The global economy is at its most vulnerable state since the international banking crisis of 2007/2009 when the western banking system collapsed under a cascade of bad debts

Policy debate has now increasingly focused on the risk that the world economy might fall into a double-dip recession. Stock markets around the world have been erratic, experiencing dramatic falls and some recoveries.

Although the uncertainties conjured by the American default-that-wasn’t did nothing to help economic confidence, the main reason for the instability in the equity markets is that the eurozone debt crisis appears to resist all efforts to resolve it. Investors do not believe that the European institutions, notably the European Central Bank, are strong enough to bail out the heavily indebted countries of Europe (with the exception of Malta, these are located mainly in southern Europe – but not only: Think Belgium and Ireland), or to stabilise these countries’ financial markets by buying their sovereign debts.

The inherent inflexibility of the eurozone currency union exacerbates the problem. The economically weaker members of the eurozone, such as Greece and Portugal, face very painful adjustments in their standards of living, which might have been made considerably easier if they still had the option of devaluing their currency. But the real problem of the majority of European countries caught up in the crisis is that they have been living beyond their means. And this is neither a recent nor a novel phenomenon. Greece, Portugal and Ireland – and possibly other members of the eurozone – are bust. The problem is not liquidity, but solvency. The integration of national economies in Europe has spread instability from weaker countries to larger ones.

The crisis over the past two weeks has been compounded by the lack of leadership – seen on both sides of the Atlantic. Romano Prodi, a former Prime Minister of Italy, put it well when he decried the hole at the heart of Europe’s governance. “We don’t know who is in charge”, he said. A common currency zone has to be able to face down market dislocations with unity of purpose. Instead, political rifts abound. There is a difficulty in reconciling French and German differences on how to deal with the crisis. There is an understandable lack of confidence in the Italian leadership and its capacity to take the necessary steps to reduce its high levels of public debt. Recent announcements of tax rises and public expenditure cuts in that country, coupled with firm intervention by the European Central Bank, may have reduced the pressure on Italian bond yields – for the moment.

But the dearth of leadership is most painfully felt in Berlin – the true economic heart of Europe. Angela Merkel, who faces re-election next year, as well as a deeply sceptical electorate fed up with bailing out irresponsible eurozone governments, is determined to resist so-called ‘moral hazard’ in her response to the continuing crisis facing the euro area. Her refusal to throw cash at spend-thrift euro-area governments and their creditors is of course perfectly understandable in principle. But the crisis has gone well beyond points of principle.

The chronic indecisiveness of Mrs Merkel has left the markets believing that inertia will continue prevailing over crisis management. If the euro is to survive in the long-term, then far greater fiscal integration and a common European bond will be needed. And large cheques will have to be written in the interests of saving the euro, not least by Germany and France. What makes the situation particularly difficult is the evidence of global economic slow-down. US growth appears to be slowing, rather than growing, and similar tales are being played out across the world. Hopes that a strong rebound in growth could defuse public debt time-bombs by reviving tax revenues are fading fast.

The response by Europe over the last week came too late to prevent an alarming new deterioration in the vulnerable euro-area countries. If eurozone governments act collectively they can still probably staunch the bleeding. But this means that leaders need to wake up to the scale of the crisis. Applying sticking plaster to the eurozone can no longer hold. The question is whether there is the collective political will to act.

I have left till last any comment on Malta’s part in all of this. We are a bit-part player in the economic dramas unfolding before us. We have responsibilities which, in our own small way as a micro-economy, we are fulfilling conscientiously. But over-ridingly there are potential and direct serious consequences. Although our economy is relatively healthy, and we cannot be numbered among the offenders of the so-called ‘Southern European periphery’ countries, our economy and our livelihoods are extremely vulnerable to any economic meltdown – if that were to occur – in the eurozone.

It has become patently clear, as I commented a few weeks ago, that if the eurozone is to be made to work, it has to be radically reformed. A single currency only operates successfully if it has wage flexibility, mobility of labour throughout the zone and a large enough central budget to be able to off-set the impact of a ‘one size fits all’ monetary policy. If the euro is to work properly, its members may have to accept fiscal discipline imposed from the centre (Brussels or Frankfurt) and even a central treasury. But the current state of Europe’s national economies – as well as their politics – are nowhere near adopting this desirable and practical model and the disparities between them are too great.

A prudent Maltese government would now be drawing up contingency plans for one of two scenarios. The first is to address the question – unlikely, but not impossible – what would Malta do if the eurozone fractures as the result of a default by a major country, destabilising the markets and threatening the euro project with a currency break-up? The second scenario – which appears increasingly likely – is a move towards greater fiscal integration. For Malta, and all countries, this will imply a considerable loss of sovereignty and autonomy over the conduct of our economic affairs, including taxation and public expenditure. Would this be a price worth paying for staying in the euro? Probably yes, but if so we need to start facing the consequences of such a move and preparing for it now.

These are turbulent economic times. Malta is not immune to their effects. Quite the opposite. We need, more than ever, to be prepared for the worst.

Martin Scicluna is a member of the IVA Campaign and the lead author of the Report ‘For Worse, For Better: Remarriage After Legal Separation’