Interview with Barry Eichengreen, Professor of Economics and Political Science at University of California, Berkeley
"The trade conflict will continue, because Trump revels in conflict"
Mr. Eichengreen, at the beginning of the year you warned that for 2019 to be a tranquil year four threats to stability would have to be averted. Of those four threats, three threats – escalation of the trade war, Chinese growth problems, and the rise of populists in the European Parliament – have now materialized. Only the US economy seems to be doing well. Do you still expect 2019 to be tranquil?
So far so good. Economic growth is robust in the US and solidifying in Europe. There are risks, as always. The trade war is a big one. On China, growth performance has been improving. Peking supplied a lot of fiscal and monetary stimulus late last year and early this one. Chinese growth is on course to hit the official target of 6,4 %. Populists in the European Parliament elections gained on the left and on the right, essentially in my view because the elections were protest elections. As a result, efforts to strengthen and reform the EU will likely be on hold for the foreseeable future. However, mainstream parties are still the largest bloc in the European Parliament, so Populist parties will be unlikely to effect change themselves.
How has the US-China trade war affected global growth so far?
US-China trade is less than 1% of global GDP. It is simply too small relative to the global economy by itself to throw global GDP off track. Hence the direct effects of the trade war have been limited. Given time, however, the indirect effects are likely to kick in, and these will be more significant. If the trade conflict comes to be seen as the opening shots of a new cold war, firms will rethink their global supply chains. Erratic U.S. trade policy will cause European governments to question whether America remains a reliable trade and security partner. All this will weigh on confidence. And anything that weighs on confidence will weigh on investment, and stagnant investment would be a decided negative for growth.
China has been selling more US Treasuries lately. Do you think it’s likely that they will use this “nuclear option” in the future? Could the current trade war turn into a capital and currency war?
That’s unlikely. If the Chinese make more than marginal adjustments in their reserve portfolios, global financial markets will be seriously disrupted. Chinese Treasury sales would depress the price of treasury bonds and, since China is the single biggest holder, the Chinese authorities would be inflicting losses on themselves. Selling U.S. Treasuries big time would push the Dollar down and Renminbi up, leading to slower Chinese growth, which is the last thing the Chinese authorities want. It’s more likely that they will pursue an alternative form of retaliation, such as making it harder for US businesses to operate in China.
Do you expect a deal in the near future?
No. The trade conflict will continue, because Trump revels in conflict. Trump thrives on chaos, noise and threats, in general and specifically in relation with China, since these enable him to distract attention from domestic economic and social problems. The conflict with China has a geopolitical angle as well, insofar as China has come to be seen in the United States as a strategic rival. At the same time, the Chinese are proud people, having suffered foreign incursions in the past, such as the Opium wars. Memories of this history mean that they won’t back down.
Is there not a chance that Trump will stop the trade war before the presidential elections in 2020?
Only if you think the trade war would damage the US economy. But the trade conflict hasn’t had a seriously damaging effect yet. Moreover, Trump will point to how firm he has been with China as a way of demonstrating that he is a “strong leader” and “tough negotiator.” So the trade war will roll on.
Meanwhile Germany and the EU are worried about car tariffs. How do you expect that trade conflict to play out?
It’s somewhere between difficult and impossible to predict what Trump will do. The positive from Europe’s point of view is that Trump is focused on China, not Europe, Mexico or Canada. The negative is that Trump’s worldview associates economic strength with manufacturing strength, motor-vehicles being the number one case in point. Europe, and specifically Germany, are of course big producers of motor vehicles, which puts them squarely in Trump’s sights.
Could a movement away from the dollar as reserve currency slow Trump down?
There has been a slow but steady movement away from the dollar for some time now, although that trend was interrupted by the euro crisis. This movement is now likely to accelerate, insofar as Trump’s efforts to weaponize the dollar incentivize governments to explore and develop alternatives. The EU, for example, is attempting to set up a barter system with Iran (INSTEX). I think such initiatives will proliferate. And if the euro area and China continue improving their situation, financially and monetarily, movement away from the dollar will accelerate.
Do you expect one dominant currency or a multipolar system of currencies?
A multipolar system. I like to distinguish between the old view and new view of this question. In the old view, there is one dominant currency at any point in time. In the new view, to which I subscribe, several international and reserve currencies can coexist.
You like to turn to economic history to explain present day phenomena. You wrote a book about the lessons of the Great Depression for the Global Financial Crisis and now one about the lessons from past to present day populism. What did you find out?
In my most recent book, “The Populist Temptation”, I argue that some political systems are more vulnerable to populist capture than others. Proportional representation systems, like the one you have in Germany, tend to be more robust than winner-take-all systems, like that of the UK. Presidential systems like that in the U.S. and many Latin American countries seem especially prone to capture by populist strongmen. And insofar as people are tempted to turn to populist politicians in response to a growing sense of economic insecurity, an efficient and encompassing welfare state can be part to the solution, insofar as it addresses their core concerns.
How do you then explain the success of the AfD in Germany, where the welfare state is quite strong?
To be clear, the welfare state is not a vaccine; it doesn’t inoculate those who are displaced by globalization or technology from a sense of economic grievance. Still, Germany’s welfare state is something of a bulwark against populism. Consider the contrast with the United States, where we do little to restrain the operation of market forces. The US lets creative destruction do its work, but Americans are also deeply skeptical that government is capable of doing anything to aid the casualties of what has been destroyed. Americans are taught that government only creates problems, rather than solving them. In the US we don’t do trade adjustment assistance; we don’t provide support for the unemployed. In countries with a Christian Democratic and Social Democratic tradition, social solidarity and dealing with disruptions caused by trade and technical change are central elements of the public policy agenda. And of course support for the AfD is not all about, or even mainly about, economics. It’s also about hostility toward immigrants and identity politics more generally.
Which economy, the US or Europe, is more vulnerable to populism?
The key vulnerability in Europe is the EU. The EU is a rich populist target and always will be. The EU is an elite project, and populism is anti-elite. The EU is dominated by foreigners, and populism is anti-foreigner. In the US, the key vulnerability is this awkward combination of letting the market rip and not helping the casualties of creative destruction. Consequently, Americans are chronically insecure. Against this backdrop, populist candidates who promise to “bring back good jobs to the United States” and punish our trade partners for “unfair competition” have an obvious appeal, whether or not their proposals are realistic.
In Europe the populists have also only grown stronger in recent days. Why is that?
The underlying economic and social problems that cause people to turn to populist leaders, such as stagnant incomes, growing inequality and economic insecurity, are greater now than in the past. Similarly, consciousness of immigration and of the challenge of successfully assimilating different races and ethnicities into the resident population are more prominent now than in earlier years.
How can politicians channel populist forces into fruitful, rather than destructive directions?
At the national level, growth with equity solves many problems. Europe is seeing rising levels of inequality now, not as high as in the United States but rising at a disturbing rate. That said, growth alone won’t help if it isn’t shared. In countries like Italy that seemingly can’t grow, the promise of populists on both the left and right that they will take some kind of forceful but unspecified action to solve the growth problem has obvious appeal. So putting in place a mainstream program that effectively fosters growth is a way of heading off the populist threat. In principle, fostering growth is straightforward; it mainly requires investing in education, training, research and development. The problem is that, politically, this is easier said than done. Moreover, it takes time for the results to materialize, and an impatient electorate may not be inclined to wait.
What role do digital companies play in societies with rising inequalities?
Digital platforms are a problem when they have market power – when they can deter entry and prevent competition. In this case they should either be regulated or broken up.
What about the problem of wealth inequality?
In many cases and countries, wealthy people are able to escape paying taxes. Tax avoidance is too easy, between creative accounting and offshore tax havens. Top tax rates on income and wealth are too low. I am not advocating going back to the tax rates of the 1950s and 1960s, but we have plenty of evidence that higher taxes on the wealthy, if operated in a sensible way, are consistent with economic growth. My Berkeley colleagues Emmanuel Saez and Gabriel Zucman have a concreate proposal for wealth taxation that they argue is realistic and which appears to have caught the eye of the US senator and presidential candidate Elizabeth Warren.
And at the European level? How do EU institutions need to change to be targeted less by populists?
To start, national leaders should respect the “Spitzenkandidaten” procedure and not impose on voters a commission president for whose party no one voted. When it comes to selecting the president of the commission, they should the voters speak and respect what they say.
The Euro is turning 20 this year. You have called the euro an enduring success but a fundamental failure. What is the biggest danger to the future of the Euro, Italy or the Hanseatic League?
I don’t know whether the Hanseatic League or Italy is the greater problem. The main problem is lack of agreement about what kind of reforms to pursue and therefore lack of ability to implement the reforms.
What is your recipe for euro area reform?
First, complete the banking union. Europe learnt in 2009/2010 that banking problems don’t stay in the country where they begin. Rather, they spill across borders. Europe now has a single supervisor of its big banks, which is good, but it doesn’t have the deposit insurance that should go with it.
Germany is very much against a European deposit insurance scheme.
At some point, people in Germany may rethink that position. They will see that the banks themselves can be made to pay the insurance premia and that it’s possible to devise a formula that makes the relative contributions of the Italian and German banks fair in an actuarial sense. And since we’re on the topic of euro area reform, the other thing that the EU needs to do is to get rid of its fiscal rules.
Its national fiscal rules?
No, the EU fiscal rules. I am not talking about the debt brake, but about the Stability and Growth Pact and its cousins and successors.
Why should the EU do that?
I thought this assertion would get your attention. The answer is: for two reasons. First, administration of those rules by faceless bureaucrats in Brussels is all but guaranteed to incite a populist reaction. Can you imagine anything that would excite a more dramatic populist reaction than when EU technocrats go to Rome and tell national politicians what to do with their budgets? Second, the rules are unnecessary. With other modest reforms in place, the euro area will be safe and stable without them.
That’s probably where many people would probably disagree.
May I refer you to a study published in 2017 by none other than the European Central Bank? It shows that fiscal problems, unlike banking problems, spill across borders only to a limited extent. Consider first the impact on spending and inflation. The direct effect of Italy pumping up government spending is that Italians spend more on imports from Germany. This stimulates economic growth in Germany. But there is also a second effect. When Italy boosts its deficit spending it pushes up borrowing costs Eurozone-wide, which slows investment and growth in Germany. On balance, the two effects cancel out, and Germany is all but unaffected by demand-spillovers from Italy. This is what the ECB study in question concluded. The one qualification is that if Italy runs an irresponsible fiscal policy and defaults on its debts, it will damage the German banking system, assuming that German banks have significant holdings of Italian government bonds. But if you have a Single Supervisor enforcing strict bank regulations that prevent the German banks from holding concentrations of Italian government bonds, then the German banking system will be safe. It will be insulated from Italian default risk. The only country that will then suffer from Italy’s fiscal profligacy will be Italy.
But wouldn’t the ECB step in if markets bet on Italy defaulting on its debt or exiting the Eurozone?
No. If Italy behaves irresponsibly, then the ECB would prefer Italy to suffer the consequences and learn a painful if necessary lesson. The ECB’s responsibility is to the European economy as a whole. If the European financial system is insulated from a debt default in Italy, through the mechanism I just described, then there will be no need for an ECB bailout.
Would you not also need more developed capital markets in Europe?
Absolutely. Completing the Capital Markets Union will render the EU less dependent on the banks. Europe would be better diversified financially. The Eurozone as a whole would be more resilient.
Is there a need for greater fiscal policy as monetary policy reaches its limits?
When interest rates are near zero, as is the case currently, monetary policy is less effective than in normal circumstances. So yes, there is a case at the moment for relying more heavily on fiscal policy, since this is the more powerful tool.
So Germany can afford a looser fiscal policy?
Germany can afford more public investment. And there are productive infrastructure projects in which to invest. In his presidential address to the American Economic Association this past January, Oliver Blanchard, former chief economist of the IMF, observed that interest rates in Europe are currently lower than economic growth rates, so sustainable levels of public debt are higher than much conventional wisdom and public discourse would have it. Blanchard’s argument is directly applicable to the German case, since the interest rate on bunds has been below the country’s growth rate for some time now.
Many German Economists don’t think Blanchard’s comments were targeted towards Europe, saying the low interest rates are not because of secular stagnation but mainly because of Quantitative Easing (QE). When the effects of QE end, interest rates will rise again, so one should be careful about accumulating too much debt. Will the German aversion to debt ever change?
Will bund rates rise above German growth rates when the European Central Bank exits QE? I doubt it, given the bund’s status as the EU’s preeminent safe asset and the fact that German investment rates are below German savings rates, consistent with the secular stagnation hypothesis. Will German attitudes toward debt change in my lifetime? I doubt it. The German aversion to debt is deeply grounded in the country’s history. History matters profoundly for how politicians and the public think about such issues.
Is there time for a review of monetary policy strategy? Not just for the US but also the Eurozone?
It’s healthy for central banks to review their strategies from time to time. After all, both the ECB and the Fed have been unable to hit their inflation targets. This suggests that their current strategies are not exactly working as intended. So some re-thinking is in order. Careful reflection never hurts.
The interview was conducted by Julia Wacket.
Börsen-Zeitung, 31st of May 2019
Barry Eichengreen is Professor of Economics and Political Science at University of California, Berkeley.