World Economic Update

Wednesday, May 17, 2017
George Papaconstantinou

Former Minister of Finance, Greece; Author, Game Over: The Inside Story of the Greek Crisis

Rebecca Patterson

Chief Investment Officer, Bessemer Trust Company, N.A.

Lewis S. Alexander

Head of Fixed Income Research in the Americas and U.S. Chief Economist, Nomura Securities International, Inc.


Paul A. Volcker Senior Fellow for International Economics, Council on Foreign Relations; Author, The Man Who Knew: The Life and Times of Alan Greenspan

Experts discuss the state of the global economy.

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

MALLABY: OK. I think we can get started. Welcome to this “World Economic Update.” It’s called a “World Economic Update,” but I think one can probably assert that the two areas of the world where things most are in need of updating: sort of how you think about the policy stream coming out of Washington, D.C, which is clearly in flux; and, secondly, Europe after the Macron election. So we’re going to focus mostly on that, maybe a question on China. But if you have other regions which you feel are sorely neglected, we’ll be reserving half the time for your participation and you can bring up whatever you want. I guarantee that the panel has answers to everything.

You know, Lewis Alexander, on my immediate left, chief U.S. economist for Nomura; Rebecca Patterson, in the middle, chief investment officer for Bessemer Trust Company; and then George Papaconstantinou, a former Greek finance minister, also just written a book about the Greek crisis. So when we get to Europe, we will be—have the inside track.

So I thought we’d start with kind of the unavoidable elephant in the room. Maybe I’ll pick on Rebecca for this one.

PATTERSON: Ladies first.

ALEXANDER: Yeah, right.

MALLABY: Which is to say, look, you know, Washington has been in a—you know, in a state of turmoil. It’s only just gotten worse. Maybe last week the wheels were coming off a little bit. This week it’s screeching downhill backwards time. The markets have been—at least the stock market’s been calm up to now, but is this now perhaps an inflection point?

PATTERSON: Yeah, it’s an easy question to start with. (Laughter.) You know, it has been really interesting. Immediately after the U.S. election, you saw all this hope very, very quickly priced into the market around deregulation and potential fiscal stimulus. And as a result of those expectations shifting, we had a sharp rise in U.S. yields, 10-year Treasury. We had a sharp rise in the dollar, in part because of yields. We had a sharp rise in oil prices. And when we look at where we are today, we’ve basically round-tripped. Everything has come back.

I’d say the area that hasn’t come back is going to be cyclical assets outside of commodities. So you’ve seen equities basically continue to gain, and to a degree credit has continued to hold in very, very well. And I think some of this comes down to some hopes still being priced in, although I’d argue today they’re much more realistic on the stimulus side of things for the United States. I’d argue some of it is that earnings coming out of the United States, in the last couple of weeks in particular, have been quite a bit better than expected. You’ve had relatively good economic data, not only in the U.S. but around the world—better than expected in several countries outside the United States, especially China, in the first quarter of the year. So I think there are reasons—you know, justifiable reasons that cyclical assets have been able to hold in there.

At the same time, though, we’ve seen the VIX—the Volatility Index—for the S&P 500 touch all-time lows. Today it’s up a little bit, but still near all-time lows. So where is this disconnect? When I talk to corporate executives, to a degree they say it’s just how do you hedge it. You know, what—do you buy S&P puts? How do you hedge against these things? You can’t time it. You don’t know how bad it’s going to be. So you’re aware of it, but is there much you can actually do?

MALLABY: But, Rebecca, just on that, I mean, the VIX is supposed to be the fear index.


MALLABY: You can hedge against a collapse in equities.


MALLABY: You can buy, you know, options coverage. So what’s the story here? I don’t get that.

PATTERSON: So getting insurance on a portfolio, whether you’re buying the VIX index or buying options, the stars have to align. You have to get the time frame correct. You have to get the degree of the move correct. Otherwise, you could be overpaying for insurance that doesn’t help you. If you—if you bet on the French election, for example, and you thought there was a risk Le Pen would win, and you wanted to buy option protection against your European exposure, you need to get that window right and the degree of the fall correct. Otherwise, it’s money wasted. And so I think, over time, a lot of folks have realized that it’s just not worth the insurance.

And I would—I would just share one little historical factoid which is always useful for me in times like this. You know, on average, going back 30 years, the S&P has had a minimum pullback per year of 3 percent, minimum. And on average over the last 30 years, it’s fallen 11 percent. So minimum pullback of 3 (percent), average pullback of 11 (percent). Obviously, that includes recessionary periods.

So could this be a tipping point? Yeah, it absolutely could. We have near-peak valuations on the S&P 500. We have this uncertainty. We have this very low-volatility regime which is unlikely to last. So could we have a pullback? Yes. But even in those years with an 11 percent pullback, you still tend more often than not to have positive calendar-year returns for markets. So could we have a pullback on the back of these events or other factors? Absolutely. But I would argue, more likely than not, unless it’s a fundamental paradigm shift or the beginning of a recession, you buy that dip.

MALLABY: So, Lewis, let me put a kind of central-bank angle on this, right? So if what’s going on here is that people could buy insurance against the S&P being overvalued, but Rebecca’s saying that the cost of that insurance might be too high in people’s minds, and yet when the VIX is low it means the insurance is sort of cheap, and yet they still think it’s not worth it, right? So one explanation as to why people are willing to take risk and not insure might be that we’ve just had this long period of supportive monetary policy that has kind of bathed us in cash and made risk feel theoretical. Is there some truth in that? You still have negative federal funds rate. You still have a big balance sheet.

ALEXANDER: So I guess my answer would be yes, to some degree that’s part of it. I do think there is a presumption that the way central banks would respond to bad outcomes in some sense does tend to minimize those risks. But I think to explain it as largely that or entirely that is to overstate that case.

Look, I think the essence is people don’t feel that—aren’t that worried. I mean, essentially the argument is, yes, you can—you know, insurance is available; it’s just it’s—and it’s relatively cheap—people just don’t feel—don’t see the risks as being all that large. And I think the question you have to ask is, why is that?

And one of the points I would make is, in some sense, if the downside is gridlock—you know, in some sense, if you ask, you know, if a bad outcome in Washington is nothing gets done, that isn’t such a bad outcome in a—you know. And to some extent, I think when you kind of go through the thought process of what is the worst-case scenario, from a Washington perspective it looks horrible, but from a perspective of what does it actually mean for the economy it’s not obvious that it’s all that bad. And so, to a certain extent, I think that’s an element of what’s going on here, is people—you know, if that’s what the worst-case scenario is, which is just nothing gets done, that isn’t so awful.

MALLABY: Well, there is a possibility that negative things get done, but we’ll come back to that.

PATTERSON: And I just want to finish the VIX point one second.

MALLABY: OK. Yeah, quickly. Yeah.

PATTERSON: Just to say that while the VIX that we see on TV and in the newspapers is very low, it’s important to remember that these—the cost of that protection changes as you go out in time. So, if you are buying protection three months out, six months out, it is notably more expensive. So just to clarify that.

MALLABY: Sure. Yeah, good point.

So, George, what I’m wondering is, as the—you know, as Rebecca was saying, we’ve had a kind of roundtrip on the dollar. The dollar strengthened after the November election. Now it’s back down again. Is this really a story about changing perceptions of the reflation potential in the U.S.? Or is it actually a story about better news out of the eurozone, better news out of Europe, which has—you know, the euro having a very big weight in the dollar index? Talk a bit about Europe and the rest of the world, and how that affects this market balance.

PAPACONSTANTINOU: It’s very hard to draw one-on-one links here because Europe was—initially looked at the U.S. results and was very worried, then saw—was surprised by the fact that the markets, you know, interpreted it in a positive way. Perhaps it shouldn’t have been, but it was surprised. And at the same time, Europe was grappling with its own issues, from Brexit to what was coming in 2017. So, in terms of the currency—and there were a lot of moving parts there, so it’s very hard to say how the impact on the dollar was.

Europe—and I’m sure we will talk more about it in the second part—is in its fifth year of growth after coming out of the recession. And the politics and the economy are almost kind of going in separate directions. There seems to be an understanding that a lot has been fixed—not enough, but a lot has been fixed in terms of the kind of lack of mechanisms to deal with crisis and completing part of the banking union and making moves towards repairing the institutional infrastructure. There’s still many, many flashpoints, but the underlying fundamentals are rather decent, with a number of very serious problems that I’m sure we’ll discuss. So, in that sense, I think you’re in a situation where the internal stuff within Europe has been dominating what—the movements in the currency and the overall economic data, rather than a reflection of what was happening in the U.S.

MALLABY: Right. But that better story out of Europe, that greater optimism, supports a stronger euro, which in turn is the flipside of the dollar coming back down to where it was in November.

PAPACONSTANTINOU: Except that that better story out of Europe in political terms didn’t materialize until a couple months ago, or now really, after the French election. Until then, we were all looking at 2017 and thinking how much worse is it going to be after 2016, and fearing for a disaster. So it’s taken some time for that positive feedback loop to work.

MALLABY: Did you want to comment?

ALEXANDER: Yeah. Just one point on the dollar. I think it is worth noting that this administration has a very different approach to the dollar than what has come basically since Bob Rubin was secretary of Treasury. For basically from, you know, when Bob Rubin came in until Trump came in, the official position of the U.S. government was essentially not to have a dollar policy. You know, we would say we support a strong dollar, but it was effectively a kind of pretty overt, you know, sort of saying we’re not going to sort of intervene, we’re not going to try and affect markets. You know, there’s only really one case of intervention that was material during that period.

Trump has a very different attitude. I think Trump’s made it very clear that they do have a view on the dollar. Now, what they’re actually prepared to do about it is an open question. But this administration talks about the dollar in a very different way than what preceded it for 20 years. And so, to a certain extent, I think part of what’s gone on has been a reflection of that. And—

MALLABY: You mean weak is good?

ALEXANDER: Yes. Trump’s been pretty explicit about it.


Let’s talk a bit more about Trumponomics. And I want to get to, particularly, this question of, you know, is the worst that we can imagine that Washington does nothing? Or could it actually make stuff worse for the economy?

So, Rebecca, let’s talk about the tax plan, you know, which was released a while ago. It was a very long document. You may not have read the whole thing. I think Lewis told us it was 291 words.

PATTERSON: Two hundred and ninety-three. (Laughs.)

MALLABY: Two hundred and ninety-three, I’m sorry. My apologies. (Laughter.) Do you suppose that—you know, they’ve obviously got to do health care first. What do you expect that we actually get on a sort of 12-month view from now in terms of either tax reform or tax cuts?

PATTERSON: My hope is that self-preservation will help result in some sort of tax reform getting done. If I am a member of the House or the Senate and I’m facing an election next year and I’m a Republican, I want to show my voters that with a Republican president and a Republican majority, yes, we can actually do something we promised them to do. And I think that political motivation, as much as anything, still makes me hopeful that something can get done before next—call it next spring.

MALLABY: And the something is tax reform, or just a tax cut?

PATTERSON: Well, yeah, tax cut/tax reform is an open question, in my mind. I’m not even sure they know yet. I think they’re still trying to figure out what can they get passed and in what format, is it reconciliation or some other format. And I think that’s a very open question.

But that’s my hope. My fear is that the events like those we’re living through this week are distractions, and distractions delay focus. It’s very hard for Congress to focus on any kind of legislative initiative if they are constantly having to deal with the media or deal with constituents who want to talk about what’s going on in the papers today. And the longer it gets delayed, the greater the risk that it just doesn’t get done at all. So I’m hopeful, but I am—I’m certainly not confident at this point on tax reform.

MALLABY: And, Lewis, I mean, you know, one feature of this team is that there are a lot of empty chairs in the administration. Another feature is that those people occupying chairs may be focused on hiring lawyers. (Laughter.) Is this sort of personnel distraction such that the budget—I mean, how do you see—they’ve got to produce a budget next week, right? How is that going to play out?

ALEXANDER: So, on the specific issue of the budget, I think it’s less of an issue. The budget is produced by OMB, very strong career staff. It’s mostly done by the career staff. There will be a budget. I don’t think that’s the sort of thing that is particularly constrained by this.

Tax reform is a bigger problem, in part because it involves complex policy choices. I’ll go a little bit further than Rebecca did and say my expectation is, is that we will get a tax cut by the end of the year. And the distinction that I would make is 1986 was broad-based corporate tax reform, took many years to put in place—essentially revenue-neutral, but, you know, obviously a very complex thing to put together. Tax cut, 2001, Bush comes in, let’s just lower the rates for those purposes. I do not think the political process that we have can sustain the difficult choices that have to be made in something like 1986; 2001 is a lot easier. I think it’s basically the one thing Republicans can agree on is cutting tax rates, and so I think we’ll get some version of that. But I view that as relatively simple.

On the staffing problem, I think the way to think about that is if you think of the nexus of things that the administration can do kind of on their own, those things do depend on there being kind of bodies in place. So, for example, if you think of the deregulation agenda, some of that is legislative, but frankly, not much. Most of that is stuff that’s going to be done through the normal process of redoing regulations. That is dependent upon having your appointees in place, and the fact that that is all being delayed is a problem. I think ultimately that stuff happens; I just think it takes longer.

I’ve heard people argue—and this makes sense to me—that the scarcest resource in Washington right now is actually time on the Senate’s calendar, right? If you look at the fact that they’ve got all these appointments they have to do, if there’s comity and the minority is willing to let people go through without exhausting the full amount of debate that is theoretically required for each nomination, that can all happen relatively efficiently. The notion that you’re going to get that kind of comity in this environment I think is doubtful, given the nature of the appointments that Trump has made. The bottom line is you have a significant kind of bottleneck in the Senate at this point, and adding a confirmation of a new FBI director is not going to make that problem any easier.

MALLABY: George, perhaps, you know, come to you a bit about—did you want to say something about this? Yeah.

PAPACONSTANTINOU: Yes. No, the view of the outsider here is the following. The main concern was disruption, was a real translation into actual economic policy of a lot of the stuff that was said before the elections. And now we seem to be in a period where some of the symbolic things tried to happen, didn’t quite make it, but the others which could have important ramifications for global trade, for example, kind of took—either went on the backburner or went into much more traditional kind of negotiating. And that has made everyone outside the U.S. pause with relief. And in that sense, the various obstacles along the way can be seen as a positive thing because they take away the ability to move very quickly in a doctrinaire direction that the rest of the world—at least the part of the world that I would sort of like to speak for—(chuckles)—would think is the wrong direction, and would be detrimental for growth and for markets.


ALEXANDER: Yeah, if I could just follow up. You asked the question, like, could bad things happen? And trade is one of the most sort of important areas. And I would very much agree with the way you characterized it, which is certainly the way the administration has behaved is at the moderate end of the spectrum that seemed plausible coming out of the election.

Now, the one thing I would qualify that with is there are a bunch of ongoing negotiations. That trade—the process of developing trade policy has itself been held up by appointments. We’ve only recently gotten the USTR in place, Lighthizer. So it is possible that that will actually speed up.

I do worry a little bit about, if you’re blocked in this area, you become more active in this other area. But the evidence, which seems to be that Trump is susceptible to arguments that doing things that are overtly disruptive are bad, is encouraging. I mean, the way the whole NAFTA thing played out I think you have to look at and go, gee, there was a policy that he wanted to pursue, people objected, he listened and changed course. That’s reasonably constructive.

And I would—I would very much agree that this kind of positive sense of, well gee, the odds of something really bad happening have gone down I think is a very important aspect of where we are. Trade is the most obvious place for that. There are other places where that’s, you know, not so obvious.

Like immigration is another area where he has a lot of control. How disruptive, say, for example, they’re going to be on legal immigration is an interesting and important question that we don’t really know the answer to. It’s kind of up to Justice.

And so—but I think that sense of, like, the downside risks have gone down.

MALLABY: The other factor here is presumably the potential for frustration and how that impacts on decision-making. And one place where the frustration could come from might be nasty budget politics—that, you know, you get to another debt cliff and so forth, a debt ceiling problem.

But on trade, I mean, to the extent that the nation’s current-account balance is the flipside of savings minus investment, you know, if you got a tax cut that reduces national savings and all other things equal, so that implies a worse current-account performance; if you got a(n) infrastructure plan, that implies more investment, which implies a worse current-account performance; if you did something which allowed corporations to repatriate offshore profits, right, which are held in other currencies, about half of them, and they come into the U.S., that implies a stronger dollar and a worse current-account performance; you can see a bunch of ways in which the selected metric which the administration prefers to look at, namely what is the trade balance, actually starts going against them, and then they get angry. Is that—who wants to—

PATTERSON: I think that’s a risk. I think maybe the good news there is that it takes quite a while to see a meaningful change in a current-account deficit. So for them to react to a significant change in the deficit is probably quarters, if not years away. That would be my hope.

You know, I would also say, with the trade, you know, I agree that we’re not out of the woods completely. But not naming China a currency manipulator last month by the Treasury Department, I saw a great deal of relief on that one. Using the scalpel rather than the sledgehammer on some of these trade negotiations, removing the negative or reducing the negative equals a positive in terms of market sentiment. And I’d say the same is true for the French election: removing that negative risk equals a positive. And so when we look at all the uncertainties in the world and we look at where the market levels are, I think it’s not just the positive news on GDP or earnings, it’s also the fact that some of the worst-case scenarios that we truly feared and were partially reflected have been reduced and/or removed.

MALLABY: Maybe that’s a good segue to move to Europe. I mean, so, George, I want to ask you one question about Greece and get the benefit of your particular expertise there. I think I’m right in saying that Greece is now in recession for the first time since 2013.


MALLABY: But the potential release of money from the EU creditors is expected to fix that, is that right? So how do you see the outlook?

PAPACONSTANTINOU: But 2013 was an outlier because it was the only positive—slightly positive year in a seven-year itch, kind of, of recession. (Laughter.)

So despite the fact that the numbers that came out for the first quarter of this year were worse than expected, I maintain a positive outlook here—and that has to do with the fact that I think that the tail risk is pretty much gone. What we lived through in 2015 is not about to be repeated—that the boxes have been ticked in relation with the creditors. You have a deal. People are kind of shrugging it off and the markets are shrugging off Greece now. We’re no longer in the headlines the way we used to, which is a good thing. And the remaining question is whether you will have a coming of minds between the IMF and Germany—I won’t say the European; I say Germany—on the issue of debt relief, which will trigger Greece being included in the quantitative-easing program of the ECB and some kind of return to normality.

It doesn’t solve all the problems, but we will stop being the outlier in that sense, because at the moment we are the only country which had negative growth in Europe and the one which continues to have the biggest structural issues. So it’s going the right direction. It’s very painful. It has taken—wasted a lot of time. There are still potential problems, and the underlying—some of the underlying issues have not been resolved. But I think both in—

MALLABY: The sheer size of the debt stock surely is still—

PAPACONSTANTINOU: Yes, although the way of looking at it has shifted from the part of the institutions—no longer looking at the headline figure, which is very high but also misleading. And it’s very hard to talk about sustainability—look at Japan, for example—because at the end, with the kind of debt stock that we have—because three quarters of it is held by the official sector, which means that it can be varied by fiat—it does not depend on market reaction. So it has—the discussion has shifted from the headline figure to the ability—gross financing needs, the ability to service that debt over the medium term.

And if there Europe, prodded by the IMF, kind of gives assurances and specific measures—extending maturities, grace periods, capping the rates; that’s the hardest part of the three—which gives investors some ability to look forward with some confidence, then that will be the last remaining obstacles—obstacle for growth to resume. And then the rest of the stuff, which is structural reform, is reformed.

MALLABY: That’s rather a big caveat at the end. (Laughs.)

PAPACONSTANTINOU: It is a very big caveat. However—and it goes hand in hand—any kind of debt relief will go hand in hand with very strong conditionality on the structural front. And the structural front isn’t only a liberalization of markets. It’s also institution-building, judicial reform, and the like.

MALLABY: So I think you were delicately hinting earlier—when we talked briefly about the European Union’s economic performance, you said there were some weak points. I guess you meant Italy. I mean, Italy is the country after Greece with the highest debt ratio. And the growth numbers are—you know, despite the overall better news out of the European economy, Italy is still lagging.

How do you think—is this going to be a crisis in the next three, five years, or—

PAPACONSTANTINOU: Well, Italy is problematic in both political and economic terms. I think the politics are well understood. We are—

MALLABY: I mean, the politics are unfathomable, actually. That—

PAPACONSTANTINOU: We’ve dodged a bullet in the Netherlands. France gave a big hope for a renewed discussion around where Europe needs to go, with a young French president willing to sort of cut a grand bargain with Germany. So the remaining political question is Italy, because you just don’t know where the politics will go. And if you couple that with an economy that continues to be weak and with a banking sector where you have not had the repairing of the balance sheets—you have NPLs of 300 billion euros there—that’s a real danger point, because the private and the public-sector debt are feeding on each other.


PAPACONSTANTINOU: And not enough has been done to clean up the banking sector.


Rebecca, maybe I could come to you on the question on France. So the thing that strikes me about the Macron agenda is that he’s promising supply-side reform, labor-market reform, and so forth. At the same time, he wants to cut the fiscal deficit. So he’s going to reduce demand while sort of trying to be, you know, reformist on the supply side, which, in the short term, can be negative for demand; all of this in the context of a 10 percent unemployment rate.

Does this work out well for him?

PATTERSON: I think the probability of Macron achieving his agenda is incredibly low. I think the June parliamentary elections will be important to see what sort of support he has to push forward on an agenda. But even if the unions in France are not as powerful as they were 20 years ago when I lived there, they’re still a very loud, powerful voice in the country. And we haven’t seen politicians in France very successfully push back against them and run over them.

So, again, I think Macron winning removes a negative risk. But do I expect that this is a catalyst for substantial positive change for France? I don’t. I think this is just kind of steady as she goes.

I think the German election will be quite interesting this fall. You know, it does appear from the recent state elections that Merkel is in a pretty good position, which I think is good news. I’m curious to see what happens with her finance minister. And I think that could be the seat to watch in terms of policy shift, at least at the margin, in Germany.

And George, please jump in if you disagree or want to add to that.

But if you could get a finance-minister change, which I suppose would be more likely if Merkel doesn’t have a very strong mandate, and that person is less in favor of austerity, relatively speaking, that could be an interesting catalyst for growth or catalyst for more pulling together of Europe than we’ve had previously. And that could be—that could be a positive, I think, or at least perceived that way by a lot of investors. But I’m not expecting big change or big success out of France. I mean, I’d like to say I am, but I’m not.

PAPACONSTANTINOU: Wolfgang Schäuble became finance minister in October 2009, two weeks after I did. He’s met nine Greek finance ministers—(laughter)—some of which were more flamboyant than others. (Laughter.)

But, yes, I completely agree with Rebecca in the sense that there is—for a long time I’ve lived with this narrative of a slightly different outlook between the chancellery and the finance ministry. And I think there’s something to that. It’s not just a good-cop-bad-cop routine. I think the finance ministry has hardened its position on a number of things over—especially in the last few years, especially over Greece, but not only over Greece.

And the slightly more optimistic take on Rebecca’s concern with the Macron presidency, which I share, is that a lot will depend on what kind of response he gets from Berlin.

If there is a bit of a leeway there which allows him to sell a more radical liberalization agenda, which goes against many of the things that France operates by, but with a more Europe kind of approach and a correction of the cap in European economic policy, that will give him the kind of degrees of freedom perhaps to be able to move forward where others have failed, because when Chirac tried that in the very beginning of his first term and then abandoned it, there was not much outside support. And it was also a very different context.

I think one shouldn’t underestimate the dynamic that this election creates, while not, of course, at the same time—I don’t want to dismiss the traditional problems that they have in reforming France.

MALLABY: Right. I mean, Macron is clearly a political phenomenon. He came out of absolutely nowhere and beat all these experienced politicians. So we shouldn’t discount him.

I’m going to ask Lewis to comment on Europe, and then I’m going to come to members for questions.

ALEXANDER: Just very quickly, I want to make two observations. One is I do think Brexit kind of shakes the mix, changes the mix in Europe. And it’s not just Brexit. It’s the fact that some of the expansion looks somewhere different now. So say, for example, if you look at the attitudes of governments in Hungary and Poland towards EU, it’s different than sort of the assumptions that were made at the time when the Berlin Wall came down and you kind of made the expansion choice. Obviously, Turkey is in kind of a very different place.

And if you take Britain out of the mix, the argument for sort of intensifying the integration among the core, it starts to take on a bit of a different character. And in some sense the question of does that create opportunities that allow you to kind of move in a different way.

So, on the one hand, I would argue that circumstance is potentially positive. On the other hand, you kind of look at Germany right now and kind of go, why did they really want to change anything? To some extent, their performance has been so good, it’s hard for me to see this election as generating a lot of sentiment on the German part for, gee, we need to take risks to change things.

This feels very much like a kind of status-quo election to me from the German perspective and the argument that they’re not going to be inclined to take a lot of risk. I just—I’d like to be more optimistic, but it’s—I just kind of look at where Germany is, and it’s kind of hard to see that.

MALLABY: OK. So questions from members. Remember, this is on the record. Put your hand up if you have a question to ask. Otherwise—I can see one over there. Yeah. Microphone coming.

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

You mentioned Italy. I wonder how important you view the criticality or the importance of Italian economy in the EU or world at large going forward. You’ve got a major still G7 country we all should be paying a lot of attention to. Or in the grand scheme of things, especially with the rise of China and other countries, it has been largely marginalized in terms of its impact.

Secondly, in terms of Chinese currency, RMB’s rise globally thanks to the latest push by Xi Jinping’s One Belt, One Road initiative, that will get to Europe. So while we stay on that continent here, what’s your estimation of the RMB currency value, the euro, the pound, and the U.S. dollars in the next couple of years, if you have a sense of any of that?

MALLABY: OK, there’s a lot there. I mean, maybe we could actually focus this on the China piece, One Belt, One Road. There has been some debate, I think, as to, A, how much of the announced infrastructure spending in the headline is new stuff, and how much of this is sort of a Washington-type game where you package together a bunch of old things that you were going to do anyway and you’re sort of exaggerating the overall effect.

I mean, there was this moment when, after the crisis, we were told that the renminbi was about to be a global reserve currency. It hasn’t happened, as far as I’ve noticed. Is One Belt, One Road more impactful or less impactful? I think that might be a way of coming at this.


ALEXANDER: My inclination is less. I’m skeptical of the fundamental economics of it as being transformative. Look, more infrastructure is better. You know, those things become facts on the ground. We’re having this meeting today in New York, as opposed to in Boston or Philadelphia, because of the Erie Canal that was built that made New York the most important city in the U.S., as opposed to those alternatives. But it’s hard to see this one as really kind of having that effect.

I think your point about renminbi as a reserve currency is a very important one, which is there are a lot of things that make a reserve currency. And one of them is the willingness of parties who are not in that country to contract in it because they have essentially confidence in rule of law and all of those things that come with it. And it’s hard to see China getting over that hump any time soon.

So, look, I think this is an evolution. Obviously, China is growing very rapidly and is going to continue to be an important part of the global economy and is going to grow over time. But I don’t see those things as being kind of things that are going to transform this overnight.

PATTERSON: If I could just add on the RMB, you know, the triennial survey that the Bank for International Settlements does on currency transactions, I think, is very telling, because if you look at where the RMB was 20 years ago, it didn’t even make the top 20 list. And year after year after year it continues to grow in terms of international usage. I completely agree with—

MALLABY: That’s in trade, or that’s as a—

PATTERSON: That’s total transactions.

ALEXANDER: As a total of those transactions.

PATTERSON: But it’s mainly going to be trade. But it’s happening. It’s happening with trade first. Obviously, China has done a few two steps forward, one step back, on the capital account. Am I going to open it? Maybe not. And they’re worried about disruptive capital outflows that could affect the overall economy. So I think it’s understandable that they’re being very careful and slow and deliberate on that.

But I would note that the usage of renminbi continues to slowly grind higher. I’d also note that the correlation between China’s economy and the rest of the world and China and the United States continues to grow. And if you look at our two stock markets, the positive relationship between the U.S. and the Chinese stock market continues to rise; not in a straight line, but if you look over the last 20 years it’s amazing how much that’s changed. And so we are increasingly interlinked.

I think for China to be a real contender as reserve currency, to me the two big missing pieces are the more open capital account, so the usage is not only trade, and then a much bigger, deeper bond market. You know, the U.S. is saved by the liquidity of its bond market. Even when we create our own problems, people still need to hold our treasuries, because there’s nowhere else to go.

China doesn’t have that yet. Maybe it’s 10 or 20 years from now. But China, if it gets there, then I think it really would be a contender as a reserve currency.

MALLABY: George, the bullish story on One Belt, One Road is—you know, the story that says it’s impactful is essentially that the world is becoming a series of regional factories with supply chains that are actually not global, because that’s logistically inconvenient, but they are regional. And so there’s factory Asia, you know, factory U.S.-Mexico-NAFTA, and then a sort of European one.

So, to take Rick’s question—and there was a part of it which was about, you know, the relative importance of Italy or the EU more broadly and the rising powers of Asia—do you think this factors into, let’s say, German decision-making with respect to how much to care about France, how much to stimulate in order to help Macron? You know, if you don’t build this region, there is this looming threat in Asia. Just talk about the psychology of European decision-making on that.

PAPACONSTANTINOU: Well, I think that Europe looks at Asia, and in China in particular, with a very mixed—has a very mixed view. If you look at it from a Greek standpoint, the only country that has really invested in Greece in the last few years, in the middle of the crisis, has been China. So, for us, it’s been a positive.

However, at the same time, we’ve seen the European Commission blocking or being concerned about specific acquisitions made in a eurozone country by China. Yesterday only, in the midst of the privatization of the country’s largest insurance company, the U.S. Commerce Department sent a letter—well, there’s two contenders, one of which is American—Greek-American, actually—and the other one is Chinese—saying we hope that you respect the rules of the game here, and therefore the U.S. contender gets it. So, you know, there is this mix. I think everyone has it, and certainly Europe has it, but also the U.S.

My bit of sort of—in the discussion on the One Belt, One Road is that a lot of the impact will depend on whether this will be accompanied by a real shift in the Chinese attitude towards global capital markets, because it is clear that that’s—that is what will make it—will take it beyond the positive infrastructure bump to something beyond that. And we haven’t seen that yet, but that will be.

One last, if I may, comment on Italy. If we learned something from the eurozone crisis, size doesn’t really matter, I mean, because you are in a very imperfect institutional arrangement. And Greece almost exploded the whole eurozone. And Italy, of course, is much bigger. And so you have that, but also you have the size element.

The only reason why people are not too worried about Italy at the moment is because the rest is pretty much functioning OK and has been fixed compared to where it was in 2010. And that’s what makes people a little bit more relaxed about Italy, because if you look at certain of the numbers around Italy, you have more cause to worry.


Yes, let’s come down here. Arturo, microphone behind you.

Q: Good morning. Arturo Porzecanski with American University.

I was—this is a question about inflation, deflation, and interest-rate outlook in the U.S. versus in Europe. It looks to me like we may have left the world of deflation behind us. And so let’s talk a little bit about inflation and interest rates going forward. And in this connection, I don’t think you made a sharp enough difference between the starting point in the U.S. versus the starting point in Europe, right.

Here we have unemployment of 4 ¼ percent, and we can discuss how much labor slack there is. In the eurozone, it’s 15 percent, and—


Q: Pardon?


Q: Ten now. And the—you know, the gap between actual and potential output in both areas is very, very different.

So what’s your feeling? Could we be underestimating inflationary pressures in the U.S., particularly with a weakening dollar and maybe not worrying enough about deflationary forces still in Europe?

ALEXANDER: I’ll take the U.S. half of that.

Look, I think, for all the reasons you describe, the right outlook for inflation in the U.S. is up. I think what’s hard to imagine is some very dramatic acceleration in inflation in the U.S. So all of the evidence would suggest that since the Volcker disinflation, the Phillips Curve has gotten a lot flatter. And so, yes, the output gap is—you know, we’re probably now operating beyond full employment, give or take, and we’re probably going to push further beyond that. And that will tend to push up inflation. But it’s hard to, I think, make an argument for why it ought to sort of dramatically accelerate.

And so I do think inflation is going to go higher. What I would just argue is it isn’t at all obvious to me that there’s a good argument to expect it to go up quickly. So, for example, in the late `90s, for example, we got the unemployment rate down to the high 3s. And that was a period where core inflation continued to sort of come down. Inflation expectations remain very well anchored. If anything, they’re falling; they’re not rising.

So if you look at, say, for example, survey measures, like the Michigan survey, those are continuing to trend down. The market-based measures came down, went up, have come down again. But when you look at sort of the broad things that you ought to think ought to drive that, it’s—I think it’s tough to make the case that there’s going to be some sort of dramatic acceleration.

PATTERSON: Yeah. When I’m watching inflation and breaking it into components, oil prices, at least in the near term, very hard variable to forecast. But for whatever it’s worth, you have a lot of producers trying to put a floor under the price for a variety of fiscal, geopolitical, and other reasons.

And then you have technology allowing U.S. production to turn on and off much more quickly. Rig counts in the U.S. have popped back up to about 700. That’s putting a ceiling in terms of supply, at least, in the near term. So oil is probably not going to be the main variable driving us. It’s probably in a range, at least in the near term. You go to housing, which is, I think, if I’m getting my numbers right, about 40 percent of the CPI basket. It’s probably trending higher. So that’s a positive for inflation; wages trending higher.

But one thing that’s different this cycle that I keep thinking about, the technological disruption that’s creating more transparency and slowing the pace of inflation, because so many costs are able to get pushed down. I think that’s another reason why I’d add to Lewis’s comments, why we don’t have to fear the spike in inflation that perhaps we might have seen in the past with an unemployment rate where it is.

MALLABY: George.

PAPACONSTANTINOU: Yeah, I think you’re absolutely right to make the sharp distinction. There’s an additional distinction, which is that in Europe, where there is more fiscal space, certainly in a number of countries, and where we don’t expect the ECB to stop its accommodative policy any time soon, even though there’s pressure there, you can have a situation where you have more demand stimulus and yet unemployment is still not going down, because of the well-known structural rigidities that Europe has. So the supply-side stuff needs to come a long way to help the demand-side action.

MALLABY: Yes. Let’s go here; just behind you. Yeah.

Q: Hi. Juan Ocampo with Trajectory.

I want to ask about the difference in corporate reinvestment rates that apparently are going on between the U.S., Europe, and Asia. From what I’ve read—and correct me if this is incorrect stuff—if you take a look at share buybacks and dividends to shareholders versus corporate reinvestment, it’s roughly one to one in the U.S. In Germany it’s four euros to one in terms of four reinvestment, one payout; I think in France two and a half to one. And in the growing Asian economies, I think it’s like Germany, four to one.

Why is this going on? Because in Europe in particular, with lower growth, older population, you might think in first principles it would be the reverse. It doesn’t matter. If this persists, will that make a difference in productivity, in growth, or what have you? It’s a conundrum to me, so I’m just posing the question.

ALEXANDER: I don’t know the answer to it. I’ve thought a lot about the sort of dynamics in the U.S. And so I haven’t looked at the other regions. So let me offer kind of a few reactions.

I think, for the question of why is it, why is corporate investment so low in the U.S., I think there are a variety of answers. It starts with, frankly, growth prospects just aren’t that good. So you look at potential growth here. It’s not that strong.

Second of all, if you look at what is the nature of innovation today, it’s very different than it’s been in the past. So if you think about a company like Uber, for example, it can create a tremendous amount of value with essentially very little capital expenditure.

You compare that to, say, you know, what Henry Ford had to do in the middle of—in the beginning of the 20th century to build the auto industry. That required, to essentially realize the idea of the innovation, a tremendous amount of capital spending. And so you have this kind of nature today where the innovation is, in some sense, weightless and is just generating, and you see this kind of across firms.

I think the—a lot of people have raised questions about whether or not there are particular incentives for corporate CFOs in the U.S. that boost those payout rates. I’m—I have no doubt those things exist to some degree, but I don’t think you can kind of explain this entirely.

The last point I would make is U.S. corporations are quite profitable. So I suspect part of the difference is when you look at, say, for example, investment rates sort of independent of what corporate earnings are, they’re not that different in the U.S. and Europe. You know, partly the answer may just be the overall corporate profit level is higher here.

And so it’s not that they’re—U.S. corporations are investing in some absolute sense less. It’s that they’re earning a lot more and turning it back to shareholders, as opposed to, particularly in Europe, where I suspect corporate profit rates are lower, but as I say, I haven’t really—

MALLABY: You did mention concentration in your story. So some people would say more concentration in the U.S., less competition, and therefore higher profits, therefore maybe also less incentive to invest.

ALEXANDER: So when you look at that across industries, it’s less obvious. So there are some industries that are more concentrated than others. This general pattern of low levels of capital spending is something which is kind of independent of that. It—so people talk a lot about that in the tech sector.

That is something that has changed fairly dramatically over the last 20 years. So if you look at kind of the tech world that existed 20 years ago, it was not dominated by kind of a handful of very large firms. But, to be perfectly frank, the investment rates weren’t higher then either. So I wouldn’t totally discount that, but I don’t think that’s a total explanation as well.

MALLABY: Do you guys want to comment, or should we go for more from the floor?

Members, who’s got a question? Yes, I can see one right here.

Q: Art Rubin with SMBC.

The commodity sectors had kind of a wild ride since the U.S. elections, with a tremendous rally, driven largely on the expectation of reflation in the U.S. and stimulus. More recently you’ve seen a lot of commodity prices tumbling. It may be that each unhappy commodity is unhappy in its own way. (Laughter.) Or it may be that there’s some broader theme here and that the rosy scenario for growth in Europe, China, and the U.S. is masking something else that’s causing this decline in commodity prices.

Any thoughts on that?

ALEXANDER: I’ll just offer one observation. To be perfectly frank, I think the growth expectations that followed the election were kind of unreasonable. And to a certain extent, things are coming back to normal. I certainly—you’re certainly seeing that in the U.S.

I think Europe is—you know, if you look at the global story, Europe’s obviously a place where things are kind of notably doing better. I would argue China and Asia, it’s kind of up and down, but it’s generally in a context of the election didn’t generate some, you know, transformation of the growth outlook. And that, I would argue, is the primary issue.

PATTERSON: And I’d add to that. I think there’s something to your comment about each of them being unhappy in their own way. I think often market commentators will try to lump them all together and generalize, and I think often that’s oversimplifying the story.

So, you know, when we saw oil prices falling from March to early May about 13 percent, a big, sharp move, and copper prices were also falling, everyone could say, aha, it must be China, because China is such a big delta in demand for both of those commodities. And there might be some truth to that. China is clearly trying to do some fine-tuning, tightening, to keep the credit bubble from getting too big. But there’s also other variables, supply and demand, that’s affecting both of those commodities.

So I think there’s a lot more nuance to it. I think there are some demand—broader demand drivers. But there’s also a lot of commodity-by-commodity issues there. You know, it’s interesting, because towards the end of an economic cycle, when you see inflation—we were talking about inflation earlier—that’s when you tend to see commodity prices start to rise, people buying them as a hedge against inflation in part.

And that’s when you often see emerging markets do well, because so many of those economies are commodity exporters. So they all tend to outperform together at the end of an economic cycle. And you wonder, will that occur again or is this time different? You know, can China stay stable enough to keep that demand driver going? Will we have enough inflation, given technology and other issues, to cause people to go back to commodities?

We haven’t really seen that yet. But historically, if you go back the last couple of decades and you look at the end of each cycle, those last few years, before things tip over into recession, that’s the period where commodities, inflation, and emerging markets tend to shine.

MALLABY: Interesting.

Do you want to comment on that?

PAPACONSTANTINOU: I’m struck by Rebecca’s word of caution in the end, actually, because, yes, it is—if we’re seeing a brightening or a brighter outlook globally, then one should expect commodity prices to go up, irrespective of their particularities. But the danger point that Rebecca is pointing out is a very interesting one, actually.

MALLABY: Yes, let’s go right here.

Q: Talk about an upcoming recession is rather commonplace and appears to be not highly predictive. My friends tell me that the best you can say is there’s a 25 percent chance every year that there will be a recession. And that’s about what you can say.

The thing that I don’t see as much commentary on—and I’m interested in what the panel thinks—is at some point, presumably, we will have a recession in the U.S. And what sort of commentary can we make on the likely depth of this recession? You know, we’ve had an economy that’s been growing for a long time, on the one hand. But it’s not been growing very big. And those seem to be two factors pointing in opposite directions. So I’d love to hear the commentary.

MALLABY: So a question about resilience.

ALEXANDER: I’ll make two comments. One is, the indicators of financial imbalances which preceded the recession in 2008 and 2009 are absent. I think it’s likely, if we have a recession in the relatively near future, it’s not going to be one that’s driven primarily by financial imbalances. And so that suggests that it certainly won’t be as deep as the most recent one and will—and so you can kind of put that to the side, I would argue.

The second point I would—

Q: But that’s too easy a comment. It’s not as deep as the last one. (Laughter.) (Off mic.)

ALEXANDER: So I’m not done.

PATTERSON: He’s warming up.

ALEXANDER: I’m not done. I’m not done.

The other big change to me from the election is the fact that I now think you’ll get a pretty decent fiscal response. So one of the things I think about when I think about those options is, before the election I would have assumed continued gridlock and essentially the Fed was going to be on its own, and that was sort of daunting. So I think this time you’re more likely to get some sort of fiscal response which will have the effect of sort of dampening it.

Look, I—if you kind of look at the sort of history of these things, there’s the world that existed before Volcker, when we had recessions relatively often. They tended to be deep and have sort of Vs. There were minor ones, but that was kind of that world.

Since the early `80s, we’ve essentially had two very minor recessions and one really big one. I think we’re much—the next one is more likely to be in the two minor ones than the really big one. That’s, I think, about as much as I feel like I can say.

PATTERSON: So I’ll go dark. I agree with Lewis. My base case would be a shallow recession, in large part because you don’t have the same imbalances that we had certainly around the last one, not even by a margin.

What makes me a little more nervous, going back to a few of my comments earlier about the interlinkages between the United States and China—and we look at the structural challenges China is facing in terms of how its economy is growing and what’s driving that growth—even if the U.S. recession is shallow, is that enough to be a tipping point to cause this Chinese hard landing that everyone’s been fearing and talking about for years and it never happens?

That is something that keeps me up at night; very hard to predict. We know China has a lot of tools it can use to try to stabilize things and prevent that outcome. But especially after we get through the fall party congress in China, and President Xi Jinping feels maybe he has more flexibility on policy for the subsequent years, if we had a shallow recession in the U.S., maybe it’s shallow in absolute terms, but we think about the global spillover effects.

Could something happen in China that creates a much deeper global issue? I don’t know if that’ll happen. I just don’t know. But it’s something I think about quite a lot.

MALLABY: George, dark or light?

PAPACONSTANTINOU: I’m closer to Lewis, with one—one sort of comment only, which is that, yes, I think that fiscal policy will be able to help in ways that it couldn’t. But there’s less scope from the monetary side to also help. So that—you know, you’re again with the one-legged policy, so to speak.

MALLABY: Maybe we can squeeze in one last question, if it’s a quick one. Has anyone got a—otherwise I will—OK; quick one there. Right. Microphone right there.

Q: Peter Gleysteen, Progow Corp.

So what would tip the U.S. into a shallow recession?

MALLABY: OK. What’s the trigger? Let’s go down the line; quick comment each. Go ahead.

ALEXANDER: Look, the consumer is the biggest part of the economy. And something that would sort of rock the confidence of the consumer is sort of the obvious kind of first answer.

Consumers have been quite cautious since the last recession. And in spite of, say, for example, the relatively strong confidence numbers we’ve had recently, consumption has been relatively weak. And I can imagine circumstances where political developments, you know, could cause people to pull back, and it would be something like that.

MALLABY: The Brexit vote led consumers in the U.K. to spend more, interestingly. Yeah, Rebecca.

PATTERSON: So I’ll go through the happy traditional scenario. So we get to spring next year and the Republicans are able to get—let’s go with a tax cut. That’s even better. So we get a tax cut. We have some fiscal stimulus where the unemployment rate is already at 4 ½, 4.2 percent. And that juices up the economy a little bit. The Fed has more confidence to hike a little faster. Mortgage rates go up. Borrowing costs go up. Profit margins get squeezed further because wages are going up. And we tip over into a shallow recession initially. And then if China makes it ugly, it gets ugly. Otherwise it’s shallow.

MALLABY: So overreaction from the Fed, really.

PATTERSON: Yes, perhaps.

MALLABY: George.

PAPACONSTANTINOU: And I’ll add an external factor, which is a full-scale trade war, which I think is highly unlikely, but—

PATTERSON: But possible.

PAPACONSTANTINOU: —could be the one to do it.

MALLABY: On that dark, unhappy note, thank you very much for coming. (Applause.)


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