A wild forecast for Euro pain

Revisiting my predictions for Europe in 2011 (Don't believe this forecast, December 23, 2010), I can today declare without any false modesty that I was right on the money. Not only has 2011 been very much like 2010, but it is also emerging that we will celebrate Christmas on December 25 this year – just as I forecast last December.

Having thus established myself as a trustworthy futurologist, it is time to dust off the crystal ball so I can give you an exclusive preview of 2012. I hope you are seated with your seatbelts fastened. It's promising to be a bumpy ride.

The New Year starts slowly; nothing much is happening in January and early February. This may come as a bit of a surprise to some but it is precisely what EU leaders decided when they met for their last summit in December 2011. Back then the global economic environment looked reassuring and Europe's minor problems manageable, and so the EU Council left the details of their new stability treaty until they meet again on March 1 2012.

In this sense, British Prime Minister David Cameron's veto was a tad premature since there was in effect very little on the table that he could block. But thanks to Cameron's noise, few observers had noticed this lack of detail at the time, and so January remains a very quiet month in Europe.

While Europe's politicians are enjoying their extended Christmas breaks either skiing in the Alps or escaping the grim winter continent for sunnier climes, markets sadly do not take a break. This is unfortunate since it means yields on Italian and Spanish debt keep rising – only intermittently interrupted by central bank interventions.

The chaos after the Greek elections in late February is then finally restarting political action in Europe. Papandreou's socialist PASOK party is reduced to just a handful of seats, and even the main conservative party Na Dimokrata only scores about a fifth of the vote. The new Greek parliament is so fractured between right-wing populists, communists and the surprise winner, the Radical Left Coalition, that no stable government can be formed. The only consensus in parliament is a broad alliance against any further austerity measures.

As the parties cannot agree on a successor, interim Prime Minister Lucas Papademos stays in office but is immediately instructed by parliament to renegotiate the bailout conditions with the IMF and the EU. Being a good public servant, Papademos does as he is told and travels to Brussels for the EU's first summit of 2012.

Thus at the March summit, it finally comes to the long overdue showdown between Greece, Germany and France. In return for not declaring an immediate default on its debt and for not joining the British veto on the new stability pact, Papademos demands a bigger aid package and an end to all austerity measures for as long as Greece's economy is contracting. France and Germany are outraged. Nicolas Sarkozy is overheard mumbling that it's all David Cameron's fault, though nobody knows why.

The summit is saved when EU President Herman van Rompuy moves the delegations to tears with a self-composed haiku on European unity. Leaders agree to install a high-level working group until another summit in late May. The next morning, markets are embarking on their traditional relief rally.

But jubilations are short-lived. A couple of days later, two US ratings agencies conclude that Herman's haiku has not solved Greece's problems after all. But since Greece's rating cannot be revised without an official Greek default, the agencies resort to unusual measures. So they take the whole of Europe hostage. For every day without decisive political action, they threaten to downgrade a European bank, an insurer or a government at random. The EU Commission quickly condemns this blackmail and announces its intention to declare all ratings agencies terrorist organisations at the next opportunity.

The May summit is overshadowed by the result of the French presidential election. Having beaten Nicolas Sarkozy in the first round, right-winger Marine Le Pen is stopped in the run-off by socialist candidate Franois Hollande. The new president's first announcement is to reverse the German-led initiative for fiscal stability and austerity "even if that means siding with the British”.

Chancellor Angela Merkel is fuming and threatens to pull Germany out of the eurozone. In a dramatic confrontation at midnight, she forces the newly-elected president to make room for a new technocrat administration led by former ECB chief Jean-Claude Trichet. "Such solutions previously worked well for Greece and Italy,” she tells an impromptu media conference at Versailles. In the following weeks, many other European leaders "voluntarily” decide to step aside for technocrat caretakers.

With so much political harmony in Europe, it is easy to forget that the European rescue funds are running out of money. But at the last minute a glorious solution is found. The European Central Bank is providing unlimited liquidity at zero interest to commercial banks on the condition that they immediately invest these funds in eurozone government bonds, now triple-A rated by the European Commission. These bonds are fully insured against default by the IMF, which reinsures this deal with the EFSF and the ESM, which in turn are now officially backed by the ECB and the EU, which are ultimately underwritten by Germany and Luxembourg. EU Commission President Jos Manuel Barroso announces the scheme as "Europe's firm commitment to financial transparency and stability”.

Under Barroso's grand plan, central bank independence is secured, commercial banks are generating healthy profits, and all eurozone governments remain solvent. This mechanism is fully compliant with EU treaties that outlaw any kind of intra-government bailout or debt monetisation. Above all, the scheme is so complicated that national parliamentarians and the German Constitutional Court do not stand the slightest chance of understanding what is really going on. The resignation of Bundesbank chief Jens Weidmann is therefore widely met with incomprehension.

The new scheme soon becomes known by its acronym of 19 letters beginning with 'E' though nobody knows exactly what it stands for. When it is confirmed by Angela Merkel and the leaders of Europe's technocrat governments at a summit in late June, analysts are jubilant. "This is not just a bazooka; this is an arsenal of H-bombs,” one bank economist writes in a client briefing. As Europeans celebrate the return to seeming financial stability by Christmas 2012, little do they know that soon the first of these H-bombs will detonate in the form of a sudden surge in inflation.

You may think that all of this sounds utterly ludicrous, and perhaps you are right. But ask yourself whether only two years ago you could have imagined elected prime ministers being replaced by technocrats, the European Central Bank purchasing vast amounts of public debt, or governments committing their taxpayers, present and future, to multi-billion euro rescue funds.

In a more optimistic scenario, European politicians would realise that the euro cannot be saved and stopped pretending otherwise. But perhaps it is already too late for such nave Christmas wishes.

On that note, Merry Christmas to everyone. And a better New Year.

Dr Oliver Marc Hartwich is a Research Fellow at the Centre for Independent Studies.