2018: Trouble is brewing between Germany and Italy and between China and the US

Prediction is a mug’s game; you are more likely to miss something important than demonstrate insight. And yet it is the only good way to put your insights to the test. Science may be mostly about gathering and reviewing evidence, but the true test of its worth is prediction. And so, in line with tradition for this time of year, I feel I must have a go.

When I started to think about it, my feelings about 2018 were anticlimactic. The British political deadlock will continue: there will be no election and no change of PM. The Brexit negotiations will somehow manage to put off the more difficult problems yet again, probably through a transition deal that will look very like staying in the Single Market. The investigation into the Trump’s campaign’s connections to Russia may snare members of his team but not the man himself; he will stay in office. The Democrats may take the House of Representatives, but they won’t manage to retake the Senate. And so on. Things will limp on much as they are now.

But none of that is very brave. It just guessable, keep-your-head-down fare that does not put my understanding of the world under any real stress. And yet proposing something more exciting is a matter of luck, especially if I am confining my predictions to a twelve month period. I need to look at things another way. Where do I see trouble brewing, even if the chances of something breaking in 2018 is less than 50%?

Let’s start with the world financial system. There is something unstable about it, even if it does not look as dangerous as it did in 2007 – it is more like the tech bubble of 2001. Asset prices look too high, largely because there is more saving than than the system is able or willing to convert into productive investment. This applies to the West, where too many assets are piling up in the hands of businesses and rich individuals, while many forms of investment are commercially unattractive to most people. And it applies to China, where there is something not right about the volume of money invested, especially through state owned businesses; a lot of useless assets don’t seem to have been written off.¬† But what will be the proximate cause of a financial crisis? A Chinese banking breakdown? Inflation breaking out in the US? A panic in the property markets? And when will the crisis strike? Personally I feel that government bonds are a better bet than other asset classes in the medium term, though that would not be the case if inflation got going. But that is more of a threat in America than it is in Europe or Japan.

And there is something not right with the capitalist system. Technology has changed the way it works, and our political systems have not caught up – rather like the mid 19th Century world in which Marx wrote¬†Das Kapital. Most conventional economists really haven’t grasped this or it implications. The answer will be political change, but what? Without answers, political pressures will build up, and not just in the developed world. It is fashionable to suggest that liberal democracy is in danger, but the situation in the autocracies of China, Russia and Turkey, to name but three, don’t actually look any less tractable. But where will the political system crack? Governments have become better at repression. And there is no convincing alternative to sell. Yet.

What of Britain? The Conservatives look to be in deep disarray, but they have a lot of strengths – especially the widespread fear of the alternative, and the substantial funding that could unlock. We need to remember how close Theresa May came to a triumph, with the coherent ideology of Nick Timothy behind her – she might have destroyed Labour’s working class base. Their introversion did for them in the end. Can a new leadership revive their fortunes? I see similar strengths and weaknesses in Labour. Are they peddling new or old wine in their old bottles? I suspect more new than their critics give them credit for, which will make them a much stronger proposition. But there is an introversion too. The leadership is not sharing its thinking about what to do with this country; it just wants disparate people to project their hopes onto their vague pronouncements, so that they can gain power; only then might they share their real thinking with us. Meanwhile, the tensions within British society – the stagnation of the left-behind places, the squeezed funding for public services and benefits – will serve to increase frustration. Something spectacular could break the deadlock. But what and when?

And Europe? This looks like another deadlock. The populist xenophobes may have stalled a bit in 2017, but they are alive and well. It is striking that Poland’s ruling party remains very much in control, in spite of the fact that many Poles do not share their paranoia – their economic policies, which involve widespread cash handouts, are popular, and may not be as disastrous for the economy as many critics suggest. Economics is at the heart of politics – and politics is at the heart of economics. But the biggest threat to European stability comes from Italy, where elections are to be held in 2018. We might well get a strong pushback from that country against the way the Eurozone is run, at a time when German politics is being pushed in the direction of more conservatism on the Euro, and not putting Germany’s savings surplus to constructive work across the zone. That conflict could cause the system to break. But maybe the French can intermediate to give the Italians what they want while making the Germans feel they have won?

In America I see a strange mix of euphoria and anger. The tax reforms passed before Christmas were a big win for the Republicans, and it will give them real momentum. While the Administration, and the tax reforms, are generally unpopular, relentless propaganda from the many rich winners may baffle floating voters for a bit. That could be good for the Republicans in the congressional elections. It is a tall order for the Democrats to take either house, especially the Senate, where Republicans have plenty of opportunity to win back seats lost at Barack Obama’s high point. But the Administration’s malign neglect of the healthcare system could bite back.

Perhaps more significant for the world as a whole is the thought that China and the USA are on a collision course. Donald Trump is itching to start a trade war with China, to reverse what he sees as America being ripped off. China’s ambitions are increasingly global. At the moment the two have come to an uneasy accommodation, with North Korea a joint focus of attention. But this looks unsustainable; China will not stop North Korea from developing nuclear weapons, as only a military intervention of some kind will achieve that, and China surely does not have the appetite for that. But a trade war between China and the USA would be an attack on one of the central economic and political pillars of the early 21st Century world. It would be extremely destabilising economically and politically. China still needs exports to the US to sustain its economy; the US still requires to be bankrolled by Chinese money. This is surely the most likely source of a financial crisis.

And then there is the risk of war. North Korea is determined to develop a genuine nuclear threat to America, and this is a huge provocation. It’s not a happy situation when we seem to be relying on military men to provide the restraint on the President.

So to summarise: the two critical developments to watch are a clash between Germany and Italy over the economic management of the Eurozone, and a clash between the US and China over trade. Either or both could precipitate a global financial crisis resulting in a substantial reduction in asset values and the banking woes that would follow from that. I am cautiously optimistic that the problems of the first of these will be contained; I am not at all optimistic on the second.

6 thoughts on “2018: Trouble is brewing between Germany and Italy and between China and the US”

  1. “And there is something not right with the capitalist system…..”

    OK. Those of us on the left are on record as saying pretty much the same thing!

    ” …….Technology has changed the way it works”

    This has been said many times in the past. After the mechanisation of agriculture. After the introduction of steam power to boost factory production. After the telephone reduced the need to have Morse code operatives and telegram delivery.

    Whenever there are economic woes, there’s invariably been some recent change in technology which tempts us to make such statements.

    1. I am certainly amongst those that thinks that technology has a profound effect on the overall economy. The point I am trying to make here is that politics and technology are out of sync. As a result demand is being squeezed, because too much of the rewards of capital is going to its owners. I am put in mind of a description of the railway boom in the mid 19th century by Eric Hobsbawm. I think you’ve in fact you have been saying something very similar. The current political setup is leading to austerity which is choking the economy to death, and the solution is political – to get governments to pump up demand through public spending. While I remain unconvinced of the solution, I mostly agree on the problem. But this wouldn’t have happened in the days of plentiful manufacturing and office jobs, backed by strong trade union power. It is the movement of technology that has brought this situation about.

      1. Matthew,

        You seem to be inching towards a more leftish view of the problem of capitalism with your acknowledgement that “too much of the rewards of capital is going to its owners”.

        I agree that it wouldn’t have happened ” in the days of plentiful manufacturing and office jobs, backed by strong trade union power.” But the change hasn’t been entirely due to a change in technology as the link below shows. In the USA the wages of workers kept pace with rising productivity until the 70s but then levelled out. The process started, at least in the USA, well before the advent of the internet and cheap computing power. Probably the same thing is happening in western Europe too.

        The call to increase aggregate demand should have an appeal to capitalists too and this will be reflected in better business figures. The downside, however, from their POV is that is also tips the balance of power back towards working people. They don’t much like the idea of those strong trades unions. Which is probably why, short of an outbreak of war or a severe depression, the type of economics which I’m advocating won’t find much mainstream support.

        The problem still remains, though, that stuff needs to be sold. So how is that to happen if wages don’t keep pace with productivity? One way is for the gap to be filled with increases in the levels of private borrowing and we’ve certainly seen this happening in recent decades!


        1. Yes there is a gap in my narrative from when the light manufacturing boom ended in the 1970s to the start of the high tech revolution 25 years later. That period saw the end of the Bretton Woods, Keynesian system of management with strong trade unions, to the rise of neoliberalism. But there is a technological narrative to that, as your article makes clear. There was a big drive to higher labour and energy productivity in manufacturing. Also globalisation advanced (this was when South Korea and Taiwan came of age). There was a bit of a white collar boom though, no doubt providing the votes that kept Thatcher and Reagan going.

          While much of the analysis in the article is basically sound, the proposed solution looks like trying to turn the clock back. Manufacturing and construction are not the answer; there is a limit to how much stuff we want to consume, and construction productivity is awful. The stuff that needs to be sold is healthcare, social care and education. There is plenty of scope for increased employment there. But no money. That is the conundrum. The capitalists might collude in the solution, which is where they intermediate between the state and the customer, like they do in US healthcare. We are rightly sceptical of that here in the UK, but can we come up with a better solution?

  2. “The stuff that needs to be sold is healthcare, social care and education”

    OK but there’s no real export market in these. If we go back to basics, every country has either to produce what it needs for itself of it has to trade (export) what it can produce for what it can’t. So, say, for a landlocked country in the Sahara with few natural mineral resources and low levels of human skills, it’s always going to be a struggle. No amount of economic theory can change the fact that if there’s nothing much available by way of resources, then poverty is the inevitable outcome. It’s all about resources.

    You could be right in that it’s better to leave manufacturing to the Germans and Chinese. Governments are usually not very good at picking winners so it is probably better not to try. Government instead just needs to do is whatever is necessary to keep the economy working at its full potential. This does mean the whole of the economy and not just London and the SE of England. Governments can spend more in the regions without it causing extra inflation.

    We do need to get away from austerity economics. We have to choose two out the following three. A healthy economy, a low debt economy, and a high pound. Choosing the first is a given. So we need to get away from our usual “the higher the better” attitude to the pound or, if we don’t, accept that levels of debt are going to be relatively high. There’s no real danger to highish Govt debt levels but there is a danger in high levels of private debt. So, in practice, this means that we have to choose between a high pound/high levels of Govt debt or a lower pound which will give us more balanced trade and allow lower levels of Govt debt.

    I really don’t mind which. This isn’t saying much about the politics of the situation. We do need to divert extra resources towards the three things you mention, which is all the more reason not to waste any of the total resources we do do have.

    1. The interesting thing is that productivity is still advancing in stuff that gets traded, while in the developed world demand is largely saturated. That means that trade in the old fashioned sense (as opposed to the information economy) is becoming less important. Also I suspect that technology (additive manufacturing, etc) is making economies of scale less important, undermining another aspect of trade. That gives me a sort of intuitive confidence that the UK’s trade deficit will not be destabilising in the longer term – though a lower pound may be part of the mix. I suspect the Germans will have some longer term problems, as will the Chinese – though in the latter case there is every sign that the ruling elite have spotted the problem and are trying to head it off.

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