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Clem Chambers' Column
EU Must Follow UK's Lead for Credit Crisis
By Clem Chambers
Senior Markets Correspondent
EU Must Follow UK's Lead for Credit Crisis

The volatility in markets is a reflection of uncertainty. The mood swings of stock prices underlines that the markets of the world don’t know if they are coming or going. The Dow, Dax, Cac 40 and FTSE all show the same, extreme swings. Markets — be they commodity, foreign exchange, bonds or options - are all in trauma.

Will there be a big rally or a jumbo crash? The market doesn’t know.

The key reason for this is what’s at stake and the sheer scale of what will happen if things go wrong.

No one believes Europe can let itself go up in smoke for the sake of political grandstanding. Yet a clean solution to the European credit crisis is unclear. The say madness is caused when the mind is trapped into a “double bind” where the logic of a situation is mentally irreconcilable. Markets have gone “mad” because they cannot bear the thought of the consequences of failure yet see no way out of the mess.

Banks lent long and borrowed short - many went bust. Governments taxed short and took on long term overhead commitments, which is effectively the same thing.

As such, western governments are like broke banks on a giant scale.

Of course, a broke creditor can keep partying if a crazy credit card lender or a mortgaging bank is happy to keep lending. If lenders stop shelling out, however, meltdown occurs.

Of course, in this financial crisis, pain is inevitable, but no one - particularly spend thrift governments or their cosseted electorate - wants the pain now or on their patch.

So the system attempts to let things unwind gently. Instead of a lot of short term pain the economy gets slow motion agony.

There are many layers of problems needing to be solved to see the back of this crisis.

Not only must governments heal financial systems, they also have to balance budgets or at least get them back to something that looks like sane economics. Then they have to solve the balance of payments crises draining the west white before getting their economies on a footing to compete with developing markets - all while hoping to avoid social unrest. The scale of the underlying problems is immense.

It’s no wonder political paralysis reigns.

The UK is about the only country in this mess that has already taken the bitter pill of realignment.

The problem is how to lower government debt, boost the economy and right size government.

Of course you can do this by suddenly running surpluses in trade and government, but to do so would need both a miracle and a terrifying shrinkage of the government sector. With trade and budget deficits at historically high levels, this is simply impossible. Without tearing the state to pieces there is no way to repay these titanic debts. The only way is to make the debt go away, is to dissolve them with the acid of inflation.

Imagine inflation at 5.5% for five years, approximately the rate of inflation in the UK. This takes a debt down in real terms by a quarter over the five year period.

A trillion sterling national debt over this period will have fallen in real terms to 750 billion. This 250 billion drop is an improvement that could never be made by repayment and inflation has done it almost invisibly.

If you scare the public sector into pay freezes with the implied job loss threats of austerity, you have in effect let inflation cut your overheads by a quarter.

Meanwhile in the private sector, prices have risen by 30%, so with a little luck, the national tax income has risen by nearly that figure. So a big rise in income with a freeze in costs sees the state finances back on track or at least greatly improved, all without dropping a guillotine on spending.

Of course everyone is paying the bill, but the levy is invisible to many, chronic and hard to fathom by most. As such it is the perfect solution, however poisonous the medicine.

The UK has already taken this road and the rest of the west will follow.

In the UK a 5%+ inflation has existed for some time, the currency was crashed in 2008, public sector overheads are being squeezed and the populace is being scared into taking the haircut that inflation is inflicting.

Five years of this arduous plan will right the economy of Britain although the pain of the ordeal will be significant. Inflation is unfair and ugly yet it has been brutally effective since the dawn of economics, in bailing out countries whose state has run out of control and bankrupted the country’s treasury.

The US will follow this strategy after the election and the cash ‘Bazooka’ the EU requires to stop meltdown, will achieve the same result.

Germany has been against this simple but certain path from the start but it seems about to open the gates to this hard road at the end of the month, when Europe must state its solution to the imminent unravelling of the EU financial system or perish.

Merkel and Sarkozy have set the deadline for their plan at the end of October. It is one more shot at averting an enormous, global , financial crash and perhaps the last chance to do so. Time is most certainly running out.

It should be a simple matter to set the wheels of rescue in motion: printing money isn’t hard. However German’s are historically utterly against inflation and its uses. The end of October 2011 will show whether they are prepared to suffer it for the future of Europe.

Inflation will insidiously level the playing field, delivering realignments, one tiny wicked slice at a time.

The active: the borrowers, get to win out and the passive: the savers: get robbed. Yet when there is no way to pay off debts because they are overwhelming, inflation is the only course of escape bar default.

This is why Gold is US$1600 an ounce and why the Swiss Franc and the Yen are so strong. The “money” is running for inflation hedges. No heavily indebted country with a trade deficit has an alternative to austerity and inflation. Those that see inflation coming, want ‘out of money’ or have got into currencies which look unlikely to inflate disastrously.

Germany and France have one more shot at stopping a contagion that could trigger a lenders strike across the globe. Such a strike would wreck disaster and a soviet style disintegration. As such the famed ‘Bazooka’ of reflation is likely to be wielded at the end of October and an era of high inflation in Europe is sure to follow.

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Clem Chambers serves as Senior Market Correspondent for The Seoul Times. He has been writing investment columns for a number of international media including Wired Magazine, the Daily Mail, the Daily Telegraph, the Daily Express, the Scotsman, and Forbes. He can be reached at aliceh@advfn.com His website is advfn.com

 

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