Politicians in the West are struggling with the recent rise of populist parties . Conservative and Labour in the UK, Democrats in USA, the EU leaders are pushing back against Salvini, (Italy), Orban (Hungary) and the government of Poland. AfD is also giving cause for concern (for the EU) in Germany.They haven’t seen the half of it. The West is just one financial crisis away from chaos.
Consider this. Extreme economic hardship almost always produces dramatic political changes. The economic collapse following the Great Depression ushered in National Socialism throughout Central and Southern Europe. The USSR was born from the toppling if a Tsarist autocracy as the economy decayed.
The stagflation of the 1970s gave us Margaret Thatcher and Ronald Reagan, whose apparent political and economic successes nudged the rest of the West toward some form of conservative economics.
Even in the late 1990s, nations that experienced extreme deprivation because of the collapse in the price of oil, such as Venezuela and Russia, overthrew their established political orders in favour of undemocratic regimes.
This pattern even held true following 2008. The economies of Greece, Ireland, Iceland, and Spain essentially collapsed under the strain. Each has since either elected a populist-led government (Greece), or seen the share of the vote of the pre-crisis established parties drop by between one-quarter and one-third. The slow-growth countries of France and Italy have both ended the domination of their politics by traditional Right-Left parties; elsewhere the old duopoly is hanging on by a thread, often in coalition with one of the new, populist parties.
The events of 2008 also changed things closer to home. The United States and Great Britain were hardest hit, each experiencing large increases in unemployment and expensive bank bailouts.
Each has seen the Right promoting anti-immigration and anti-globalist standpoints, unthinkable standpoints until recently. And the Left has become more militant, rising to obtain or battle for control of the leading centre-Left parties. Even placid Australia, whose economy declined after 2008 but never dropped into recession, is seeing record numbers of voters embracing anti-immigrant or other protest parties.
All of this is well known, but the economics in these developments is often under-appreciated. According to the OECD, 28 of the 32 member countries increased their debt-to-GDP ratio between 2007 and 2018. Countries that experienced deep downturns dramatically increased their debt, to the point of doubling it (UK, Iceland) or nearly tripling it (Ireland, Spain).
Virtually every major economy now has debt-to-GDP ratios at the level that, pre-2008, would have worried the financial markets. Among the wealthy economies, only Germany, Switzerland, and a couple of Nordic countries are close to pre-Crisis debt levels. As rich as they are, there is not an endless supply of cash.
Wealthy countries throughout the world bought off political reaction the old-fashioned way; they borrowed massive amounts of money to fund high levels of government spending. Given what we know from history and our recent experience, the political reaction to a combination of crash and austerity will be swift and severe.
With all the fire fighting that has occurred since 2008 the far East has been quietly going about its business. China’s economy is now the largest in the world, and while its household and business debt is high, its government debt is not. China’s central bank holds over $3 trillion in currency reserves! If a financial crash in the West does not crush the Chinese economy, one can easily imagine Beijing absorbing some of its own domestic debt with capacity to bail out strategic countries that are currently part of the Western alliance.
Coulda newly-elected populist governments – or even an established one who see the writing on the wall – turn down offers of low-interest loans from China to avoid collapse? Do the longer-term ramifications of that stop those nations from signing on the dotted line if it was the only option to avoid further civil unrest?
These considerations should cause Western governments to sit up. They need to start serious economic reforms now to avoid the risk of everything blowing up.
There are only three ways to get a debt problem under control. The first is devaluation – if the currency is worth less, then the value of the debt would be reduced. Devaluation also can spur growth, as the costs in the devaluing country are suddenly cheaper in terms of the purchasing country’s currency.
But this only works for a first-mover country, gaining a relative advantage over other countries that do not devalue. If a group of countries devalue, or if a small country’s devaluation is then followed by a large country’s move, the advantage is cancelled out and the much needed future growth will not occur.
The second is inflation – again, with high rates of inflation, the dollar amount of the debt held drops in real terms, making it in theory more affordable if all else remains equal. The problem with both of those remedies is that all else rarely remains equal.
Inflation in particular erodes confidence in the future, which erodes investment. That in turn reduces growth, which reduces nominal GDP in future years and thus undermines a country’s ability to service its debt.
The third option is increasing economic growth without currency debasement,but this comes with its own problems. Orthodoxy from the Right – labour deregulation, lower tax rates, and so on– can worsen the debt problem initially, they also prove politically difficult in the face of opposition from some parts of the general public.
Orthodox medicine from the Left – higher levels of public spending and increasing taxes on capital – produces worse financial results and resistance from pretty much any one who has enjoyed the fruits of an earned wage.
And so the West slouches on. We are due for a global reset, markets have been dipping and are being propped up, having holes plugged- but that cannot go on indefinitely. 2008 was never really resolved, Quantitive easing just deferred the inevitable.
If, again, out leaders refuse to grasp the nettle, they are in for a rude awakening.
Unfortunately we will all have a share of that too