the failures, real as well as imagined, of free-market capitalism can wait.