Where next for Europe?

We've been waiting for nearly a decade for the credit bubble and its consequences to play out. We've waited, and dipped in and out of various markets, through the commodity supercycle, the bull market in gold, various global property bubbles, the credit crunch itself and through the endless (and not over yet) rounds of quantitative easing (QE).

Now we're watching the slow implosion of the eurozone, thinking about what happens if Greece goes, and wondering if Europe will get deflation or inflation first. Right now, the seemingly obvious answer is deflation, that being the natural consequence of a broken banking system and a system that allows governments to run up debt, but won't allow their national banks to print up the payment of those debts.

But it's worth remembering that inflation and deflation aren't opposites. Instead, they are examples of the same thing (monetary instability) and both have as their oppositesthe same thing (monetary stability).

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Jonathan Ruffer of Ruffer describes (more on him here)this well. Look at it, he said last year (see Independent-investor.com for the full interview), like a car driving along a straight road. A tyre blows out. That's the credit crunch. The car lurches to the left. That's deflation. The driver has the wheel, but with his tyre gone he has to end up in the left or the right ditch (deflation or inflation). Which is it? If you do nothing, "the deflationary events that are created by this dislocation mean that you are condemned to depression, as the bad drags down the good".

If you go the other way, pouring in liquidity to "fill the void", you make eventual inflation inevitable. In America it seems obvious which way things will go. The last time America was faced with the choice, it created the depression, "the iconic awful event of the 20th century". It won't go that way again: "if you are confronted with a rock and a hard place and the rock is the iconic event that must always be avoided, don't be surprised if you end up in the hard place".

In Europe, it isn't so simple: with so many different countries involved, there will always be a lot of argument about which is the rock and which the hard place. But given the political instability across Europe, the rising odds of Greece leaving the euro, and the arrival of Mr Hollande and his growth strategy' (or money-printing strategy, to give it a more realistic name), I think we have to assume that it won't be long before the eurozone also chooses the hard place.

While the German finance minister is still insisting Greece must "accept the conditions", Angela Merkel has been persuaded to say that she is prepared to "study the possibility of additional growth measures in Greece". I suspect she will be doing a lot of studying in the coming weeks. Then she will conclude that extra growth measures are a really good idea. Or at least better than letting Greece go.