The day that Toytown went to war, the traffic stopped. For more than a week Liechtenstein (population 35,000) and Germany (population 82 million) have been locked in an extraordinary row involving spies, bankers, a whistle-blower with a shady past, a furious prince – and tens of thousands of well-heeled but anonymous tax evaders. From Britain, from the United States, but, above all, from Germany.

This strange international flare-up is having its effects on the cramped streets of Vaduz, the capital of Liechtenstein. The Mercedes Sclass limos that usually convey wealthy Germans and their earnings to one of the safest tax havens in Europe have disappeared from public view. The German taxpayer is running scared.

“If you listen to people at home, in the office, in the pubs, it is clear that Liechtenstein is bubbling with rage, boiling over,” says Günther Fritz, editor of theLiechtensteiner Vaterland. “We can’t be treated like this.”

Germany provoked this angry response by using its secret service to buy four DVDs bursting with information about tax evaders or simply tax-saving investors who had put their money in Liechtenstein. According to the LGT banking group, out of the 1,400 individual names on the stolen list, 600 are resident in Germany. German tax authorities said yesterday that they had traced €200 million (£150 million) deposited by 100 wealthy tax-dodgers.

British tax authorities are studying details of accounts held at the Liechtenstein LGT bank. America, Australia, France, Spain, Italy and Sweden are also trawling for information about their tax exiles.

The Germans paid €4.2 million for the DVDs and are using the information to spearhead a campaign against tax havens across Europe. Next in line is Prince Albert of Monaco, who is due in Berlin this week. Angela Merkel, the German Chancellor, is set to read him the riot act. Soon, German officials say, the Chancellor will be on her way to Switzerland to make her case there. German secret agents have information from a second bank, the Vaduz subsidiary of the Swiss private bank Vontobel, according to the Süd-deutsche Zeitungnewspaper yesterday.

Germany threatens to impose sanctions against Liechtenstein if it does not seal up its tax loopholes. The Liechtensteiners are stubborn. However, if Germany is going to continue to use espionage to end anonymous bank accounts in fellow European states, then it is going to threaten the very existence of the principality.

Liechtenstein, perched on a barren mountainside between Austria and Switzerland, used to be dirt poor, living off the vineyards that still tumble down through the middle of the capital. Big, colourful postage stamps were also part of its financial strategy.

That was about it until the father of the current ruler, Prince Hans-Adam, started to invite banks on to his mountain and construct a small, rocky, tax-free paradise. Drain away the customers from these banks and Liechtenstein becomes a failed state.

“We don’t have an intelligence service,” Gerlinde Manz-Christ, a senior official in the Liechtenstein Government, says. “In fact, we haven’t had an army since 1868. So we were taken completely by surprise by the action of the German agents. And you know what hurts Liechtenstein most is that we are actually changing fast – we sign the Schengen agreement on Thursday, which will have tax implications, we are negotiating the terms of a money-laundering agreement and, by the summer, we will have a new law on financial foundations.”

She emphasises that banking anonymity will stay: there is no alternative for Liechtenstein, however loudly the Germans complain.

The timing of the German move and its harsh tone baffle the locals. Germany seems to be shifting to the left and the grand coalition Government appears to believe that it can mobilise votes by playing on the German sense of envy. For the Liechtensteiners – and the neigh-bouring Swiss – it is plain that the German tax system is to blame.

Times Recommends

• Tehran cannot live up to its rhetoric
• The new unicycle that will ‘change the world’
• We cannot wish away Iran’s bomb