World Economic Update

NYU Stern Professor Nouriel Roubini, CFR fellow Brad W. Setser, and Goldman Sachs' Ángel Ubide join CFR’s Sebastian Mallaby to discuss U.S. economic growth, global monetary policy, and trends in the global economy.

The World Economic Update highlights the quarter's most important signals and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy. This series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

MALLABY: Great. Good morning and welcome to the Council. We arranged this meeting for September the 13th knowing that September 12th and also September 9th would be particularly exciting and volatile in the markets. In fact, it’s not entirely a joke because these days people hang on the Fed so much that it’s a reasonable bet that the last day on which Fed officials can speak publicly there will be somebody who sneaks in just before the deadline and the quiet period sets in and then there will be a kerfuffle.

So we’ve got great people to discuss this in this World Economic Update. Right next to me here is Nouriel Roubini who is chairman and chief executive officer of Roubini Macro Associates and a professor of economics at the Stem School of Business at NYU. Next to him in the middle is the small guy, Brad Setser, my colleague here at the Council, who is the acting director of the Maurice R. Greenberg Center for Geoeconomic Studies. And beyond the basketball player, there is Ángel Ubide, managing director at the Goldman Sachs Group.

So I want to start with this markets question, Nouriel. And I guess the obvious one is simply, is this a meaningless blip or some kind of canary in the coal mine of a bigger worry?

ROUBINI: Well, I would say overall I think of it as being a minor blip in several dimensions of it. First of all, we’ve had in the last year or so at least three episodes of a risk-off; two of them were serial and lasted for almost two months, August/September of last year.

As you remember, the risk of hardlining of China and the 10 percent correction in global markets. At that point, incorrectly, people worried about hardlining of China, but that led to ripple effects.

Then you had another major episode in January and February. It was not just worries about China, it was worries about the Fed saying we’re going to hike four times this year.

U.S. growth in fourth quarter looked weak, oil prices were collapsing below 30 (dollars). The dollar was strengthening, emerging markets were in trouble, worries about Brexit, Brexit and you name it, so it was a perfect storm, but you had multiple factors.

And then we had another third episode right after Brexit. And this time around actually was mild, it lasted only one week, was temporary rather than persistent, was regional rather than global. And it was actually a shock rather than a crisis—it was not (a little ?) moment, for a whole bunch of reasons.

Now, the volatility we’ve seen in the last couple of days reversed partly yesterday just because the markets have gotten used to central banks always giving them more and more and more. And now, people say, oh, my God, there’s some chance that maybe the Fed is going to hike in September rather than in December.

You know, I would say my reading of the data was the data in the U.S. were mixed enough, given the latest one in August that had been weaker than in June and July that the Fed would rather be playing safe rather than sorry. What’s the point, you know, to hike and also hike before the election when Trump is saying, is bashing Janet Yellen and the Fed and so on?

So I would say, you know, maybe the markets have not been pricing a December hike, but, you know, the economy is good enough that unless there is a significant slowdown, in December it will occur.

And then people got nervous because last Thursday the ECB didn’t say anything about extending the QE program, but Draghi in the past had said we’re not going to gold cold turkey from 80 billion per month to zero, after March we’ll have to continue. Well, are they going to continue at 80 as opposed 60, to be discussed.

You know, I was in Frankfurt last week. There are a bunch of committees discussing the options on how you extend, whether you’re going to essentially move away from the capital key and how, whether you can start buying bonds below the deeper rate, whether you’re going to extend a type of semi-solvent assets you’re going to buy, whether you’re going to extend the limits on issuers and issuance.

All these are technical issues, they’re not legal after the recent judgment by the German Constitutional Court on OMT, and some political costs of doing one rather than the other.

But to me, it’s clear they’re going to extend the program. The only question is when they’re going to decide, whether in October or most likely December.

So I think the market got a little bit too nervous, both about the Fed and ECB, and after the speech by Lael Brainard and so on things are more calm.

So you need something bigger. And you had some really concerned that their growth in China is faltering or that U.S. growth is faltering, whether the Fed is really hawkish or other global factors, like oil going sharply down to trigger a real risk-off episode has persisted.

So for me, it’s a bit of a noise for now. Not that asset prices are not slightly overvalued in many markets, fair enough. But to have a real persistent risk-off episode, you need something bigger than just worries about the Fed and ECB.

MALLABY: So I’m going to go to Ángel now, but this is a bit of an irony, isn’t it? I mean, you have a methodology of central banking, forward guidance and communication, which, when it was adopted roughly a dozen years ago, was heralded as the way to stabilize markets, as the way to calm people down, tell you where the central bank is going, and we’d all be in a much less volatile situation.

Now communication appears to create these jumps, even when they’re really non-events. So summing up what Nouriel just said, Mario Draghi was perceived to have delivered news on Thursday when he said we’re not saying anything right now, but extending QE. But the expectation is that it will be extended, so what was the news there?

And equally, you have a bunch of different people, policymakers at the Fed saying this and that. I mean, Rosengren of the Boston Fed on Friday just said that gradual normalization would be reasonable. That’s what he said. And yet, it produced this big reaction.

So, what’s going wrong here with central bank communication which is producing the opposite of what it’s supposed to produce? And is there a better way to read central banks?

UBIDE: Well, if I knew how to do it. So, let me add a couple of things to what Nouriel said. Right?

I think one important change in the last several weeks is this perception that maybe we are reaching the limits of monetary policy as we know it. And that conversation has started with the Bank of Japan which typically leads this process.

And the Bank of Japan has been suggesting to markets that the impact of their policy of QQE, the asset purchases they’ve been putting in place, has led to a yield curve that is too flat. And there is this worry that at some point maybe we need to refocus again on interest rates and go away from quantities.

So we were doing monetary policy with interest rates. Then when interest rates got to zero, all central banks move into quantities, and we sort of forgot where the level of long-term interest rates was because we wanted interest rates to go lower.

It is possible that now we have reached a point in which long-term interest rates in a place like Japan, where the yield curve is at historical flat levels, are too low. And they are too low because they are creating instability and worries about the business model of the financial sector. So the Bank of Japan has started this conversation.

When Draghi said last week that they will see what they do with their QE program, I think people connected the two dots. One is the Bank of Japan may be doing less or maybe trying to push long-term interest rates a little bit higher, or if the ECB is thinking something similar.

And therefore, what we have was the selloff in long-term rates. I think it was more related to these QE programs. So it’s the end of a very long process of constantly adding a combination in terms of quantities rather than what the Fed is doing.

What the Fed is doing, I think, is different. They have a continuum of opinions and none of them are really validated by the data. You can make a case today about raising rates, you can make a case about not raising rates, and all the opinions in between. And if they don’t agree, they don’t agree.

And what we as public and market participants see is the combination of those opinions being put together in the open, which maybe is leading to our situation of more confusion than clarity. But I think it’s more confusion because they themselves as a group don’t necessarily know what they want to do. And the data is not pushing them in one direction or the other.

MALLABY: But just to follow up with you, Ángel, for a second on the Fed, it doesn’t have to be this way, and it wasn’t in the past. So, you know, famously, people who served on the FOMC with Alan Greenspan, if they went off making speeches and said what they thought about monetary policy, you know, he told them what he thought about them, and they desisted from speaking too forcefully in public.

And then you have a shift at Bernanke who made a big point about being a less authoritarian chairman and encouraging more of an open debate. And this was thought to be a good thing because people expressed their views and that created a higher-quality interaction and leading to better policy.

But the downside of this democratic openness at central banks is that you might sow confusion. And it’s sort of also ironic because it doesn’t seem to buy you any political space.

I mean, you have Donald Trump whacking Janet Yellen in a way that, really, you have to go back to the early ‘90s to find a senior American political leader attack a central bank that directly. He’s just torn up 25 years of precedent.

So it’s not as if by being open and democratic and sharing the sort of spotlight with her colleagues that Janet Yellen is protecting herself at all or protecting the institute.

So I guess the question is, you know, has it gone too far in allowing everybody to speak their mind? Should they, behind closed doors, come up with a joint view and then go out and defend it or let the chairman defend it?

UBIDE: I guess there is always a downside to transparency in that way. It’s very difficult to roll it back, right? So when the Fed decided to start publishing the dots essentially was the way of giving accountability and transparency.

Now, once you put the dots in there, if you have basically a bad draw from the distribution in which people cannot really agree on their views, then it’s very difficult to fix that problem.

So we could be in a situation in which we are being unlucky because the data, as I said, is not giving us guidance on which direction to go. Is it possible that there could be a strong leadership essentially forcing the opinions one direction or the other? That would perhaps increase a little bit if you want the clarity in the communication to the market.

But it would have a downside. That is, we as the public wouldn’t understand all the nuances about what’s going on.

You think about, for example, when the ECB was not releasing minutes and it was, in some sense, following the model that you are suggesting, right? And the complaint was that, yes, they were always operating by consensus, but we didn’t understand what the details of the discussion was. So, unfortunately, we don’t have an optimal model here.

MALLABY: So, Brad, what we’re discussing here, in a way, is that central banks exist to stabilize the business cycle, but it’s not necessarily working out that way. And part of the reason, just to broaden out the discussion here, is that there’s too much expectation on these central banks, that other things that could be supporting demand in the global economy have been underperforming, under-contributing.

One avenue of this discussion is, of course, that there might be more fiscal stimulus in the big, developed economies. But you’ve been doing research here at the Council, which I’ve been privileged to get an early look at, on another kind of reason for why demand has been inadequate, which has to do with global imbalances.

So talk a bit about how you see particularly Asia contributing to the weakness of demand, which then forces everybody to look to the Fed and central banks to stimulate.

SETSER: So right now it’s not just that U.S. interest rates are low, it’s global interest rates are low. And interest rates are low in Europe and in Japan.

And there is, in addition to the monetary explanation for why interest rates are low in Europe and Japan, it is quite clear that both Europe and Japan run quite significant current account surpluses, which means that even at current interest rates, which are very low, they are saving significantly more than they are investing.

In Europe, an obvious policy tool to put more of Europe’s savings at work inside Europe will be a slightly more expansionary fiscal policy.

One of the ironies of the global economy today is, for all the talk about Europe’s fiscal problem, the Euro area as a whole runs a tighter fiscal policy than the United States, than the U.K., than Japan, by a quite substantial margin, the aggregate fiscal deficit of the Euro area, between 1 and 2 percent of GDP, which isn’t very much, particularly when you have high levels of unemployment.

What is the consequence of not doing fiscal policy? It is that there is this excess of savings that has to find a home, and that is contributing to low U.S. rates even when the Fed is not buying long-term U.S. bonds. So it’s an indirect effect of other central banks’ policies that is pulling down U.S. rates.

MALLABY: This is a savings glut argument, right? Just to pick up on that echo from Bernanke’s famous speech 10 years ago.

SETSER: Exactly. And if you look at Asia, which was the original home of the savings glut, with the fall in oil prices, with weaker investment in China, though it’s kind of picked up a little bit, with Japan’s fiscal consolidation, and with Korea running a fiscal policy that is as tight if not tighter than the fiscal policy in Germany, in aggregate Japan, Germany, Korea, and Taiwan are running a bigger surplus than the big surplus economies in Europe. And that is adding to the global downward pressure on rates.

Now, I think what is interesting about this savings glut in Asia is that it is really a savings glut. There is an aggregate current account surplus, even when investment by any reasonable measure is way too high in China, and even when the fiscal deficit in Japan is about 5 percent of GDP.

So even with two things that should really bring the current account surplus down in place, you have an ongoing surplus, which tells you that there is this very high, underlying level of savings and that savings is getting pushed out and is influencing other parts of the world, adding to some of the deflationary pressures.

MALLABY: So, Nouriel, the scary thing about what Brad’s saying, I think, is that, you know, if we agree that there’s been a lot of malinvestment in China, money has been invested stupidly and that’s got to change, they’ve got to change hat model, so if the I goes down, if investment falls, if the gap on the savings comes down, too, the savings surplus will go up.

So China could be exporting way more savings in the future than it is now if they correct their domestic problem of badly directed investment.

And equally, if Japan were to get its fiscal position under control, same effect, government saving reduces, so saving goes up and excess capital increases and that floods out into the rest of the world.

So you get, potentially, a much bigger problem even than you have now. And we’re already worried. Do you share that concern?

ROUBINI: Well, I share it with some caveat. I would say Brad is absolutely right that globally we’re at a global savings glut. It’s not just a global savings glut, it’s also, with exception of China, a global investment slump, investment as a share of GDP. CAPEX fell during the financial crisis and in the aftermath of it. And for a whole bunch of reasons, we don’t fully understand, has not recovered, and that’s also partly behind this slow economic growth, potential growth in advanced economies.

And now emerging markets have fallen, so you have to ask yourself why we have both a global savings glut and a global investment slump. And the combination of those things implies the equilibrium of real savings rates globally are low, if they are not negative.

You know, if China were to have a fall in its investment rate, and that’s occurring only slowly, and truly do the kind of structure reform, the literal balancing of growth towards private consumption that’s occurring, but slowly, then you could say, you know, investment falls, but savings will fall, too; and therefore, that gap is not going to increase. That’s a big if since many of those reforms, for a bunch of reasons, are being kicked down the road.

And I would say that in a world where we agree—I agree with Ángel, as well, that central banks are reaching the limits of what they can do. You know, they’ve done lots of various—(inaudible)—stuff. You know, who had heard even 10 years if terms like a zero interest rate policy or QE, quantitative easing, or CE, credit easing, or FG, forward guidance, or now near-negative interest rate policy. Stuff that didn’t even exist, you know, 10 years ago, now has become conventional. And while ECB, BOJ, my view is—(inaudible)—more and this and that, we are reaching the limit.

So, effectively, I think that what’s going to happen is that there will be some passing of the baton, not in a coordinated way at the G-7 level, but informally from monetary policy to a fiscal policy way of sustaining aggregate demand. If that were to occur, public saving will be shrinking, and that might be compensating for that global savings glut.

And you see. You know, it started with Trudeau being elected in Canada and saying I’m going to do public investment, now Abe saying I’m going to postpone the consumption tax hike and I’m going to do supplementary.

You know, in the U.S. whether, you know, Clinton or Donald Trump were to be elected, you’ll have more infrastructure spending, and under Trump you’ll have tax cuts that are going to lead to another big hole in the fiscal deficit.

In Germany, they’re doing a little more in terms of, you know, spending on the migrants, maybe cutting taxes and a little more spending. There’s a little more flexibility in even the periphery or the eurozone given the new rules of the commission. It’s not a big deal, but at least it’s moving in the right direction.

And after the Brexit, you know, vote and with main power, you know, the U.K. has totally given up on fiscal austerity and they’ll have to do, in addition to monetary stimulus, also some fiscal stimulus to backstop the economy.

So I would say throughout the G-7 probably you’re going to see a slightly easier fiscal policy, not in a radical way, not as much as some people recommend. You know, many people, starting with Larry Summers and others, are making a very compelling case for very aggressively increasing infrastructure spending. We’ll see more of it throughout the G-7, but not as much as probably is desirable, optimal.

So I think there’s a bit of a passing of the baton from monetary to fiscal policy de facto, if not in a coordinated way.

MALLABY: So, Ángel, give us a bit of an update on the eurozone here. I mean, what we’re hearing from Nouriel is that not only is, in some sense, fiscal—sorry, monetary policy reaching the bound, as you were saying, but also when we start thinking about fiscal expansions, I mean, you know, they—you know, they can be troubling as well. I mean, you know, there’s a public debt issue and there is a limit at some point.

UBIDE: Right.

MALLABY: So the other sort of leg in the stool, whether we’re talking about Abenomics or whether we’re talking about Europe is, of course, structural reform. And I was interested to see that Mario Draghi made a speech today about the single market and the need to push further in making it work better.

And in some sense, Brexit gives the rest of the eurozone or European Union a reason to address that more forcefully if they want to take it. There’s the referendum coming up in Italy, there’s some turmoil in Spain. How do you see the politics around structural reform? Are people just exhausted, or do you see positive momentum anywhere?

UBIDE: There is, I mean, there has been momentum, right? I think the euro area has always been judged with a different sort of yardstick.

There has been important movement in several countries. I mean, Spain obviously had a problem and had to do a fair amount of things, including the cleanup of the banking sector.

Italy, for all the troubles that they show, they have done important things. The labor market reform is a very good step in the right direction. The political reform and electoral reform and the judicial reform that is now going into the referendum, it’s very important because one of the main issues in Italy is not really structural reforms in the old-fashioned way, but it is how many years it takes to really execute a number for Milan.

I mean, the kind of issues that in other countries take a couple of years in Italy can take six or seven years. And that is something that deters private investment in a significant way. So the kinds of actions that Prime Minister Renzi has taken are all right and they are all going in the right way.

Obviously, we have elections next year in France and in Germany. And that’s going to put all of this process on hold. But I would note that the labor market reform in France, it has been effective because the socialist party has opposed in the parliament. And at the end of the day, it had to be approved by executive order, by the prime minister.

So in some sense, there is movement, there will be more. I think what Nouriel was saying about fiscal policy is important. There is going to be fiscal expansion in Europe always ex-post, not ex-ante. So it’s not a big deal, it’s not a big announcement that will have a better impact, but it is ex-post looking back, we’ll see, OK, they didn’t meet their deficit targets again, and that’s fine, that’s the right policy. And that’s where we are going.

So I think what Europe now needs is to go through the process of the elections next year in these two main countries and then chart a plan for the subsequent five or 10 years. They need to give a vision of the future. What is the euro area going to be? Are you going to complete it with a fiscal facility, which is what you need?

There is now and proposals about creating a defense sort of entity, a defense union, that is being promoted by France and Germany. That would be a good way of deepening the integration and adding a fiscal capacity to it. So that could be an avenue in which you could get both things at the same time, the political and the economic integration looking forward.

MALLABY: It could also go wrong, right? I mean, if Renzi and Italy were to lose the referendum and then have to resign, you’re into a whole new, almost Brexit-like quagmire.

UBIDE: Well, I wouldn’t say that much. So what Renzi has said is that if he loses he will resign, but there will be no new elections until 2018, which I think what it means is that he would plan to put in place a technocratic government that carries on with the plans and the reforms that they have in place, and then they have the new elections as planned in 2018.

So I don’t think it would be as dramatic, although markets would definitely have a view on that if he were to lose and resign. So that’s definitely an important event to watch. It would be late November, early December.

MALLABY: Brad, coming back to your work a bit on imbalances, so, you know, clearly, whether fiscal policy has more space to act depends on which country one is talking about. The surplus countries do have space.

Talk a bit about how you think, whether it’s Germany or China or the other Asian surplus countries, what’s the smart way to change the excess savings problem in a way that really underpins global growth and doesn’t create new problems?

SETSER: Maybe I’ll pick up with Ángel’s point about sort of ex-post there being fiscal easing, because it turned out that in Germany ex-post, rather than there being fiscal easing, there was fiscal tightening.

Most people thought that with the refugee crisis and the additional spending, Germany, which had been running a budget surplus, would come back and be in rough budget balance. It turned out that Germany is running a fiscal surplus of about 1.2 percent of GDP this year.

So there was a surprise, but in the opposite direction. Germany turned out to have been tighter than expected.

MALLABY: Only the Germans, right?

SETSER: Well, actually, it’s not just the Germans. The Koreans have a lot of German similarities.

MALLABY: OK. (Laughter.)

SETSER: There is a meaningful subset of countries that have much tighter budgets in practice that they’d like to admit in public, which gives them space to do miniature fiscal stimulus that don’t, in effect, change the fiscal stance. But Germany, it turns out, is running a very tight fiscal policy, tighter than is needed under even the German definition of the rules.

I think the smart way to reduce the euro area savings glut would be first for Germany to move to balance. Actually, I don’t think there’s any particular reason, in an economic sense, why Germany shouldn’t be doing more public investment and having a, say, 1 percent of GDP fiscal deficit, which it could easily afford, and address some of Germany’s own infrastructure deficits. And I think that would have a meaningful impact on the world.

Korea also runs a, when you take into account the social security system, a fiscal surplus. That fiscal surplus is projected to get bigger rather than get smaller over time. And Korea, unlike Germany, clearly underinvests in its social safety net. So Korea is running one of the biggest, as a share of GDP, current account surpluses. It has space to stop running fiscal surpluses and to provide a much more generous social safety net.

And one place where I think I maybe would go a little bit beyond Nouriel is that in China I think Xi has put many important reforms on the table. But to my mind, he hasn’t gone anywhere near far enough in proposing really significant expansions in the Chinese social safety net, lifting some of the hukou restrictions so that benefits are truly portable, improving minimum pensions, making it possible, if you lose your job in a steel or coal-mining region, to move to a big city, to have access to public schools, to have access to public health.

If those reforms were put in place, then I think that would help bring down China’s excess saving. But I think in the short run, that would have to be financed or would be best financed through a fiscal deficit done at the central government level, which would imply that China would have to lift the 3 percent of GDP cap that it has insisted on for the central government fiscal deficit. So I think when you go around the world in the big-surplus countries, there are concrete ways they could use fiscal policy to provide more help to the global economy.

And the reason why that’s important is that in each of these cases you could provide more demand with almost no risk, no worries about levels of public debt. And this would help address the demand shortfall globally and also bring down some of the big surpluses in these countries.

MALLABY: So, of course, one of the difficult things about what Brad is saying is that, in some sense, if you go back a few years and the debate about imbalances often took place through the lens of currency manipulation or alleged currency manipulation by China, et al, we’re now out of that. It’s not about currency, it’s about internal policies on social safety nets, how much you invest on infrastructure and so forth. And that’s a harder thing to coordinate, and the G-20 does not appear to be quite up to it.

But I want to ask one last question to Nouriel before we open it up to members in the room. And that is just simply for you to reflect, Nouriel, a bit on what we’re learning about political risk. Because it seems to me the irony is that all the long-term studies of what drives economic growth emphasize the quality of institutions, a stable legal environment. And it’s sort of a very political understanding of the underpinnings of growth.

When we look at things in a shorter-term basis, though, the Brexit shock, which threatens enormous regime instability in the U.K., has not translated into all that much uncertainty or panic, except just for a currency correction.

Equally, we have in this country a candidate who might become president, who is saying a lot of things which undermine basic assumptions about the U.S. will repay its public debt, the central bank will be independent, and all that stuff. He’s basically willing to go at them.

So you’d have thought there would be more financial market reaction to these kinds of risks, but we don’t see them. Why is that?

ROUBINI: Yeah, I would say it’s an interesting question because I would say that while there are plenty, of course, of still economic and financial tail risks in the last year, some of those political and geopolitical risks are becoming more important.

And example, you know, the Middle East is burning, and we are in the middle of a 30-year war between Sunni and Shi’a, and oil prices have been lower and lower. In the past whenever there was a geopolitical turmoil in the Middle East, you had a spike in oil prices, like, ’73 Yom Kippur War, ’79 Iranian Revolution, 1990 Iraqi invasion of Kuwait. And in this case, I would say the reason why there is not a shock to oil prices that there is a glut of supply thanks to shale gas and oil and increasing supplies of oil throughout the world, from Latin America to West Africa.

And so far, while many of these countries are collapsing, none of the key producers of oil has had a disruption of supply the way we had it in ’73, ’79, or ’99, or the case of an embargo. So that explains that, why the oil market has not been responding to the fact the Middle East is burning.

Now we have a series of other political risks. I mean, Europe we have had Brexit. If Brexit goes wrong, it would mean eventually the breakup of the United Kingdom with Scotland and all the islands leaving.

In Europe, we have had, you know, things could go wrong, right? I mean, Italy’s referendum could lead eventually to Renzi failing and Cinque Stelle and anti-Europe party coming to party.

We have now a referendum in Hungary. You’ll have a new election in Austria, and a neo-fascist could come to power. You know, in Germany and France things can go wrong. America looks weakened, and the Netherlands might have another referendum.

You know, if things really go wrong and the U.K. leaves and breaks up, the Catalan say me, too, me, too, then all the members of the EU, like the Swedes or the Danes, would say a Europe without the U.K. is mostly euro zone, I don’t want to be a member of the euro zone. What’s in it for me?

So you can see a whole bunch of things are going wrong in Europe, let alone in the other parts of the world.

I think that part of the explanation is that central banks have surprise volatility by doing their unconventional monetary policy. Whenever there is a tail risk, whether it’s economic or financial, the—(inaudible)—of central bank, whether it’s Fed, ECB, BOJ, BOE, SNB, Riksbank, PBOC comes, and we saw it with the risk-off episode last summer, risk-off episode, you know, in January and February. Even the muted reaction of the markets to the Brexit is in part because central bank signaled massive dovishness by the Fed, and more action by ECB and BOJ that is still to come, and all the rest. So I think that’s part of the explanation.

And part of the explanation is also that, while many things politically can go really wrong—like really populists could come to power in the U.K., in parts of Europe, in the U.S., and you name it, and so on—so far the most extreme versions of these political tail events have not yet materialized. You know, even in Greece, after all, Syriza and Tsipras under pressure of the troika to backtrack and go back to the main fold.

So far, Trump has not been elected. We’ll see if he’s elected and whether his policies are going to be what they’ll be. The prediction markets are still assigning a 70 percent probability of success and win for Hillary Clinton.

So I think that the financial markets are still assigning maybe a relatively low probability to extreme political tail events in significant countries becoming mainstream. But increasingly, as we know, there is a bit of a backlash against trade, against migration, against globalization, against capital mobility because, you know, as economists we know that all these things are good for growth, but even basic trade theory suggests that whenever you do trade liberalization there are winners and losers.

And losers tend to be low value-added, unskilled workers. It used to be blue collar, but now it’s availability of services, even white-collar jobs, and it’s not just low value-added, increasing the technology is also replacing middle value-added jobs. And we forgot about the losers, and the losers in the past were quiet and now they’re getting organized.

And it’s not even anymore a divide between right and left. Because in the U.S., the losers within the Republicans have decided to have their candidate and champion in Donald Trump. And in the Democratic Party, of course, Bernie Sanders gave a really hard time to Hillary Clinton.

And even in the U.K. it was not just Tory versus Labour. Within Labour, the losers voted for Brexit; and within the Tory Party, those who don’t like trade globalization and migration went against the city. And this is a risk. Over time, I would say the biggest risk eventually is backlash against globalization becomes more severe. That has not been priced in by the markets.

MALLABY: The biggest divide is not left versus right, but open versus closed.

ROUBINI: Yeah.

MALLABY: Let’s go to questions from members. I can see one over there. Remember, this is on the record. Please state your name and make it quick.

Q: Juan Ocampo, Trajectory.

A question, maybe Brad wants to try this one first, low investment and productivity growth in the past decade or so. You’ve talked a great deal, all of you, I think quite appropriately, about fiscal stimulus and how anemic that’s been.

My question about the private sector, have corporations around the globe reduced their hurdle rates for investments commensurate with the drop in interest rates? They don’t seem to have done this. I mean, if you look at, you know, the publicly stated ROE targets that corporate entities have here, they’re still in the often mid-teens, which doesn’t seem to add up if you have long-term rates in the very, very low single digits. Is this underinvestment over a decade a material factor in why we’re seeing low productivity growth?

SETSER: And I think your question almost answers itself. I tend to agree with you, that while the economics profession has moved on and increasingly accepts the view that long-term equilibrium interest rates are now substantially lower and so, therefore, the return on financial capital is much lower and so, therefore, the hurdle rate for long-term investments should also be much lower.

It isn’t clear that private actors have internalized those same expectations about low, long-term rates, implying that a project that yields something 20 years out might be quite valuable today.

You could also put it around and turn it around on the other side, which is that institutions, like pension funds, have perhaps unrealistic return expectations written into their projections for how their assets will grow over time.

I, though, suspect Nouriel can answer this question better than I.

MALLABY: You want to try?

ROUBINI: No, I agree with what Brad said. The paradox is, yeah, long real rates are very low and private investment is also very low. And it’s a bit of a puzzle. There are plenty of different explanations.

I think that one of them may be that, you know, in this world where shareholder value is key, firms are deciding to use all these excess profits not to do more CAPEX in part because we are also in a low-growth environment for potential growth because of demographic, global savings lag, and a whole bunch of things, including even the rising inequality is low, but giving it back to shareholders, either in forms of dividends or share buybacks and so on. So they are definitely not using it for CAPEX, so there might be also corporate governance explanation.

After the global financial crisis, managers and CEOs became more risk-averse, both have become more risk-averse, and then better safe rather than sorry, given these global economic uncertainties. And therefore, the profit share isn’t rising, but it’s giving back to shareholders and it’s being saved rather than being spent. That might be part of the story behind it.

SETSER: And, you know, just to emphasize, if you look at the cash holdings in, say, Japan, corporate cash holdings, if I remember correctly, are, like, 60 percent of GDP. And it really is cash, it’s bank deposits.

And even with the Bank of Japan’s negative rates, you have not seen Japanese investment go up in the way that you might think would make sense given the magnitude of the cash holdings and given what you would think would be the right hurdle rate. That that is, to me, a little bit of a puzzle.

ROUBINI: I mean, if I had to add one point, I mean, this rising income equality, leaving aside whether it’s good or bad, at least it shows a backlash, from an economic point of view, redistributing income from labor to capital, from wages to profits, and from those who have a margin propensity to spend, households with low-middle income, to those with a have a high margin propensity to save that are corporates and high-net-worth individuals.

And after the global financial crisis, of course, every corporation had to survive and thrive and they had to cut costs to achieve the earnest targets of Wall Street. And which costs did you cut? Labor costs and wages. But my labor costs are somebody else’s labor income and they’re also somebody else’s consumption. So what in the micro level looks rational, trying to achieve your earnings target, in the aggregate at least, or a distribution of income, that reduces consumption growth and aggregate demand.

And that’s why, actually, throughout the world now, thinking about wage policy, whether it is increasing minimum wage or, in the cases of Germany and Japan, talking about maybe an agreement with workers, firms and so on, increased wage growth has to be part of the solution. If there is not enough labor income growth, there’s going to be too much savings and there’s not going to be enough aggregate demand. And if there is not enough consumption, there is excess capacity. And then—(inaudible)—firms say: there’s excess capacity; why should I invest more? So I think that link with inequality is one that has to be taught in trying to explain why we’re in this vicious circle of low growth, low spending, low investment, and so on. That’s part of the explanation.

MALLABY: Ángel, you want to weigh in on this?

UBIDE: No, just maybe to add on what Nouriel is saying, right? I think what we are seeing is that the investment doesn’t depend on the cost of capital. It depends on the—(inaudible, background noise)—demand. And if we are constantly and persistently revising lower our expectations of future growth, it could make sense that the private sector doesn’t feel that it wants to engage in a multiyear program of investment.

Now, I think this is a key reason why public infrastructure and public investment can play a key role now, crowding in the private sector. So we have to forget about all the stories about crowding out. In this case, it would be coordinating expectations towards a better outlook for aggregate demand. And that could lift mutual rates. It would make monetary policy more effective. And it could encourage the private sector to invest.

So it’s a question, if you want, of lack of risk-taking on the government side, that it doesn’t want to risk investment for the future and lifting potential growth that I think is depressing views today and is leading to this weakness in private sector investment.

MALLABY: So more public investment might lead to more private investment.

Let’s go to another question. Yes, right here in the front, microphone coming.

Q: Bhakti Mirchandani, One William Street. Thanks for a very informative discussion.

I have a follow-on question about corporate share repurchases. From 2012 to 2015, U.S. companies bought 1.7 trillion (dollars) of shares back from the market, while pension funds and other investors sold 1.1 trillion (dollars).

So what happens when rates go up and companies don’t have such cheap debt to keep repurchasing their shares?

MALLABY: Anybody want to take a crack at that?

ROUBINI: Well, you know, I would say, you know, if you look at corporate balance sheets, they’re not homogenous. I mean, during the global financial crisis, the financial sector was very overextended, high leverage, the household sector was. The corporate sector that, as a share of GDP, was relatively small. It fell further because everybody was deleveraging after the global financial crisis, and now probably there has been some meaningful increase in the leverage of the corporate sector. And if you look at things like issuance of junk bonds and so on, they’re back to, you know, 2007 levels, and all these issues about cov-lite and PIK toggles and lots of the practices that were risky are there.

You know, so far, we have not really seen a shock to high-yield spreads. I mean, there was a spike in January and February when they went all the way to 900, and then they retraced. And in this search for yield, people like stuff that gives you a yield.

I would say if the economy grows in this mediocre 2 percent, plus or minus, then, you know, the risk of significant rise in default rates in the corporate sector, even if some fat tail of the corporate sector is right now highly leveraged, is relatively low, if an economic downturn were to occur, I would say that, given the re-leveraging we’ve seen in some parts of the U.S. corporate sector, you will see significant stresses in those sectors that are kind of high yield.

But I would say my baseline for now is neither of a recession or a very rapid hike by the Fed and normalization. So those things are vulnerabilities that are going to somehow materialize if and when either the Fed really hikes significantly more and/or there is an economic downturn.

So you’ll see strengths in those corporate balance sheets, but it’s a problem probably down the line.

MALLABY: But the crude answer presumably is simply that your mechanism you’re describing of share buybacks is one way in which extremely loose monetary policy is propping up the stock market. Take that away, and guess what? You know, the stock market might fall again. And that’s why you see these jitters.

Anytime people think that the central banks are tapped out, I think everybody panics. And you were describing one part of that phenomenon.

Another question, yes, OK, over here.

Q: Rick Niu from C.V. Starr. Good morning.

Two questions, if I may. Brexit, which all of you touched on, in five years from now, what is your prediction as to the actual net outcome of Brexit, whether that will actually unite Europe or actually that would disintegrate Europe.

Second question. Secretary Jack Lew was here yesterday, he talked about the possibility of the U.S. government taxing U.S. companies with foreign cash reserves to bring essentially a windfall back to the U.S. government to fund infrastructure investing in this country. What is your macroeconomic point of view about the policy’s short term and long-term impact on the United States?

Thank you.

MALLABY: OK. So let’s deal with the Brexit question. I mean, what’s the prospect, Ángel, that the shock of Britain’s determination to leave triggers some deeper integration in the EU?

UBIDE: Or disintegration is the question. (Laughs.)

MALLABY: Well, right. I asked it the way the question was asked. But—(inaudible, laughter)—I agree.

UBIDE: Well, I think we are seeing it already, as I mentioned. At the council in Bratislava at the end of the month, there is going to be this proposal for more integration in defense and security.

There has already been action below the radar to create a European force to handle immigration and refugees and all that. So there are steps, if any, in the direction of more integration. Whether they will go as far as we hope or they will go as far as they planned remains to be seen.

This is Europe. You asked for a five-year forecast. I think the—(inaudible)—five-year forecast would be huge. But if I had to bet, I think the direction will be for more integration rather than less. Whether that is one velocity or two velocities, whether that creates two groups inside the European Union, whether along the way there can be, you know —today, there was, I think it was the foreign affairs minister in Luxembourg complaining about Hungary and some of the policies that have been going on in Hungary and whether Hungary should continue to be part of the European Union.

There are going to be steps along the way that are going to be bumpy. But I think there is a clear political determination for Europe to survive.

Now, my worries, if they don’t complete the Europe area, if there is not a common fiscal policy that can support the next recession when it comes in the euro area, then the strengths from an economic standpoint are going to be important.

I’m not making a prediction. I’m not saying that there is going to be calls to leave the euro area or anything like that. All I’m saying is that you need both legs to move in parallel, the economic and the political. If the leaders are moving both, I think the path will be towards more integration.

MALLABY: This question about Jacob Lew and the repatriation of corporate profits which are abroad, and it does actually have a European connection because, of course, it’s the Ireland/Apple tax issue which I think has maybe brought this up the agenda a little bit, the notion that if the U.S. does not persuade Apple and other U.S. corporations to bring back profits which are now abroad, you know, the Europeans may impose a tax that tries to grab some of that money before it comes back to the U.S.

Now, I’m looking a bit hopefully at Brad in hopes that he can comment further on the prospects for U.S. tax reform and funding infrastructure with that.

SETSER: So, I mean, I think when you, I mean, when you look at the data on this, you know, the magnitudes involved in the Apple case are obviously quite big. They’re quite big because the sum of either call it currently globally untaxed or, in the U.S. point of view, tax deferred until it is eventually returned to the U.S., the sums held in Europe now and some other places are quite big.

I looked at the balance of payments data because that’s kind of what I do. And if you sum up the reported income of U.S. multinationals operating in Ireland, the Netherlands, and Luxembourg over the last four quarters, it’s about $150 billion. And there’s an accumulated stock that reflects that over time.

Almost all of that will not be taxed at the Irish rate. It will be taxed at a way-lower rate because most of the profit will flow through to pass-throughs in Caribbean tax havens and the like.

The amount of profit that U.S. multinationals reported in Germany, France and Italy is an interesting comparator, and that was less than 10 billion (dollars). So it gives you a sense of the magnitude of the ways that companies have allocated profits to jurisdictions in which there is very little tax.

I think the magnitudes have gotten to be so big that there really is some distortion. You can debate the legal merits of the commission’s case, but the basic notion that there is a distortion seems undeniable.

And I think there will be, there’s an obvious gain to the U.S. from a reform which has a set of elements. One element is a rate, probably a slightly discounted rate, whereby some of the profits that are now held outside the U.S., which are permanently tax deferred for now, are brought home, and that this one-time windfall funds an infrastructure program.

I guess I need to do full disclosure. I support Secretary Clinton, but that’s a big part of her plan. The infrastructure increase, the 250 billion (dollars) in new infrastructure spending would be financed by the one-time gain from this tax repatriation.

I think there’s another issue going forward.

MALLABY: Just a minute. How do you compel the repatriation? Do you induce or you compel it, or how does it work?

SETSER: It would be induced by the lower rate.

MALLABY: So much lower then.

SETSER: Remember that, in principle, the profits held offshore are to be taxed at the high U.S. tax rate. They are just tax deferred. So presumably, the opportunity to bring the funds home at a lower tax rate than the rate at which they should, in theory, pay would break the Gordian Knot that has led to the ever-larger accumulation of tax deferred as opposed to untaxed. Although from the point of view of many who look at this around the global economy, it seems untaxed.

But then I also think there is an important second component of the reform, which is much more controversial, which is, in some sense, to address the problem of globally untaxed profits, not the question of whether Ireland taxes at 12.5 (percent), but whether some companies can effectively not pay even the Irish tax because their intellectual property is located in the Caribbean, whether there should be a global minimum tax on U.S. multinationals’ corporate earnings.

I think there should be. That was something that President Obama proposed. I think that would go a meaningful way to addressing the problems of tax competition.

And then on top of that, this is where it gets even more technical, you need to start or reach an agreement where once you start taxing these profits as opposed to not taxing them, then reach an agreement on where they should be taxed, whether it’s where the country that is producing the intellectual property or it’s where the sales are happening, the so-called base erosion and profit-sharing agenda becomes more important.

But I really do think that there is some fairly low-hanging fruit here and that this is one relatively simple way —nothing simple, it obviously involves big sums of money and big interests —where you can make meaningful change and that it would address some of the populist concerns about the unfairness of the current global system.

MALLABY: Good, OK. Another question, let’s go right down here.

Q: Nis Abuaf, Pace University.

A good part of the earlier discussion was about the global savings glut primarily coming out of Asia. What about the reverse of that? What about the case in the United States with unfunded pension liabilities, emerging markets, and so forth? How do you put the whole picture together?

MALLABY: Brad, you want to try that?

SETSER: Well, the U.S. does run an external deficit. I don’t think the external deficit is, per se, a direct consequence of all the unfunded liabilities, although, obviously, if you were taking more out of your current income to build up more assets, that would raise U.S. savings and would lower our need to borrow from the rest of the world.

Interestingly, the country which has, you know, been the biggest borrower from the rest of the world as a share of its GDP was Britain. And in some sense, Britain has the biggest current account deficit and, arguably, the most unsustainable current account deficit.

And the exchange rate moves that came with Brexit, in some sense, pushed Britain in the direction that Britain needed to go anyway.

The other part of your question is, you know, in some bigger sense, what’s going on with the emerging world? Why can’t the emerging world do a better job or absorbing some of this excess savings that rich countries are churning out?

And I think for now the answer is that the emerging world is still in the later stages of adjusting to a very profound shock to commodity prices, and that that shock to commodity prices came at a point in time when, for various reasons, if you remember back to the Taper Tantrum, also the China jitters, the world was, relatively speaking, unwilling to finance deficits in emerging economies.

So Brazil, which arguably should have been able to borrow to accommodate the fall in iron prices, because of its own politics obviously, but also because of global markets, found itself attracting less capital than it had before, and it was forced to do a pretty big, short-term adjustment.

All this, there’s a positive story here, which is I think there is growing evidence that the adjustment in the emerging world is more behind us than ahead of us and that there are some emerging economies with rapidly growing populations, that are once again in a position when they should be able to borrow.

And I think, you know, in some sense, the solution to the problem of excess savings is, on one level, less savings by those countries that are churning out too much savings in a world that’s having trouble finding good investments for that savings. And then the other element of the solution is, within a framework without everything getting out of hand, having some emerging economies that have stronger potential growth feeling comfortable borrowing from those high-savings countries, and making sure we have the institutions in place globally that allows that flow.

MALLABY: One more question, I think, if we’ve got one last one in the audience. I can see it right there, OK. Thank you.

Q: Thanks, Sebastian.

Nouriel and Ángel, with your experience in Italy, how do you see Italy getting a bank bailout for the country, all the banks? And how do you think it ties —when do you think they get it, and how do you think it ties in to Germany and their need to equitize Deutsche Bank?

ROUBINI: Well, you know, there is a hole in the Italian banking system. Even if the numbers are bandied around to be, you know, people say 300 billion of bad assets, the MPLs are 200, but net of a few things, the number is more like 90 billion euros and is backstopped by property and assets. So, you know, there are different estimates of how much it will take to re-cap the Italian banking system.

The biggest constraint right now to doing it is that there are the new bail-in rules. And unfortunately, the Italian banks peddled some of these subordinated instruments to retain investors—(inaudible)—5 billion of them. And if you wipe out thousands, thousands of small retailers who were really being deceived, then you’ll have a massive political problem for Renzi. So the issue is more political how you achieve a re-cap of the banks without bailing-in retailers, that this is going to create a nightmare.

You know, I was in Berlin, you know, recently, a few weeks ago, and I spoke with senior officials. And they said, yes, we have bailing rules, yes, we have fiscal rules, but the last thing we want is for Renzi to fail and then having this anti-Europe party Cinque Stelle coming to power, and the last thing we want is to have a systemic panic in the Italian banking system that that could spread to other parts of Europe. As we know, fragility in Portuguese banks, Spanish banks, and some people say even some of the German banks could be in trouble.

So I think the view in Berlin is we have to give a chance to Renzi because, as they say in Italy, it is l’ultima spiaggia, the last beach. After him, you might have an anti-Europe party coming to power. So even the German(s) realized that, you know, a sinking Italy and sinking the periphery is not going to work, is going to be bad for Europe and the eurozone. And, therefore, there will be a bit of a fudge. Now, the terms of that fudge still to be found, but I think eventually there will be a way of re-capping the Italian banks without having a significant bailing of retail investors. And then you have to find ways of doing it.

MALLABY: So, Ángel, last word on this. I mean, I suppose David Cameron hoped that, just as the Italians now need something, some wiggle room on their banks, Britain needed some wiggle room on freedom of movement, didn’t get it. Will Berlin be more cooperative with Italy?

UBIDE: I think so. So let me give you one anecdote, right? In the past several years whenever there was an issue in Europe, there was typically a Franco-German summit, so Angela Merkel and Francois Hollande or whoever was the leader there, they would meet and then they would go to the European Council and decide their common position.

In late August, that meeting was Angela Merkel, Francois Hollande and Matteo Renzi. And there is a symbol that is very important there. That is to say, and I think as Nouriel is saying, if Renzi goes it’s over. That was the symbol, is it was a political message to the world that Italy, if you want to put it in these terms, obviously, is too big to fail, and we are going to do whatever is necessary to make sure that it goes on with Renzi at the head.

So how will the resolution of the banking sector is going to be? In an ideal world, they would have done like Spain two years ago: do a big bank with, you know, a big resolution, bad bank cleaning up quickly and all that. That opportunity is gone, so they will have to continue to muddle through. It’s going to take longer. It’s going to be less efficient. But I think the message from Berlin, as Nouriel was saying, is that we are with Renzi, and we are going to help him succeed as much as we can.

MALLABY: So we’ve taken you from the Korean social security system to the Italian banks. Thank you for coming to this World Economic Update. Thank you to the panelists. Have a good one. (Applause.)

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