It'll all be over by Christmas.

It strikes me that the economic situation is very similar to the Great War, where the attitude in many governments is “just one more push, and then it’ll all be over by Christmas” – which is, of course, about as true now as it was 100 years ago.

You cant do austerity on this scale in a few years – even the UK’s plans, which are very ambitious only call for an elimination of the deficit (ie the annual increase in national debt) by 2014/2015 (ie the next election whenever that is) and then a reduction of national debt. Trying to force debt reduction by austerity alone in such a short-time is preposterous & self-defeating, which is why I’m so scathing about the European Fiscal Pact – its worse than irresponsible, its stupid, and obviously so.

On the other hand, the situation is actually solveable, and you can keep the Eurozone together, but it would require political chutzpah of almost unimaginable proportions. Given unlimited levels of political will, you could, in theory solve it by:

• The ECB announces that it will act as a lender of last resort to the EU and will buy government debts, throwing a lifeline to the threatened states, stabilising the markets in the short-term & allows a more normal political dialogue to start taking place, undercutting the extremists,
• The EU agrees to use Eurobonds, issued by the ECB, to reduce the debt burdens of specific countries & further stabilise the markets though this time over the longer term – buying time to implement longer-term market reforms, like raising the retirement age, eliminating corruption & ensuring that taxes are collected etc,
• The austerity package is renegotiated, so that the final ‘get back in balance’ goals are pushed back a decade, reducing the pressure to have austerity in the crisis hit countries,
• Countries that receive the EU bailouts are forced to submit their budgets to an EU body, whilst they are on parole (ie if they accept money, they have to agree to repay & they are monitored to make sure that they do). Incidentally, only nations that get into trouble would have to do this, so there would be less public ire at ‘diktats from Brussels’,
• The European Investment Bank gets a significant amount of money from the ECB to prime the pump by investing in infrastructure projects in countries with high unemployment burdens, giving them the ability to perform deficit spending on beneficial industries, bringing down unemployment & taking up the slack following the collapse of the private sector,
• The Euro gets reformed so that all debts issues by countries (note, not debt issued by the ECB) are printed in 2 currencies – a Euro amount & a local currency amount. In the event that they are expelled / leave the EU, debts automatically convert back to the alternative ‘local’ currency (Franc, Lira, Punth etc) – which can be inflated away by means of the printing press. This will build in a safety valve to avoid future crises & not lead to these intractable problems, and also ensure that countries cant accept a load of European money and then walk off without paying the bills.
• Ratings agencies become more regulated, with them required to submit their models to audit every year and to the ECB for approval every 5 years. Also, the use of rating agencies in European decision making in the sovereign risk financial markets is moved more towards a basket approach (ie using the average of several ratings) and limits are placed on how long a financial entity can remain with a ratings agency. Crucially, laws to be passed to ensure that if agencies are found to ‘materially misstate’ the value of a product, they can be sued for redress.

This would solve it.

And do you know what?

Its not going to happen.

S