Charting the Course of the Global Economy

Wednesday, September 16, 2015
Issei Kato/Reuters
Carmen M. Reinhart

Minos A. Zombanakis Professor of the International Financial System, Kennedy School of Government, Harvard University 

Global Chief Economist, Citigroup; Adjunct Senior Fellow, Council on Foreign Relations 

Joyce Chang

Global Head of Research, Corporate and Investment Bank, JPMorgan Chase & Co.


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations

Willem H. Buiter, global chief economist at Citigroup, Joyce Chang, global head of research at JPMorgan Chase & Co., and Carmen M. Reinhart, professor at the Kennedy School of Government at Harvard University, join CFR's Sebastian Mallaby to discuss the state of the global economy. The panelists discuss recent equity market volatility in China, the fiscal health of emerging economies across the world, and the possible impact of the U.S. Federal Reserve tightening monetary policy. Over the course of the conversation, the panelists consider the impact of an emerging market slowdown on the U.S. economy and the possibility of a new, prolonged economic crisis.

The World Economic Update highlights the quarter’s most important signals and emerging trends. Discussions cover changes in the global marketplace with special emphasis on current economic events and their implications for U.S. policy.

MALLABY: Well, welcome to today’s Council on Foreign Relations World Economic Update. I’m Sebastian Mallaby here from the Council.

With me to discuss the world economy we have, on my left immediately, Carmen Reinhart, professor of international financial system at the Kennedy School of Government in Harvard University. Next, Willem Buiter, who is the global chief economist at Citigroup and also an adjunct senior fellow here at CFR. And Joyce Chang, global head of research at JPMorgan Chase & Co.

So I’d like to welcome you, welcome the CFR members around the nation who are watching us on the livestream. And this meeting is sponsored by the Maurice R. Greenberg Center for Geoeconomic Studies.

So let’s get going. And the obvious place to start—and probably in some way to come full circle back to once we’re been around the world—is the U.S. and the Fed meeting just starting today. Maybe I’ll pick on Willem first, since he has been on the monetary policy committee of a central bank—the U.K. central bank—and ask: you know, there’s a sort of balance here between below-target inflation and employment that seems to be pretty much full. How would you balance those considerations?

BUITER: Well, I would also look at the third responsibility of the Fed, is financial stability, and that is naturally playing a role now.

I think the issue is actually quite straightforward, and it’s unfortunate that so much attention and effort gets devoted to guessing the next move of the Fed when it is really—from a fundamental economic perspective, it’s a matter of almost no significance. You know, they either move tomorrow 25 basis points and talk dovishly to keep the consensus, or they don’t move tomorrow, in which case they talk more hawkishly to keep the consensus. We all know that rates are going to go up only very slowly when they do, and not to a very high level, before they have to be cut again.

And so it really is only of interest to people who have—that have large positions riding on it, but it is really not a first-order economic event. And at the moment, I think, since the world is such an ugly place, especially if you look at China and emerging markets generally, I would keep my powder dry and not do anything. But that is really a de minimis position.

MALLABY: OK. Well, we’ll get to China in a second. But Carmen, would you agree that financial market considerations play in? How concerned would you be about—I mean, complacency seems to have been somewhat disrupted in the last couple of months.

REINHART: I think when the Fed first started talking about the normalization process about—more than two years ago, domestic considerations were the sole factor. I think, given as—and I agree very much with what Willem said—given that domestic considerations are not really one-sided, are quite, quite tame relative to the international, I think that will weigh in.

Having said that, let me add another factor: I think the Fed has just been nervous at the zero bound. So even 25 basis points above zero is, at this stage, I think seen as a step in the right direction.

My own view is that the critical factor, which Willem mentioned, is gradualism—that, if it does it this week or if it does it at the end of the year, that it is seen as not really the beginning of a series of sequential steps but just really as, in essence, moving off the zero—the zero bound.

MALLABY: But does 25 basis points off the zero bound make any difference at all? I mean, it’s meaningful if it’s part of a series, but one hike by itself—

REINHART: I think—I think operationally there is, you know, some elements of more standard policy when you’re not in zero—and certainly when you’re not in negative territory, as some of the European central banks have been courting.

MALLABY: Mmm hmm.

Well, as I think both of you are saying, a big factor in this calculation is how worried to be about the global picture, and that starts with China. So I want to come to Joyce. And particularly, there’s lots of pieces of the China puzzle which we can get into, but the thing that makes people worry that it could be acute and not sort of something chronic is this capital outflow story. When you see this country, which has had enormous, you know, accumulation of reserves suddenly losing them, and then people talking about reserves being already illiquid and pre-committed, it’s a huge turnaround in a short space of time. So how do you read those capital kind of flows in China?

CHANG: We think that capital outflows in China in the month of August actually hit a record level, around 130 billion in outflows. And so I think you had concerns move from, you know, the slowdown, the equity markets all off, the devaluation, and now looking at the capital outflows overall. A lot of that is, you know, corporates unwinding the position, and some of this is deleveraging the government wanted to see, but I do think that there’s still further for that to go.

In the overall backdrop, I think the China story has become much more significant than what the Fed does later this week. And looking at the China impact on overall global growth, we estimate that every 1 percent slowdown in China takes about half a percentage point off of global growth, but that impact on emerging markets is much more severe than it is on the developed markets. That has led to us taking down the Japanese growth forecasts. It has more of an impact, actually, on the euro area than on the U.S. forecasts.

MALLABY: What are the numbers there? So, in the U.S., how does the forecast change with China?

CHANG: So the U.S., it doesn’t change that much. I mean, developed market group we’ve only moved like 0.2 percent, more of an impact on Japan and on Europe. But in emerging markets, you have pretty much a one-to-one impact. So this year, Latin America is actually contracting, negative growth. A recession in Russia, as well. So at 3.4 percent for emerging markets growth, this is actually the worst emerging markets growth performance that we’ve seen in many, many years—the smallest differential between developed market growth and emerging markets growth.

So whether the Fed, I agree, moves this week or before the end of the year—which I think will happen—you’re still going to have the shallowest liftoff that we’ve had probably since the American Revolution. You’ve got more QE coming out of Europe and out of Japan as well. But I do think the emerging markets story is one that is changing the whole global outlook and the forecast for 2016.

MALLABY: Well, I’m going to jump back to Carmen for a second because you’re famous for writing about financial crises. So Joyce has just described a situation in which capital account outflows were 130 billion, I think you said, in August.

CHANG: In August. And we think they will probably be running at about double the pace that they had before the devaluation. Some of this is healthy—it’s corporate deleveraging. And, you know, the corporate deleveraging is different in China because it’s much more going to be shown through the FX reserves moving down and perhaps the currency moving a bit weaker.

MALLABY: But nonetheless, you are starting from a position of reserves which are around 3 ½ trillion. People still seem to be thinking that this is putting pressure on the exchange-rate regime—if we understand what the regime is after the devaluation—that they’re kind of in the middle between a credible peg, which they used to have, and a sort of, you know, wasn’t a big devaluation, which might have reestablished credibility at a different equilibrium point. So they’re in the middle. It’s a bit of a mess.

How do you—I mean, do you think that the run on the reserves is enough to actually matter, given the huge amount? And how do you see the exchange rate? Will there be a renminbi devaluation, which then impacts the world economy in a new way?

REINHART: China is not having sort of the classic twin crises—currency crisis, banking crisis—that we saw in East Asia in ’97-’98. It doesn’t have the levels of external debt, the current account deficits that we had seen in Asia at the time. It’s not—it’s very much an internal financial problem. However, that internal financial problem still produces the leakages that—of the order of magnitude that we’ve seen.

I think to—I haven’t taken a particularly negative tone on the devaluation because when you put in perspective what China did relative to what has happened in most emerging-market currencies in varying degrees, it’s nothing. Since the spring of 2014, the taper tantrum, Russia, Brazil, places like Colombia and Chile—which are not the immediate crisis-prone emerging markets that one would point to—have seen depreciations in the order of magnitude of 40, 50, 70 percent, and even higher. And so what China did relative to what has happened in emerging markets is very modest.

I’d like to go back just to make a point on the China-U.S. link. I think we can’t lose sight of the fact that foreign central banks—of which the biggest, of course, by a huge margin is China—hold more U.S. Treasuries than the Federal Reserve. So even if we have a very gradual and orderly unwinding of policy, we cannot say the same of what happens abroad. So I think that one element to keep in mind when one thinks of U.S. financial markets as they relate to what is happening in China and what is happening to emerging markets is the issue that orderly is not what—how you would characterize this process.

And I want to connect that to—I know we will get there, but I want to connect that to the issue that it’s not just China losing reserves. Brazil just had a downgrade. And all these things, I think, are tightening market conditions in a way that’s far more unpredictable.

MALLABY: So just to make sure I understand your point, you’re saying that we’re discussing the Fed hiking short rates by a potential 25 basis points, but China might hike U.S. long rates by selling off by a heck of a lot more than 25 basis?

REINHART: Absolutely.


So it sounds as if the currency, as you said, is, in the terms of the emerging market movements we’ve seen recently, not such a big thing. The capital account bears watching, but 130 billion on a stock of 3.5 trillion, it’s not yet that alarming. But, Willem, maybe you can talk a bit about another way of looking at the China challenge, which is not the capital account or the external balance, it’s the domestic dynamics of growth. Their model seems to have hit a big wall.

BUITER: China, in my view, is set for a very classical cyclical downturn, even if they don’t have a financial crisis. They have massive excess capacity in most of the traditional industries—not just the SOEs, but also the private traditional industries. There is massive and still rapidly rising leverage in the corporate sector. And most of this domestic debt, admittedly, and the bad assets that are held by the local authorities, directly/indirectly, and by the corporates are mainly domestic assets. And they’ve had two booms, bubbles, and busts—first housing and construction, and then more recently the embarrassment of the stock market implosion and the government’s astonishing response to that.

So here is a(n) economy that is slowing down rapidly. It has to achieve a sustainable growth model, move from investment-led to consumption-led growth. We’re seeing the deceleration of investment. We don’t seeing the pickup in consumption. This, to me, reads recession—recession, Chinese-style. There won’t be negative growth, whatever the data mean, but growth, say, 2 or 3 percentage points lower a year plus from now than it is today. And that would have repercussions not just for the capital account, but to traditional trade channels. Indeed, it would have effect through the capital account because there’s no doubt that the weakening of China through commodity prices would cause currencies—never mind the renminbi, but currencies of emerging markets outside China to weaken further. And this would make the U.S. and the few currencies tied to the U.S. dollar the appreciator of last resort, so that will be a very painful process.

So this China, which is now the largest trading nation in the world—16 ½ percent of world trade is Chinese—it is a major global player that is at risk of putting the world economy, on average, into what I would call recession territory growth, at 2 percent or less at market exchange rates. And that doesn’t mean that every country, even the U.S., goes into recession, but you can knock easily, you know, 0.2, 0.3 (percent), depending on how—(inaudible)—you are, 0.4 percent growth, of the growth in advanced economies, while emerging markets as a whole would lose very seriously. So a recession made in China would spill over through emerging markets and affect advanced economies in a more muted way, but still in a way that will not be welcome.

MALLABY: But, Willem, isn’t it—I mean, to describe this as a classic cyclical downturn strikes me as not saying quite enough. In other words, this is an economy where an extraordinary high share of growth was based on investment.


MALLABY: Investment is especially sensitive to a slowdown in growth because you’re not going to invest to produce products if no one, you know—so that can be far more sensitive in its response. And when investment falls, that brings the growth down by more than it would in a different economy because investment was so key in China, so you get this negative spiral. And then you start thinking about, what does that do to the political cohesion? Isn’t there a—isn’t there a tail risk here?

BUITER: Oh, no, no, sure. But I mean, there is a(n) obvious policy response to this. While it is now getting a bit late in the day to completely, you know, lift this sinking economy up again, it’s a—it’s consumption-oriented, private and public consumption; fiscal stimulus funded in the first (instance ?) by the central government, the only entity with deep pockets; and then, I think, indeed monetized through the PBOC, through the central bank of China.

China has inflation well below target, so it is not financially, you know, and fiscally irresponsible to have what is effectively, you know, helicopter money, Chinese-style for once in a response to this. This would be a cyclical stimulus that supports the longer-term structural rebalancing of the economy towards consumption demand. But when you try to peddle this story in China, the same people that tell you in one moment they’re trying to rebalance towards consumption—tell you, OK, why not send a check to grandma or granddad or increase public spending on health and education—they tell you, well, you know, consumption only gives you return for a minute and infrastructure investment is good for 25 years.

And so there is a complete cognitive disconnect in the leadership there. They’re not focused on this issue. I think that there are power issues—political control issues in China that have simply distracted, I think, the attention of the—of the leadership from mundane matters of economics. But they will come back and bite them where it hurts.

MALLABY: Perhaps others who know Chinese history more than I do will correct me, but I think that, just as in Germany, austerity economics is driven by the memory of inflation in the 1920s. So in China the allergy to the proposal you just put forward of monetary financing has to do with the history of inflation before the communists took over.

BUITER: Yes, that is an explanation but not an excuse, right? (Laughter.) And it’s true. Just ask—you know, I can understand the Bundesbank, you know, inflation phobia and the monetization phobia because of Weimar. But it’s still—it’s still nonsense, right? So we have to keep on repeating that until the right measures are taken, history or no history.

MALLABY: Joyce, talk about—more about the spillovers to emerging markets, because I mean, I think everyone understands that there are commodity-dependent economies that have been obviously hit, massive terms of trade shock because Chinese demand has fallen off. But then there are other emerging markets which are actually net commodity importers—I’m thinking of Turkey, for example—which are also in trouble. So if there something broader going on about EM growth?

CHANG: Well, I think that the commodity story is affecting emerging markets across the board. So if you look at Latin America, that’s been the most exposed, but you have the downgrade to non-investment grade, you know, in Brazil, some deleveraging that is going on, the need for a fiscal anchor. And, you know, in China’s case, the currency devaluation was really more to keep in line with what’s happening in the broader markets.

So there are some winners. You know, India is one of the winners. We have growth above 7 percent—7 percent above next year and also for this year. But I think that you had a commodity story which really touched every region—the Middle East and Africa, Latin America. The China story touches emerging Asia. So that’s brought potential growth in emerging markets, you know, lower than what had been forecast at the same time that developed markets have also lowered potential growth. So I think there’s still more that will play out in this. The attention right now is focused on the credit growth in emerging markets and the pace of deleveraging and what the capital outflows could be.

But there are winners and losers from that that—much of this also gets tied into the political cycle. Is it a coalition government? Can you get a policy regime in that actually does create a fiscal anchor? Or are you in a situation where the currencies are going to have to overshoot? And that’s where we think we are with Brazil, for example. We see more currency weakness because they haven’t been able to establish that anchor yet. And so I think, you know, China in many ways has had to, you know, catch up. That was what the move was meant to be. It’s still very small, as Carmen mentioned, in the scheme of things, but we see overall that emerging markets currencies will go weaker, probably another three to four percent between now and the end of the year overall.

And we still see more downside risk to the growth, even at only 3 ½ percent growth in emerging markets. So that’s very different from the emerging market story we had been talking about right after the global financial crisis, where that really had been providing, you know, the marginal growth and lift to grow. And QE hasn’t, you know, resulted in the growth story yet, you know, turning around.

MALLABY: Do you want to add to that?

REINHART: So let me also backtrack a bit, and put some of the longer cycle, complementing with what Joyce just said. Emerging markets, as a whole, were in very solid condition. They had—they had had all kinds of crises in the 1990s and the early 2000s, and they were lean and mean at the time of the global financial crisis, which helped them, unlike the 1930s, withstand the shock to the advanced economies. And emerging markets enjoyed basically from 2003 to early 2013, late 2012, a long period of capital inflow bonanza, you had low international interest rates, interest rates were stable, commodity prices were rising, China was growing exceptionally fast, creating new markets for their exports. So this had—this was really a 10-year cycle in which also—especially if you look at crisis-prone Latin America—was exceptionally noted for lack of financial crises.

Now, all those factors are unwinding now. But what happens typically during these bonanza periods, during these periods of rapid capital inflows, is they had their own credit bubbles, they had their own property bubbles, they had their own currency overvaluation problems. And so the—I think one of the reasons we’re seeing emerging markets, as a class, even those like Turkey that are not necessarily commodity—dependent on the commodity cycle affected, is that in addition to all the external factors now working in the opposite direction—sharp declines in commodity prices, prospect of rising global interest rates, the uncertainty over China—you’ve had sort of the excesses, if you will, of that cycle coming to roost and hitting emerging markets as a class. And I think that downturn could easily, easily translate to localized banking crises and worse.

MALLABY: That’s very interesting, yeah.

BUITER: Just on Turkey, it may look like a commodity importer, but it’s a commodity exporter once removed, right? It is the big beneficiary, on the capital account, of capital inflows from the Middle East when oil prices are high. So that’s gone off. It’s equivalent to the import bill going up in terms of the balance of payments.

And then there’s also—I think the general commodity price problem is compounded by country-specific but, you know, simultaneous flare-ups in a number of key emerging markets—Brazil, big political crisis; Turkey, not too healthy; and Russia has a small problem with Ukraine. So this is—and so there is all this idiosyncratic factors coming on out of the blue, really, at the same time that we have this global unifying theme of slowdown in China via commodity prices.

MALLABY: I’m wondering, and this is perhaps a little bit of a stretch, but as I listen to both of you I’m thinking that the good times of capital inflows and easy credit lead not merely to financial excess of the type you’re talking about, but kind of hubris. There’s a sort of metal excess which may show up in an invasion of Ukraine, or it may show up in corruption, as in the Brazilian Petrobras scandal, or Malaysia has a big scandal as well. So you know, the excess can be more than merely credit.

REINHART: Well, let me add that almost a routine part of banking crises—banking crises often occur at the end of these credit booms. But a routine part is also corruption. So you know, to what extent one can systematically say this is really part or an outgrowth of the capital flow cycle, I don’t know. But it’s certainly—in the past, the two things have often traveled hand-in-hand. I think I would add that one of the things that’s also hitting emerging markets across the board is that for many years—and this goes back to China—is for many years we lived under the large—what now obviously is a mistaken—belief that growth in China was something quite precise. That, you know, you could talk about a cycle slowing down from 7 percent to 6.8 percent and actually hit it, which would be nothing less than miraculous if one looks at the historical cycles, which are not only much larger than that, but very imprecise. And I think that uncertainty is really impacting emerging markets across the board, whether this is permanent, or whether it’s more transitory, and how big.

MALLABY: So I can now announce that I’ve just won a bet with a friend of mine, who said it would be impossible to conduct a 25-minute discussion about the world economy without mentioning the words eurozone or Greece. But having won the bet—(laughter)—I am now going to just quickly raise that before coming to the members for questions. Maybe I’ll throw this one at Willem, perhaps. You know, A, is the eurozone crisis sort of quiet durably? And, B, does migration and that stuff change the picture in any sense?

BUITER: No, the eurozone crisis is temporarily dormant. The European Union—the eurozone has done what it does best: that is, kick the can down the road. And with a bit of luck, we will get to the first—we get a Greek government, we get to the first review, and they won’t blatantly fail, and the IMF will come back on board, and they may extend it until next summer. But the programs simply doesn’t add up. It asks—

MALLABY: The Greek program, you mean.

BUITER: The Greek program, yeah. The additional austerity they’re asked to implement is insane. And the structural reforms, many of which are very sensible, won’t be implemented because the implementation capacity is not there. So it’s going to become acute again. And the risks of Grexit are still there.

For the rest, yeah. I think that eurozone—the EU, I’d say, politically is under greater stress now than at any time since the Coal and Steel Community was put together in 1951, which I don’t quite remember because I was two years old. But we have the material risk of Brexit, or British exit, from the EU when the referendum is held, probably sometime later in 2016.

And then this refugee crisis has put at risk the other sort of almost-defining element of the European Union, although only 26 out of 28 countries participate in it, the Schengen Zone—the free, passport-less, borderless movement of people through the European Union. That’s gone now. And the granddaddy—grandmother, I should say, of the scheme, Germany, has also suspended it now. Unless this is just a temporary correction to allow a common policy for dealing with this huge humanitarian crisis to be worked out, it could spill over into more permanent restrictions, not just for would-be immigrants crossing borders inside the EU, but for, you know, EU citizens. So the single labor market which is supposed to exist would be undermined. And that, I think, could be the beginning of the end.

So we are really playing high stakes. It’s not sort of an urgent matter, but it’s very, very important, and keep your eyes on it.

MALLABY: OK, so let’s go for some questions from the members. Henny. Wait for the microphone, please.

Q: Henny Sender from the Financial Times.

I wanted to pick up on Carmen’s point about the possibility that the Fed essentially loses control of the long-term rates. And I wanted to ask you whether in fact it’s just China who we will see having less reserves to deploy into the treasury market. I can also make a case that Japan will have less money to put in U.S. Treasuries. And at the same time, the Gulf and Saudi, who has been a huge purchaser of Treasuries, also has less money to recycle in the treasury market.

What does your worst-case scenario look like when you think about the cumulative impact of all these countries, for various reasons, having less money to deploy? Who picks up that, you know, gap? Or do you think the federal budget deficit, you know, is going down, so it won’t be a problem? Thank you. And I just wanted to add that this has been the most riveting discussion and thank you so much.

MALLABY: Before you answer, just I should have said, to remind people this is on the record. Go ahead.

REINHART: So I—let me reiterate that I view the issue of reserve losses not as—you put it very well. This is not sort of some Machiavellian thing in which you have a sell-off of Treasuries. This is Treasuries being sold by various countries as their own conditions mandate it. So by that statement, it also highlights that there is not necessarily anything terribly predictable or synchronous. And I don’t want to use the term volatility as a cop out, but I think that is the upshot, that if you look at the period 2003 to 2013, it was a one-way bet what foreign central banks were doing.

Now, one interesting note—and this is—I don’t want to overplay it, but I really was taken aback that—I tracked the flow of funds data from 1945 to the present. The flow of funds for the United States reports the amount of Treasuries held by the rest of the world, and then breaks down—or used to break down—what was official institutions and what as the private sector. It stopped publishing that breakdown very recently. I mean, I’m not saying this is like Venezuela not publishing inflation statistics for seven months, but it’s—it complicates really sorting out or reconstructing what’s going on.

I do think that the—it’s not a loss of control. I think the Fed can and will adapt to the situation. But I do think that there is an inherent big source of tightening in the markets that is not going to come from U.S. policy. And in some work that I’ve done with Vincent Reinhart on this issue. Post-financial liberalization there was—there’s been an increased decoupling between long rates and short rates as international influences have kicked in. And they’re kicking in with a vengeance right now.

MALLABY: I think both of you want to come in. Joyce first.

CHANG: First of all, 80 percent of foreign—FX reserves being in emerging markets had become excessive. So a lot of the foreign exchange reserves in emerging markets, in China, really need to hold 3 ½ trillion (dollars) in foreign exchange reserves. But the other point I would just add in on the demand for U.S. Treasuries is now you’ve gone to having negative interest rates in certain parts of the world. And if you look at our overall government bond index, about 10 percent of it is at a negative yield.

So we’ve actually seen that even though you’ve seen the reserves come down, which I think in many cases had become too excessive, we actually saw in August that there were inflows going into Treasuries as you had more global stress, flight to quality trade, but also with negative yields in some parts of the world you’ve seen the demand for Treasuries as actually, you know, remained very robust, just because the return itself is still attractive compared to some of the other asset classes, if you’re worried that the risk premiums are not being priced properly.

So I do think that some of the—some of this money does get recycled as well. The EM FX reserves have been something that is very different this times compared to other emerging markets downturn. So we’re seeing it an emerging market’s adjustment that’s more being adjusted by the currencies, you know, that you have the reserve pushing, which is allowing you to smooth out some of the market liquidity, but you also have the market liquidity, the shocks that we’re seeing. You have increased, even since Fed taper tantrum, just because of some of the shifts in the market structure over the last couple of years—you know, more algorithm trading, you know, more volatility because the broker-dealer community isn’t providing as much liquidity as they used to be able to.

BUITER: You know, I’m really not worried about reserve losses in the end, unless an unsustainable exchange rate is being defended with these reserves. That ends in tears.

The great thing is countries don’t sell U.S. Treasuries, right? When reserves go down, the central bank sells them. They may be selling them because private agents at home are buying them. So I’m really—and at the moment, I think that the global private demand for U.S. Treasuries is probably more than making up for the desire or the need, in some cases—in China—for official holders to get rid of it. So, yes, it can happen, sure.

You know, the Fed can only, you know, pick one point on the yield curve, not the whole yield curve. It can try to guide by making commitments which will be believed to the future path of interests rates, but that’s all it can do. And it’s certainly possible that if China were to go in a deep slump, right, and financial stress arises, that in order to sort of—what do you call it, sort of circle the wagons, right, Chinese private and public holders of U.S. Treasuries will try to sell them to get liquid funds and to build up their domestic balance sheet. So that could have exactly the effect, but that would be a response to a systemic crisis. But it could even be associated with losses of reserves. It’s a total demand—domestic, as in the U.S., and foreign private and public for U.S. Treasuries. And I see no shortage of that at the moment.

MALLABY: I think part of what you’re saying is that, if you think about China, the reason for the accumulation of official reserves is partly that private Chinese—

BUITER: They couldn’t hold it.

MALLABY: —could not—couldn’t hold foreign assets, and so the government held it all. And if you had a flip where the capital account is more porous, then it could adjust.

BUITER: Yeah. Exactly.

MALLABY: Right here.

Q: Carter Bales from NewWorld Capital Group.

I wanted to ask a question about the global profit approval as a percentage of global GDP. There’s a report that McKinsey’s Global Institute has just published that basically says that it’s been operating at about twice the percentage of global GDP in recent years, compared to historical rates, and that’s what actually happening is a real step-up in head-to-head competition in the corporate world, which is perhaps benefiting customers—transferring value to customers, but impairing the ability to invest. And that is likely to drop back to historical levels, namely at about half the current level. Now it has a major effect on the intermediate-term growth outlook. What’s your perspective on that?

MALLABY: So you think the share of profits in GDP would fall by half, back to its old—

Q: Yes.

BUITER: I don’t believe it. (Laughs.)


Q: Well, I suggest you read the report.

BUITER: I’ve read the report.

Q: Oh, good.

BUITER: It’s singularly unconvincing. (Laughter.) It forgets that—

Q: Singularly? (Laughs.)

BUITER: What it does is, you know, the share of profits generally—it just looks at corporate profits, actually, which is only a very small part of capital income. The share of capital income in GDP globally, and indeed in the U.S., is probably still rising because the share of labor is going down. That’s, in some sense, end of story. How is this distributed among different corporates, right, where you have lots of competitive corporations getting a bit each or a few large monsters with huge margins getting a lot each, is a second-order issue.

I think the undermining of the share of labor because of technical change, and—not so much because of globalization, because that’s going to reverse to a certain extent, but certainly labor-saving technical change is probably going to go on. So I do agree there may well be more acute competition for the incumbents, but that’s totally unconnected with the share of capital in GDP, which is likely to go up.

Q: (Quite likely discussed ?) a lot more.

MALLABY: And then if labor’s share of GDP continues to decline or stagnate, we’ll get populist tendencies.

BUITER: Big political issues, yeah.

MALLABY: We will see more of that on left and right.

Let’s go over there.

Q: Eric Stein from Eaton Vance. A question for Joyce, I guess.

You know, with all the stress on emerging market countries, they can kind of respond in a good way and do reforms, or in a not-as-good way. You know, what countries do you think are responding positively, given the shocks they’re facing, and maybe also second question, how do you expect China to respond to the shocks that they’re facing?

CHANG: Yeah, so I think—you know, it’s a mix in emerging markets countries, but those responses are, you know, playing out and will continue to play out next year. So I would say that, you know, in China’s case we do see that their Central Bank has chosen to, you know, do some easing. And I think that that will continue. But you still have tighter financial conditions across emerging markets. And I think it’s looking at the countries where they are going to do more fiscal reform. So that is at the heart of the debate in Brazil right now. And they’ve come over the last couple of days with some statements which put some more clarity around that in response to the downgrade to non-investment grade.

But I think that you see China continuing to have to ease up the Central Bank, but I think some of this corporate deleveraging is actually a very healthy thing, and it’s actually been happening pretty rapidly. We think about half of the margin lending actually has come out over the last couple of months. So that will actually leave the balance sheet in a much healthier position than where it had been a year ago. So some modest currency adjustment there is something that I actually think is—needed to occur over the longer term. That’s a good thing. So you don’t see this as the emerging markets crises of the past. The currencies have adjusted more. The reserves have provided some cushion for them.

So what you do need now is the fiscal reform and the longer-term structural reforms, also changing some of the tax structure in some of these countries as well. But I don’t think that’s just an emerging markets problem. I mean, going back to the issue in Greece, you know, a lot of people forget that the first bailout package in Greece in May of 2010 was supposed to be a five-year package—you know, five-year package repaid at 300 base points. And this has become something that now is being stretched out, you know, indefinitely. So I think what emerging markets have is that the reserves have given them some time because they’ve moved to a creditor status.

So they probably haven’t moved as quickly as they needed to, whereas the downturn in commodity prices occurred much more quickly. I mean, sitting in this forum with Sebastian, at one point just, you know, last July you were talking about oil 110, then to 45, back to 75, back to 45. So this is not smooth. (Laughter.) You know, and so I think it is those countries that are putting in more of a fiscal anchor, you need to let the currencies do some adjustment. And you still have countries in emerging markets that have some scope to ease. But inflation is coming back as a problem in certain parts of emerging markets, particularly Latin America.

MALLABY: Do you want to add to that?

REINHART: I think one of the things not to lose sight of is we tend to focus, obviously, on the more conventional policies—monetary policy, fiscal policy. But I think also one of the things that happened—well, it had been the case for China for a long, long time, but it happened also to other emerging markets, post the crisis of the 1990s, is they looked inward for financing. So a lot of—a lot of the debt is—a higher share of the debt is domestic than it was before, which also provides more policy options to deal with the current problems. And let me highlight one important one.

One of the things we can’t lose sight of is one of the ways that China is dealing with the excess that’s left over by the property boom and the state, the role of the provinces, rather—I misspoke—the role of the provinces is by restructuring internal debts. There’s a lot of consolidation of what were high-yield short-term debts that were actually financing investment projects and properties—some of that debt very low quality, some of that debt is being written off, but others is being consolidated into an internal market. That’s actually a very positive thing. But of course, I would highlight that it’s also something that takes time, which, you know, would argue for slower recovery.

BUITER: I wouldn’t be too positive about that. It clearly is better for basically bankrupt local authorities to owe long-term, lower-interest-rate debt than, you know short-term, higher-interest-rate debt. But at some point they’re going to actually have to restructure this stuff. And unless these governments get additional sources—the local authority—of recurrent revenues—you know, a property tax is the obvious example—I think that they will not be able to manage even the new, you know, consolidated debt, and it will have to, at some point, be written down. And China isn’t there yet.

REINHART: My understanding is that there is—some of the worst debts are being written down. That’s my understanding. Whether the initial write up is going to be sufficient, that—probably not, because usually, the historic experience is you seldom get the first haircut right. It takes actually more often than not more than one to get it right. But I think the direction of consolidation of internal debt is kind of critical when you have that much of it.

MALLABY: But the big picture question—answer to the question is, I think, listening to you all, is that whereas in the past you had emerging market crises with fixed exchange rates, which were disastrous, now they’re flexible. Whereas in the past you had emerging market crises with enormous foreign currency debt, now more of it is domestic and you have the resources to absorb that and write it off and manage it internally. So it’s not a cakewalk, but it’s a heck of a lot better than—

BUITER: But remember the U.S. had a floating exchange rate and no foreign exchange reserve constraints because of this world’s single global currency, and it had a massive financial crisis not that long ago. So you can still do it. (Laughter.)

MALLABY: If you try—

BUITER: If you—if you want to make a mess of it, it’s not impossible.

MALLABY: Let’s have another.

REINHART: Japan. Japan.

BUITER: Yeah, absolutely. Same thing.


BUITER: Yeah, yeah.

MALLABY: Let’s go over there.

Q: Nick Bradford (sp) with Zad. Thank you for your comments.

I wonder if you could discuss a little bit the impact of the pronounced weakness of the price of oil. Obviously, there are winners and losers.

MALLABY: We’ve mentioned India as a winner by, Joyce, wants to pick that up.

CHANG: Well, the analysis that we’ve done is that it actually is getting much less of a boost to some of the overall oil importers than one would have thought. And so I have been running this debate internally at JPMorgan, how much of a benefit will the U.S. economy get from lower commodity prices? So there’s been a consumer benefit at the gas pump, but there’s been much less of a benefit than one would have thought, just because the share of energy had been coming down, you know. And then you had the dollar strengthening at the same time, if you look at the overall trade in the U.S.

So I think there’s probably been less of a boost in the U.S. than one would have thought. But even in the emerging markets countries, I mean, you have—these moves have occurred so rapidly that the question now is where are many of these countries really budgeting the price of oil going forward? And what is sort of the break-even for them as far as looking at the fiscal accounts? So, you know, we’ve seen some countries that had been budgeting oils at $100, you know, in their budget—some Middle Eastern countries, concerns that Russia had been doing that. And in emerging markets countries, some of the countries where—like, in Venezuela, where 90 percent or more of their export earnings are from oil, they are the most dramatically impacted.

So I think the question is, where are oil prices going to settle from here? I mean, and the forecast has—you know, we have a forecast that’s in the low 50s at this point in the stage. We’re now looking at the rest of the commodity cycle, that is the risk premium now getting priced properly for the energy markets, but in precious metals, some of the commodities that really are very tied to China, like iron ore, is there more of an adjustment that still needs to occur as far as making these market adjustments?

MALLABY: One thing I’d be curious about is, we haven’t mentioned Russia. And, you know, not so many months ago that seemed to be the classic victim of falling energy prices, huge exchange rate movement, central bank reserves flying out the door.

BUITER: Well, Russia is macroeconomically well-managed, of course, right?

MS. REINHART: (Laughs.)

BUITER: No, it’s true. They are—have had two really bad shocks. And I think the politics are terrible and their microeconomic industrial investment climate is terrible. But in terms of monetary and fiscal policy, they have responded exactly in the right way. So they actually are making, from that point of view, the best of a bad job. But they’re hurting. If your main export is oil and gas, and the price has halved—more than halved over—about a year and a half ago, you will hurt, yes.

But I think it really is—again, I wouldn’t say this is a first-order issue. The oil price decline itself is redistributional, right? And clearly, if you’re an oil exporter—net exporter you hurt, if an importer you gain. It should roughly, in terms of consumption effects, wash out. If it’s very sharp, it can be disruptive. And if they haven’t budgeted for it, it can be very disruptive. So sharp swings are painful, but that is simply because the losers will, in the short run, be worst affected than the gainers.

On the investment side, yes, if you’re producing oil, especially if you’re a high-cost producer, you’re out of luck. But all these industries—in the U.S., 98 percent of GDP that use oil and gas as an input rather than producing it are benefitting. So I really think this is—the original oil price decline was, of course, the result of a positive shock—that is, is the increase in supply of oil due to the arrival of shale gas and tight oil. The recent further decline reflects weakness in the global economy, and that’s the bad news. The oil price decline itself is just a redistributive aspect of that. It’s like interest rate increases, you know? If you’re a saver, you love it. If you’re a borrower, you hate it. But if it’s done in an orderly way, it shouldn’t be a big story.

MALLABY: Carmen.

REINHART: Very quickly, I think the winners are very dispersed. The losers are very concentrated. I’d like to focus on some of the more marginal cases, because I do think that we are in the kind of environment that produces more defaults. It is bordering on the miraculous that Venezuela actually hasn’t defaulted on external debt, as it has already defaulted on internal debt. Now, there is one question—I don’t want to sidetrack from the issue, but one question that I’d like to put on the table. There has also been a lot of financing to emerging markets, like Venezuela and Ecuador, from China.

BUITER: From China, yeah.

REINHART: And so, it is questionable—I do hear that many of those loans already are in arrears—whether this is already happening. But I think also countries like Nigeria, which, you know, are a much more precarious situation, are among where you start really looking for signs of renewed stress and signs, not that we’re back in the 1980s, but that the odds of real significant economic problems, despite very low levels of debt, may start emerging.

MALLABY: Have a question? Yes.

Q: Thank you so much for the comments. Rebecca Patterson at Bessemer.

I would love to get your thoughts. A year from now, if we’re all sitting here, is the migrant crisis in Europe—is this something that goes from humanitarian and political to economic? And if it becomes an economic issue, particularly for Europe, do we have to assume it’s bad, or is it possible that this ends up not necessarily being bad if people are integrated, if there’s more social spending that lifts growth?

MALLABY: Who wants to take that?

BUITER: Well, it feeds populism, both on the left and the right. (Inaudible)—although the unbearable sights that we’re seeing of, you know, the children’s body washing onto the shore, is the humanitarian response, which in some ways has been positive. But I think the medium-term impact of this is going to be to move European politics even more radically towards anti-foreigner, xenophobia, and—(inaudible)—xenophobia, and nationalism, or even regionalism.

There is an opportunity here. This is a crisis, a humanitarian crisis. The immediate economic impact on budgets—you know, putting fences along the border—is small, probably positive—if they spend more, it’s engaging in stimulus—(laughs)—but small. But if they can reach an agreement, it could strengthen Europe. If Europe finds a way, first of all, of peacefully allocating these refugees and then, hopefully with the help of other big players, doing something about the net flow—we do something about the sources of the problem in Syria, in Libya, soon in Yemen, right, Afghanistan—that would be a huge contribution.

But within Europe, this is—I think it’s make or break. We either are going to have a pulling apart—Schengen goes, you know, the single market goes, the core of the EU is undermined—or we pull together and solve this really difficult problem. And I think that Western Europe is much better positioned, in a way, than Eastern Europe, because at least Western Europe has some tradition of dealing with immigrants and immigration. Eastern Europe has none—at least not in living memory, that is.

And so there are real problems in countries like Hungary, Poland, Czech Republic, Slovakia, and soon Bulgaria and Romania, who have never had to deal with significant inflows of foreigners, except for the Roma, right? And we know how well they’ve handled that. (Laughter.) And so I think there’s a challenge here, but it could—and challenges, you know, if they’re met, strengthen the EU.

I’m hopeful? Yes, I suppose I am.

MALLABY: OK, let’s take one last question. We’ll go right here.

Q: Bhakti Mirchandani, One William Street. Thanks very much for an enlightening discussion.

As financing transitions from bank loans to the capital markets, often through alternative investment vehicles, and as financial intermediation broadly transitions from the financial sector to technology, what are the implications for global growth and stability?

MALLABY: Gosh, well, with a couple minutes we’ve got a small thing on the table. (Laughter.) Maybe Carmen would like to have a crack at that, to financial deepening, the shifting of intermediation onto internet platforms. Does this make, you know, this time it’s no different?

REINHART: It’s really—I mean, it’s really hard to say. You know, financial intermediation by definition keeps, you know, remorphing. And I think one of the interesting questions that keeps coming up is the role of bitcoin, among other forms of intermediation. And you know, I have little to say, because it—you know, you’re really looking at whether something like that could lead to a quasi-currency, whether—I’m sorry, I—

MALLABY: Well, let me—let me—we’ll wrap it up this way. I’ll put something on the table—

BUITER: Let me say, it’s—


BUITER: Really, it’s not significant, right? You don’t have financial intermediation moving from the financial sector to technology. I mean, whoever uses technology to do financial intermediation is in the financial sector, right? Just because you do it automatically rather than with human intervention, just because you use big data, right? If you can, through the Internet and crowdfunding, reach a new population of lenders and borrowers, that may be good news or, if it means that new—the ranks of the uniformed are augmented, it’d be greater scope for abuse—sort of subprime to the Nth degree.

As regards bitcoin, it’s a huge social regress. The blockchain, the technology of bitcoin, is very important. Bitcoin itself is just, you know, gold without the shiny stuff, right? It’s costly to produce, artificially costly, and substitutes for something that can be produced at zero cost, electronic money. So it is a social waste. (Laughter.) But it’s fun because it underlies—it’s a great means for hiding your presence from the government.

CHANG: Well, I’m going to say that I do think that it is significant, the changes that we’ve seen in market structure, because you’re going to have certain moments where the technical do overwhelm the fundamentals. So the way that we watch how markets react to fundamental developments, and whether we’re tracking the flows, the technical and the liquidities, I think that mix has to change. So look at the U.S. equity market sell-off. Over a 90-year period you had one of the longest uninterrupted rallies, and then you had three days where you had technical selling of about $150 billion.

So it may not change the longer-term structural story, but it certainly changes the story that you need to watch as an investor and as a market participant as far as what’s driving the market volatility. So are you in for these much bigger spikes, unnatural periods of stability, and then these very sharp sparks that you can’t explain by a fundamental development, and all of this exacerbated by the QE policy. So I do think it’s significant. Even if it doesn’t necessarily change some of the longer-term structural movements, it certainly changes the way in which you need to look at markets.

MALLABY: I would just conclude by saying that financial technology is like your laptop. It increases your productivity most days of the week, and occasionally it crashes and destroys your productivity for a full 24 hours. (Laughter.)

OK, with that, thank you all for coming. Thank you to our panel of experts. (Applause.)


This is an uncorrected transcript.

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