World Economic Update

The World Economic Update highlights the quarter’s most important 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: Well, good morning and welcome to today’s World Economic Update at the Council on Foreign Relations. This is Davos without the icy sidewalks. I see that in Davos they’re actually handing out shoe clip things for walking along the sidewalk. We don’t need that on the Upper East Side. It’s much better here.

I am Sebastian Mallaby, and I work here at the Council. And with me I have on my immediate right Jens Nordvig, founder and chief executive officer of Exante Data. And then Catherine Mann, global chief economist for Citi. And Lewis Alexander, chief U.S. economist and head of fixed income research in the Americas for Nomura Securities.

So we’re going to discuss the state of the world economy. And I’ll give you the spoiler at the beginning: It’s OK. (Laughs.) The IMF just released its newest forecast, 3.3 percent for 2020. That’s better than last year, worse than 2018. In fact, it’s quite in between the two of them. So the central forecast is kind of central, neither great nor terrible. But of course, the interesting thing is to discuss what could get us away from that central forecast—what could go wrong, what could go right? And I’m going to start with the panelists here by positing that there are some things which relative to January of last year, or the January before that, maybe we can worry a little bit less about. So in that sense, we’re in a better place. And I’ll start with Lewis and see whether he agrees that the Fed in particular, and central banks more generally, there’s less discussion that they’re on a tightening path, that they could change the outlook by actually raising rates.

ALEXANDER: Absolutely. I mean, I think that’s clearly the case. Certainly relative to where we were a little over a year ago when the Fed was sending the message that it was in the middle of an upward adjustment of rates. And they clearly thought better of that, and they’ve lowered rates three times. And I think, frankly, one of the upside risks in the U.S. is the fact that the whole structure of rates is just lower than we thought it was going to be over a year ago. And that creates its own sort of upside risk.

I’ll think you’re seeing in the other major central banks they’re obviously at different points in their own cycles. That gives—puts them in a different position. But things like the ECB’s engaging in this strategic review, which I think has the potential to change the way they approach things over the medium term is important. I think potentially you’re talking about rate cuts at the Bank of England which, frankly, even a few months ago didn’t seem all that likely. I do think we’re on a very different place in that regard.

MALLABY: And is there one possible qualification in the sense that since around October the Fed has engaged in this reliquification of the repo market? They say that’s not QE, but if it was to be stopped, which it looks like the Fed doesn’t want to carry on forever with this, that that stopping would be perceived as a tightening of monetary conditions?

ALEXANDER: So I think you have to be careful what you mean. I think they’ve been very clear that they don’t—they want to make sure that we don’t see a repeat of the pressures you saw in September. I think that means they’re going to run a permanently larger balance sheet than they had thought was likely even a few months ago. So the process from here is they’re going to continue to buy assets on a permanent basis that ultimately will reduce the need for these repo transactions. In terms of the overall size of the balance sheet, I think it’s going to remain elevated. So I think that risk is relatively low. There’s always the question of, you know, do they get the right mix of these things? And they could certainly make mistakes. But I think they’ve turned pretty hard on that, and I think that’s actually a relatively low risk.

MALLABY: OK, so that’s—we can see if others want to disagree. But for now, let’s just say relative to the past, monetary policy seems pretty benign in terms of supporting growth.

Now, Catherine, something which we were talking about a year ago and the year before that was sort of trade belligerence coming out of the White House. And with this phase one deal with China, it’s not the end of trade problems, obviously. You’ve still got average tariffs of something like 20 percent between the U.S. and China. But it’s kind like if you think of it in terms of Fed speak, it’s sort of forward guidance about the path. It’s, like, we don’t want to escalate this for now, it seems to me. Do you agree with that, that the risk of further escalating trade friction has been removed?

MANN: I think you need to put the U.S.-China deal phase one agreement in the broader context of the—of the current administration’s approach to international trade. We have to remember, let’s go back to even prior to USMCA negotiation, the strategy is bilateral, as in divide and conquer. We saw that in KORUS—renegotiation of KORUS. We saw that U.S.-Japan. We saw that with even USMCA, breaking apart Canada and Mexico. So it’s bilaterally fundamentally. U.S.-China, bilateral. Who’s next? You know, who’s next? The EU. And even within the EU, let’s break apart those countries. So that’s the first thing.

The second thing, of course, is quantitative targets, whether—so it’s a completely non-market-oriented strategy for quantitative targets for specific sectors. And, again, that has been a feature of every single one of the bilateral deals that we have seen currently on the table, negotiated and forward-looking. So even though this particular agreement might have been signed—and of course, the details—we don’t actually even see the details. They’re classified, right? I don’t know exactly how you’re supposed to achieve a quantitative target on a particular sector if you don’t know what it is.

Moreover, how do you enforce such a target if you don’t know what it is? Or the parties who are supposed to facilitate achieving that target don’t know what it is? So—and so I think this particular agreement is representative of the broader context. So even though this particular agreement may, you know, dial back some of the greatest tensions, to assume that there will be no more increase in tensions vis-à-vis some other party going forward, I think, is a mistake. I think there’s plenty of opportunity for lashing out, for taking on another party. And, you know, there’s a lot of time left to do that.

MALLABY: OK, so we should continue to worry a bit about trade.

Jens, I want to raise another possible thing that one could offer as, you know, an area of less concern than in the past. And that is the general state of Europe. The appetite amongst sort of populist politicians to call openly for leaving the euro, as Italian populists were doing a while ago, Marine Le Pen has done in France, it feels to me that maybe because of the way that in the Brexit negotiations Britain has had to cave because it was negotiating with a bigger party—and guess what, the big guy wins—that some of that appetite for questioning the very structure of the European monetary system has gone away. Do you feel that’s correct?

NORDVIG: Yeah, I think the—I think the lesson from the French election was that when Marine Le Pen sort of ventured down that path it actually backfired for her. So I think a key thing to look at in Europe is that if you monitor opinion polls, there is actually a rise in support for the euro in some countries from a lower level. But even in Italy, right, where we had this big question mark around the euro—like, the public support for the euro is actually grinding high over the last two years, right? So I think that is the key thing. If you’re a populist obviously you’d doing something that’s popular. (Laughs.) If you’re not really seeing that the public sentiment is dramatically against the euro, you’re not going to push it further. So that’s why you’re seeing Salvini and so forth sort of take a step back with that rhetoric.

And I think that feeds into the Brexit negotiation as well. Like, the EU knows that in terms of broad public sentiment, like, the euro is not a risk. Overall support for the EU was low a couple years ago, and also recovering in some countries. So I think they definitely want to send a tough message to the U.K. that it does not benefit from leaving. And I think that’s going to play very forcefully into the negotiation. I think what we don’t know is on the U.K. side we can hear what is being said, but we don’t know the degree to which there’s bluffing involved, right? So at the moment, it sounds like we escaped the hard Brexit in the short run, but essentially the rhetoric sounds very hard now from the chancellor and so forth. And the question is whether they really mean it. Does this mean that this is going to be a hard negotiation where there’s going to be no possibility of an extension, it’s going to be make or break? Or when we get to the deadline are we going to get another form of extension? I think that’s what we really don’t know. And I guess that’s the wild card that is associated with more populist policies.

MALLABY: Yeah. I mean, as someone who lives in London, I agree that the risks for Britain is still very high. But I guess the point I was getting at is that the risk within Europe around questioning kind of the whole monetary structure—I think we agree that that’s backed off quite a bit.

So we’ve talked about the stance of central banks, the outlook for trade, the sort of European cohesion. Now I want to raise some risks that strike me, at least, as a bit more serious. And I’m going to try to asking Jens first to tell me which of these three he worries about most, or if he wants to propose a different one. What is the thing that you do worry for 2020? So my list of three possible ones include the tension in the Middle East, particularly with Iran, does push up energy prices. The amazing thing so far is that it hasn’t. But could there be an inflection point where it does? That’s number one.

Second, that the tech-lash produces suddenly a fall in the share prices of the big publicly listed tech companies, then that coming on top of WeWork leads to a fundamental repricing of tech, which kind of creates a repeat of the Nasdaq 2000 bubble explosion. And then the third one is simply U.S. electoral year election politics writ large. Either that Warren/Sanders win the primary and you have the risk of a major regulation of important sectors like health, and finance, and so forth, or that a kind of resurgent Donald Trump, looking at a second term, spooks the market somehow with a second-term agenda that seems disruptive. So U.S. politics, tech-lash, and Middle Eastern oil. Do you want to—

NORDVIG: How long should we make the list? (Laughter.)

MALLABY: Well, add one. If you don’t agree that any of those is the main one to worry about, tell me what the one is—the single one that you—

NORDVIG: So last week I would have said something to do with climate-related issues, right? So we’ve had—we’ve had a very dramatic couple of weeks in Australia. My company has staff in Australia. Everybody’s personally affected by what’s going on. It’s really getting to a point with these extreme events where it’s impacting a lot of people. And obviously it sort of seems a little bit—it’s not the right step to take to move that into GDP numbers and so forth, given the human suffering that’s involved. But nevertheless, I think we’re getting to a point where these events can really have an impact.

And it can also have a political impact. So I think one thing I’m monitoring a lot, actually, is what’s happening in Australia now. So we can see that the PM has taken a major, major hit in terms of popularity as a function of this event. And that’s something I think is worth thinking about very carefully. I think in Europe we can already see that this issue is starting to really impact election results, especially in Northern Europe. So if that’s something that’s broadening, I think that could have a big impact.

But to go back to your list, Iran seems weak to me, and therefore I never thought that the Iran issue was going to be, like, a big driver of economic or market dynamics in more than a couple days. In terms of the U.S. election, I think it’s very linked. I think your point two and three, and you call it a tech-lash and you call it U.S. politics. I think they’re integrally linked, right? It has to come from some evidence in terms of polling, primaries and so forth, that we can get a very left-wing president of the United States. Then that would really put the market in motion.

So it’s hard for me to see exactly how that would play out in that our current president’s approval rating is, like, just—it never moves. It just literally never moves. It’s always 42 (percent). So if that went dramatically down and given that that regime is being viewed as being market-supported, that would be a big shock. But it’s a little bit hard for me to see, OK, what is that’s going to catalyze a big shock to that? It’s ironic I’m saying that here, when we have the impeachment trial literally having in a couple days, but that’s just the fact of that matter. (Laughs.) But I would mention that.

And then I’m not allowed to mention anything else. But I’d say everything that’s driving markets today is the coronavirus in Asia. So we don’t know where that’s heading. But at the moment, it’s not a path that seems like the SARS virus in 2003, that ended up being pretty meaningful. So that’s—I think I the next couple days we’ll probably know whether that epidemic is accelerating to a degree where that could be something we have to add to your list.

MALLABY: And a big disruption/slowdown in China is very bad for emerging markets, bad for Germany. Which—just quickly—which countries do you see as exposed?

NORDVIG: So when I look at the SARS situation, it looked like the transmission mechanism economically that was the most important was actually tourism, because people just stopped traveling to those countries. So, like, there would be countries, like Thailand, that have had, like, a major, major tourism boom. They could be, like, dramatically impacted. So those are the numbers we’re crunching today. (Laughs.)

MALLABY: OK. So Catherine, put the same question to you. My list was, again, Iran, tech-lash, U.S. politics. Jens of course is right that the second and the third overlap. Do you want to add one? Do you want to—what do you want to do?

MANN: Well, we have five on the table now. That seems like plenty.

My approach to thinking about these rather than pick one is to think about what the possible transmission mechanisms are and then evaluate, you know, what do I think about those. So on the—on the Iran side, you know, other than the war, which is—that’s a—that’s a tail risk. The transmission mechanism is through oil prices. And so one of the things that I think is important to recognize for Iran and oil prices in general is the wide range between the bull and the bear case. Our commodities team, headed by Ed Mores has for 2020 a very, very wide range between bull and bear, widest that it’s been in over a year. And so it’s hard to take a bet. You know, you can bet on the middle if you want, but, you know, you could be way wrong.

And so that additional uncertainty that’s added into the electoral uncertainty, which is I think number three, you know, adds to the potential wait and see attitude on the part of a lot of investors—real investment. And that is, I think, one of the biggest risks for the year, is that everybody holds off until they know kind of the lay of the land towards the end of the year, because that just delays—you know, that undermines progress in terms of the real economy, and potentially also in terms of the—in terms of the financial markets.

Number two, which was your tech-lash, if we go back to 2021, you know, we remember that was a big dot-com crash, but kind of nobody cared. And if anything since then—

MALLABY: You mean 2000-2001?

MANN: 2001, yes, the dot-com crash in the end did not generate any big recession on the real side, in part because the asset valuations were very high but also the ownership was concentrated in terms of—in terms of the holdings. So I think that is, if anything, more true today than it even was back then. So the tech lash can’t—if we think about the tech-lash has having a transmission mechanism through the markets, that I’m not particularly worried about.

MALLABY Tech is a bigger share of the market now.

MANN: It is, but the ownership of the market is more concentrated for the direct holdings. And research shows that direct holdings is what matters. Plus, the valuations are even more elevated than they were back then. So I mean, if we took 25 percent off the top right now, we would kind of be back to September, something like that, right? So the market—you know, because market valuations are so high, having a correction takes you from a very high level. The delta might be big, but your drop is taking you back to not something that’s particularly low.

So the tech-lash, I actually think that there are a whole range of issues having to do with technology that are a slow boil, that are eroding the global—part of the erosion of the global fabric of international trade, data exchange, et cetera. That’s a slow boil. I think it has long-term consequences for globally integration and for companies that, rather than thinking of data as exhaust, data—which is, you know, a term—now data is a direct input and a nutrient, so to speak, for firms, instead of an exhaust. So I think there are serious concerns that we have about technology, but that’s not—I don’t see it as a tail risk. I think it’s a mean—changing the mean of the distribution.

Climate I actually think—climate, of course, is extremely negative in terms of its impact on insurance companies, all the banks are now doing climate-related stress tests following guidance from the Financial Stability Board. But it’s also a great opportunity. And I think Europe is the one that is most likely to actually see—to out-perform expectations, which are terrible. You know, Europe is sort of in the doldrums and everybody believes they’re even worse than they are. But it’s an opportunity for Europe to really galvanize around, I call it, climate transition financing, because you don’t want to use the word fiscal policy.

Then SARS, I think that’s a very—that’s a—that’s probably the biggest wildcard.

MALLABY: So sort of—it’s the European Green New Deal which you see as the upside?

MANN: Well, so it’s not just the Green New Deal. I think trying to use vocabulary that comes out of the United States and apply it to Europe is probably a bad idea. But they’re—you know, the—as you say, the—as Jens says, the politics. The citizens are far more behind climate-related activities. They are—they are—climate—low-carbon footprint ETFs or stock portfolios are out-performing general index. That shows a lot of demand. Firms are responding in terms of product characteristics. You’ve got the citizens voting for Green parties, a very good response in a number of different places. You’ve got that showing up in Brussels. OK, the Green New Deal. I wouldn’t call it that.

So in Germany in particular there is tremendous opportunity for, as I say, climate transition financing. The budget is being put together now for 2021. Firms are looking at that for guidance about where they should be putting their private sector activity this year in order to be ready for the public sector both regulatory and fiscal tools when they get to next year.

MALLABY: And you see the driver of this as the German government or the Brussels—

MANN: Well, I see it—I see it as coming from Europe, actually. Individual countries—you’ve got Macron. You’ve got Netherlands already doing it, having done some fiscal activity, having some guidance there. Brussels talking about it. You’ve got the European Investment Bank being retitled the Climate Bank with the mandate agreed in the Brussels context by all those countries to eliminate fossil fuel-associated investments by, I think, 2025. Maybe it was 2021, but it could be 2025. That’s more reasonable. So that—there’s momentum there. So it’s really across the board. As I say, it’s playing out in individual countries, but it is also in the Brussels context. So I think that is something that really does have momentum in Europe. Maybe there’s a little bit in Japan. Of course, there’s nothing in the U.S.

MALLABY: I want to give Lewis sort of two bites at the cherry here, because there’s two issues now on the table. One is this interesting discussion of climate and what that might do to the world economy, which I know you’ve been thinking about. And the other is this question the others have addressed about what risks do you worry about most? So why don’t you do the risks first, and then—

ALEXANDER: Sure.

MALLABY: Yeah.

ALEXANDER: So I agree with most of what my fellow panelists have said, and so let me just make two points that are nuanced ones. You talked about the risks around the election, and you framed it as Sanders/Warren as being the risk. The point I would make is the debate on economic policy in the Democratic Party has changed. And I think it’s a mistake to think of it as it’s only Sanders and Warren. So I would argue no matter who the next Democratic president, whenever that happens, you’re going to see a different approach to economic policy than you saw under Bill Clinton, under the various campaigns, under Obama. It’s going to be different. And the ideas that have been raised in this campaign—be it some sort of version of greater access to health care, climate, a tax structure that is more overtly redistributive—those ideas are not going away.

And so one of the things I think it’s worth thinking about is I think that is going to become apparent in this electoral cycle, regardless of who the nominee is. So there’s a—there’s an obvious risk that, you know, Warren or Sanders does better than expected in Iowa and New Hampshire, and we look up, you know, six weeks from now and go, oh my God, it could be Warren or Sanders. But I would argue even if it’s Biden, there will be a point in this electoral cycle where people will look up and realize that my friend Larry Summers is not going to be the one driving economic policy in the next Democratic administration. And I think that will be a shock.

And I think it is very much related to these attitudes around tech. The whole issues around competition I think is an area where that debate has just moved. And so to the extent that people think of economic policy in a Democratic administration as being the kind of Bill Clinton, Obama crew, it’s going to be different. And that’s true even if Biden’s president.

The one other thing I would just note on oil, I always think it’s important to remember, the dynamics of oil in the U.S. economy are just very different because we’re such an important oil producer now. So that things that used to be negative for the U.S. economy are really much more neutral because you get this offsetting thing. So if we get the bad outcome in terms of oil prices going up, it is going to mean more investment, more oil production. It is a very different thing in terms—and I would argue that’s partly why markets have been relatively benign in terms of how they’ve reacted to what are pretty extraordinary events in the Middle East.

Now, in terms of climate change, I’ve been trying to think a little bit about what a truly robust kind of response to climate change could really look like. And I think there’s, on the one hand, we need to change patterns of consumption. And the obvious way to do that is a carbon tax. And you can think about whether or not we’re on a path to something that makes sense by how close we are to that. As you can imagine here, we’re kind of a long way from that. I think globally we’ve got a better shot at it. But that’s one side of it. I think it’s also pretty clear that that’s not going to be enough. If you just simply look at how the—how these issues have played out in France it’s clear that there are limits to how far you can go by just dealing with that.

I think what that means is you then need a response that’s designed to promote innovation and to promote a rapid transition of the infrastructure. And that’s where the spending comes in. I totally agree with Cathy that Europe is, like, further along on this—further along on this than we are. It will be interesting to see how that plays out. Australia’s an important example. That’s another aspect of the U.S. election here, how far do we get on that? But I think there’s a pretty strong case for investments that are aimed at both promoting fundament innovation that allow you to come up with sources of energy that don’t generate carbon emissions, but also the need to sort of redo the infrastructure.

And then there’s just the broader case for mitigation. Look, there’s an awful lot of warming that’s going to happen no matter what. And there’s going to be a need for investments to sort of mitigate those impacts. And I think how quickly we kind of transition to realizing those things is very important. I think it is very political. It is very dynamic. I think those are things that are kind of in play now.

MALLABY: Good. OK. Well, we’ve just hit the halfway mark, so I want to invite members, if they have questions, to identify themselves. Remember that this is on the record. So who has a question? Let’s go right over here. There’s a mic behind you.

Q: Yes. Ed Cox of the Trump Campaign.

I’m surprised that no one on the panel has addressed China and whether its economy—what happens between it and Hong Kong, or it and Taiwan impacts oil prices. Whether depending—it’s the second-largest economy in the world. Whether China.

MALLABY: Great question. Who wants to? Jens, maybe. OK.

NORDVIG: So I spend almost all my time on China, so thanks for—thanks for this. (Laughs.) So I think we have—we have reached an interesting point, right, where the tariff impact is starting to lessen after accelerating for a period of time. So that’s an important signal. But if you look at the data, it’s really just—I think it’s just incredibly mixed, right? So we had a period where the Chinese data looked terrible in the first half of last year. And then since then, there’s been various efforts to tweak the policy. And I really mean tweak. Like, as opposed to sort of the big bang approach to fiscal policy, we’ve had all these tweaks, right? So we’re seeing commodity imports are starting to pick up. We’re seeing some evidence that some retail indicators are picking up. But it’s really very, very different from the previous cycle, right, because it’s these tweak-y little policy responses. Like, even on monetary policy, right?

Like, to be honest, the one thing last year I was totally wrong about was that, OK, I thought: We’re facing a major economic challenge in China. We’re going to have some serious monetary easing. And we ended up having just totally stable interest rates in a world where interest rates were collapsing. It’s counterintuitive, right? But it’s all the tweaking they’re doing. And a reserve requirement rate cut here and there, right? And I think that’s very much reflected in the numbers now, that you have some kind of bottoming going on, but it’s very, very moderate. And obviously don’t look at the GDP numbers. Like, how can a company—a country have, like, always 6 percent GDP growth? But if you look at the actual fluctuations and other indicators, it looks like we are bottoming, but it’s not a really big recovery, right? So it’s kind of a bottom around a very moderate pace of growth. And that’s what we’re going to see.

So on the currency, just a final comment, right? So I essentially advise investors on the currency risk taking. And last week people got really excited that, OK, now the currency is embarking on this multiyear new bullish regime, because it had appreciated for a couple weeks. But keep in mind that the tariffs have not been eliminated. We have had a tiny cut to one tranche of tariffs, right? We have higher tariffs than what we had before the August escalation. So I think the Chinese authorities are going to look very carefully at where the trade with the renminbi is, and they’re going to see, OK, the current level—before the coronavirus took it down, a little bit down—is exactly like the level we had in June and July last year when tariff levels were a little bit lower than what they are now. So I don’t think we’re going to get a major further appreciation of the currency. They’re just not going to let it, because they need a little bit of help on every single part of policy they can, including the currency.

MALLABY: I think it’s worth—I’d like to piggyback on the question, because this is so important, and bring in Catherine or Lewis. But it seems like one thing which is very hard for outsiders to gauge is that China felt pretty brittle, even before this latest pandemic. You know, there was Hong Kong. There was the question of the, you know, global condemnation of the treatment of Uighurs, which I think, you know, is a public relations—it’s a human rights disaster, but it’s also a public relations disaster, which I think they underestimated how much that would get resonance abroad. And so you’ve got this leader who has arrogated unto himself unprecedented power, at least since Mao. And it’s unclear how much the regime, the people around him, are going to tolerate that forever. And you know, economic performance is part of the variable that will presumably determine that.

And if you’ve got a health disaster freezing travel and messing the economy up—and I think these tweaks are sort of symptomatic of this brittleness as well, that there isn’t the confidence to go to the full stimulus. There’s a concern about bringing the debt levels down to make the system less fragile, but at the same time not let the growth rate fall below 6 (percent) because that’s perceived as politically important. I wonder whether you have thoughts, maybe Catherine first.

MANN: What we’re painting here is—when we go back more than a year—is a country that has domestic challenges that are in fact more difficult to address than external ones. You’ve mentioned the debt and other financial instability. And that, of course, was what originally started the softening of growth rates in China, was the approach to deleveraging and reducing the vulnerability in the financial sector. And then—and then there was the trade issue, right? And so the tweaking of the policies was very much an effort to come up with an alternative strategy to achieve domestic equilibrium—you know, using tax cuts and so forth, new polices for them, which of course in a—in a high savings and precautionary savings society don’t have much traction. You don’t get any multipliers from that.

Which is why they’ve tentatively moved more and more towards their traditional set of instruments which I think we’re seeing much more. The traditional set of instruments being more money creation, more local government financing vehicle and expenditure through those channels. Those are actually being kind of trotted out of the drawer, having not been so successful with the new style policies last year. And that also effectively said that this effort to rebalance, reduce financial vulnerabilities, has taken second seat or back seat to achieving the economic performance. The main goal of the—of the policy is to achieve appropriate degree of economic performance to stabilize the overall economy.

So, you know, then you layer on top of that trade. So although I agree with you that the whole point about the tariffs, we have been left with a much higher level of tariff incidence, there’s a lot to be said for there’s also been a lot of adjustment to that tariffs incidence. And if we look at Chinese trade data, it is true that U.S.-China bilateral trade has fallen dramatically. But Chinese exports, not so much. So in terms of responding to the relative price shock that’s associated with putting on a tariff, you’ve—there’s—you know, they’ve effectively redirected their exports to other locations. And so same thing with imports. So there’s been adjustments. There’s been adjustments.

And so where does that put China? It puts it in a—I wouldn’t—I mean, fragile, is—that’s a—that’s a tough word for an economy that is so large and so—I mean, it’s still—effectively, it’s a large closed economy. More open than the U.S., but it’s a large, closed economy. And that means an awful lot of what happens in the economy is not affected by—is affected domestic policies as opposed to external ones. The SARS, that is a—I think that is—of the three set of things that you were listing there, some political some external, the SARS one is probably the most challenging one.

ALEXANDER: I agree with a lot of what’s been said, so let me just say a couple things. First of all, I have long felt that—and I should be clear. It’s never been my primary responsibility to cover China, so I do this as an interested amateur. But it’s always seemed to me the fundamental problem is, as China advances the problems they’re going to face are simply going to become more complex. That’s just the nature of the beast. And the fundamental thing you look for in governance in some ways is feedback. Problems arise, how do you respond to them? I think you have to look at the record of China over the last thirty years. It’s remarkable what they’ve been able to do. And in some sense, I’m—we are yet again at a point where you wonder whether or not the complexity of the challenges that China faces are somehow going to overwhelm what has been up until now a remarkably successful policymaking process.

I share your unease at some level, just because for all the reasons you suggest it’s getting more complicated. Look, my initial read on where things are going with the particular viral outbreak at the moment is it’s quite different from SARS. And it suggests to me that they’ve learned things that are successful. And I’m—you know, we don’t know, we’re going to learn a lot in the next couple weeks. But I’m—I think there’s a case to be made that they’re doing a better job and therefore will get a better outcome.

I look at another thing which nobody’s mentioned yet, which I will just mention in part because it’s kind of in the things I’ve experienced. So China has just agreed to open up its financial system in an environment when any of the conventional measures of vulnerability and systemic risk, you kind of do that calculus around the world and China sticks out like a sore thumb. Huge credit creation over the last several years. All those metrics are screaming red at you. And they’re beginning to engage on kind of a form of liberalization, that they just agreed to allow more openness in the financial sector. They’ve also done things like they’re starting to allow people to go bankrupt, or be more liberal about allowing that to happen, which we’d all agree we want market discipline. And, yeah, people need to be able to go bankrupt.

But there’s a long history of bad outcomes of financial systems that are sort of overburdened that start to liberalize. So, look, again, it’s not like there’s some obvious problem I can point to, but this general problem of the problems that China faces are just more and more and more complex. That’s the nature of where they are. And you know, part of the problem I think for all of us on the outside is it’s very hard to really understand how decisions are made. As an external observer, it’s like I don’t feel like I really understand the policymaking process. And that I think tends to reinforce this kind of tension we all have.

MALLABY: Yeah. Let’s go right here.

Q: I’m struck that—

MALLABY: Could you just—

Q: Mahesh Kotecha with the Council on Foreign Relations and SCIC.

I’m struck that the discussion on China that has been quite substantive right now hasn’t focused on the major thing in China that I see, which is a substantial slowdown in growth rates from near double—well, 8 percent or more—to half that, down the pike. Six percent, 5 percent, projections are even lower. It used to be said that if they had 8 percent or 6 percent, disaster was going to happen because they could not absorb the labor force coming in every year. Where has that gone? Have they suddenly become passive? Or are they repressive?

MANN: They’ve gotten older. Their demographics mean that they don’t have as much of an inflow to satisfy. Yeah, I mean—I mean, it was—there was a time when the—you know, moving from the farm into the cities required a growth rate that was commensurate with that movement. And we both young as well—both the age demographics as well as the geographic demographics, so to speak. But that’s changed. And our own folks, you know, calculate something like 6.1 percent growth is satisfactory in order to keep the labor force in equilibrium. So they’re not quite at that now, but they’re close.

MALLABY: OK. Yes, let’s go right in front.

Q: Thank you. Tara Hariharan, NWI.

I notice we don’t talk much about inflation anymore. It’s become kind of boring and somewhat range bound. But as it pertains to the advanced economies, and given how the Fed is still sort of waiting on inflation and, of course, the ECB is going to be doing its framework review, I just wanted to know if any of you had any maybe counter-consensus views on whether we’re going to see any kind of inflation pickup, whether it be from the wage side or—I know oil may be—may not be so much of a factor anymore, especially for the U.S. But any thoughts on this would be welcome.

NORDVIG: I can start briefly. So if you look at the inflation surprises, like the way people get inflation forecasts wrong on a global basis, there’s just incredible persistence in the too-optimistic forecast, being too high on inflation, right? So it’s very, very hard, I think, from a market perspective to say, OK, now we’re suddenly going to have some big surprise, everybody’s going to miss something, because it’s just been the other way for a long, long period of time.

So if there’s something that’s going to shock it, as far as I can see it is—it is the climate, again. Like, if we’re having a seismic shift on the political front where people really are willing to spend—and, obviously, if we really want to address the challenge, like, we are talking about trillions and trillions—that could be a fiscal boost of an extent that that could change it, especially because there could be supply-side effects that also go in the same direction, food prices and so forth. So I think for everybody who has bond exposure, right, if you think about, OK, what’s going to totally change my bond portfolio over the next ten years, it is that the inflation regime changed because of that.

I don’t really see any other major channel. So that’s what I have in the back of my head.

MANN: I have a narrower—more near-term focus and more micro, I guess, in that there are two elements of the inflation process. One is the passthrough from labor-market tightness to wages, and then the second part of the—and we are seeing some of that, right? There’s been a—sort of a re-steepening of the Phillips curve. It always was steep in Europe.

And then the second component, of course, is the passthrough of costs generally—not just wages, but other costs—into prices, you know, the firm’s pricing strategy. And Europe and the U.S. are different in that regard in the sense that there is a view in the U.S. that technology is playing a more important role in dampening firm pricing power, even as concentration of firms would put you in the other direction. So there’s a tension in the U.S. between technology that dampens the transmission of costs to headline prices, or firm-level prices, at the same time concentration of firms giving them more capacity to pass through prices.

Concentration also gives firms the ability to effectively do third-degree price discrimination. Think of, you know, a well-known hotel chain that has many, many different components to it, one at each price point. So it gets all—and you know, that’s third-degree price discrimination.

Now, in Europe, less of a technology focus, less of—a more fragmented marketplace, more capacity to pass through. And there is—if we do a decomposition of pricing power and firm margins, there’s more potential upside on the margin side to avoid margin compression in Europe.

And then of course, you were mentioning the advanced economies, but emerging markets are actually seeing quite a bit of a—of a hike in prices right now.

MALLABY: OK. Yeah, let’s go in the back. Yeah.

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

If we could just stop talking about China for one second, I would switch over to the U.K. What do you think should be the economic priorities of the British government this year? And on a related note, what do you think the prime minister is actually going to do? Thank you. (Laughter.)

MALLABY: I guess I could—

NORDVIG: You should take that.

MANN: Yeah.

MALLABY: As the resident Brit.

MANN: Yes. (Laughs.)

MALLABY: Look, I think that the government of Boris Johnson is deliberately engaging in a sort of distraction tactic where there’s an awful lot of noise about rebalancing domestic policy, shifting institutions based in London to the north, building infrastructure in the north, addressing the concerns of the north. All of that is pretty consensus. I think, you know, just about everybody in Britain would acknowledge that growth and prosperity being too southern-concentrated, and so there’s this whole popular agenda which fits with Johnson’s electoral mandate, because he won big time in the election by capturing traditionally Labour Party seats in the north for the Conservatives. He wants to keep those, so he wants to be seen to be delivering.

The problem is that the reality of Brexit won’t go away. You know, Britain will leave the EU at the end of this month, but then there is the negotiation about the future relationship with the EU. And they’re kind of hiding from that, putting it off, sending signals that are totally unrealistic. So last week the finance minister, or the chancellor of the exchequer as we call him, said that there would be regulatory divergence from the rest of the EU and British companies needed to get used to that prospect and adjust. But of course, there was immediately an enormous pushback from the auto industry, which will suffer deeply if that goes through, and other manufacturing groups which are linked into the supply chains of the EU, and so to diverge in regulatory terms is extremely costly.

So as somebody said earlier, we’re not sure how much of this British position is bluff. I’m fairly sure that the European side won’t give an inch. Why should they? The cost to them of a messy Brexit at the end of the transition period is way lower than the cost to Britain and they held firm during phase one of this negotiation. I don’t see why they should stop holding firm in phase two.

So I think Europe’s position will be if you want to trade fairly freely with the European Union, you need to accept that your regulations in Britain will be aligned with ours. We don’t want any dumping. We don’t want you to have a different climate policy and then have a cheaper cost of production so that you can send us stuff that’s being produced cheaply. Social dumping, all these kinds of dumping, they’re very concerned to shut that off. So the Europeans are going to have a tough line.

And Britain will have to choose in the end if it wants to have regulatory alignment and relatively good trade access or regulatory freedom but then quite bad trade access. They’re sending the signal they’re going to go for the second option, where they have—Britain has its ability to make its own rules but loses trade access. That’s where they seem to be going. It won’t be good for the economy, but politically that might be the choice they make.

Another question?

If there’s no question, I’m going to actually ask a question to Jens which picks up on the last one, which is a currency market question. He loves currency questions. And it’s—it relates to Britain. So in the period of Theresa May’s premiership, where, you know, Brexit had been voted for, the referendum had happened, the currency had adjusted—you know, sterling had fallen in response to that—sterling was basically at 1.30 to the dollar for most of the time. Today it’s again at 1.30 to the dollar, and yet the type of Brexit that Britain is heading for is way more disruptive economically than it was in Theresa May’s premiership. Back then there was an expectation that Britain would be in the customs union of Europe, and now there’s an expectation that it won’t be.

So I would have thought that if 1.30 was the right level under Theresa May, 1.30 is rather strong under a harder-Brexit Boris Johnson. Can you explain this consistency around 1.30?

NORDVIG: So the first thing I would say is that normally I would never look at cable. I would always look at euro sterling because there’s euro dollar embedded in it. But since euro dollar is always around 1.11, it doesn’t matter these days. (Laughs.) So—

MALLABY: Exactly. You’re right. I noted that. You get the same question. You can phrase it as: Why is sterling consistent against the euro?

NORDVIG: So in this occasion we can use both.

MALLABY: Yeah.

NORDVIG: I think the market typically has a very hard time worrying more than three to six months ahead. So if there’s some risk that we have a real hard Brexit at the end of 2020, it’s just—it’s just too early—to really embed those risk premia. So there is not of risk premia in there now. Like, if we look at the range in euro sterling, we’ve defined essentially 0.83 to 0.93 is the range we’ve had now over the last six months, and we’re pretty close to the strong end of that range. And I do think if we knew that there was no bluff involved—that’s why I emphasized that earlier—if there was no bluff involved and we knew that this hard-Brexit rhetoric is for real, then we would be literally at the top of that range. So—maybe not quite 10 percent, but something in the region of that. But I think when we get to the summer period, right, where we will know whether an extension is feasible or whether there’s no bluffing, then that risk premium’s going to come into play. And I think then if euro dollar is stable around 1.11 then we can get to the low 20s, potentially.

MALLABY: Yeah.

NORDVIG: So that’s the key thing. I think it’s pretty hard to read these politicians, to be honest. So for me to tell, OK, are they bluffing, like, isn’t—if you could say then a further extension is impossible, the market would trade totally different now. But people think Boris is just essentially bluffing.

MALLABY: Another question? Yeah, over here.

Q: Hi there. Jove Oliver, Oliver Global. Thank you for the great panel.

Really quickly just about South America, looking at Venezuela, the chance that it might become a completely failed state this year, other problems in the—(laughs)—or is already a completely failed—just prospects for that region this year. Thank you.

ALEXANDER: So let me—let me say a few things. Look, the situation in Venezuela is—I would argue it is a failed state, and I’m not terribly optimistic about things there.

What’s more interesting to me in some ways is the protests that have sort of broken out across the Southern Cone. In many respects the most extraordinary thing is what happened in Chile, which was arguably, you know, for two decades the most successful state in the region, or three decades. And it does speak to the fact that, you know, the sort of wave—the concerns about populism, income distribution, all those things even in an—even in an economy that has been very successful, are—have a—have a real resonance there.

Look, I think the circumstances for the region of a world where the rest of the global economy is doing OK are not bad. Obviously, they tend to do—you know, the region as a whole tends to move up and down with the global economy pretty well, so the fact that growth this year is going to be a little better than last year I think is good for them.

But the crucial question is how are they really going to handle those challenges. You know, Argentina is, obviously, in another point in its cycle where I—I can’t believe this; I did my dissertation on the Latin debt crisis in the 1980s—this is the third cycle of sovereign default in Argentina that I will have experienced in my professional career. I didn’t expect it to be quite that many. But that’s its own sort of story.

Brazil, obviously, is dealing with sort of a fundamental political transition that has been to some degree successful in achieving things, but it has further to go.

But I think what happens in Chile really matters because it has always been kind of the thing that’s held out there. And whither or not they’re going to be able to come up with a constitutional reform that sort of addresses those concerns in a positive way I’m cautiously optimistic, because it’s got one of the strongest political cultures, I would argue, and if anybody can match those challenges they can.

I haven’t mentioned Mexico, which is another—is another sort of interesting case. I would argue the positive story for AMLO has come off a bit and the challenges are coming through. And so it’s going to be a kind of interesting time, and as is always the case in Latin America there are kind of different versions—different versions of the story.

Venezuela is a true tragedy. And one can—one can hope that we can get something there that would change that, but I’m actually not that optimistic.

MALLABY: I think I’m right that in the IMF forecast released yesterday there were four countries where growth was expected to accelerate by a percentage point or more, which were the BRIM not the BRIC.

MANN: Brazil.

MALLABY: Brazil, Russia, India, and Mexico.

MANN: Mmm hmm, not Mexico.

MALLABY: Not?

MANN: We would—I mean, in terms of the—in terms of the—you know, going down the countries—and I’m not going to comment at all on Venezuela—but we actually—I think there are two things that you need to be thinking about. The near-term recovery of a number of countries in Latin America—Brazil, Chile, Colombia being in that category—there is going to be a significant recovery, not so much in Mexico. But the long—but it’s a recovery to a rate of growth that is really unsatisfactory from the standpoint of delivering on increasing living standards broadly for people within the countries. And so that’s where the political protests, which have—or the protests, the social protests, which have sort of died down now because of some, you know, stopgap measures and so forth, have the potential to reemerge. Because if you have a recovery and you’re still in bad shape at an individual level that’s not much of a recovery, and that doesn’t create a political or an economic climate that is sustainable and improving in the longer term.

MALLABY: OK. Well, I want to say thank you to all of you for coming. You can head out and you won’t need any crampons on your shoes. (Laughter.) Thank you to Lewis Alexander, Catherine Mann, and Jens Nordvig.

NORDVIG: Thank you. (Applause.)

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