So now we are the ‘poster boy’ again. Do we ever get sick of being the poster boy?

A few years ago, we were the poster boy for deregulation, low taxes and free capital movements. Our politicians went around Europe advising the rest of the continent to copy Ireland. Just be like us and it’ll all be grand, they said.

Having fallen so sharply, we are again the poster boy, but this time for austerity. Our politicians are now advising the rest of Europe to be like us. If you – Greece, Portugal, Spain and Italy – can just do austerity like Ireland, it’ll all be fine, they say. Sound familiar? The problem with austerity is that it has never worked anywhere in the world without either being preceded, or followed, by a massive devaluation or massive credit injection. Our ‘successful’ period of austerity from 1987 to 1990 was preceded by a devaluation in 1987 and followed by another one in 1992, and all the while interest rates fell dramatically.

Likewise, Reagan and Thatcher’s massive fiscal contractions of the early 1980swere accompanied by the most rapid injection of credit either economy had seen since the 1920s, leading to a bubble and two housing busts in the late 1980s.

Without a massive injection of credit or a massive devaluation, austerity can’t work. It will lead to long-term, higher levels of unemployment and emigration. This is what is happening in Ireland right now.

In many ways, economics is really very simple. If you try to do something that isn’t governed by the basic rules, you will fail. If there is one thing most sensible economists can agree on, it is that too much money in circulation causes inflationary booms which, if not checked, will crash. Too little money in circulation will cause deflationary depressions which, if not checked, will lead to social upheaval.

The way to stop an inflationary boom is to take money out of the economy; the way to stop deflationary busts is to add more money to the economy. Simple. Deviate from this at your peril.

One other thing most economists also agree on is that wages and prices are ‘sticky’. This means that it is very hard for wages and prices to fall in response to a fall in demand. Typically, if there is a fall in demand, it will be felt much more in unemployment and emigration than in falling prices.

This is because of what is termed in labour market economics the insider/ outsider dilemma, which examines the dynamics of the labour market when demand changes. When demand falls, those with jobs stubbornly defend their own pay rates, which keeps wages from falling. But those who have lost their jobs need general wages to fall, so that they can look attractive to potential employers.

But if this doesn’t happen because the ‘insiders’ in a job are keeping wages up, short and long-term unemployment rises.

This is what is happening at the moment in Ireland. Figures last week revealed that unemployment is still rising, as is emigration, while wages and prices have remained stubbornly high. They are ‘sticky’.

The implication of this is that it is nearly impossible to get a competitive edge via austerity – or it is possible, but the cost to society in terms of unemployment and emigration is horrendous.

As a result of the stickiness of wages and prices, and the need for depressions to be offset by injections of new credit, all austerity programmes are destined to fail because they can’t succeed mechanically.

This is why all slumps are ultimately followed by massive falls in the currency of the country, with the new exchange rate repricing everything downwards.

This is what happened in every Asian tiger in the 1990s.This adjustment makes everything in the country cheaper and all imports more expensive. Once the economy has found a new price level to match its fundamental position, money floods back in.

Some of that money is new, looking for investment opportunities at the new lower price level, but most of the cash tends to be domestic money that has fled the country because it was afraid of higher and higher taxes as the ‘austerity with no growth’ madness took hold. Once this cycle of dogma is broken, the economy can prosper again.

This is why there is so much talk in Europe of the euro breaking up. It is not driven by ideology or politics, but by basic economics. If you don’t have a single budget to dole out cash in a slump, then the exchange rate has to adjust downwards.

If you don’t have an exchange rate, you get no adjustment, growth stops and austerity fails. It is not hard to understand, is it? Countries need away out. There is a choice. One is fiscal federalism for all. This would need a referendum in many countries, and would never pass. Think about it, three of the last four referendums seeking greater integration in Europe have been beaten by electorates as diverse as the Dutch, the French and the Irish.

So this is not a runner and, if it were put to a vote in Germany, it would be blown out of the wasser. So what is left is some break-up of the currency, and Greece is the first candidate. Yes, there would be huge capital flight in the months after Greece left, but a major European crisis might give us the opportunity to move back to our own currency.

Back in 2007, this column argued that one of the upshots of the financial crisis that was coming, but not appreciated by many, was that we would leave the euro, not just because it was inappropriate for Ireland, but because it would implode as it was half-baked.

We are now close to this moment. A new currency and a massive devaluation will make us no friends in Europe, but by that stage they will be scrapping with each other so viciously that what we do won’t matter. Such a bold move will accelerate a recovery, just as the same policy has done everywhere else in the world – Iceland being the most recent example.

Otherwise, the poster boy will trip up, having exalted everyone to follow his example as he waltzes himself up a financial cul-de-sac of unemployment, emigration and asset-stripping.

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