This week, market watchers around the world are justifiably fixated with the high-stakes, high-drama political developments unfolding in Italy. While a political crisis in the world's 9th largest economy (International Monetary Fund figures, 4/17/18) would normally not be enough to cause an international meltdown, given how thin the global economic ice has become as a result of ever-increasing debt loads, even small disruptions can create systemic problems. But from my perspective, what makes the Italian drama so interesting is that it parallels so precisely developments in the United States. It's amazing that more Americans do not realize, that when looking at Italy, they are looking at a fun house mirror reflection of the United States.
Italy is currently dealing with the results of an election in which populist political forces scored a big victory over the establishment, which they had judged to be both corrupt and ineffective. In other words, the Italians replayed the 2016 Presidential election in the U.S. The big difference is that here the anti-immigrant tendencies of the right and the economic populism of the left were united in one person: Donald Trump. In Italy, those positions are represented by two separate parties that normally would be rivals. But politics can make very strange bedfellows, and the absurdity of the current economic reality has made them partners.
As a result, the top two finishers in their recent election, the left-leaning Five Star Movement and the right-leaning Northern League have cobbled together a contradictory political program that mirrors the Trump agenda. While both parties share nationalist goals to curb immigration and fight for greater autonomy from the European Union, Five Star's secondary policy goal is to lower the (already low) retirement age and institute universal basic income for all citizens, while the Northern League's secondary policy goal is to lower income taxes. In other words, their proposed coalition would look to spend more and tax less. That's the Trump agenda with a little Parmesan cheese on top. Apart from the appointment of a conservative Supreme Court Justice, Trump's major political achievements have been massive government spending increases and tax cuts that have significantly widened the projected budget deficits. The irony is that the governments of Italy and the United States are among the most indebted countries in the world. (2017 IMF figures) And the solutions being proposed by both countries are to go even deeper into debt!
This seems to be the fundamental problem of populism. As its name suggests, the goal of the ideology is "to appeal to what is popular." As a high percentage of people enjoy getting free stuff, government spending programs tend to have a high degree of popularity. Similarly, as a high percentage of people enjoy lower taxes, tax cuts also tend to be popular. But pixie sticks and cotton candy tend to be popular among first graders. Does that mean teachers should be handing out those goodies in whatever quantities their students demand? Will these items do the kids any good in the long run? Good government is about making difficult decisions, not popular ones.
But as we in America sit back and laugh at the goings-on in Italy, we would do well to recall that our problems are not all that different. Like Italy, we have debt that is spiraling out of control and, like Italy, we have absolutely no plan to confront it. What makes us different is that Italy is a part of the European Union, and the European Union is heavily influenced by German fiscal preferences. The Germans don't like debt and, as a result, the European Union insists that member nations maintain annual deficits no higher than 3% of their respective Gross Domestic Products (GDP) as agreed in the Stability and Growth Pact. This is to ensure that the countries that share the monetary union also pursue relatively similar fiscal policies. This is meant to ensure those enjoying the benefits of a strong currency assume the responsibility of living within one's means. Absent such controls, overly indebted countries could live off the fiscal responsibility of others. This would create resentment and political disunion.
But the United States has enjoyed this advantage without having to join a currency union. Just as Rome has largely outsourced its monetary policy to Brussels and Berlin, Washington has outsourced its monetary policy to the rest of the world. That is because the U.S. dollar is the world's reserve currency. Financial markets need dollars to conduct international transactions. In addition, a good portion of public and private global debt is denominated in dollars. This has meant that the U.S. has been able to run up enormous deficits without exposing its currency to the selling pressure experienced by other countries. Countries that don't have this ace in the whole, like Argentina and Venezuela, have seen their currencies plummet for their failures to rein in their debts. The fact that we have not had to pay this price, at least for now, has blinded us from the danger.
