The real threat to our global economic and political order

Economics and history didn’t end with the fall of communism after all. TS Lombard’s Charles Dumas tells Merryn Somerset Webb where they’re going next.


Everything seemed so simple after the Berlin wall fell

Twenty five years ago, it was perfectly standard to think that the multi-millennium struggle to work out how best to run society had come to an end witness The End of History by Francis Fukuyama, published in 1992 . The collapse of communism left the US as the world's sole super power and, as Charles Dumas says in his book Populism and Economics, appeared to make it clear that "a blend of capitalism and democracy" was the ideal political and social system. Globalisation a fast rise in the free flow of goods, capital and people around the world followed, as did a stunning hi-tech revolution, and for a time all seemed well.

Then it suddenly went less well. Only a few decades later came the worst financial and economic crisis since the 1930s. Today it is perfectly clear that the struggle is no more over than it was in 1989. So what went wrong? And what next? Dumas's answer is worth listening to. It comes down, he says, to a mix of four key elements: globalisation, technology, demography and financial imbalances, with the latter being the key to understanding the crisis itself.

The burgeoning global labour market

The better understood part of the story starts in the early 1990s as communism fell and China turned back to the world after the trauma of Tiananmen Square. This effectively "tripled or quadrupled" the global work force as three billion extra people entered the global economy, but they were almost all "prepared to work for wages far below the norm for western companies." That in turn gave us lower overall wages, a much lower level of capital assets per worker, and a fast rise in profits as labour costs slid.

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In a totally free global economy this would all have worked itself out reasonably quickly. But we don't have a totally free global economy, particularly when it comes to labour. In the 1990s workers couldn't simply move anywhere in the world to bump up their income and the UK, Ireland and Sweden aside, even the EU has only really had free movement of labour since 2011.

The result then was not a shift in workers to high-wage economies but a shift in "amoral and culturally neutral" capital to low-wage economies in order for a rising proportion of global production to be done cheaply by the new entrants to the global economy. This round of globalisation has manifested itself mostly in a huge rise in export growth from developing economies "most spectacularly China" and a corresponding fall in wage growth in developed economies (one of the main drivers of what we now call populism).

Emerging markets have exported a lot more than they have imported and the rest of us, apart from aggressively mercantilist Germany and Japan, have done the opposite. This dynamic has in turn given us what Ben Bernanke identified back in 2004 as the "savings glut." Money has piled up in these exporting economies, leading to an excess of savings over investment, something that causes nasty imbalances in the global economy (those excess savings often end up invested in US Treasuries for example, something that pushes yields down and asset prices up).

The consequences of all this are complicated to unravel and not entirely uncontroversial. But one of the key points for now is that for every surplus there is a deficit and, with President Donald Trump having noticed where they come from the US trade deficit hit all time highs with China and the EU over the summer. His reaction to those deficits is beginning to threaten the world of free trade we have all become used to. Trump does not like America's trade deficit. China he says, is "robbing us blind..and stealing our jobs."

From China to Europe

So what's to be done? One interesting point here, says Dumas, is that the over the last few years the "Chinese surplus has almost disappeared." If you are looking for the savings glut "it is no longer in China". Instead it is almost all in Germany or "German-centred Europe", in which Dumas includes Scandinavia, Benelux, Switzerland and Austria. Add them all up and they have a surplus of not far short of $700 bn. That's huge: "more than 8% of GDP in Germany itself."

Why does that matter? Because the result is massive capital inflows into the debtor countries such as the UK, something that has driven up our currency and made us even less competitive, says Dumas. It's all "very nice for London and not so nice for the industrial zones of the north, the midlands and Wales", as might have been reflected in the Brexit vote.

So the fall in the pound since our Brexit vote should be seen as good news? It was at least the point at which "quite a lot of people said, oh, wait a second, I'm not putting that money (into the UK) anymore" and the one at which our current account deficit started to fall. The OECD, an association of developed countries, expects it to be 3% of GDP this year against 6% two years ago.

So hooray for Brexit then? Dumas is a tad more cautious than that: "I think it has produced to some degree, coincidentally, a needed rebalancingRemainers may think that those who voted for Brexit are shooting themselves in the foot. But the reality of the matter is that jobs will tend to shift towards industrial zones, which means that those people will actually not do worse. And in addition, if there is eventually certainly there's no sign of it some restriction on immigration, that presumably takes away some of the downward pressure on wages at the low end of the scale."

That's an unconventional opinion, albeit one I share. The UK has seen two huge waves of immigration from eastern Europe firstly when we opened our borders to all newcomers to the EU in 2004 (few other EU countries did this) and secondly in the wake of the European financial crisis when we became the employer of the last resort for the Mediterranean countries. Common sense might tell you that an influx of low-skilled labour on this scale would hold wages down. But the establishment has nonetheless continued to insist that it has not.

The immigration debate

That, says Dumas, is because they rely on a Bank of England study on the matter by Steve Nickell and Jumana Saleheen. Their work found evidence of only a very small impact on wages and really only on already low wages. But the problem here says Dumas, is that the study does not allow for the lack of investment that a ready supply of cheap labour encourages. We haven't trained nurses for example. We have imported them.

And we haven't invested in robotics in the same say other economies have (if we had we wouldn't be worrying so much about who will pick the fruit post Brexit "there are perfectly good robots that can pick fruit"). Instead of investing in capital of any kind (human or not) we have just thrown more cheap labour at any problem something actively encouraged by our tax credit system (which tops up low wages with cash welfare payments). The upshot is that productivity and wages stay low.

Leave out this rather vital part of the equation and any study is "inherently incapable of capturing a long-run tendency to depress wages at the lower end." England is now more densely populated than the Netherlands, says Dumas. If low-wage immigration doesn't help the economy "how much more do we really want?" None of this is to say that there aren't perfectly good arguments for Remain as well as Leave, says Dumas (he outlines these in the book). But overall it does seem that "the consequences of Brexit are largely misunderstood and, you know, that it may well be that in [the] short term, there's not very much effect at all" on growth.

Solving the savings glut

We go back to the savings glut. If China is no longer the real problem but Germany is, what needs to happen? There are two possible solutions, says Dumas. Italy, which hasn't the devaluation options open to the UK, could leave the eurozone. It insists that it won't and the French wouldn't be very keen on the move because "the pressure would then move on to France".

This would clearly push the euro up and hence German competitiveness down. However, this isn't likely "in the near term." The other solution is that the "Germans step up to the plate and say, yes, well, we've had all this catalyst benefit from the euro and we're going to pay for it now" think fiscal union. There is very little appetite for this either (particularly in Germany).

No solution then? None, says Dumas. Or at least none until Trump gets it, swings his big guns around to Germany and says "we're going to penalise you guys until you do something about it". One way or another the euro is going "way higher". A region that is in "perfectly healthy condition" has no need to have negative real interest rates and shouldn't have them. All these cans have been kicked down the road for years. But the interesting thing about Trump is that "he isn't very tolerant of this kind of thing".

He's a "genuine maverick character". He could be the catalyst for real change by forcing it. So could Italy, by recognising the disaster the euro has been for them and leaving, and so could Germany (by paying up). But, concludes Dumas in his book, as long as Europe works to preserve the status quo rather than to propose useful change, the "sad consequence" could be that the current promising world advance could well be cut off by a breakdown in globalisation.

Who is Charles Dumas?

Charles Dumas is chief economist at TS Lombard, which provides asset managers, banks and companies with macroeconomic, political and policy analysis. Dumas's previous books are The Bill from the China Shop (2006), which anticipated the financial crisis, Globalisation Fractures (2010) and The American Phoenix (2011).

I have barely scratched the surface of his thoughts in this piece and strongly recommend reading his most recent book Populism and Economics to get a real sense of why today's imbalances threaten our political and economic order.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.