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It's not just Europe that makes no sense ...it's everything

THERE comes a time in every crisis when everyone just stops making sense.

Right now, with the spectre of an economic depression settling over Europe, political and financial leaders have run out of options. They don't know what to do next; but they have to sound as if they do, which is why they seem to talk in riddles and contradictions.

The head of the IMF, Christine Lagarde, said last week that if Britain hadn't cut its deficit she would have "shivered" at the consequences, while in the same breath urging an expansionist policy to promote growth.

David Cameron went one better. He called for Europe to fast-forward to federalism, complete with eurobonds with common interest rates across the entire EU from Greece to Finland. However, this is precisely the reverse of what his own Conservative party stands for. They want less Europe, not more.

This has broadened the smile on the face of the Labour shadow chancellor, Ed Balls, "the muttering idiot" as the PM described him last week. He says his alternative vision of an economy boosted by job-creating public investment is now the only game in town.

But Mr Balls is unable to explain how the growth spurt could be achieved without Britain taking on even more borrowing – borrowing that would increase the interest on the colossal debts Britain has already piled up since 2008.

And it isn't only politicians and bankers; the markets themselves seem to have taken leave of their senses. Last week's numbers confirmed that Britain really is back in a double-dip recession, as growth figures were revised down again.

This will make it even more difficult for us to pay our debts. Yet the bond investors piled into sterling last week and the cost of Britain's sovereign debt actually fell to a record low. One reason suggested for this was that Britain, being out of the euro, can print money and devalue. But since this would actually reduce even further the value of their British sovereign bonds, why would the money men see this as a good deal?

Meanwhile, EU officials in Brussels insist that Greece is not going to leave the euro even as the European Central Bank (ECB) and the IMF admit they have started making contingency plans for precisely that. The smart money is now on a "Grexit" on January 1, 2013.

But this speculation about the break-up of the eurozone is accelerating precisely the processes that have been making it unstable. Again – a contradiction between what people say and what they do.

The only place where real growth has been happening is Germany, which is still enjoying the remains of what might be called an austerity boom as the price of its exports fall along with the value of the euro.

However, Germany, through the ECB, has been urging austerity policies on its neighbours that will help destroy the very markets for cars and domestic appliances that have been making Germany an export powerhouse.

To make sense of all this, we need to start at the most fundamental contradiction of all – between productivity and demand. For an economy to grow it needs consumers with enough money to buy all the commodities produced. This is called demand.

However, enterprises tend to grow and compete with each other by reducing the number of workers required to make these goods. Just think of the sterile robot car factories and compare them with the old labour-intensive British Leyland plants of 30 years ago. Those sacked workers mean less money to spend in the high streets – which is bad for business – but it also means less tax revenue for the Government, which is bad for the national accounts.

When the economy is expanding, maintaining employment and demand is no problem. Banks lend to firms seeking to grow, and this generates more economic activity employing more workers/consumers. It seems effortless, not least because the banks are allowed to lend money they don't actually possess thanks to fractional reserve banking.

Expansion allows the companies to repay the debt plus interest to the banks. More workers are employed more efficiently and can buy all the goods that are produced.

The problems arise when the economy stops expanding. Then the reverse happens. More and more workers are unemployed, or – in Britain's case – under-employed. This means less money around to buy the goods that the economy produces. It also puts pressure on the Government because fewer workers means reduced tax revenues. Which means cuts in the workforce of the public sector.

This vicious spiral operates also between nations. Everyone wants to produce exports as cheaply as possible and sell them for as much as they can get. But if everyone does this at the same time, there is a crisis of over-supply and firms go bankrupt. In essence this is what has happened in Europe.

The northern countries, such as Germany, are immensely more productive than the weaker Mediterranean economies, which cannot compete. But they are forced to allow their countries to be flooded with cheap exports, which destroys their productive economy. All this has been magnified by the banks, like Bankia in Spain, which are insolvent because they have lent huge amounts of money they never had in the first place.

Short of war or a severe economic depression, it's difficult to deal with this. War destroys assets on a colossal scale, allowing an upturn to emerge from the wreckage. No-one wants that, so the responsibility for restoring demand falls to the state.

The government has to maintain demand in the economy, perhaps by redistributing wealth to those at the bottom. Alternatively the state has to start acting on its own account – borrowing more money to launch productive activities. But we have reached the limit of the ability of individual nation states to do this without sparking a sovereign debt crisis.

Europe now has no choice but to manage demand on an EU-wide scale. Piecemeal bail-outs and support mechanisms are only making it worse. To get Europe back to work, all the states will have to get together and put their strength behind common euro debt.

Germany will have to accept that Greek bonds are as good as German bonds, Greek credit is as good as German credit. That is the only way to stop a domino default across all those indebted, under-productive Mediterranean countries.

The US marines have a saying: no-one gets left behind. That now has to become the mission statement of Europe.

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