August 9, 2010
Last year, I was lucky enough to interview Elizabeth Warren, a Harvard law professor and likely new head of the new US consumer protection agency.
We discussed the US banking crisis, but my interest in writing about Warren stems not from her views on the US banks, but from what she has been saying for years about the financial fragility of the American middle class.
In her book, The Two-Income Trap, Warren documented how middle class working families in the US were in a trap, and how their financial existence was becoming increasingly precarious.
She contrasted this experience of huge debts and constant bill-juggling with the reasonably secure experience of the same middle class in previous generations, particularly the post-war generation.
This phenomenon featured in an excellent article in the Financial Times last weekend.
Warren’s view is that the American middle class is getting progressively poorer, relative to those at the very top of the tree in the US, as well as to people with similar jobs and education elsewhere around the world. She has been writing for some time about the disappearance of the old US middle class and the American Dream.
This is not a revolutionary idea; many others have various theories as to why this is.
The reasons vary from the breakdown of the trade union movement to the rise of China and the constant peddling of debt from an unregulated finance industry.
Whatever the overall reason, the trend of a middle class that is either running to stand still or actually falling backwards is of crucial significance here, because the Irish middle class is about to take a giant leap backwards.
This group is now getting hammered by the collapse of property prices – which, ironically, has to continue if we are to get competitive and become a proper trading nation once again.
This is the central dilemma for all of us: we need to ‘lock in’ cheap property as a competitive advantage for the country, but that means trapping the property-owning middle class in a brace, where their debts remain static but the value of their assets falls.
This means, in its simplest form, that middle class Ireland is broke for the foreseeable future.
We can only avoid this vista by reengineering a property boom, which will just end in a bust a few years hence, putting us back to square one – with more debt.
This is not an option and, even if it were, it is unclear where the credit would come from to push up property prices, due to the broken banking system.
So the Irish middle class is stuck in a debt trap.
On top of this, we face the prospect of huge increases in taxation in all sorts of areas in the next few years, and we are using a currency which is far too strong for our enfeebled economy.
Regarding the currency, what our conventional wisdom peddlers don’t realise is that a strong currency makes weak economies weaker. In fact, no country in history has ever got out of a debt/deflation spiral without changing the value of its currency.
Meanwhile, the argument that euro denominated debts would just rise if were to have a new currency, while accurate, is not particularly compelling – because the ability to pay back debt is a function of being competitive.
This means generating a cash surplus from whatever you do for a living to pay back the debt.
This dilemma remains the case, irrespective of what currency you choose to pay yourself in.
The challenge is to get that economic surplus first and then translate it into hard currency – not get the hard currency first and hope to translate it into an economic surplus.
But there is little point explaining this basic economic truth because we will not leave the euro: the political establishment just won’t countenance it.
This leaves us with the prospect of the Irish middle classes overpaying themselves in an overvalued currency that bears little relation to the economic facts on the ground.
So the insiders who pay themselves in the hard currency, the euro, but don’t actually generate the surplus, get a huge subsidy from those who have to go out and actually generate the surplus in the first place.
This policy choice is a recipe for what we saw last week – much higher levels of unemployment.
This is what our government appears to tolerate.
The ‘insiders’ who have jobs will try to protect themselves, and the ‘outsiders’ – the ones who lose their jobs, or are already on the dole – have to make do.
It was the same in the 1980s and the 1950s. History is just repeating itself.
As in the 1980s,unemployment has now begun to rise dramatically among white collar workers.
This spreading of unemployment is always the way it happens. Initially, the jobs in construction go, but gradually, as demand evaporates, unemployment seeps into other areas which were initially thought to be immune.
In the 1980s, the middle class responded by emigrating. Atypical emigrant in the late 1980s was three times more likely to have a university degree than one who stayed at home.
This trend will probably repeat itself, and the fiscal situation will deteriorate as unemployment rises and tax revenue falls. Ireland is on course for a failed fiscal adjustment – all the indicators are pointing to it.
The state will then try to get its hands on cash from wherever it can.
This is why a tax on savings is likely to be introduced, as are all sorts of other charges and stealth taxes.
All the while, the position of the middle class – which seemed to be so strong a few years back, when the property scam blinded people – will become more and more edgy.
This is exactly what Warren documented in her book.
So what are the alternatives? Whether we like it or not, with the balance sheet shattered, some form of debt restructuring for Ireland’s private sector is a given.
Time will tell how this will work out.
Also, given an anticipated last-gasp, smash-and-grab exercise from the state, the middle classes will take some of their cash out of the country and the Irish banks.
This is what happened in Latin America for decades when capital flight was endemic.
The Irish middle classes have a choice. Either they vote for massive and radical economic change – if a new party emerges which advocates such a manifesto – or they will experience slow but gradual impoverishment.
The issue isn’t about the direction of the move; just the speed of getting there.