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Italian and Spanish officials are clearly aware of the fact that their nations will miss fiscal targets and commitments by a very wide margin. The Italians and Spaniards now appear to be convinced that implementation of further austerity measures in their countries would be economically self-defeating and, in any event, politically impossible.

As a result of this epiphany, the Italians and Spaniards - which have heretofore been going along with Germany's insistence on orthodox austerity - have launched the first few salvos in what will become an all out international public relations and diplomatic assault to pressure Germany and the rest of Europe to dramatically change the course of fiscal and monetary policy away from orthodoxy and towards full-fledged Keynesian counter-cyclical stimulus.

The changes in policy that the Italians and Spanish are calling for are radical: A huge increase in the European bailout funds, massive bond-buying QE by the ECB, increased government spending on a massive scale, Eurobonds and a debt union.

The Italians Open Fire

Representing the Italians, Italian Prime Minister Mario Monti recently told German Chancelor Angela Merkel point blank at a public press conference that Italians will not tolerate any more austerity measures. Furthermore, he warned that in his country the Germans were being perceived as intransigent.

A few days later Monti told Der Spiegel that the European Stability Mechanism (ESM), a bailout fund as currently designed is insufficient and must be doubled to 1 trillion euros. Monti knows what an expansion of a European bailout-facility entails: No less than full approval by the German parliament.

The German response to Monti's suggestion has been to say that the ESM is just fine and dandy as it is, and therefore that Germany will not support expansion of the bail-out facility.

Spain Prepares to Go Nuclear

Representing Spain, Foreign Minister José Manuel García-Margallo y Marfil over the weekend in an interview with El Pais, seconded the Monti proposal for a bigger bail-out facility. However, he went much further and it is worthwhile to examine this interview because both the substance and the tone of what he said were quite remarkable.

First, he said that the European Central Bank (ECB) must do much more, calling for the ECB to follow the Bank of England's lead and engage in a massive QE program of sovereign bond purchases. He pointed out that while the Bank of England has engaged in a QE program equal to 20% of GDP, the ECB's bond purchases have been 2% of GDP or only one tenth of the British effort.

Second, Garcia-Margallo called for a massive Europe-wide fiscal stimulus program to be coordinated by the European Investment Bank, saying that it should be on the scale of the Marshall Plan. Furthermore, he called on the European Commission to spend $120 billion euros to stimulate youth employment. Youth unemployment is 49% in Spain and well over 25% in most European nations except Germany.

Third, Garcia-Margallo rather bluntly and spectacularly called for a debt union and the issuance of Eurobonds, saying such measures were a necessity.

Also interesting were some of the rather sharp criticisms that Garcia-Margallo directed towards Franco-German handling of the debt crisis.

First, he expressed profound displeasure of the handling of the Greek situation saying that "if the problem of Greece would have been dealt with in time, the cost would have been much lower. Every day that passes the disease spreads and the treatment that will be needed will be much more traumatic."

Second, he essentially accused the French and Germans of hypocrisy. He said that said that the real cause of the crisis was that "the mechanisms that were put in place so that this would work were blown off, starting with the Stability Pact, which were violated by Germany and France. And the three red lines to never be crossed -- no bailout, no default and no exit -- have ceased to be so."

Third, he scolded the Germans and French for their habit of offering much rhetoric regarding the salvation of the Euro, but few concrete and practical solutions. "We have to send a clear signal that those solemn declarations that we make that we are going to save the euro are not just empty rhetoric… and that signal is debt mutualization…."

Finally, Garcia-Margallo said that the sort of half-measures proposed until now will not due and that "the only way out of the crisis of the euro is a to take a quantum leap towards a Federal Europe… Or Europe makes a leap towards a federal Europe or there is no way out of this. When you have formed a common currency you have to assume the consequences of that and translate its requirements into a coherent political architecture."

Garcia-Margallo's startling proposals, delivered in a trenchant tone, were breathtaking in their utter defiance of German orthodoxy. Indeed, it would scarcely be difficult to imagine a more clear rebuke and gauntlet being thrown down by a Spanish Foreign Minister.

Conclusion

Italy and Spain's economies will collapse and be forced to default if they are forced to strictly adhere to recent fiscal agreements. The Italians and Spaniards have understood this clearly (they are seeing the data) and in response they have launched the first salvo in a desperate public campaign to get Germany to reverse its policy of fiscal and monetary orthodoxy.

It is now official: Europe is divided in its approach to the sovereign debt crisis. Teutonic austerity is widely perceived to have failed and there are important voices warning that unless there is a dramatic change of course in Europe-wide policy, a continental disaster will be the result.

Fundamental political and diplomatic rifts are emerging in Europe, tension is building and a showdown looms. Financial markets will not be amused.

I reiterate that cash will prove to be the most valuable asset over coming weeks and months. Even widely favored stocks such as Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT), McDonald's (NYSE:MCD), Exxon (NYSE:XOM) and Pepsi (NYSE:PEP) should be avoided as they will likely fall in value in relation to cash - and the value of cash will rise in relation to these stocks. Major equity indices such as the S&P 500 (SPX), Dow Jones Industrials (DJIA) and Nasdaq (IXIC) and their corresponding ETFs such as (NYSEARCA:SPY), (NYSEARCA:DIA) and (NASDAQ:QQQ) will probably decline more than 20% from current levels while the value of cash measured in terms of these securities will rise by more than 20%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Italy And Spain Launch Frontal Assault On German Austerity