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Stop fighting the last battle, just tackle the one we're in

SINCE the beginning of organised warfare, every general has had the same problem. He (it's usually been a he, let's face it) is confronted with a battle. He has a range of tactics at hand to use in order to win the battle. The trouble is his tactics are the result of learning from the last battle his country was in, perhaps a generation ago.

If the general applies outdated tactics to a novel situation, he loses spectacularly. Military history is full of examples of this. Generals trained in the tactics of the American Civil War applied them to the trench warfare of the First World War. The result was utter carnage because the solution -- pitched battles -- no longer fitted the problem of advanced ballistics.

Until Thursday's European debt summit, the debate in Ireland was focused on the interest rate we will pay on the loans we are receiving from the EU and IMF to run the country and recapitalise our banks.

The Government's tactic is still to 'renegotiate' that interest rate on more favourable terms for Ireland in exchange for discussing some changes to our corporate tax base and rate.

This is, and has been, the wrong battle to be fighting.

Like Greece, Ireland is not in a situation where it can both grow the domestic economy and pay back debt accrued by the private sector. The growth rate of the domestic economy is forecast to be at or around one per cent this year, if we are lucky.

Even with the welcome interest-rate reductions, the growth rate of debt is way above that one per cent growth. Even still, the interest rate -- or the flow of our debt -- is not the problem. The problem is the stock of our debt. We need to do something about our stock of debt. Once we recognise what battle we are in, we can plan the appropriate tactics.

Europe's leaders are fighting the same battle with debt levels. Up to last week, the core nations could pretend the problem in Europe was profligate peripheral nations spending hard-earned German and French taxes. The core nations' tactic was thus to penalise those nations with high interest rates and punitive austerity terms on bailout loans. But as we saw this week, that's the wrong battle.

We have clear evidence that the markets view Italy -- a nation with €1.9 trillion of debt -- as a risky proposition. If Italy goes, the eurozone nations will have to consider measures beyond beefing up the European Financial Stability Fund (EFSF).

I'm not one for premature catastrophisation -- the euro will survive this -- but I do think there will be an increase in the level of fiscal austerity and co-ordination among European nations if any debt write-off is considered for nations like Italy, Ireland, Spain or Portugal, as there is today for Greece.

So what is the problem? At an EU level, the problem is that markets won't lend to highly indebted nations at low levels of interest and rollovers of this debt aren't being considered. Default has been ruled off the cards and banks aren't being allowed to go under. This means the level of debt can't go down, because no one is getting burned.

So the debt has to go somewhere. It needs to be paid for somehow. The only entity big enough to consider paying for this debt is the European Central Bank or a turbo-charged European Financial Stability Fund (EFSF).

The ECB/EFSF has to expand the range of its operations, either by allowing debtor countries to print money via extraordinary liquidity assistance -- which Greece and Ireland are doing now -- or by buying this bad debt off the banks and countries in question with bonds printed specifically for that purpose. Depending on how they are implemented, both solutions could lead to higher-than-expected levels of inflation, which hurt savers, the old and the poor. Inflation helps those in lots of debt, however.

So much for the correct tactics from an economic point of view. This is all being played out in a political space, where economics is of secondary importance.

How does Angela Merkel sell higher taxes for the eurozone to German citizens in an election year? By wrapping herself in the flag. She must argue that this is an existential crisis. She must argue that without the eurozone, Germany's citizens would suffer more than they would through higher taxes.

She must appeal to their self-interest. Germany's export markets are designed to sell to Europe and to China. China is in the middle of a bubble that may or may not blow up this year. The eurozone is Germany's best bet. Germany, like Ireland, needs the eurozone to be healthy for it to prosper.

Abandon the tactics of the last war and we might just win this one yet.

Stephen Kinsella lectures in economics at University of Limerick. His new book, 'Quick Win Economics', is available on Amazon and for Kindle and iPhone.

Sunday Indo Business