Meeting

C. Peter McColough Series on International Economics With Christine Lagarde

Monday, April 17, 2023
Speaker

President, European Central Bank

Presider

President, Council on Foreign Relations

President Christine Lagarde of the European Central Bank discusses inflation, interest rates, and the challenges facing Europe’s economic recovery.

The C. Peter McColough Series on International Economics brings the world’s foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

 

HAASS: Well, good morning, for those of you who are in this time zone. Welcome to today’s Council on Foreign Relations Meeting with Christine Lagarde. I’m Richard Haass, president of the Council, and I have the good fortune to be presiding here today.

This meeting is part of the C. Peter McColough Series on International Economics. Today the meeting will be here in New York City, but will also be everywhere thanks to the wonders of digital technology. It will also be on the record.

Madam Lagarde is her fourth year, if my math is right, as president of the ECB, the European Central Bank. She previously headed the International Monetary Fund. And she headed several ministries in the French government, including that of finance. Is that mostly accurate? Excellent. Mostly accurate is our goal here. Here’s the scenario. I’m going to step off the stage. Madam Lagarde will give some remarks. She has a prepared statement, which I urge you to listen to closely. Having just read it, it is a truly interesting statement, entitled Central Banks in a Fragmenting World. She and I will then have a follow-up conversation, and then we will open it up to questions from both you in the room and those in the digital space.

Christine.

LAGARDE: Thank you, Richard. So, good morning to all of you. Good afternoon to those online. And let me tell you that it’s really nice to see some good old friends, and I’m sure some new friends as well. But, Richard, thank you very, very much for the invitation to speak at the Council on Foreign Relations.

And I think it’s really nice to be together to compare notes and to share views that we have about current developments around the world, challenges. And I hope some of my old friends will forgive me if I look at things from a central bank president angle, which is something that I have to do in my current position. And if I do step out a little bit away from the pure monetary policy angle, please forgive me and assume that it’s off the record. Which I know it’s not. (Laughter.)

So I decided to accept the idea—and I do that reluctantly because I don’t think that it’s necessarily a pretty picture—but to accept the idea that we are moving towards a fragmented, or a more fragmented, world than we’ve had it. And that we are not necessarily in a completely bipolar situation, but that we might move in that direction. And as a result of that, as central bankers we have to look at what the options are, what the risks are, what the scenarios could be.

So we have seen the global economy go through major transitions, and through a transformative movement, which I will summarize in steps. So we had the pandemic. We had the totally justified, unjustifiable, and horrifying war of Russia against Ukraine. We had the weaponization of energy. We had the sudden acceleration of inflation. And we had this growing rivalry between China and the United States. And as a result of that, the tectonic plates are shifting, and they’re shifting faster than we have seen.

We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values. And this fragmentation, as I have mentioned, may well coalesce around two blocs, led respectively by the United States of America and by China, the two largest economies in the world at the moment. And all this will have far-reaching implications across many domains of policymaking. But today in my remarks, I would like to explore what the implications might be for central banks.

In short—and I’m deliberately focusing on those two dimensions because there might be many others, and I’m sure that academics and scholars will explore many others. But from our perspectives, we could see two profound effects on the policy environment for central banks. First, we may see much more instability as global supply elasticity wanes. And, second, we could see more multipolarity as geopolitical tensions continue to mount.

So let’s backtrack a little bit. And let’s remember the decades after the Cold War. The world benefitted from a remarkably favorable geopolitical environment. Under the hegemonic leadership of the United States, rule-based international institutions flourished, and global trade expanded. And this led to a deepening of global chain. And as China joined the world economy, soon the WTO, a massive increase in the global labor supply took place. And as a result global supply became more elastic to changes in domestic demand, leading to a long period of relatively low and stable inflation.

And that, in turn, underpinned a policy framework in which independent central banks—not in all countries of the world, granted, but in our corners—could focus on stabilizing inflation by steering demand without having to pay too much attention to supply side disruptions. But that period of relative stability may now be giving way to one of lasting instability, resulting in lower growth, higher costs, and more uncertain trade partnerships. Instead of more elastic global supply, we could face the risk of repeated supply shocks.

Recent events have laid bare the extent to which critical supplies depend on stable global conditions. And that has been most visible in the European energy crisis that we have just gone through. But this is not it. It extends to other supplies. Today the United States is completely dependent on imports from other countries in the world for at least fourteen critical minerals. And Europe depends on China for 98 percent of its rare earth supply. Supply disruptions on those fronts could affect critical sectors of the economy, such as the automobile industry, especially as it transitions toward electric vehicle transition.

In response, governments are legislating to increase supply security, notably through the Inflation Reduction Act in the United States, and the strategic autonomy agenda in Europe. But that could, in turn, accelerate fragmentation, as firms also adjust by anticipation. Indeed, in the wake of the Russian invasion of Ukraine, the share of global firms planning to regionalize their supply chain almost doubled to around 45 percent, compared with a year earlier. And while we could assume that it was a mere intention, we’re now seeing implementation of those determination.

This new global map, as I have called it in another speech elsewhere, is likely to have first-order implications for central banks. One recent study, based on data since 1900, finds that geopolitical risks led invariable to high inflation, lower economic activity, and a fall in international trade. And ECB analysis suggests similar outcomes may be expected for the future. If global value chains fragment along geopolitical lines, the increase in the global level of consumer prices could range between around 5 percent in the short run and roughly 1 percent in the long run. I’m talking about consumer prices here.

Now, these changes could also suggest that a second shift in the central bank landscape is also taking place. We may see the world becoming more multipolar. During the pax Americana after 1945, the U.S. dollar became firmly ensconced as the global reserve and transaction currency. There is a very interesting piece, by the way, in The New York Times of today, which has the perfect graph describing how sterling came down from, I think it was, 80 percent as a reserve currency in 1945 down to 20 percent in 1970-ish.

So the U.S. dollar became really the international—the global reserve and the transaction currency. More recently, the euro, which is only a young currency, has risen to the second place, to the point where today the U.S. dollar is about 60 percent of international reserve, the Europe is 20 percent, and the other 20 percent is shared between renminbi, yen, sterling, Australian dollars, Canadian dollars, and a few other currencies as well. Not all necessarily in the SDR basket, but quite spread out.

This had a range of mostly beneficial implications for central banks that access that level of international reserve. For example, the ability of central banks to act as—and I will quote Keynes here—the director of the international orchestra. It has also enabled firms to invoice in their domestic currencies, which made import prices more stable and predictable. That’s for currencies.

But in parallel, payment infrastructures—and that’s a topic, I’d tell you. (Laughter.) But it’s highly technical. It can come across as not so glamorous. But it’s pretty important. So Western payment infrastructure assumed an

increasingly global role. For instance, in the decade after the Berlin Wall fell, the number of countries using the payment messaging network called SWIFT more than doubled. And by 2020, over 90 percent of cross-border transmissions were being signaled through SWIFT.

But new trade patterns may have ramifications for payments and international currency reserves. In recent decades, China has already increased over 130-fold its bilateral trade in goods with emerging markets and developing economies, with the country also becoming the world’s top exporter. And recent research indicates that there is a significant correlation between a country’s trade with China and its holding in renminbi as reserves. New trade patterns may also lead to new alliances. One study finds that alliances can increase the share of a currency in the partner’s reserve holdings by roughly 30 percentage points.

Now, all this could create opportunities for certain countries seeking to reduce their dependency on our Western payment system and currency frameworks. Be that for reasons of political preferences, financial dependency, or because of the sanctions that have been imposed for a decade now. Anecdotal evidence, including official statements, suggests that some countries intend to increase their use of alternative currencies for invoicing international trade, such as the Chinese renminbi or the Indian rupee. We are also seeing increased accumulation of gold as an alternative reserve asset, possibly driven by countries much closer geopolitically to China and to India.

There are also attempts to actually override or set up an alternative system to SWIFT. Since 2014, Russia has developed such a system for domestic and cross-border use with over fifty banks across a dozen countries, using it last year. The accurate data in those matters are a bit difficult to assess, as you can imagine. But based on what we see, it’s probably still the case that those banks in those twelve countries are using this alternative system. And since 2015, China has established its own system to clear all payments in renminbi.

Now, these developments—and here I would agree with Krugman, in the Times this morning—these developments do not point to an imminent loss of dominance for the U.S. dollar or for the euro. The latter being far more dominant—sorry—the former being far more dominant than the latter. So, so far the data do not show substantial changes in the use of international currencies. But they do suggest that international currency status should no longer be taken for granted, and that we should be really attentive to the currency in which trade transactions are organized. And that is, in my view, particularly the case for oil.

So how should we, central banks, should we respond—how should we respond to these twin challenges that I have tried to explain? First of all, and I will totally second the comment that was made by Treasurer Yellen over the last week at the IMF, we have to show a bit of humility. But at least we know probably what not to do if we don’t necessarily know absolutely what to do. But what not to do I think we know, when we are faced with sudden volatility, because we’ve seen it before.

In the ’70s, central banks faced upheaval in the geopolitical environment as OPEC became more assertive and energy prices that had been stable for decades ballooned. Central banks at the time failed to provide an anchor of monetary stability, and inflation expectations de-anchored. A mistake that should not be repeated for as long as central banks are independent and have clear price stability mandates. So if faced with persistent supply shocks, which is likely, independent central banks can, should, and will press on to ensure price stability.

But—and that’s where monetary and fiscal and structural come together—this can be achieved at a lower cost of other policies are cooperative and help restructure and replenish supply capacity. For example, if fiscal and structural policies focus on removing supply constraints created by the new geopolitics, such as securing resilient supply chains or diversifying energy production, or saving on energy, we could then see a virtuous circle of lower volatility, lower inflation, higher investment, and higher growth. That’s the virtuous circle.

But if fiscal policy instead focuses mainly on supporting incomes to offset price pressures, that will tend to raise inflation, increase borrowing costs, and lower investment in new supply. The choice is clear. In this sense, insofar as geopolitics lead to a fragmentation of the global economy into competing blocs, this calls for greater

policy cohesion. Not compromising independence, but recognizing the interdependence between policies and how each can best achieve their objective if aligned with a strategic goal.

We certainly could see the benefit of that in Europe, especially where the multiplier effect of common action in areas such as industrial policy, defense, investing in green and digital technologies, is much higher than if member states are acting alone. There is another benefit, that of achieving the right policy framework, will not only determine how our economies fare at home, but also how they’re viewed globally in the context of greater system competition. And while the international institutions established in the wake of Bretton Woods remain instrumental for fostering a rules-based international order, the prospect of multipolarity raises the stakes for such internal policy cohesion. Charity begins at home.

For a start, an economic policy mix that produces less volatile growth and inflation will be key in continuing to attract international investment. And although 50 to 60 percent of foreign-held U.S. short-term assets are in the hands of governments with strong ties to the United States—those that I think Janet Yellen calls the “friends,” meaning that they’re unlikely to be divested for geopolitical reasons—the single most important factor influencing international currency usage remains the strength of fundamentals. And by that, we know that it is the rule of law, strong respected institution, as well as open capital markets.

By the same token, for Europe long-delayed projects such as deepening and integrating our capital markets can no longer be viewed solely through the lens of domestic financial policy. To put it bluntly, we need to complete the European capital markets union. This will be pivotal in determining whether the euro remains among the leading global currencies or others, those exotic ones that I mentioned earlier on, take its place. Central banks have an important role to play here, even as simple protagonists in that situation.

For example, the manner in which swap lines are used could influence the dynamics of major international currencies. Both the Fed and the ECB, within their respective mandates, have been proactive in providing offshore liquidity when recent crises have hit, including most recently, actually. But we’re not the only one. Others are moving too, which is consistent with their aspiration to become those rising international currencies of reserve status.

We have already seen the People’s Bank of China set up over thirty bilateral swap lines with other central banks to compensate for the lack of liquid financial markets in renminbi. This is hardly surprising. How central banks navigate the digital era, such as innovating their payment systems, which I touched upon earlier, and issuing digital currencies will also be critical for which currencies intimately rise and fall. And this is an important reason why we at the ECB are exploring in depth how a digital euro could best work if launched while—and I know this is a debate in this country—respecting the privacy of European citizens, and any of those using the digital euro.

So, concluding my remarks and offering myself to the scrutiny and the questioning of my friend, Dr. Haass, we need to be ready for the new reality that may lie ahead. The time to think about how to respond to changing geopolitics is not when fragmentation is upon us, but before. And I would like to paraphrase someone whom I have read extensively, and who spent a good share of his time in Europe, Ernest Hemingway, talking about a bankruptcy situation in The Sun Also Rises. I will paraphrase. I’m not talking about bankruptcy here, don’t get me wrong. He said—I’ll say about fragmentation: Fragmentation can happen in two ways, gradually and then suddenly.

The central bank must provide stability in an age where it’s anything but stable. And I have no doubt that central banks will measure up to the challenge. Certainly at the European Central Bank, we will. Thank you. (Applause.)

HAASS: Merci.

LAGARDE: Oh, parles-tu francais? (Laughter.)

HAASS: It’s special and good to have someone who’s an international public servant but also an intellectual—public intellectual. It’s rare treat, so thank you.

But I can’t let you off that easily. First of all, I’m usually second to none in my pessimism, but you’re right up there. I just want to—I want to compliment you. So moving up, there’s geopolitical competition, industrial policy, fragmentation, supply chain disruption, accumulation of gold, and inflation and rates are much higher than they were, and probably staying pretty high. Down is economic growth and growth in trade. Is that fair? Does that about sum it up?

LAGARDE: (Laughs.) I think it’s a good summary of the key features, you’re right, Richard. But I don’t think that we should be necessarily pessimistic as a result of that. I think we should be determined. I’ll tell you how—all of that is correct. But I can’t help looking back. You know, immediately after the infamous invasion of Russia, not the 2014 into Crimea but the latest one in the eastern part of Ukraine.

At the time, the odds were that Europe was going to decline, growth will fall through the cracks, energy crisis would be such that we would be rationing the use of gas, petrol, oil, whatever you call it, and that we would have social unrest. That was roughly the picture that was painted at the time. And, you know, much to the surprise of many projectionists, of sorts, Europe last year, 2022, delivered 3.5 percent growth. Which, if you look at it, is more than China, more than the United States. And that’s just little Europe. So that’s number one. I mean, we all need to have reasons for hope, right, because it’s easy to be totally in this sort of doomsday loop. So, number one.

Number two, I think it was the European Commission who said, you know, we all have to save on energy. And please try to save 15 percent, because it’s going to be tough. Well, guess what? The Europeans delivered 20 percent savings. Germany was highly dependent on Russia for its gas supply, and it was notorious that the building of LNG facilities, particularly the floating LNG facilities, would take at least eighteen months. Well, guess what? They managed to build three floating LNG facilities in less than six months. And this is operating. And they are now not any more dependent on Russian gas.

Now, this is not the case for all countries, because you still have some much, much smaller countries in Europe that are still receiving—Hungary is a point in case—that are still receiving some Russian gas. But this is, you know, an indication that when we want to do things to, you know, fight for the right cause, we can actually do it. So I draw some comfort from that ability to develop resilience and to do it together. In the same vein after, you know, COVID hit all of us, the Europeans who had never, ever thought about that decided to borrow jointly, to go in the market together, to allocate part of that borrowing in a very asymmetric way. Because the Italians got more, the Greeks got more, the Spaniards got more, because they were hit worse. And to reimburse on the basis of, you know, per capita and per GDP-weighted measures. So I’m not—I’m not—OK, right, prompted. (Laughter.)

HAASS: To be concerned is not to be paralyzed. But you’re great. And so over the last—

LAGARDE: Oh, no, one more thing, because you mentioned inflation is up, interest rates are up. Yeah, of course. And sometimes, you know, when I hear that, I say don’t think that to fight inflation we have to raise interest rates? And the answer, of course, is yes. And it is beginning to work. We are seeing—you know, last October, the reading on inflation was 10.3 percent. Our projection for ’23 is 5.3 percent. So ware dividing by two. I’m not saying that it’s all on monetary policy. Don’t get me wrong. The fact that oil prices have gone down significantly, that there are base effects and all that, and that the bottlenecks are gradually fading out is also playing a role. But yes, one comes with the other.

HAASS: Speaking about rates, is there any reason to tie ourselves in knots to reach the 2 percent level? Are you one of those central bankers who believes that anything about 2 percent automatically institutionalizes inflation and builds expectations? Or do you think that’s an arbitrary rate for which we have to thank New Zealand for, and we can safely ignore it?

LAGARDE: (Laughs.) I think for the moment, given the strategic objective that we have, given the fight that we take, there is absolutely no reason to change that 2 percent medium-term objective. So it will be that 2 percent medium-term objective. Once we get there, once we are confident that it stays there, we can discuss that again. I’ll come back, I promise, and I’ll answer your question.

HAASS: OK. I look forward to it. You’re always welcome. I may not be here to issue the invitation, but you’re still welcome.

LAGARDE: You can come!

HAASS: Of course, I’ll have to. So let’s talk about banking for a second. Given where you sit, is it your sense that we have a banking crisis right now? Or simply that we have a crisis that is affecting several banks?

LAGARDE: You know, I come from Normandy. And in Normandy, you say p’têt ben qu’oui, p’têt ben qu’non. For those who speak French around here, you will understand that there is a little bit of yes, a little bit of yes on both sides. So if I look at what happened in the three weekends prior to Easter/Passover weekend, we had Silicon Valley Bank and Signature Bank, followed by Credit Suisse, followed by some trepidation around Deutsche Bank. And I would say, particularly on the first two episodes—Silicon, Signature, and then Credit Suisse—I would say that those three institutions had serious management issues, some of which was well known and had been for a long time.

That is the case with Credit Suisse, for sure. Others, clearly given the risk management that became apparent, the lack of hedging, the maturity transformation that was applied, and the concentration that aggregated cliental of those banks, plus in the case of Signature Bank the very strange—I have no reason yet to believe that it is the case, but I think the audit and the review will demonstrate it. But the alleged money laundering and hanky-panky business going on around the cryptos, that were cleared through a Bahamas bank using then Signature Bank.

So you have all that in a context—and that’s where I come to the second part of your question—in a context where the financial markets, which was used to very low interest rates, sometimes negative interest rates in the case of Europe, suddenly saw a major transformation of the environment in which they were operating, because interest rates increased at a speed that we have not seen in decades. And that was not anticipated. So to take the example of the ECB, we went from minus 0.5, so minus-fifty basis points, to 300 basis points, for the key policy rate. So 350 basis points in a matter of nine months. It’s unprecedented. And the Fed moved by higher amounts, having started a little bit earlier than us and facing a slightly different situation.

So the environment in which they’re operating, the business models that they have developed over the years was suddenly transformed under their eyes. And those who had not anticipated it, or who have not anticipated it, clearly are facing and have faced issues. I think that lesson learned just in the way in which the Liz Truss budge development taught all of us a lesson about, you know, how you can’t just mess around with fiscal policies unless it’s properly funded. I think that banks are observing and regulators and supervisors are also observing very carefully the lessons learned from these—from these situations.

HAASS: You talked in your opening comments about the fact that the world has made some move, I wouldn’t exaggerate it, in the direction of currency multilateralism—dollar, euro, others. We face a rather significant decision in the next few months, probably this summer, which is the question of raising the debt limit. Say something about how that will be looked at, and what you see the implications of that for the future of currency multilateralism.

LAGARDE: Well, I was on Face the Nation yesterday, and I was pretty explicit in saying that I had confidence in this country not to go to that extreme. And I was hoping that politicians of all ranks, files, sides of the aisles would come to their sense and put the nation first, and not their political preference or the bickering that often is associated with difficult debates, because no one in this room or beyond can imagine the United States

defaulting on its debt. This is beyond imagination. And that would be the natural consequences of, you know, not making the right decision come June. And it would not be—you know, deflagration in this country, it would send shockwaves around the world.

HAASS: And more specifically—

LAGARDE: You know, I remember 2011, because I came to that—I came to Washington in 2011 when I was appointed head of the IMF. And there was the same debate. And I’ll never forget, I don’t know if it was Margaret Brennan or somebody else, who turned to me and said: Well, is the United States going to knock on the door of the IMF? (Laughter.) It was like, what? I hadn’t been told that it would be a walk in the park, but the United States knocking on the door of the IMF? And I said, no, this is not possible. Not possible.

HAASS: So, you know, you’ve run the IMF. You’ve now spent the last couple of decades dealing in this world of international financial institutions. Quite a few of them are older than either of us. They’re getting long in the tooth. What is your sense? Is it simply adapting existing institutions? Or, given the change in the politics that you talked about, given the change in technologies, given what lessons we’ve learned, do we need essentially Bretton Woods, or something like it, 2.0? What is your sense of what we need in order to help us navigate the world that you describe?

LAGARDE: I will address your question from two angles, Richard. I think that there is one revolution which I have not touched on which will transform the ways in which all of us conduct business, the way in which institutions operate, the way in which we inform our decisions, and maybe the way decisions are made. And that is the role of artificial intelligence. I think that’s—you know, we have considered that technology would be a tool, would be the backbone of things that we, human beings, up on the top. I think we should just be very, very attentive to what is happening and what generative artificial intelligence is going to help produce as additional layers are added to this.

And I’m not saying that specifically in relation to the Bretton Woods institutions, but I think that, you know, the more global the role, the broader the volume of data and the information and the difficulty of decision-making is—are, the more artificial intelligence should be leveraged, used, controlled, and put to the service of those who are giving mandate to the institutions. So that’s one thing.

You know, I’ve been head of the IMF for eight years. And for many years, I have worked hard as the head of the IMF to reform the quotas. There’s been a perennial discussion, and it always was in debate, before me and after me. And it’s a terribly complicated topic, because you have—it’s like having a big cake. And some members—the United States, the European countries, Japan to a certain extent—have a share of the cake. And then all the others have much, much, much, much smaller shares. And you can increase the size of the cake, but the size of the share as a proportion of the overall cake are jealously, scrupulously scrutinized as an indication of authority, power, role in this world.

And I don’t know how we sort out this issue, but it cannot be so that some of the largest emerging economies, including China, remain with that relatively small share of the cake considering their size, considering their development. And if we want to avoid that new institutions be strengthened, set up, and in a rival situation to existing institutions, we need to break that knot. Because otherwise, we shouldn’t be surprised to see, you know, the Asian Infrastructure Bank, other institutions being set up in the future. And we shouldn’t be surprised to see that some of those debts that need restructuring, particularly in some of the most fragile and lowest-income countries, are in debate, because one of the players, who is becoming a big lender, doesn’t want to participate because he or Xi—

HAASS: Very good. Not easy to pun in a second language. (Laughs.)

LAGARDE: Doesn’t seem a part of the club. (Laughter.)

HAASS: Last question from me, then we’ll open it up. Talking about the club of central bankers. Say something about the interaction between and among you. And in particular you’re not all equal. The American central bank, the Fed, obviously has a bit more clout. But also what it does has tremendous implications not just for the United States, but for the rest of the world. And without putting you in an overly awkward position, there are lots of criticisms about how the Fed managed inflation, whether it was slow to take the punch bowl away. And say something about the formal and informal interaction among you and your colleagues in the United States, and Japan, and so forth. Is it adequate? Is the problem where it’s inadequate the machinery, or is it simply it’s not an institutional question, it’s simply a communication and personality question?

LAGARDE: You know, I will not go into the debate of—

HAASS: I knew you wouldn’t, but I thought I’d try. (Laughter.)

LAGARDE: But, no, I’m happy to address the issue of our communication. Because we are interdependent. What happens in the United States matters for the rest of the world. I happen to think that what happens in Europe can also address the rest of the world. And we saw very clearly a few years back that what happens in China can also have an impact on the rest of the world. And we are—we remain to see what the Bank of Japan is going to do with its yield curve control, and what the consequences will be going forward. So I think that we are—I don’t think anybody would dispute that we are interdependent and that what we do affects markets in general, with a prevailing role by the Fed. It’s obvious, given the depth of the markets, given the role of the dollar, both as a reserve currency and others.

And we do communicate a lot. It might not seem institutionalized enough to some who like to write about that and produce reports. We see each other very much at meetings of the BIS, the Bank of International Settlements, which operates like the sort of central bank of central banks. And we see each other. And we saw each other on WebEx. And we have a mix of physical and WebEx meetings to continue to be in touch on the same focus of research. And when there is a crisis, you know, there’s nothing like picking up the phone and talking to each other, and assessing what tools we can use, at which pace, and when we do or we do not communicate about it. But there is intense communication between us. And that’s certainly the case for the Fed and the ECB.

HAASS: Why don’t we open it up? More hands than there are minutes left in the meeting. We’ll start with my old friend Bob Hormats. But if people could wait for the microphone, and introduce themselves, keep it short. And then we’ll do our best to squeeze as many in, physically and virtually.

Q: Bob Hormats, former government official and former close working partner with Christine for many, many years. So want to thank you for coming and sharing your thoughts.

And I would like to get your thought in particular. You used the pun “he and Xi.” In this case, it’s one person. And the idea of what China faces as its biggest challenges over the next couple of years. One of the—we tend to look to China from an international point of view and its policies vis-à-vis the U.S. and the world. Whereas China is looking very deeply at its own challenges, its own internal challenges. Can you share your thoughts on what they are and what challenges it needs to deal with at home over the next, say, two to five years?

LAGARDE: Shall I answer right away?

HAASS: Sure.

LAGARDE: Bob, thank you so much. And it’s lovely to see you.

I would say one word: Demographics. I think that’s the big issue. And it’s one that President Xi has recognized for a long time. And I’m not sure that anybody knows how to solve it.

HAASS: He can’t do much about it. Well, Bob, I want to squeeze in some others. But just—obviously—actually, one follow-up on China. Do you see China potentially playing a role with the current banking challenge? Could you see—you know, people are always saying, we got to bring China into things. Is that an area where China has a potentially important or constructive role to play?

LAGARDE: Well, as I said in the speech, they have multiple swap lines with a range of countries. And they can be of support for those countries. They can also, and hopefully will, play a significant role in debt restructuring for the low-income countries and the fragile countries. And that clearly would have an impact on private creditors as well. And they—yeah, they could play a key role.

HAASS: Let’s get a digital question, virtual question.

OPERATOR: We’ll take our next question from Andrew Gundlach.

Q: Greetings. Can you hear me?

HAASS: Yes, sir.

Q: Madam Lagarde, I share your view on fragmentation, and thank you for sharing it. Your vision of fragmentation for Europe, however. Is your banking system optimized for that world? You don’t have a global champion like JPMorgan or like BlackRock. You have some significant national champions. But do you see a need for greater European banking cross-border integration? And how will you achieve it? Thank you so much.

LAGARDE: Thank you, Andrew. The answer to your question is yes, by all means. And I think that the developments that we’ve seen lately—you know, the mad March developments in particular—will hopefully push policymakers in that—in that direction. Those who can make decisions here are the European Commission, the European Council, the European Parliament. All I can do is push, push, push, push. The other person who is also push, push, push, push is Paschal Donohoe, who is the president of a subset, which is the Eurogroup, which brings together twenty member states, including France, Germany, Spain, Italy, and many others. And we are strongly pushing in that direction because we need to have cross-border mergers taking place in order to have the scale and the size that would compare with some of those that you have just mentioned.

I think there are two projects that really warrant a big effort. And it’s difficult, because I’m not sure that voters—and we are heading towards 2024 where there will be a European election—I’m not sure that voters are going to be terribly excited if you tell them that we need banking union, we need capital market union. That’s a tough political message to have. But it’s critically important. And not just to compete, but to coexist and to be strong together.

HAASS: You don’t think that would get people out of the streets of Paris? (Laughter.) Yes, sir.

Q: I’m Mark Rosen. I’m the former—was also at the IMF, U.S. executive director, and served with you and with great pleasure. And great to see you again. Thanks for coming.

Christine, you mentioned offshoring, friend-shoring, and Janet Yellen’s concept, which is, I think, very interesting. Could you talk a little bit about your thoughts about friend-shoring? And particularly, what is the prospects, in your view, for deepening economic, financial relationships between Europe and the U.S.? is most of it done? Or are there still many areas that we could build on right now?

LAGARDE: Thank you, Mark. Good to see you too.

Friend-shoring, an interesting concept, as long as you know for sure who is a friend, who is a foe. And I have discussed that with Ngozi, the head of the WTO, who is obviously—who has a much larger view of trade 

movements and how much volume inflows, outflows there is at the moment as a result of the geopolitical changing landscape. And the point she makes, which I would endorse and I’ve thought about it, is that it’s not just the sort of natural friends, those who share values, who have had history together, who fought shoulder-to-shoulder which should be taken for granted. But we, together, do not necessarily have access to the right minerals, to the right rare earth, to some of the components that are going to be used more and more in this technologically shaken world.

So I think we need to go a little bit beyond the pure definition of “friends,” by reference to principles, values, shared history, and go beyond that and make sure that we institutionalize links—I was going to say dependency, but I don’t really mean dependency. But sufficient bounds so that we are in this together, everyone has skin in the games. And this is something that has been played out quite well by others. And I think that we should not drop that ball. We should also hold it together and play that game in order to have a combination of friend-shoring and localization of joint materials, resources, that we can search and secure together. I think that’s an area where the Europeans and the Americans can actually join forces and be strong allied, I would hope.

HAASS: OK. Do you think they can join forces in a way that is not inherently protectionist?

LAGARDE: Yes. Yes is the answer. Absolutely.

HAASS: Ms. Hariharan.

Q: Thank you. My name is Tara Hariharan. I work for a hedge fund in New York.

Madam Lagarde, a question—

LAGARDE: You’re a what in New York?

Q: A hedge fund.

LAGARDE: Oh, hedge fund, OK.

Q: And so you must prepare for a question—

HAASS: It’s the American dream now to work at a hedge fund.

Q: —on monetary policy, I’m afraid. A question about the banking system and European interest rates. Isn’t it the interesting case that European banks would actually benefit from higher interest rates, given that they’re coming in from a negative interest rate environment? So this would improve their net interest margins and their capitalization. And how would you balance that against the comments you, yourself, have made, Madam Lagarde, about tightening financial conditions and the prospect for monetary policy? Thank you.

LAGARDE: Thank you very much. Last time I heard about hedge funds was when I read Gary Gensler’s article in the FT, which I thought was interesting. I’m sure it did not escape you either. And I’m very much on his side on that one.

You know, I think the instant reflex and reaction is, yeah, of course. Interest rates hiked, better for the banks. That’s, I think, the instant reading. But then you think of it longer and harder, and you think about the other side of the balance sheet, and the impact that it could have on, you know, the solidity of certain loans, the credit conditions, the provisions that should be taken. And I think that we are still exploring, and the banks are also exploring, those aspects as well. So I’m not sure that it’s a net-net positive.

HAASS: Thank you. Another one from afar.

OPERATOR: We’ll take our next question from Samuel Visner.

Q: Thank you, Madam Lagarde. I’m Sam Visner. I’m a cybersecurity expert at The Aerospace Corporation.

I would be grateful for your view regarding the regulatory challenges and the challenges associated with maintaining a stable international financial system as we move in the direction of cryptocurrency. So far, it seems to me that stability has not been the first word that comes to mind. And in terms of managing a stable financial system, I would be grateful to hear what you think are the challenges associated with crypto. Thank you.

LAGARDE: With huge respect for the work that you do, because cybersecurity experts are rare commodities and high values. And I thank you for the work that you do to protect us all. My personal view, and that might not affect the views of the ECB but I don’t think we’re very far out on that, is that cryptos are not currencies. Crypto is often referred to as assets, or more liabilities than assets. And I have my doubt as to whether or not we should actually regulate them, which is something that we are considering both at the BIS, the Bank of International Settlement, at the Financial Stability Board, and in various circles, including at the European level.

I would not want that regulation, which unfortunately—and you would understand that, being in cybersecurity—is lagging behind. I mean, cryptos move at the pace, and try to sort of transform technologies at a pace where the legislature is necessarily going to lag behind. And I would not want us to give them, as a result of soon-to-be updated legislation, a standing and a credibility that they don’t deserve or warrant. I am not impressed by cryptos. As I said, I see them as liabilities more than assets. I respect that people want to produce speculative instruments. If they’re prepared to lose it all, that’s fine.

I’m very concerned that it’s seducing young people who don’t really understand what they’re getting into. And one of the reasons I have pushed out project of the digital euro has to do with the fact that our societies are becoming more and more digital. And we cannot just operate with central bank money that is comprised of banknotes, coins, for the central bank money. The rest is commercial bank money. And I’m convinced that we must be able to produce a digital central bank currency. And I’m using all the words—currency, central bank, digital. That’s what we should be able to produce, as well as having a payment infrastructure that is conducive to fast, cheaper, more efficient payments cross-border.

HAASS: Was what you said about digital currencies, about the lag between innovation and regulation, would you say the same thing would apply to AI? And as a result, we ought to be very skeptical at this point of regulating it, for purposes that fall under your responsibility?

LAGARDE: I think we should—you know, I’ll—I’m not expert in artificial intelligence. And I try to read and inform myself as much as I can, including from those people who, being experts themselves, are saying, whoa, watch out. Let’s just hold it, and make sure that we are not going too fast, and that we’re not transforming our societies in ways that we don’t intend to. But I’ll give you the example of our digital euro, which we have worked on for two years now.

We went out to the Europeans. And we asked them, across the twenty-seven member states, do you value a digital payments system? Do you value—we didn’t say central bank currency, because it doesn’t make sense for anyone, but it’s important to have an anchor. It doesn’t make sense to many people either. But would you like to be able to pay, just as you pay with banknotes, in a digital form? And the answer was invariably, “yes,” particularly in some countries. You know, the Netherlands is a case in point. But almost in the same breath they would say, yes, but I want my privacy to be respected.

To which I think we can give the right answer. It will not be anonymous, but it will be private enough so that your privacy rights are respected. And all the data collected as a result of this digital use will not be monetized, as is the case currently with the big tech of this world that do collect data on you, and how you use them, and then monetize it.

HAASS: We have hit that point which is the witching hour. I apologize. You generated more hands than there are minutes or time, for which the only remedy for that is for you to come back. (Laughter.) So we look forward to having you again. (Applause.)

(END)

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