Economic sleight of hand, market crash and wages cut by 25% – we’ve got it all to look forward to

As Chancellor Merkel, President Sarkozy and Prime Minister Monti meet with IMF boss Christine Lagarde, the future of the European economy continues to weigh heavily on the minds of business leaders, investors and traders.

Germany, France and Italy’s markets crashed in 2011 – those in the US and UK, however, didn’t. The FTSE and Dow teetered and tottered yet didn’t fold. In 2012, they probably will. Maybe it will be in April/May when giant developing-world countries bloated with western currency put on their hedges and re- adjust their vast stashes of cash. Maybe it will just kick off randomly.

To avoid a crash, the whole sorry credit crunch saga will need to be over. In 2012, that would seem but a dream. There are probably three to five more years of economic lumps and bumps before re- alignment proper is achieved. A US/UK stock market crash is likely to be one of those bumps.

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Along with a potential crash, inflation is set to zoom in Europe and will likely hit levels now seen in the UK. The US is following suit, inflation being standard treatment for state debt. In fact, it’s the only way out of the fiscal dead-end Europe and the US have found themselves in.

Inflation rates of 5 to 10 per cent are the only way the mess left behind by binge-spending governments can be cleared.  Expect plenty of denials and lame explanations from those in charge as prices rise on the shop shelves. The age of price stability is rapidly coming to an end.

Crucially, the UK is already part way down the inflationary road of repair.  It has created a recovery blueprint Europe and the US are set to follow. In fact, the US has already begun its journey down the unpopular route to recovery. It will accelerate the plan when it is close enough to the presidential election so as not to interfere with it. Europe, on the other hand, can set off as soon as the new treaty is ratified.

“The London Plan” as I call it, is simple. Over a five-year period, create 5 to 7 per cent yearly inflation by printing money; use “austerity” to scare the public sector into pay restraint; and let the public sector shrink through natural wastage at levels of 2.5 to 5 per cent a year.

For example, with 6 per cent inflation and 3 per cent natural wastage, in five years the government head count will be cut by 15 per cent. If wages are pinned to zero increase, then “real” wages will have dropped by 25 per cent. Meanwhile, inflation in the private sector will boost tax takes by a third.

This is purely nominal rebalancing, but it cuts the real value of government debt by a third, slashes government spending in real terms and balances the budget by inflating income and deflating liabilities and overheads. It’s the classic economic sleight of hand, one as old as the Roman Empire and used throughout European history, right up to the 1980s.

There’s no denying question marks still hang over Europe. Yet it’s the US which remains the key driver of the global economy. It should be noted that amidst all the gloom and economic trouble, the first green shoots of recovery appeared Stateside during 2011. If this progress is sustained then the US will be on its way to a bounce. The remaining question is what impact such a bounce would have in Europe; something that no doubt is on Merkel, Sarkozy and Monti’s minds.

l Clem Chambers is chief executive of stocks and shares website ADVFN