Meeting

World Economic Update

Thursday, January 23, 2020
Issei Kato/Reuters

MALLABY: OK, so welcome to the World Economic Update from the Council on Foreign Relations. This is Davos without the icy sidewalks. (Laughter.) You can all congratulate yourselves on the virtuous carbon footprint you’ve achieved by realizing that there was no point in going to Switzerland when you can get your insights right here at CFR. (Laughter.)

So I’m Sebastian Mallaby. I work here at the Council. I’m going to preside over this discussion. First of all I’ll introduce the world economy and then I’ll introduce my friends here.

The quick introduction on the world economy is that it’s steady. The latest IMF forecast was for 3.3 percent in 2020. That’s better than last year, less good than the year before, right in the middle between the two. The central forecast is, therefore, central, which is sort of dull. But of course, the interesting thing is—always is to discuss how the world might diverge from the central forecast.

And to discuss that I’ve got, starting over there, Heidi Crebo-Rediker, adjunct senior fellow here at CFR; Susan Lund in the middle, partner at McKinsey Global Institute; and next to me Adam Posen, president of the Peterson Institute for International Economics.

And I’m going to start by suggesting, and then inviting disagreement, the proposition that there are at least some downside risks that we would have obsessed about in 2019 January, 2018 January, but in 2020 January maybe we’re a little bit less worried. So, Heidi, the first one is trade. We’ve just had the phase-one trade deal. If you think about it in terms of Fed-speak, there’s a sort of forward guidance that, you know, there’s a pause for the moment maybe? Or do you see it a different way? Do you think this is not really a pause and trade will continue to be disruptive as a factor in the world economy?

CREBO-REDIKER: So I think the only agreement in the trade bucket that really took uncertainty off the table for a durable period is the USMCA, because even though there’s not likely to be a significant economic impact for having that agreement in place it was—it had very strong bipartisan support, and it actually took that bit of uncertainty off the table.

The other issues it the trade basket I would say not so much. I think it’s a fragile and temporary pause, particularly on U.S.-China phase one, on—you know, on any of the potential escalation with Europe. There have been some positive signals that came out of the past—this past week with conversations in Davos, particularly, you know, out of the blue on WTO and a potential trilateral push for tackling Chinese subsidies with Japan, Europe, and the U.S. together. Don’t know what is going to come of that, but it sort of—you know, there are more positive signals than I think we’ve seen in a while. On France and data services tax, I think, you know, we’ve got a pause, but it’s very difficult. And so I don’t know, you know, to what extent that multilateral agreement’s going to be there for the rest of the year.

Biggest issue is really what’s next on the U.S.-China economic and security agenda.

MALLABY: Either of you want to chime in on trade? Susan?

LUND: Well, I would agree with the assessment that the risk is not off the table. So in the work that we do with companies, whether or not there’s further trade deals with China, the notion that you can have long, complicated, just-in-time supply chains and run in today’s world has been shattered. So future trade deals with China is not the issue. It’s now that suddenly we’re in a different world than we were for twenty-five years where most of us in this room thought trade went in one direction, which was more open, liberalized, freer, and now it’s very clear that that’s not true. And companies are actively thinking about building inventories, redundancy, giving up a little bit on efficiency to get more diversification. And then you add in cyber risk, intellectual property theft, climate risk, and all of those things just compound the fact that supply chains are being actively rethought.

POSEN: I think I’m going to go one step more pessimistic, I guess, on the trade front than my colleagues.

MALLABY: Folks, I tried to be optimistic. (Laughter.)

POSEN: No, no, no, no, no. But the way I’m going to do it is by talking about investment.

And so if you take what Heidi and Susan said, and you think about the fact that the threat of U.S. arbitrary intervention in the trade system is going to always be there—I mean, the fact is, I agree with Heidi, USMCA is the most secure piece we’ve got. It’s the most important piece we’ve got in some ways. But as the Fed has noted in the Beige Books, you know, when Trump said irrespective of the USMCA negotiations I’m going to put on tariffs to get on you about migration, or just this last week or this week Trump says I’m going to do what Secretary Mnuchin called arbitrary—in a rare moment of honesty—arbitrary trade measures to force you on digital tax, so the system is fundamentally undermined.

And trade gets around that. Trade adjusts in the ways that Susan was talking about. But this is a longstanding damper on productive investment.

MALLABY: One of the—just one more thing on trade. I mean, it is an interesting tension at the heart of the U.S.-China issue that on the one hand the dispute encouraged both sides to be more self-contained—I think that’s what you were saying, Susan—and on the other hand there are non-numerical targets ordaining that they should be more integrated. And how that plays out and what kind of distortions flow from that? Could—

POSEN: Well, it’s—Sebastian, I have to push back on the word “integrated.” Integrated is a lot more than just trade.

MALLABY: Right.

POSEN: So this just says the volume of trade may have to go back up—bilateral trade might have to go back up, but you can still have all the things happening that they were just talking about. And in fact, as my colleague Chad Bown has shown these numbers are not going to be reached, and to whatever degree these numbers can come close to being reached it’s going to be by trade diversion by the Chinese government, taking away trade from other allies in the Chinese marketplace, and it’s going to be by, frankly, non-market measures, encouraging China in the wrong direction. So, again, sorry, it’s just the bilateral trade thing, as all of us have said, was always the least important part of the U.S.-China relationship, and now it’s the tail wagging the dog in other bad ways.

MALLABY: Adam, let me try on you a second attempt to be mildly optimistic. I think it’s fair to say that a year ago, you know, it was unclear whether the Fed was going to tighten more and which direction central banks more generally were moving. Now there’s really no sign of central bank tightening, and if anything the policy review in Europe might push in the other direction?

POSEN: Yeah, no, I—there I’m with you. If your goal is to interpret stimulus as good, which frankly I do but I know some people don’t—but if your goal is to interpret stimulus as good, then you should be pretty happy where central banks are because they’re either going to be simulating more or they’re certainly—or they’re simply not going to be cutting back.

This kerfuffle over what the Fed is doing in the repo market, it’s not QE because they’re buying cash substitutes with cash and they’re just moving money around. But they’re also not tightening anything, and they’re clearly intent on either not doing anything or cutting.

The ECB, I don’t think it’s going to be that easy for them to ease more, but certainly they’re showing an easing bias. And their review will at least attempt—Madam Lagarde, the president of the ECB—I should say President Lagarde—will at least attempt to put more of a floor under inflation expectations.

BOJ’s not going to change anything.

Bank of England is probably going to loosen, if only just to show that they’re responsive.

So, yeah, I think on that front you’ve got a lot of ease coming along.

LUND: Let me be pessimistic here—(laughter)—and point out the irony that, why is it a good thing that growth is so weak and inflation targets are not being reached, that we’re back in the easing world after we’d gotten, you know, up to the great heights of 2 percent? I’m still longing for those days when we could actually have interest rates—long-term interest rates higher and get growth strong enough and some productivity growth going that would justify higher rates. And to me—

POSEN: I’m longing for my hair to come back. (Laughter.) You know? At some point it’s—the hair’s not coming back, so I’m not doing a combover, so that’s good. (Laughter.) I agree it would be better in a world in which I had hair, but you know, you do the best with what you’ve got, and that’s what the central banks are doing.

MALLABY: So let’s go to another risk, which is the eurozone. There have been times in my memory of these discussions where that was almost the top issue, that the political pressure amongst eurozone members to doubt the whole system, threaten to leave and so forth, maybe be pushed out, was really top of mind. Maybe because of the way Brexit has played out, and the way that in those negotiations the Europeans have shown such steady unity and have basically gotten the Brits to cave on each issue, maybe that’s dissuaded populist politicians in France or Italy from talking so openly about challenging the single currency system. So that feels like a risk that’s abated a bit, but maybe, Susan or Heidi, you have a different take.

LUND: I would say the risk—yes, the talk of leaving the euro has died down, but the underlying drivers of populism I don’t think have died down at all. The work that we did, first in the U.S. looking at growth and employment patterns across the three thousand U.S. counties, showed really polarized growth in the U.S., and that there are huge swaths of this country that saw unemployment rise during 2008 and have not regained those jobs still. And all the job growth that we have nationally is in twenty-five U.S. cities, and you can name them: Austin, Seattle, New York, all the obvious candidates. And we’re doing the same work in Europe, and it shows even more polarized growth in Europe. So forty-eight what we call superstar hubs that have 30 percent of the population have accounted for 50 percent of job growth, so it’s even more starkly different across local economies in Europe than it is in the U.S.

And I think that that is the economic underpinning of the populist resurgence, is that a lot of people are living in places that they, frankly, don’t have good job prospects or economic prospects. So even though talk of leaving the euro has died down, I would not write off the complete erosion of the social contract and the fact that growth has been grossly, you know, unequally distributed.

MALLABY: You want to go?

CREBO-REDIKER: So I feel like I was given the mandate to do—to be the optimist at the beginning—(laughter)—and I never got a chance to sort of like, yeah, I’m with you on, like, pretty much everything you’ve said.

On Brexit, though—I mean, obviously, I’d be interested in Sebastian’s opinion since you’re actually living through it on the ground there—but I do think that while that sort of is also on my list as a temporary—very temporary—off of the front burner, but certainly something that is going to, you know, continue to raise its head throughout this year as they negotiate with the EU, and also as they keep putting, you know, from what I can see, additional barriers on potential for a U.S.-U.K. grand trade agreement that’s going to, you know, be the savior for, you know, a post-Brexit U.K. economy. And so I do think that while, you know, you’re correct in terms of, you know, how we’re looking at Europe as not being the front and center of global crisis right now, Brexit is going to continue to play out as a risk over this year and next.

POSEN: Can I—

MALLABY: Yeah.

POSEN: Can I be optimistic, too?

MALLABY: Oh, good.

POSEN: I want to be like Heidi. (Laughter.)

But all serious, joking aside, I think the kind of divergent growth that Susan was talking about is actually going to play out in a good way in the next year or two, just putting it very bluntly. The idiosyncratic problems of Germany are exceedingly severe from an economic perspective. They are not going away. I think the consensus has vastly overestimated how much of a bounce they’re going to get from the trade side. And as a result, Germany is going to have some forced empathy for the rest of the euro area, and in particular a desire for both fiscal and monetary stimulus. And this is going to take the form of green investment, and the biggest missing link underlying the euro area’s stability remains the lack of any central fiscal balancing or central fiscal redistribution.

So I can tell a hopeful story where if things go really badly for Germany this year and the politics behind green growth continue to mount, you could see a multiyear run starting, say, in 2021—not to be too precise about this—in which Germany realigns with Macron, with Italy, and pushes Europe forward with a greater fiscal capacity. And that solves a lot of problems in Europe.

MALLABY: You know, Germany was growing, I think, at 0.5 percent annualized. In the last quarters we have numbers for—and that didn’t persuade them to go for fiscal stimulus. And—

POSEN: No, it’s definitely not—now you’re the pessimist, but anyway. (Laughter.) It’s definitely not immediate. And, you know, we’re talking to people, as many in this room are, in the German government and the European Commission. And I think things do have to get worse in Germany. But there are real changes. They have moved away from the schwarze Null, the black null, that we’ve talked about before in this forum.

On the budget the social democrats are now trying to differentiate themselves, along with the Greens, by talking about green expenditure. The German-appointed—or rather—the German national head of the—president of the European Commission, her first foray—even though it—the real water is a fraction of the numbers they’re talking about, it’s in the right direction. So no, absolutely. It’s not going to come to the rescue in the next six months. But I can see a path going that way.

MALLABY: So we’ve been discussing what I had hoped would just be the moderate/minimal risks. They may not be quite so minimal. But now I’d like to get to what kind of are the top of mind risks for everybody. I wrote down a couple that came to my mind but know from chatting over lunch just now that these folks have a whole other set of scary things to worry you with. I’ll say my two and then I’ll invite each of you, maybe starting with Heidi, to suggest what’s bothering you the most.

I mean, I wrote down a kind of continued tech-lash, which winds up taking a lot of value off the companies that have really driven the stock market performance recently. And that, coming on top of WeWork and the whole reevaluation of private technology valuations produces something a bit like the Nasdaq correction in 2000. I also put down election politics in the U.S. Whatever your political preferences might be, it seems to me that we have a sort of—in economic terms, a kind of acceptance of the Trump regime, more or less. The trade stuff may be damaging, but it’s something we’ve lived with for a while. If we woke up after super Tuesday and found that either Warren or Sanders was likely to be nominated, the prospect of regulation of finance, energy, and a couple of other big sectors, health, would I think also scare the markets.

So I put those two down, but, Heidi, what do you put on top of your list?

CREBO-REDIKER: So I would—I would flag three. But the first one would be what you just referred to, which is U.S. election risk. And that is sort of where we are this time next year. I’m fairly—you know, as confident as you can be at this stage in the cycle on the Democratic side, there seems to be more of a leaning towards an aggregate support for centrist policies and centrist candidates. But if you have a democrat win, then it’s not—it’s still unclear at this point what policy direction you’ll see. And they have very—you know, very different consequences. If you see a Trump win of the presidency, then you’re back into this world of do you see a continued disintegration of the global, you know, multilateral system? Do you see a continuation of foreign policy by tweet? And you’re sort of back into that—into that big realm of uncertainty where you may see a doubling down.

So that is—the second, I would say goes to the point of the positives on getting the phase one deal done, and that’s that the longer-term questions that were—that the original impetus for the raising of tariffs and the launching of a trade war to begin with have, you know, to a large extent not been addressed. So predatory behavior, subsidies, you know, over-emphasis on SOEs, you know, the fact that the—you know, the Section 301 report that addressed a lot of the challenges that China 2025 put on the table are really still out there. So we have a whole lot of discussion right now about instruments and ways that we might be focused on capital.

Right now if there’s anything else going up—there’s obviously impeachment happening right now. But the other thing happening in the Senate hearing rooms right now is a hearing on China and China’s capital, by the China Economic and Security Review, looking at ways to potentially restrict public pools of capital going on. I mean, it’s just—it’s something that is, you know, don’t know what’s going to happen there, but it is—it’s a conversation in Congress right now that it’s worth paying attention to. So I think there are a lot of dimensions of technology, things that have not been addressed through phase one. Congress is going to feel like it wants to take a—you know, a bite at that.

Third is liquidity. And the reminiscence I have of listening to people talking about walls of liquidity in financial markets. So the traders that you hear talking about the fact that there’s just ample liquidity, you’ve got to feed the beast, you’ve got to, you know, deal with the fact that credit standards are loosening. And it feels just like 2005. And it really—you know, it’s that time when Chuck Prince said, you know, you got to dance until the music stops. And he was specifically talking about liquidity. So it’s something that the IMF also raised in its most recent global GFSR report.

MALLABY: Susan.

LUND: I would underscore two risks. One is the U.S. political uncertainty. And as I see it, there are three possible outcomes in November, and only one of which is really—would lead to growth-conductive policies in terms of not too much regulation or taxation, but also more sanity, and stability, and support for the market-based, integrated, multilateral world system. So one out of three is not reassuring to me. But I think the thing that I’m more concerned about short term and long term is just where is global growth going to come from?

So the IMF just downgraded its world growth forecast in January, but it still strikes me as somewhat optimistic. I mean, global growth came from the U.S., but also from China, India, and emerging markets. And what’s clear is that now we know growth is overstated in China. They say they’re growing at 6 percent, but it’s probably one to two percentage points lower than that. And that’s before the coronavirus outbreak. Consumer spending is now 60 percent of growth in China. So what happens to Chinese consumer spending during this viral outbreak, and cities being shut down? Will it hit their growth?

India now, we understand from Adam’s colleague, have been using the wrong GDP (deflator ?) of growth. In fact, was not 7 and 8 percent—(laughs)—it was probably a point or two lower. And now they’ve got flooding in the south and they’ve got devastating heat waves in the north. So India is not the powerhouse we thought it would be. You look at Latin America, the IMF forecast has them going from 0.1 percent growth this—2019, that’s what happened—to 1.6 percent in 2020 and 2.3 percent in 2021. You know, but where is that coming from? That strikes me as—there’s your optimism, if ever there was optimism. (Laughter.) And as you dig into their numbers further, where is any uplift in global growth coming from?

Well, it’s Latin America. And then we have the Middle East, similarly, going from, like, less than 1 percent growth up to 3 percent, and Eastern Europe. So the growth drivers in the—and Asia’s more or less flat. Sub-Saharan Africa is flat. Europe and U.S. are flat.

MALLABY: Yeah, the countries with the big—

LUND: So all of their growth uplift over the next two years are coming from Eastern Europe, the Middle East, and Latin America. Wow.

MALLABY: I think we need the new acronym. It’s the BRIM. It’s Brazil, Russia, India, Mexico.

LUND: Right. (Laughs.)

MALLABY: Which they—which they point as being the sources of the big uplift.

POSEN: I think it’s the LAME, Latin America and Mideast. (Laughter.)

LUND: Adam, you should have been in marketing. (Laughter.) Like, that says it all. So where is long-term growth coming from? We know investment is low in the U.S. and in Europe. Companies have mountains of cash. Like, where is investment and growth going to come from?

POSEN: Let me pick up on a couple things. I want to endorse Sebastian’s—like my colleagues—endorse Sebastian’s take, particularly about the sectoral shift in the stock markets. Three years ago, three and a half years ago, the Peterson Institute warned everybody that if you took Trump’s platform seriously, our colleague Gary Hufbauer talked about how much damage the president could do through executive authority on trade. And our colleagues Marcus Noland and Sherman Robinson took us through some of the growth effects of that.

And I’ve been beating this drum, including in this room, through the years. That the ability of the president and the executive branch, through both regulatory executive orders and also through interpretation, to shift policy on everything except budget and taxes is enormous. And that’s, of course, gotten worse first under Cheney, then under Obama, and now under Trump. And whoever wins is going to double-down on that. And so you could see a further extremism in deregulation of labor markets, health, environment, energy, finance or you could see 180-degree turn the other way. And so as an investor, you know, I think you at least got to unpack the sort of general stock market that much.

Second, I want to really pick up on what Susan said. We independently agree on this. My colleague Monica de Bolle, and I, and some others feel that the consensus is way out of whack on Latin America. You are going to get probably a bit of a growth boost in Brazil. The pension reform, whatever you think of Bolsonaro, was positive. The ability of the central bank to keep the nominal interest rate relatively low and inflation not getting out of hand, those are good things. But bottom line, the kind of growth spurt people are talking about—I agree with Susan—is completely unrealistic and unsustainable.

And also, I believe Latin America, unfortunately, is basically a closed system. It’s so unintegrated. Forget Mexico. Mexico’s part of North America. South of the Panama Canal it’s a closed system. They export a few natural resources, but even the best of them, Chile or Colombia, they’re not deeply integrated in anything else. And so big—a combination of shocks, Colombia, Venezuela, Brazil, Argentina, it starts rebounding within the system. And in particular, I don’t think anybody saw coming the kind of protests we saw in Chile. We certainly didn’t. And that’s very scary. If in Chile, which has had relatively good economic performance and relatively good democratization and human rights for the last several decades, has this much discontent and frustration just brewing, it’s very hard to be optimistic about Latin America.

The other point I would make, which this leads directly into, although it’s not just a Latin American point, is going back to other aspects, more CFR-type aspects, of the China-U.S. relationship. You know, colleagues of Sebastian’s and Heidi’s here, and they themselves, have talked about this. There is competition in U.S. and China, and particular people are very concerned about China’s footprint on lending and investing in emerging markets. If you have a problem in a geostrategically important country—a Pakistan, a Venezuela becomes geostrategically important if the regime falls, a Lebanon—you end up in a situation where the U.S. and China might be at loggerheads about how to deal with the financial crisis.

And the countries involved—and you’re already hearing this from people in Pakistan, in Argentina, in Lebanon—are being told directly by the U.S. and indirectly by the IMF: Hey, don’t take so much Chinese money. And the Chinese are saying, what, here’s money. (Laughter.) And if you’re Argentina, or Pakistan government you don’t look free money in the face, especially if the IMF is not proactively being helpful, and especially—especially—if the U.S. is not funding the IMF, and encouraging, and empowering the IMF to be proactively helpful. So I worry about some of these smaller developing economies who are financially fragile having an outsized economic effect through this channel, of being a flashpoint in U.S. Chinese conflict, and of undermining or at least casting more uncertainty about the sort of safety net, as it were.

MALLABY: We’re going to come to members in a second, but maybe Heidi wants to add to that point about China and the IMF.

CREBO-REDIKER: So I would say that was pretty much a forward-looking view about where—you know, where you could see flashpoints. And I think, you know, obviously Venezuela is the one where you have the largest in Latin America, exposure with China, not being a Paris Club member. And that is key, because if you have—if you use the models that we’ve used in the past for any countries, emerging markets in particular, that have had to stress, you go to the Paris Club and there is a—you know, and there’s an agreement that involves the IMF.

And we already have, you know, a number of examples of emerging markets, particularly frontier markets or, you know, quite a few examples in Africa where you have extensive Chinese lending. You have, you know, debt distress. You have an approach to the IMF, and then a complete lack of transparency on the other side. And a real inability of the IMF to play that role that it has—that we’ve come to rely on it for, because you can’t just lend into a big, black hole where it looks like that funding’s going to be taken right out and repaid to Chinese either supported state-owned investors, to—you know, to basically go and repay China for loans that have put the countries, you know, to a certain extent, in distress in the first place.

MALLABY: Any questions from the floor? Yes, let’s go right over there. Please, as usual, identify yourself and all that.

Q: Yes, thanks. Terrific discussion. Bill Courtney, RAND Corporation.

Looking at the larger economies, what’s the potential for structural reforms to raise long-term potential growth rates?

MALLABY: I think that’s a Susan one.

LUND: I would say, look, there is a lot of potential. (Laughs.) Right? I mean, we can look at the U.S. I mean, despite Trump, right, the U.S. in many sectors is very heavily regulated. Land zoning, commercial construction. There’s a lot the U.S. could do. I see zero momentum really fundamentally addressing the structural gaps. Same within Europe, probably even less momentum in Europe. We’ll see what happens with the U.K. after Brexit. But I think there’s potential for structural reform, and for technologies that are now starting to diffuse throughout the business world, to lift productivity. I think on the structural reforms, though, I don’t see—it’s not even really being discussed seriously by policymakers. And then on technology, you know, we’ve yet to see it trickle through to the actual GDP productivity numbers. I’m optimistic, Adam is not, that it will. But in a few years we can sit here and if it hasn’t rippled through in a meaningful way in sectors like manufacturing, and retail, and logistics, then, you know, well, I’ll be scratching my head.

POSEN: So to overwork my self-absorbed analogy, when you move from trend growth to structural reform, you’re moving from my hair loss to my weight loss. (Laughter.) It’s something that’s possible but is extremely difficult. (Laughter.) And my record is not exactly great. (Laughter.) And I think that, joking aside, one has to be realistic. Part of what’s going on in Latin America is you look at Colombia, you look at Chile, you look—now I will include Mexico. You look at a whole host of countries, as our colleague Jose De Gregorio has pointed out—and he’s a reformer—that have done basically the OECD Washington consensus list of reforms. And they’ve probably avoided worse fates, but they haven’t accelerated and grown. I mean, they just haven’t.

And you know, we also have to—this is where I think the globalization in trade really matters. It’s, as we’re already seeing with Boeing, as we’ve already seen with GM, if you have American companies that are already considered too big to fail and become national champions, and can lobby for special protections and government subsidies in this country, let alone in France or China, it’s harmful to productivity, and to competition, and to structure. The only—and so the trade barriers, and anti-globalization movements, and the underlining of supply chains that Susan talked about, all this makes it worse.

You know, there’s this guy Scott Lincicome who tweets—enormously well on trade issues. And he’s got a t-shirt, and I haven’t memorized his t-shirt, but he has the right message. The real cost of trade protectionism isn’t the direct tariff effects. It’s the dynamic effects over time, that you erode the competitive pressure, and the standards, and the transparency on your own industry. And so a world in which we are more uncertain about the trade regime, there’s more conflict, there’s less competition—this is even with—besides going to, say, Thomas Philippon’s very interesting work on the decline of competition in the U.S. But even leaving that aside, this is not good prospects.

I have to say, and I apologize for repeating things I’ve said in this forum before, but the one place we’ve seen reforms pay off is labor market reforms. So in Germany, doing the Hartz IV reforms in 2003 had a hugely transformative effect on the ability of Germany to run along expansion and drive unemployment down. Womenomics in Japan, starting in early 2013 from Prime Minister Abe, has resulted in an enormous boost to labor supply and flexibility in Japan. Labor reform is one of the toughest ones, weight loss. It’s very hard to do. But it is the only one to really—besides opening up to trade—that seems to matter.

MALLABY: Great. OK. Yes, right here. Microphone coming.

Q: Grace Skou (ph), Gesina (ph) Capital.

I wanted to ask a question on inflation. So there is this unspoken consensus among smart people that the risk to inflation is almost one-sided now in this modern economy, which is downside. Can you comment on this very comfortable consensus? What can cause this consensus to be wrong? Do you see any risk factors in the horizon? Thank you.

MALLABY: Sounds like it’s for you, Adam.

POSEN: OK. Well, I was pushing that point of view eight, ten years ago when it wasn’t the comfortable consensus. So maybe I’m smart, maybe I’m not. But I’ll take some credit for getting that right. The—basically you can tell story about an inflation risk, but I don’t think the excess liquidity ones are the right ones. I think you need to tell stories about inflation risk coming through one of three channels. The first is, and the most likely one to my mind, is you end up with societies that cannot agree on basic fiscal policy, basic anything. So the Italian kind of world that we’re used to. And that inability to agree on fiscal policy in basic ways completely erodes confidence in markets, in the bonds. It puts pressure on the central bank to accommodate in ridiculous ways. So that’s first. And in this age, as we were talking about at lunch before coming in, of hyper-partisanship and division, that seems more likely—over some medium term. Not tomorrow, but it is a risk.

The second way I can see inflation coming back in a meaningful way in something other than Zimbabwe or, you know, Venezuela is, again, if you’re not the U.S., China, Japan and you exit trade and you move backwards, then you may fall into a trap of political economy where the only way out is to devalue your currency quite impressively. And within limits, this can be helpful. But again, as Italy and Britain showed in the ’70s, among many other countries, if you go too far with that, you create a lot of domestic inflation and you don’t really improve your competitiveness. And frankly, I’m more worried about the U.K. than most people, because I think there’s a real chance the U.K. goes down that road in the next few years.

The third way I can see inflation coming in the near term, again, for countries other than basket cases, is the good way. Is that Susan’s right about technology, and a lot of smart people who agree with Susan are right about technology. A lot of smart people who talk about the Phillips curve still not being dead are right, and we get a virtuous cycle over the next few years. Wages rise, new investment comes because there is productivity growth, bargaining power of workers continues to rise in a cyclical sense, and we get a good form of, you know, this is sort of Jay Powell, to restate him, I should have such problems, right? You know, this is—this is what the Fed wanted to have happen. And if we get there, again, the flipside of what Susan said, I will be delighted. Those, to me, are the three ways that we get inflation, realistically, in countries that are not small or terribly governed.

MALLABY: Go ahead, yeah.

LUND: Let me add, actually, Adam, that one of the things we can see happening with inflation is what about natural, noneconomic shocks? So we see swine flu in China, and the price of pork goes through the roof. You have a series of commodity-related natural disasters—whether it’s flooding, or wildfire—that limited supply. I look back to 2013 when there was flooding in Thailand, and it turned out 80 percent of the world’s DRAM for computers is produced there. And suddenly, you know, there was this extreme shortage, prices shot up for a few months. If we had more frequent climate disasters in critical supply chain or commodities this could drive inflation, although that would be a short-term shock—

MALLABY: Right.

LUND: —as opposed to long-term lifting.

POSEN: Right. And so, again, I am in no way going to diminish the risks of those things happening, but to me, those are as much disinflationary or negative shocks as inflationary shocks. If anything, they tend to decrease demand.

I mean, again, it will depend on the specific industry and specific context, and I would not want to be a farmer in India, you know, looking for particular products in this situation. They are going to feel real declines in purchasing power which relates to some of the very good work you and your MGI colleagues did on, you know, who in which region is suffering which prices.

But I just want to stress when we talk inflation, we’re usually—at least this is how I meant it—we’re usually talking about some kind of not one-off; something that is an upward—

LUND: Sustained.

POSEN: —general trend. And if you think about how much, for example, health care prices and college tuition prices have gone up in the U.S. in the last forty years, and that’s been simultaneous with a very low ongoing rate of inflation, you can have very wide swings in relative prices without it necessarily going to inflation.

Again, for the Indian farmer, for the business owner who needs that specific DRAM chip, it’s hugely important. But to me that’s not a source of an inflation risk in the sense I mean it.

MALLABY: Maybe it’s worth just extending this a little bit in the following way. It seems to me that price inflation, the smart consensus is robust partly because if you take Adam’s second point about the import channel, and you think about a U.K. which had a devaluation of sterling after the referendum from about 1.50 to about 1.30 to the dollar; had, you know, simultaneously all the uncertainty that might have affected supply coming out of Brexit, and yet there really hasn’t been inflation.

POSEN: No.

MALLABY: And also, you know, quite a loose monetary policy.

POSEN: Yes.

MALLABY: So you had the monetary stimulus, you had an exchange rate adjustment, and you had supply uncertainties and no inflation.

So this leads me back to the point that Heidi made earlier, actually, where maybe when you don’t get inflation in the price of eggs, you get inflation in the price of nest eggs, and it’s the markets—the financial markets that reflect the monetary conditions. Central banks run extremely loose policy, there’s no CPI inflation so they continue to run very loose policy. They even do more loose policy, and it shows up in markets.

Now that may not matter so long as the liquidity is still there. And if the Fed responds to specific problems in financial markets like the repo episode in October, perhaps the party continues for quite a while.

But I guess—is there more you’d like to say, Heidi, about this—the risks you see accumulating in the financial sector?

CREBO-REDIKER: So, I mean, given what was mentioned earlier about sort of the very—you know, a subdued macroeconomic backdrop, you have—you know, a lot of that liquidity is starting to go into less liquid investments which means that any kind of a shock could be amplified. As a result, you know, you have a building up of risks and, you know, it’s not just the ETF market but it’s a good example of where you have—you know, in a shock situation you could see a lot of that liquidity try and withdraw quickly and then have prices drop more substantially than you ordinarily expect. So that is sort of—you know, it worries me that, you know, when I—you know, when I hear, you know, hearkening to, well, the homeowner is not actually highly leveraged this time around; it’s really the corporate sector, it’s more easy to manage, I think about—I think about how, you know, just on the security side, when I was living in London, there was a huge—you know, there was a big white truck with a bomb that blew up when I was in the city, and then the next ten years, you know, everybody looked for the big white truck with the bomb in it. And, you know—and so it’s like—it’s never going to be coming from that same place you were expecting it to come from before.

And I kind of just have that feeling that that’s where we are in financial markets. But again, circa 2005 into 2006, when interest rates were around 5 percent, I just don’t think we have the—you know, the tools that we had in the toolbox back then to deal with the sharp crisis, and I think that some of those risks are building up in the market and we just need to pay attention.

MALLABY: OK.

POSEN: So Sebastian, as many of you know, had a very provocative, very nice article in The Atlantic recently where part of his point—he’s agreed I can say—is that in a democracy you don’t give up on reason. You don’t say people are unpersuadable. OK.

So I think I’ve done this event at least eight times, and I think in at least six of the eight times I’ve tried to get this across. I am going to continue to try even though it’s hopeless.

MALLABY: (Laughs.)

POSEN: The division on this issue is whether you think asset price bubbles and lack of inflation are due to central bank policies or whether you think central bank policies, such as they are, are due to asset price bubbles—(laughter)—and the low inflation.

It is the latter. The central banks would love it if they could create inflation. The central banks would love it if they could create real investment. As Susan mentioned, companies are sitting on vast stores of cash. That is a real factor. That’s nothing to do with liquidity preference, that’s nothing to do with what the central bank’s short-term interest rate is. If anything, it should go the other way.

The reason companies are sitting on vast quantities of cash is because, in the Bob Gordon/Bob Solow sense of it, there isn’t anything that good to invest in right now. And because there isn’t anything that good to invest in right now, the central banks are desperate to try to keep the economy going in the absence of investment. And that’s why they do this.

And so there are things—usually Heidi and I agree, and there are things she said, like about 2005, that I agree with. But I have to just one more time try to say it’s not the liquidity. What happened in 2008-plus was due to mostly massive deregulation and poor supervision. And the reason it is different this time is not because we’re looking at the wrong truck; it’s because the police are actually in the building.

And if the Federal Reserve and the various other supervisors massively goes backward on supervision and regulation, then we will repeat 2008. But if you run the experiment and say today is the same as 2005, and you ignore the fact that even despite the changes made under the Trump administration, that we have a better capitalized, better supervised, more liquid, less wholesale-funded banking system, then I think you are missing an important part of the picture.

MALLABY: Well, can I—

CREBO-REDIKER: I wouldn’t say—I have the utmost respect for Adam on—I would take issue that you can’t dismiss that liquidity was not a component, and it was a big component.

POSEN: Well, in 2005 liquidity wasn’t ample. In 2005 real interest rates were up and nominal rates were up.

MALLABY: No, but it’s precisely that you have—you had—

CREBO-REDIKER: But that is when—that’s when the credit standards started to weaken.

MALLABY: You had short-term rates come down to 1 percent in 2003 and stick there for a while, and even though the Fed started to tighten, long rates, you know, remained low. And so you had this liquidity. And then once you start to tighten, that’s when the trouble comes. And, look, we can—

POSEN: But I—

LUND: But mainly—

MALLABY: Regulation no doubt is important, but if you’ve got tons and tons of money, it will find its way through the cracks—

LUND: But—

MALLABY: —particularly in a balkanized regulatory system like the U.S. where there no one agency—

POSEN: OK, this is—this is another—

LUND: Let me weigh in with two examples—

MALLABY: (Laughs.)

LUND: —to support Adam. (Laughter.) Canada and Australia—

POSEN: Right.

LUND: —the same interest rates so the same liquidity and yet—and indeed Canadian households are more highly indebted than were U.S. households. But they have four banks, and they’re Canadians. They all sit down and talk to each other, they’re very reasonable—and so they had limitations on who got a mortgage and how big the mortgage was. And despite having a house price bubble and very highly leveraged households, they have not had a financial crisis.

POSEN: Nor—yeah.

LUND: And neither—the Australians, too.

POSEN: Now, nor—absolutely right. I completely agree with Susan. Throw one more on the fire: Japan. So everybody kept saying, well, when is the next bubble going to happen in Japan? Japan has had negative rates, and very low rates, and lots of money printing, and lots of liquidity profusion for 20 years. No bubble.

I mean, again, it’s—you can’t simply say liquidity. You want to make a more nuanced argument, let’s make a more nuanced argument, but it’s not liquidity.

MALLABY: We’ll move on.

OK—(laughter)—let’s go right here.

Q: I’m Larry Korb from the Center for American Progress.

Back when I was young like these people and I was in government, we worried every year about the budget deficit. Should we not care about it anymore? (Laughter.)

MALLABY: Another non-controversial thing which we’re going to fight on here on the panel.

They’re reimagining our fiscal policy, Adam, you know; the limits—the limitlessness of it. How far can that go?

(Pause, laughter.)

POSEN: Okey-dokey. Here in the—I believe it’s the Peterson-Rockefeller room—or the Rockefeller-Peterson room—

MALLABY: (Laughs.) Yes.

POSEN: Look, there is a big difference between making the statement that we worry every year about the budget deficit and—which I think always was wrong, and I said so starting a long time ago, and we worry about what the use of the money generated by the budget deficit is, and we worry about what portion of that is being wasted on interest payments, particularly to foreigners.

The real reason—again, this isn’t about Zimbabwe, this isn’t even about Greece. We’re talking about large—countries, through gift of God and history, are large democracies, OK, so the major of economies of Western Europe, the U.S., Canada, Australia and Japan. That’s who we’re talking about. If you are Greece, if you are somebody else, yes, you worry about the budget deficit every month.

So you can then say, well, what determines that U.K., or Italy doesn’t become Greece, and that’s a whole other discussion, but as I and several people tried to say in 2010 when the G-20 went crazy and said, oh, my god, we’re all going to be Greece; let’s do austerity, there were a few of us—including my colleague, Olivier Blanchard, then at the IMF, and myself at the Bank of England—were out there saying, no, there’s no bloody way you’re becoming Greece. Stop it; you’re just going to make things worse. And that’s what happened.

But there is a responsibility, as my board chairman, Michael Peterson, is right to say, there’s a difference between saying you’ve got a good credit rating and you can get a home equity loan versus I can get a home equity loan; let me blow it on going to Applebee’s every night this year, right? And next year spend the year paying off the interest payments. The debate has to be about what you use the money for. There are some public uses that are complete waste, and there are some public uses whose return is far higher than anything the private sector can do and any interest rate we are currently paying. And that’s what the discussion has to move to.

And for years, unfortunately, in the U.S., in Japan, in Europe, the discussion has been obsessively about the aggregate numbers on budget deficits—to the degree there has been any discussion. I mean, the discussion is mostly just hypocritical nonsense, as we all know.

But it’s got—particularly in a world of climate change, and particularly in a world of populist politics, the discussion has to be about what you are spending it on. And again, Larry, this may sound platitudinous to you. I know your record, I know what you’ve contributed, I mean—so I don’t—I don’t want to be saying things that sound obvious. But this is the nub: it’s not the number; it’s what you do with the money.

MALLABY: Yes, Heidi?

CREBO-REDIKER: So I completely, completely agree with Adam on it’s the productive use of the—you know, what you spend it on to actually tackle some of the growth challenges that both Susan and Adam were referring to earlier. And, you know, if you’ve been at other CFR conferences where I’ve bored you silly with infrastructure investment, you’ll know sort of where I come—where I come from on that.

But I also have to explain to my daughter, who now is quite concerned about the fact that we’re stiffing her with the bill—(laughter)—and it’s not—I mean, it’s no joke. I mean, this is—this is what—this is what, you know, kids in, you know, high teens and early twenties are really thinking about. It’s not just the climate bill, it’s the fact that bridges are—you know, are falling apart, and the education system isn’t what it should be, and the opportunities aren’t there. And what are we spending all this money on? What have we done with this big bill that we’re leaving? And so I think that’s a conversation we all should be thinking about.

MALLABY: Let’s go right over here, yeah.

Q: Thank you. Jack Goldstone, George Mason University.

I thank Heidi for raising the issue of debt. Adam, I agree with you completely. Debt is fine if you use it productively, but that applies to corporations as well as the government. Corporations have been borrowing a lot of money. It hasn’t shown up in productivity or investment. Nominal stock market is up about 150 percent in the last five years, nominal GDP up about 20 percent. So are we having a debt party? How long can corporate profit go up much faster than GDP? When that stops, what happens to the corporate debts? And don’t debt parties always have an ending that’s not great, even if the regulatory system and the banking system is in good shape? The corporations are a large sector as well.

LUND: Let me—so I think in the U.S. corporate debt picture, you really need to look at who is borrowing. So in aggregate, there is not a U.S. corporate debt problem.

There has been a lot of high-yield issuance, there have been a lot of what’s called leveraged loans, which are loans to below-investment-grade companies. Some of it’s fueled by private equity. So there is a pocket.

And you’ve seen it play out in retail. You’ve seen a lot of retail bankruptcies; a lot of that was debt-fueled. So there will be pockets. But overall the U.S. corporate sector is not hugely leveraged.

Now I agree that it’s—and my colleagues in the corporate finance practice at McKinsey would disagree with me vehemently, but a lot of the debt has been used to buy back shares, which they say is just another way of returning money to shareholders. We can argue about dividends versus share buybacks till the cows come home, but the truth is that’s where a lot of the debt has gone.

And by and large, companies have not made big investments. There has been a lot of uncertainty over the last few years over trade, over taxes, over lots of things, and so—and maybe it’s just a dearth of good ideas. I mean, certainly Google has come up with lots of things to invest in: in AI, and autonomous vehicles, and so on.

But beyond that, maybe it’s a dearth of opportunity, maybe it’s a dearth of imagination, but a lot of the debt has gone to buy back shares, which is why you see the stock market—part of why you see the stock market up.

But overall I’m not concerned about U.S. corporate debt. There will be pockets of potential bankruptcies, but it’s not a generalizable U.S. corporate problem.

Now if you look at China, that’s a completely different story, and they have, you know, a ratio of corporate debt to GDP up there where Japan was in the late ’80s. We know how that story ended. And it continues to go up.

But for the U.S., I don’t think, despite all the corporate borrowing, to me it doesn’t paint a systemic problem.

MALLABY: We have just a minute or two left, so I don’t know if Adam or Heidi want to add to that. If you don’t, I have a follow-up for Susan, which is, you know, you just raised the issue that if you’re worried about debt, you should look not at the U.S. but China.

You also said earlier that China’s growth is overstated—you know, a combination of lower growth and lots of debt doesn’t look too good. You add the political uncertainty in China created by Hong Kong, and the—I think it’s fair to say we’ve just had Davos three years ago, I think it was, when Xi Jinping went and gave his—you know, Trump has given up on globalization but I’m your man speech. You know, his external stock was recently strong; it’s not anymore. The Uighurs have fixed that.

I’m just wondering how brittle—it’s an unfair, difficult question to ask right at the end—but how brittle do you think China is?

LUND: Well, I think Adam can be more forthcoming than I can—(laughter). I’ll just say, look, I wouldn’t be alone in saying that China’s debt situation—many observers look at it and look at the growth rate, look at the fact that a third of it is coming through non-bank lenders that are not well-regulated—that there is a potential hard landing over indebtedness of local governments in China and the corporate sector.

That said, the central government has bailed out financial institutions and non-bank lenders in the past, and has the fiscal wherewithal, because they don’t have a big central government debt, to actually do so again should they choose to. So even if China does have a debt bubble burst, most of it is not linked to the global financial system; it’s all internally funded, unlike Greece. And Beijing has the fire power to just buy up the bad debt and park it into a state-owned bad bank like they did fifteen years ago.

But, yes, it does seem like there are systemic strains in the system. Adam—you know, Nicholas Lardy wrote a wonderful book. You can talk more about that.

MALLABY: So, actually, we should finish. I want to just note that we’ve extracted a note of optimism right at the end. (Laughter.) And thank you so much to Adam Posen, Susan Lund, and Heidi Crebo-Rediker. And thank you to you. (Applause.)

(END)