The 300 Club

Michael Collins is an investment commentator with Fidelity.

UK prime minister David Cameron upset his European counterparts recently when he said the eurozone crisis, that is now in its third year, is "not anywhere near halfway through".

Even if he was trying to deflect criticism from how his austerity measures have sent the UK economy into another recession, it's easy to agree with him.

The euro is a diabolical creation, as member countries tied themselves up in treaties and forsook their own monetary policies to become part of the monetary union.

Troubled euro-users have no interest rates to prod spending, nor a currency to devalue to help restore competitiveness, a politically acceptable way to engineer export-led growth.

The treaties leave no room for exit from the monetary union (whereas, say, a gold standard or a shared currency does) unless a member country leaves the EU [European Union].

Only bleak options present themselves as solutions for a crisis that was triggered by the misalignment of competitiveness among member nations.

Greece's debt dishonesty aside, it was lopsided trade flows in favour of northern Europe that led to the gushes of capital that created the property and financial bubbles that devastated banking systems and economies and, therefore, government finances when they burst.

Voters and bond investors have worked out that Germany is only magnifying the eurozone debt problem through its misdiagnosis that the crisis was caused by government overspending - thus its insistence that troubled countries suffer through austerity.

The government finances of countries from Spain to Greece are worse off for cuts to public spending because the resulting economic downturns widen debt-to-GDP ratios.

The election of the anti-austerity Socialist Francois Hollande as president of France, the plunge in votes for Greece's two main austerity-tainted parties and the consequent inconclusive general election in May, the collapse of the Netherlands minority government over an austerity budget in April and the emergence of anti-EU parties on the left and right show how Europe's fiscal compact, which makes Keynesian stimulus illegal, is political as well as economic self-destruction.

Calls are out for Europe to implement pro-growth policies, even if they entail more borrowing, because economic growth is the best way to right government finances and financial systems.

It may take some months to see if Europe steers away from austerity and sets a less-suicidal course by adopting the pro-growth, higher-inflation and expansionary credit policies that would help resolve Europe's debt and competitive misalignments.

But even if these policies come to pass, these slow-acting remedies are only likely to postpone a reckoning after loading governments with even more debt.

That denouement could easily be a Greek exit from the euro that sparks bank runs in troubled neighbours or a too-big-to-fail country collapsing, events that could cause massive global economic and financial disruption.

The eurozone crisis now needs drastic solutions to avoid a global seizure. For this crisis appears to be beyond stop-gap measures, even ones as creative as the European Central Bank's (ECB) recent injection of 1 trillion euros (A$780 billion) into banks via three-year repurchase agreements.

There are some drastic remedies around. The question is whether they will work.

Wage pushes

The problem for Europe is that the austerity imposed from Berlin is forcing the troubled eurozone countries to undergo the unsustainable adjustment known as an internal devaluation to regain their competitiveness.

This means wages and costs in Greece, Ireland, Portugal and Spain are declining as their economies shrink, a formula for economic deflation, depressions, massive unemployment (24.4 per cent in Spain in March) and political instability.

One suggested way to erode the competitive advantage northern Europe holds over the south is to prod policymakers in these countries to pursue more inflationary policies and to encourage workers there to secure hefty pay rises. The push for more pay is already happening to some degree.

In Germany, the lowest jobless rate since reunification in 1990 (6.8 per cent) is prompting the country's unionised workforce to seek pay rises of up to 6.5 per cent a year. IG Metall, Europe's biggest union with about 3.6 million members, is demanding this increase.

Two million German public servants in March secured a 6.3 per cent pay increase over two years after the services union Ver.di organised weeks of stoppages.

Faster inflation and higher wages and demand in Germany and other better-performing countries mean that wages and prices in troubled countries don't have to fall as much for them to regain their competitiveness.

This outcome would reverse the years of, say, how Spanish wages rose faster than German salaries to help create the trade imbalances that sparked the crisis - German wages only rose 2 per cent a year from 2000 to 2009 while Spanish wages averaged an annual surge of 4.7 per cent each year.

The greater demand that comes with higher wages (or government stimulus) in the north will be a further help if they boost the exports of southern European exports.

At best, though, this is a slow-working fix when time may be short. German authorities have signalled they accept this solution - German finance minister Wolfgang Schauble in May backed higher wages to increase demand, while the Bundesbank said it would accept a German inflation rate "somewhat above the average" within the eurozone - but they will struggle to overcome their anti-inflation neurosis.

Workers are unlikely to gain, or even target, high-enough wage rises to make a vast difference.

Their bargaining power is receding as the stronger northern economies are slowing while jobless rates are climbing. Businesses in these countries naturally oppose wage increases.

Rich depart

Dire forecasts about the eurozone crisis assume the troubled countries default on their debt, somehow leave the currency union one-by-one and reinstall their own currencies at a rate low enough to instantly restore their competitiveness.

The risk to the countries involved, after defaulting on government debt, is that much of their remaining privately owned debt would still be denominated in euros - thus making it more expensive to repay in their new devalued currency.

The wider menace is that, say, a Greek exit from the euro triggers bank runs in other troubled euro users that would threaten their banking systems.

The solution proposed by some to this problem is that Germany and other wealthy northern countries quit the eurozone instead.

If Germany and other strong economies depart the monetary union, the euro would drop in value against other major currencies, including the new German mark or whatever it was called.

There are two advantages with this approach. The first is the troubled European countries would receive the competitive boost they need from a lower currency at far less political cost than by doing it by slashing wages.

The other is their outstanding debt would stay in euros, but their exports would be worth more in euros (when contracts priced in US dollars are converted), making it easier for them to meet debt repayments.

The disadvantages of this solution include that many banks outside the shrinking eurozone would face losses on their euro-denominated bonds. But that's less of a problem than widespread defaults that cause banks to fail or another global financial crisis.

The pity about this solution is while it may be the least disruptive theoretically, it looks politically and legally unfeasible.

Go federal

The most dire forecast for the eurozone is its bail-out recipients ditch the euro at the same time, creating economic, political, financial and legal mayhem.

Money may stop coming out of ATMs [automatic teller machines]. Banks may collapse and savers fear they have lost everything, for governments will be beyond guarantees.

The world's financial system will be threatened and anarchy may take over in some areas as people fear heading back into the economic stone age.

Pre-1999 critics of the euro's design predicted that its flaws would even lead to wars - they have been right about most things so far.

It is to be hoped that well before this point is reached politicians trigger the solution with the most hope of success - the fiscal union that a monetary union needs to be durable.

That would take a tremendous feat of politics to achieve. What Europe has in its favour through this crisis is that, since World War II, its elite has possessed the political will to embark on a pan-European venture to spread peace and democracy, so as to avoid similar hostilities.

Hence the creation of the EU, a European parliament, European law, European standards and free trade and unrestricted people movement within the EU.

In the vision of a united Europe, monetary union was only ever a step along the way to fiscal and political integration.

Thus, as a true do-or-die moment approaches, the seeds exist for what, until now, has been politically impossible - a fiscal union or, if you like, the United States of Europe.

Harvard University historians Niall Ferguson and Pierpaolo Barbieri say German Chancellor Angela Merkel, being the only European leader boosted by the crisis, has the political capital to achieve a federal Europe.

"With the strong support of German business - riding high on a favourable exchange rate and dynamic economy - a federalist 'Ja' campaign can win," they say.

"More than most, Germans are invested in the European ideal. It has given their country a route back not just to prosperity but also to political respectability."

There's a good chance that if the eurozone stays together in the next three to five years Europe will end up a fiscal federation, as this year's tough fiscal compact hints.

More steps along the way would be eurobonds (which imply that if one country can't pay, another will), lender-of-last-resort powers for the ECB (an ability to meet government bond repayments), an expanded role for the European Stability Mechanism (countries can default to it) and a coordinated move to recapitalise eurozone banks that will lead to a banking union (common regulation and supervision).

A eurozone-wide political and fiscal union will be shaky solution, though. Europeans identify themselves by their nationality first. They have no common education system or language and vast historical hang-ups dog the continent.

Still, a political union is likely to happen if the eurozone holds together long enough. The crisis is bound to overtake all other solutions and it will be better than the chaos of the alternative.

But xenophobic politics is running against this solution in the short term. The political reaction against Germany's austerity drive is nourishing votes for anti-Europe left and right fringe parties that appear to make this resolution politically impossible for now.

The other question hanging is whether the eurozone will hold together long enough to achieve a fiscal union now that Greece's economic upheaval is ushering in a political and social collapse that increases the likelihood of a Greek exit from the eurozone.

Greece's immediate fate will be known soon enough and no doubt European policymakers can muddle through for some time.

Whatever is decided, though, grim times lie ahead for Europe for a while yet, as Cameron warned.