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Why The Euro May Be Destined To Fail

Mark Blyth, Euro
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With Mark Blyth, Consultant on International Political Economy, Eastman Professor of Political Economy at the Watson Institute of International and Public Affairs at Brown University, and author of  Austerity: The History of a Dangerous Idea, & Great Transformations

Mark Blyth is a consultant on International Political Economy, the Eastman Professor of Political Economy at the Watson Institute of International and Public Affairs at Brown University, and the author of Austerity: The History of a Dangerous Idea, & Great Transformations.

Mark has spent years studying and writing about the European economy where recently the focus has been placed on the weakening of the EU and its difficulty finding its way back to prosperity. One of the premises in Mark’s book is that austerity programs do not work when all states do it simultaneously, which is what is happening in Europe now. He explains that when both the government and the private sectors are saving, the only way for the underlying economy to go is down. This he calls the paradox of thrift.  Greece, which can’t seem to come out from under its blanket of economic gloom, is perhaps the best example of a stalled austerity program. The two sectors, private and government, simply can not both be saving at one time.

A fundamental difference between the European Union and the US—and the reason we were able to survive the last financial crisis—is that we have our own currency, which allowed the Federal Reserve and Congress to stimulate the economy by propping up the financial sector and, ultimately, giving the economy room to grow.

The EU, on the other hand, shares a common currency, over which the individual countries have no control— they can’t print it, devalue it, or inflate it. Austerity programs have been imposed, the UK has voted for Brexit, and how this plays out will have to be seen.

There has been much discussion during our presidential campaign season about how high taxes are in the US.  And as for the opposing views of our two candidates, simplistically stated, Trump wants to lower them and Clinton want to raise them.

Mark cites statistics from OECD (the Organization for Economic Cooperation and Development) showing that the United States is one of the least taxed societies in the world.  “The problem in the United States,” says Mark, “isn’t a taxation problem that’s too high.  It’s actually too low relative to the amount the government is spending, so you constantly run structural deficits which accumulate debts.”

He also says that the majority of households in the highest income tax brackets are actually upper middle class, and not the super wealthy, and if you burden this group with higher taxes, it would yield no financial benefit at all.  As it stands now, the super wealthy pay a lower nominal tax rate because of the way tax law is structured. Mark believes this is unfair and is the reason that people are angry and feeling disenfranchised.

That some of this discontent can be attributed to the changes brought about by globalization and technology can’t be denied, a subject covered in depth in Mark’s book, Austerity: The History of a Dangerous Idea, & Great Transformations, along with some interesting positions on the Reagan/Thatcher years.

Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital.  Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions.  Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances.  The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.

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Steve Pomeranz: Well, just like you, I drive along listening to the radio, and I heard an interview which caught my attention and actually shattered a few preconceived notions of my own.  I found out who the gentleman was, and I contacted him and asked him to join me today to share his somewhat unique point of view.  Mark Blyth is my guest.  He is the Eastman Professor of Political Economy at the Watson Institute of International and Public Affairs at Brown University.  Hey, Mark.  Welcome to the program.

Mark Blyth: Nice to be with you, Steve.

Steve Pomeranz: You’ve spent a lot of time studying and writing about the European economy and, of course, it definitely relates to the US economy, as well, and all the challenges that these economies are wading through.  From a layperson’s perspective on my part, the EU seems to have weakened and having difficulty finding its way back to prosperity.  What are some of the fundamental problems they’re currently facing?

Mark Blyth: Here’s a really simple way of thinking about this.  Remember the global financial crisis?

Steve Pomeranz: No. I’m sorry. I’ve tried to forget that.

Mark Blyth: Yeah, we try to forget about that.  When that one hit, when that hit the United States, for example, you have a treasury, and you have the fed, and they can work together to basically issue as much cash as they want as liquidity support for the financial sector, and they can also, in cooperation with Congress, decide to stimulate the economy.  They’re one country, and they have their own sovereign money.  The wonderful thing about sovereign money is, you can inflate it, you can devalue it through your exchange rate.  You can basically do what you want with it.

Here’s the problem for Europe.  They don’t have sovereign money.  They have money called the Euro, which they all share, but none of them can control.  When the crisis finally hit them, rather than saying, “What do we need to do?  What’s necessary?  Let’s get it done.” They said, “What can we do with money that we don’t effectively control?  We can’t print it.  We can’t devalue it.  We’ve got huge banks that are bigger than the US has got.  Oh, my goodness.  What are we going to do?” What they did was, they battened down the hatches.  They tried to cut the public sector at the same time as the private sector was going into a recession, and they got themselves in a big mess.

Steve Pomeranz: There is also the idea that after World War I, in Germany especially, there is this idea of this rampant inflation which took place and the image of the wheelbarrows of money, so there’s a tendency to move towards tightening, towards austerity.  Can you describe that, and do you think that that’s helpful to those economies or hurtful?

Mark Blyth: I think the evidence on this one is in, Steve.  You don’t have to think about it too much to figure this out.  Imagine that the whole of the private sector decides to save.  That’s great.  Your savings rate will go up, but if government stops spending at the same time, then government’s saving.  The two sectors can’t save at once.  The only way that can happen is if the underlying economy shrinks.  Even at the level of individuals, for me to save, somebody else needs to be generating an income from which I can earn and then save.  If we all try to save at once, it’s called the paradox of thrift.  You don’t end up saving.  You end up basically eating your own capital bits.

The best example of this is Greece.  Greece has lost 30% of it’s GDP, 30% of consumption, 20% of its economy overall, and it’s been tightening all the way.  They’re the ones that have really done these austerity policies.  It’s not working out for them too well.

Steve Pomeranz: In the US, we have, I think, a similar phenomenon.  I’m not an economist, so I can’t quote the details on this, but it seems to me that the savings rate of Americans has risen, and, at the same time, I don’t think the US is practicing austerity.  I know the government, for its part of the economy has not been growing as well.  Are we experiencing the same thing here in the US?

Mark Blyth: To a certain extent.  We did have the sequester here in the United States, but on a $17 trillion economy, the sequester was largely a sideshow for Congress to show off what they were doing.  What’s happened in the United States because they had their own money, and they could credibly bail and recapitalize the financial sector and try and get back to growth of the programs that they did, the economy grew.  As the economy grows, the stock of debt falls.  You can have the best of both worlds, but only if you’re growing.  The problem in Europe is they got so tight in both sectors they stopped growing, so they ended up with more debt rather than less, without anybody issuing any new debt.

Steve Pomeranz: Well, from what I understand, they’re buying bonds.  They’re doing something similar to what we’re doing here in the US, so they are keeping the markets, or the economies, liquid.  They’re putting cash into the economy, but there obviously is something missing here.  It’s not translating to consumer spending, so there’s this idea that “Why don’t we forego all of that other nonsense, and why don’t we just give citizens cash, from a helicopter, so to speak?” You know, “Just let’s drop bags full of cash and people will start spending it.” Is that a valid argument?

Mark Blyth: Well, on that basis, no.  It’s a crazy argument.  You would distort incentives and do all sorts of things, and you shouldn’t reward people for just lying around on the sidewalk, et cetera.  That’s not really what this is about.  Here’s the story behind the story on this one.  We know the figures now.  The world is more unequal than possibly it’s ever been in recorded history, and because of this, the bottom 60% of the United States has really taken on a lot of personal debt.  You can push interest rates down to 0, as we practically have, and when you’re in debt up to your eyeballs, you don’t want to borrow more.  You might want to refinance, but you don’t want to go splurge.  Unless you have real economic growth and real wage growth, those people aren’t going to borrow more.

What the central banks have been doing, quantitative easing, all these fancy terms, is essentially fire-hosing money into the economy to try and make people spend.  The problem is, it goes to the financial sector.  The financial sector, after the crisis, is a bit spooked.  They don’t want to lend and, on the other side, people don’t want to borrow.  The argument for the helicopters is, rather than sticking a fire hose of money through the front door and hoping some of it ends up in the kettle, why not actually just target the bottom 80% of the income distribution with a one-time payment?  They’ll clear their balance sheets.  They’ll get out of debt.  They’ll spend some money and, that, for the long run, will be much cheaper than all this bond buying nonsense, and it will help you hit what the federal bank calls their inflation target.  Once you hit that, you stop doing it.  It’s cheaper, it’s more efficient.  It’s not about socialism.  It’s about efficiency.

Steve Pomeranz: We’re obviously going through a presidential election cycle right now.  One candidate wants to raise taxes on those, let’s say, making over $250,000 a year, and the other candidate wants to significantly lower taxes.  Forgetting about the effect on the budget and on the amount of outstanding debt because that is an important point of discussion, but let’s put that aside for a moment.  One way to get cash into the hands of regular Americans is to cut taxes.

Mark Blyth: It is, absolutely, but at the same time, if you are worried about the national debt—and we can get into that if you like—then you’re simply going to increase your deficit, which over the long term adds to your debt.  You’ve got to wonder if that’s the right policy at this junction.  We’ve been doing a lot of that.  What your listeners may be amazed to find out is if they go look on the web at the OECD statistics on this, the rich countries’ statistics, you’ll find that the United States is one of the least taxed societies in the world.  The problem in the United States isn’t a taxation problem that’s too high.  It’s actually too low relative to what you want to spend through the government, so you constantly run structural deficits which accumulate debts.

This sounds surprising, I know, but it’s really true.  Most countries spend around 40% to 45% of GDP through the state because most of them don’t use private schools.  Most of them don’t rely on private health insurance.  Because of that, and they have a VAT which is more efficient, you can raise more tax revenue.  The United States’ problem is it’s under-taxed and it wants to have a tax cut.  That’s a bit like my 5-year-old wanting to have pizza and ice cream and more ice cream.

Steve Pomeranz: That’s the American way, so I don’t know what you’re complaining about.

Mark Blyth: I should be used to that after 25 years.

Steve Pomeranz: Look, you write that typically the majority of households in the highest income tax brackets are really upper middle class.  They’re not the super wealthy that gets all of the attention these days.  Further burdening this group would be a hard sell politically and would yield little financial benefit, and, finally, if you start raising taxes on capital or investment, that’s going to hurt as well.  I believe that those who are in upper middle class are paying a lot of the taxes.  There’s a lot of people who aren’t paying any taxes, and then in the very high echelons, the tax rates are generally lower because most of their earnings come from capital gains and the like.  How do we put all this together with some kind of substantive answer?

Mark Blyth: You’ve described it exactly right.  Now, here’s the questions you’ve got to ask.  Why is it that there are, to use Mitt Romney’s term, 47% moochers in the United States who don’t pay any tax?  Because their incomes are so low that they don’t qualify above a tax threshold.  That’s actually a problem for the country.  When the UN and the IMF are warning the United States about structural levels of poverty in the richest country in the world, that’s a problem.  You’re absolutely right about the middle classes and the upper middle classes pay most of the tax.  I pay, effectively, probably what you pay.  About 31% in tax, when you do state, local, the whole nine yards, federal, right?

Remember Mitt Romney?  The guy who wanted to be president?  His nominal tax rate was 15% because it’s all through capital gains.  His effective tax rate was probably about 10%.  Go up to the people who really sit on top of billions; they’re paying nothing.  This is a question of fairness.  If society doesn’t have fairness and equity in its taxes, you’ve got a problem politically, which is where we’re heading now.  This is why we have Trump.  This is why we have the loss of faith in the new establishment.  People perceive the system as not being fair.  That’s a prerequisite of growth.

Steve Pomeranz: My guest is Mark Blyth.  He is the Eastman Professor of Political Economy at the Watson Institute of International and Public Affairs at Brown University.  You spoke in one of your talks about the rise of what you called “Trumpism”, which is really a global phenomenon.  Take us through that idea.  Explain that to us.

Mark Blyth: Let’s think about what the establishment parties have done in all the rich countries.  You had the Reagan and Thatcher revolutions.  A lot of regulations were kicked out of the way—unions were weakened, capital was globalized, and that goes a long way to explaining why we don’t have any inflation just now because you try asking for a wage increase and see what happens.  It’s very hard for wages to go up in such an environment.  The profits, the capital, have actually never been higher.  Think of Apple’s big pile of cash.  You’ve got a world in which this is going on.

Let’s think about where Trump comes in this world.  Let’s think about a city like Gary, Indiana.  35 years ago, you’re earning $30 an hour working in a big plant.  The plant closes down, the mainstream parties come along and say, “Don’t worry. You can re-skill as a software engineer.” Well, most of you can’t.  Then, you work in a call center, and then they move the call center abroad, and now you’re working in the largest employer in the country, which is Walmart, earning just above minimum wage.  People keep coming back to you and say, “Trade is great.  Things are going to be better.  Vote for me.” There’s a sell-by date on people’s expectations, and right across the world, the mainstream parties, they’ve passed their sell-by date.

Steve Pomeranz: I think that is it in a nutshell, but how much of that is really due to globalization?  How much of it is due to technology as well?  I mean, in a sense, facetiously, you can say, “Well, heck.  Everybody’s going to learn to be a computer programmer,” because that seems to be the only jobs that are available, but realistically, America’s a big place.  There’s a lot of opportunity here, but in Trumpism, the idea seems to be, “We’re going to bring back those manufacturing jobs, those $30 an hour jobs,” when, really, I ask you the question, do they belong in this country now?

Mark Blyth: Is it even possible to do so?  I mean, here’s the problem with manufacturing, from an employment point of view.  When money is as cheap as it is throughout the world, then the cost of capital is zero, and the cost of labor is always positive.  If capital substitutes for labor, it’s always better to get a robot to build a car than it is to get a guy to build a car.  The only places you’ll be building cars is where people are cheaper than robots.  That’s just it.  Let’s go back and think about what globalization is.  Globalization isn’t some kind of thing that God gave to us one day.  It didn’t grow out of the ground.  Globalization is a series of legal agreements written by lobbyists, lawyers, and politicians that says you can sell this here, and you can move this there, and, therefore, if that’s what it is, you can reverse it or change it or put it in different directions.

The question is, how do you adopt globalization so that it serves the citizens of the countries that are supposed to benefit from it but are not benefiting from it?  If they don’t, then you get the Trump-like policies of, “We’re going to have a big tariff on China,” and that one makes me laugh because most of the companies that are exporting from China to America are American companies that have moved there, so what are you going to do?  Put tariffs on Apple, so the iPhone’s more expensive, to punish China when 40% of the return on the iPhone still goes to California?

Steve Pomeranz: It’s an oversimplification for purposes of getting people fired up to get elected.  I mean, that’s American politics, right?

Mark Blyth: Yes, absolutely.  As we said, American tax policy is ice cream and more ice cream, and American politics is just, “Make up stuff about the economy and hope it sounds good.”

Steve Pomeranz: Most, let’s say, Reagan Republicans or those who have seen the benefits, while what you say about Reagan and Thatcher is maybe true, the fact is that these economies did experience tremendous growth and renovation and reinvention throughout those years, after coming off of the Carter years and years of malaise and so on.  How much of that, of course, is due to policy?  How much is due to just the fact of change in interest rates?  Volcker had interest rates at 18% at the end of the Carter administration and started lowering them as soon as, basically, Reagan got into office.  How much is anybody’s responsibility is hard to say, but the bottom line is, we are a richer country than we have ever, ever been.  Our standards of living continue to rise and rise higher and higher.  What is everybody so upset about?

Mark Blyth: This is the classic story.  What you just gave me was the classic “Bill Gates walks into a bar” story.  Bill Gates walks into a bar, and on average we’re all millionaires, but we’re not.  There’s just one billionaire and everybody else is trying to get a beer.  Let’s start with a couple of things.  Statistically, what you said isn’t true.  The growth rates from 45 to 75 would double what they were from 85 to 2005.  That’s just a fact.  The economy’s much bigger, but it’s become much more skewed.  The returns have gone to the top 20%, and the top 20% of the top 20%.  That’s where most of the money went.  My most frightening statistic of the day, if you want it?  Since the start of doing quantitative easing and all the programs out of the fed, 90% of the returns has gone to the top 1%.  90%.  On average, we’re not going well.  We’re getting warnings from the IMF about poverty levels.  We’ve got 50 million Americans who pay no taxes because they’re too poor to actually meet the threshold.  That’s not a balanced economy.  That’s why these people are angry, and in my book, they have every right to be.

Steve Pomeranz: This is why I’ve asked Mark to join me.  Unfortunately, we are out of time.  Mark Blyth is my guest.  Eastman Professor of Political Economy at the Watson Institute of International and Public Affairs at Brown University.  Hey, Mark, can we have you back on?  I’d love to continue this discussion.

Mark Blyth: Absolutely.

Steve Pomeranz: Thank you so much.

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