World Economic Update

World Economic Update

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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 going. The Council on Foreign Relations believes in free debate, but not too much. So please be quiet now. So welcome to the Council on Foreign Relations World Economic Update with Soumaya Keynes over there, Adam Posen in the middle, and Vincent Reinhart next to me. Vincent is the chief economist and investment strategist at BNY Mellon Asset Management. Adam is the president of the Peterson Institute here in town. Soumaya Keynes is the U.S. economics editor for The Economist magazine, and also I think the last time I saw you on stage, Soumaya, was when you were singing in a jazz band called The Invisible Hands. (Laughter.) But we won’t be singing today, I’m sorry to tell you. (Laughter.)

So I’m Sebastian Mallaby. I work here at the Council. And we’re going to talk about the world economy for half an hour and then invite you all to throw in your questions to the panel. I think it’s fair to say that in terms of the sort of big picture growth numbers, we’re still in a pretty strong phase. I think the latest IMF WEU forecast is 3.9 percent for 2018, so above trend, above last year. But at the same time, there’s a sense the risks are building up. And if I were to list a few, there are the trade tensions, the sense that the U.S. interest rate cycle is disrupting emerging markets, some concerns about other fixed-income markets—whether it’s Italian sovereign debt or possibly U.S. corporate debt. We’re in the home stretch of the Brexit negotiations, which have been putting everyone to sleep for a long time, but now they actually matter because we’re coming up towards a deadline. And maybe a sense that the whole system—the sort of good growth story is undergirded by a U.S. fiscal stimulus that isn’t sustainable.

But we’re going to go through these worries, concerns one by one, starting with Soumaya on trade. And I guess on trade, Soumaya, you follow this intensively. My less sort of notes in the details kind of question would be simply: Have we seen peak trade? I mean, are we at a point where in fact now the concerns are going to diminish, because there has been a de-escalation with Europe, because NAFTA might go through. So start maybe with NAFTA. Are the Canadians going to cave?

KEYNES: (Laughs.) Well, if I—if I knew that I would be very well-informed. (Laughter.) So—right. So what’s going on right now with NAFTA is that, you know, everyone thought this was going to be a trilateral. And the most interesting political relationship in all of this seems to be the Mexican-Canadian one. I think pretty stern words from the Canadians when I transpired that actually the Mexicans were prepared to go it alone with the U.S. And so what’s happening right now is I think negotiators are working to hammer out enough technical details so that the threat that Mexico and the U.S. will go ahead with just them seems credible.

And so what does that look like? That means that everyone always thought that the most substantive change in a new NAFTA would be to the rules of origin in cars, right? So how much of a car needs to be North American for it to be eligible for these—for NAFTA’s trade preferences? And those rules are going to get rewritten. And for NAFTA to be a bilateral between the U.S. and Mexico, essentially the rules will specify the amount of American and Mexican content that will need to be in a car. And that clearly means that there won’t need to be as much Canadian content in a car for it to pass tariff-free between Mexico and the U.S.

And the big worry is that if that happens, then that will be extremely damaging for the Canadian parts makers who send a lot of parts to Michigan. And this is all a very long-winded way of saying that if they do manage to hammer out these technical rules that would effectively remove Canada from a negotiation that up until a few weeks ago assumed that Canada would be there, then it could be that we do end up with a deal that excludes Canada. And that would just be really horrible for the Canadians and could be—could have a really damaging impact.

I think the Canadians are going to see that. And so, you know, what does caving look like? Does caving look like accepting the sunset review that the Mexicans agreed with the Americans. Maybe. Maybe they could live with that. If caving means—

MALLABY: Tell us what the sunset review is.

KEYNES: So the sunset review. So originally it was that the deal would expire after five years. Now it looks like there’ll be a review after six years. And that if they don’t agree to extent, then after ten years the deal could expire. Now, that effectively gives you a sixteen-year period from day one. So maybe that’s something that they could live with. But it sounds like, you know, one of the biggest tensions is dairy. You know, how much are the Canadians going to open their dairy industry up? I don’t think we know. And then there’s this point about dispute settlement.

And this is actually a persistent theme across a lot of different areas of the Trump administration’s trade agenda, because if you—if you kind of had to put your finger on the most aggressive attack, on one of the—you know, the real pillars of the trading system, it would be this idea that there would be rules that would be assessed by this—something like an independent panel of judges. And what’s going on with the NAFTA negotiations is the Americans want to weaken that system, and the Canadians want to keep it. And so if the Canadians don’t cave, then the thing that everyone should be looking for is what—is whether—is what we have in terms of dispute settlement.

How strong are the legal protections for members of this deal, because if the Americans essentially say, nope, we care so much about weakening these that we’re willing to dismantle this deal, then that’s really, really worrying for other areas in which they’re trying to dismantle the rules-based system, essentially, which includes at the World Trade Organization, where they’re similarly trying to undermine panels of judges who adjudicate on the international rules there.

MALLABY: Yeah, that’s actually a quick segue I want to follow up with you about one other thing on trade. So there was some commentary a few weeks ago in The Economists—I don’t know if you wrote it but I assume you had something to do with it—to the effect that one outcome of the brinksmanship and bullying between the U.S. and Europe would be to force the Europeans into an understanding that they could work with the Trump administration on reforming the World Trade Organization, including changes maybe to the dispute settlement tribunal there. And it kind of presented it, to my surprise, that this was an opportunity for making the system better. Do you feel that that’s—you know, what odds are you putting on making the WTO stronger as a result of that?

KEYNES: So I did have a hand in writing that piece. And—so my kind of read on the geopolitics of this is that what the European Union is trying to do is turn—is not waste this crisis. And so there are a few irritations, frustrations that many beyond the Trump administration share. That’s to do with how the dispute settlement system has worked. There’s this feel that—there’s this feeling that these judges in Geneva have effectively—they are, you know, in their ivory tower making very academic decisions that are undermining the political legitimacy of the—of the system that they’re supposed to be upholding.

But then also there’s China. And there, the EU clearly shares the Trump administration’s frustrations. And so my—so I think when thinking about the U.S.-China dispute, it’s too narrow to focus simply on the Trump tweets. You also need to be aware that there are multiple layers of talks going on underneath that. So we have this—the trilateral negotiations which are going on between the U.S., Japan and the EU. And at the technical level, you know, people from USTR are working with Europeans and the Japanese to say: Well, OK, supposing we think the problem is that the rulebook hasn’t been clear enough. How would we actually write down rules to deal with the root of the problem, to curb these excesses that we believe that the Chinese are displaying, and to stop those occurring in the future?

So I put the odds on them coming up with some set of rules that go some way towards addressing those core complaints. I put those odds very high. The trickiest thing will obviously be, well, OK, supposing we’ve written down these rules. How do you then make sure that they’re enforceable? And there, you run into this inconsistency with what I was talking about before. Because if you’re trying to undermine the enforceable system of dispute settlement in the World Trade Organization, which actually the Chinese think fairly highly of and have a reasonably decent track record of following, there’s a—there’s a real tension between those two. This idea that, you know, actually, maybe that you can just write down new rules and force the Chinese to stick to them with this threat of tariffs being waved at them, but also this idea that you really want to weaken the system that you might have of enforcing that.

And so I’m kind of thinking five steps ahead, maybe, of where most people are. (Laughs.) And maybe we won’t get there. Maybe everything will just collapse in a flame—a bonfire of tariffs.

MALLABY: But you mean if we did get to a point where the rules were written, you’d then have the question of how you interpret and enforce them. And that seems to be an unsolved thing.

KEYNES: Exactly.

MALLABY: So, Adam, when you look at this stuff, in particular I’m curious about your view on a rejigged NAFTA. Is it possible that the new NAFTA could be better than the old NAFTA, or not?

POSEN: Well, this rejigged NAFTA is worse than the old NAFTA. In theory, yeah, you could have written something different and better. It was called TPP. (Laughter.) We don’t have that. So we at Peterson have been looking at this pretty carefully. And people should be under no illusions. Of the deal with the Mexicans goes through pretty much as we understand it—and there’s a lot of stuff that hasn’t been released yet, God knows what. But basically, the core is, as Soumaya says, is that it’s about restricting auto exports and auto part exports to the U.S. in a futile and ultimately self-defeating attempt to try to have more production in the U.S., when what you’re actually doing is making it impossible for the North American auto complex to export anywhere—close paren.

The current version is essentially you’re combining this deal with Mexico, that in some sense is a voluntary export restraint, and the threat of these speciously founded national security tariffs, because otherwise Ford and Toyota and Honda and BMW and everybody would say, well, I can just leave NAFTA effectively and export at WTO tariffs. And so the Trump administration needs this threat of these national security tariffs—which have no basis, let me repeat that—in order to force them to not just ship around this problem.

And so to us, from a—talking from a sort of modeling the impact point of view, there’s—in some ways this is actually worse than if NAFTA had been broken up in terms of direct economic effects. It’s not worse versus the rule of law. It’s not worse versus long term relations with Mexico and Canada. But it is worse in the sense that you’re essentially going to get all the damage to the auto companies and, to rather more importantly, all the damage to the auto consumer and the auto employee that you would if you had seen the breakup.

And so on our estimates—colleagues of mine like Sherman Robinson and Mary Lovely at Peterson have gone through this. And you can generate numbers that are very large in absolute terms, but not very large relative to the U.S. economy. So you can talk about six hundred thousand unemployed if there’s retaliation, some spillover effects in negative reinforcement gets you around a million people losing their jobs. A million people is an awful lot of people. But I’m not a hypocrite. I also pointed out when NAFTA came through that if a million people get displaced in an economy of 155 million workers, that’s—it was 155 million then, but anyway—you know, you got to keep that in perspective. And similarly here.

So one of the—so NAFTA is terrible, the way that they’re renegotiating it. It is going to be harmful for prices. But sort of the macro forecast, and I think Vince would agree with me—it’s not going to make a huge difference to inflation. It’s going to make our prices go up. It’s going to make a lot of things go up. But that’s a one-time shift. And the Fed is supposed to generally look through one-time shifts, as long as it doesn’t get passed on in a whole spiral up.

And similarly with China. You know, if President Trump and the administration put on their two hundred billion—their tariffs on two hundred billion (dollars) more of Chinese goods, it’s going to be a pretty lousy Christmas, especially for poor people in this country. And some people are going to be unemployed. Again, in an economy of 155 million working people and eighteen trillion (dollars), you can’t immediately scale that up and say: Oh, that causes a recession, oh that causes a recession, oh that causes inflation.

MALLABY: Well, let me just follow on—let me get to Vince in a section—but you wrote a very good piece in Foreign Affairs a few months back.

POSEN: Thank you.

MALLABY: And you talked there about, you know, an international system is sort of, you know, like the proverbial oxygen. You don’t notice it until it goes away.

POSEN: I wish I had written that.

MALLABY: And so you just talked about the macro effects of these trade tensions. But what about damage to the fabric?

POSEN: Absolutely. And I appreciate your both referencing my piece and letting me say this. So when I talk about the macro, I don’t mean only thing that matters, I mean in terms of this meeting usually being focused on the short-term forecast. This obviously matters a lot. And it matters a lot for the—basically the pressures to keep growing productivity. It matters a lot for how third countries—whether it’s Mexico or Indonesia or Thailand or Venezuela—feel about getting bullied, and how people’s investments in those countries take place.

I mean, one of the things I tried to argue in that article and subsequently, is that in some ways trade is actually the most resilient part of the system, because for the reasons Soumaya said. You can imagine Japan, and EU, and Australia, and even China sort of saying, well, if the U.S. messes with the WTO, we can still use WTO rules and dispute settlement between the rest of us. And if the U.S. closes its markets, it’s terrible. But it’s like when Russia or China closes their markets. We can find other markets. It’s not as good. It’s not the end of the world.

But for long-term investment issues and for how you—how you integrate economies in the sense of getting standards set across economies, of setting expectations and norms that actually matter in practice, it’s very bad. And so one of the things I’ve pointed out that may turn out, I fear, to be a very strong leading indicator is that net inward forward direct investment in the U.S. has gone off a cliff in the last two years. And again, that’s not just Trump. I mean, the U.S. Congress has passed these changes to the Committee on Foreign Investment in the U.S. They’ve made the environment seem less hospitable.

But foreign direct investment brings with it R&D, it brings with it some of the highest-paying jobs, it brings with it diffusion of best practices. When Toyota invested in the U.S., it actually had beneficial effects on other companies and other manufacturing. And it’s a warning sign of some of these oxygen-type background things that Sebastian was talking about.

KEYNES: Can I just—can I just add one very short thing to that, which is that supposing Donald Trump tweeted tomorrow: I’ve decided I’m not going to put tariffs on cars, I’m going to follow through with NAFTA and the trade war with China is off. Would—how—would you believe him? (Laughter.) And that laugh kind of suggests maybe not. And so there’s a—I guess the point I’d make is that the primary effect of all this is to add a huge amount of uncertainty. And it’s really not clear whether Trump, as an individual, will actually ever be able to remove that while he’s president.

MALLABY: The level of tariffs is one thing, but the uncertainty around the tariffs can be just as damaging.

KEYNES: Yeah.

POSEN: Yeah, but I just want to warn people to be careful. This sometimes—I completely agree with Soumaya that it’s very hard to take back an environment in which you’re threatening and capricious and company-specific. But I want people to be careful about the uncertainty versus not argument, because sometimes that leads to a false sense that if they’re bad, but we know how bad they are, it’s OK. (Laughter.) And similarly with Brexit, to talk about another topic, I kept running into people who’d say: Well, the real problem is the uncertainty. No, the problem with Brexit is Brexit. (Laughter.) So she’s right, but don’t take it too far.

MALLABY: Well, you’re almost echoing Theresa May saying: Brexit means Brexit. Which to me, always sounded like bedtime means bedtime. (Laughter.) But anyway, Vincent, I want to ask you about emerging markets and what we’re seeing there. You’ve published a lot, of course, with your wife Carmen, on the history of crises. And right now we’re looking at a rate cycle in the U.S. which is putting pressure on those with external dollar debt. So although on the one hand the emerging markets are still growing more than 2X as fast as the developed markets, you’ve got this financial market uncertainty—notably in Argentina and Turkey. So take either of those. And, you know, A, will this lead to a haircut for creditors in either case? And, B, will there be contagion?

REINHART: So we can really take them together in an important way, because Argentina and Turkey share four things in common. First, current account deficits. Second—so they’re relying on the kindness, in a flow basis, on the external sector. Second, a lot of that is related to fiscal deficit. So they’re borrowing from abroad to just fund the ongoing operation of the government. And then, third, a balance sheet mismatch, where they borrowed from abroad in dollars, and to a lesser extent euros, so that currency depreciation just makes their overall debt burdens greater and greater. And then the fourth similarity is they both have a history of high inflation, exchange rate crises. And so local investors there know what to look for and know what to do if they think a crisis is coming.

What is striking about the events over the last six months or so is how little Federal Reserve interest rates rose. Jay Powell has them on a path of a quarter point every quarter, signaling in advance. But it wasn’t much of an increase in interest rates that led to—led to issues. Which means it’s not just interest rates, it’s the exchange rate. That, because of the weakness we saw in Europe earlier in the year, the soft patch at the beginning, the differential monetary policy between the Fed and the ECB was so evident it was associated with dollar strength. And with dollar strength, the balance sheet mismatch becomes more acute, and they’re more sensitive to the backup in interest rates.

In some sense, and Carmen—a co-author—and I wrote about the curious case of the missing defaults. We had a massive bust in commodity prices. We had a sudden stop in capital flows to emerging markets in 2013 through ’15. Typically, if you look at the very long record, that would be associated with a pickup in sovereign defaults. Why didn’t we get it this time? We strongly suspect a new actor on the stage is providing a cushion, and that’s China. China has lent massively to many emerging market economies, particularly in Africa, but also in Asia, and also in Latin America. And that’s provided a buffer. However, if we hear about trade and there’s an existential threat to rapid Chinese growth, they are probably going to have to look more inward, because they’ll be worse—continue to worsen their own national balance sheet to generate the domestic demand to substitute for export growth.

That does suggest that it’s going to be harder to have them as the backstop, i.e.—

MALLABY: Harder to have the Chinese—

REINHART: Chinese as the backstop, meaning EM is going to be challenged for a while to come.

MALLABY: But if—you know, you might have argued that, you know, the reason there were no defaults in the last round of stress was simply that these countries now have flexible exchange rates, much more reserves. But you’re not persuaded that lessons have been learned. If we look at, say, Russia, for example, right now. Central bank is proactively hiking. The Kremlin seems to be allowing them to do that. So at least in some cases you see smarter behavior, don’t you?

REINHART: Right. And I think the emphasis should be: In some cases. There’s a lot more heterogeneity now about EM than relative—from the ’70s, or—the crises of the ’70s, or ’80s, or ’90s. There are more economies that have floating exchange rates, although technically they do manage them pretty heavily. There are more economies that have developed domestic markets. But quite often, the way they develop the domestic market is to invite foreign investors in. And so some of what looks like on the—on the outside a buffer mechanism, can be pretty thin.

MALLABY: But if you invite the foreigners in and they lend in your domestic currency, that’s still a marked improvement in how stable you were relative to before.

REINHART: If that were the case. But if you lend—if you make them short-term instruments like, say, the Argentina LEBAC, or you create a synthetic instrument that actually is borrowing in dollars, even though you settle in your own currency, you invite crisis events.

MALLABY: Right. Give us a word on China. I mean, because this is the one emerging market that is so big that it has global systemic effects. And, you know, even without contagion, just by itself, it’s enough to have big spillovers.

REINHART: So, two parts. One is, just to talk about trade for one more minute, which is I don’t know what’s going to happen, but the administration’s apparent strategy is to pick trading partners off one at a time. Mexico to Canada, then turn to the EU, and then together turn to China. The problem is it’s going to get worse before it gets better. And it’s going to last longer than you might thing because the issues with China butt heads with two presidential ambitions. President Xi has a development plan that importantly involves getting intellectual property from abroad. That involves trade. President Trump has a 2020 election deadline. And that means keeping trade as a hot-button item is—will be alive and well for a while.

So we’ll make progress in some places, but China is going to be much more difficult. What that suggests is that we will see tariffs—more tariffs. We will—therefore, China will need to generate domestic demand to substitute for the slowing in exports. And the only way they’re going to be able to do that is worsen the national balance sheet further. And that poses a serious risk. One way to think about this is how long did it take China to quadruple its income by the year 2010. The answer is nineteen years.

How long did it take North America to do that? Seventy years. How long did it take Western Europe to do that? Sixty years. How many financial crises were there in North America and Western Europe in those sixty- and seventy-years periods? All those economies exhibit a financial hockey stick, where you suddenly get a lot of balance sheet leverage. Well, take that sixty-year financial hockey stick and shrink the aspect ratio to nineteen. There are serious strains on the national balance sheet. And if trade is not the engine of growth, you have to wonder if the other engine will pull them.

MALLABY: Right. Right. Let’s quickly ask Adam about Italy. Government is going to come out with a budget soon. And they have to choose between breaking their election promises or breaking the stability of the macro picture, it seems. Or do you think there’s a third way out of that?

POSEN: There really isn’t. But I expect them to split the difference. So I expect them to push as far as they can with the European powers that be, which probably means an addition to their deficits of 1 percent of GDP a year. How much that will depend—will be allocated towards universal basic income, versus tax cuts, versus spending to hate migrants, depend on which of the two parties is in charge. But they are not—they’ve indicated, I think reasonably, they’re not willing to throw the whole economy at risk by going much further than that.

I think it is important to recognize, just as we said implicitly here, like the U.S., Italy has a government that seems to have no notion of fiscal responsibility. And the plans that they spoke about are extraordinary in their scope, if they were to be implemented. But that said, they are not the U.S., so they can’t get away with the way the U.S. can.

MALLABY: You suggested that the constraint was what the European partners would tolerate in terms of the size of the fiscal deficit. But the other constraint is the markets. And, I mean, it feels to me as if there’s a delicate equilibrium, where if you can keep ten-year bond yields, you know, at or below three percent, you can service the debt. Once it starts heading up to four or five (percent), it’s not clear you—

POSEN: Well, I’d put it a slightly different way. I think the markets on the fundamentals actually would be in some ways more forgiving than the European partners would be because, as my colleague Jeromin Zettelmeyer has really gone through the debt projections has done, I mean, Italy’s problem is partly they don’t collect a lot of taxes and partly that they’ve gotten really slow growth. And there are—they can’t spend their way out of this, but there are arguments that certain specific kinds of spending and a non-totally austerity path for their budge is probably just as good for the debt profile as throwing the economy in hard reverse. And the last couple Italian governments have, with varying degrees of political success, tried to make that case.

Now, the Europeans—meaning the European Central Bank, the European Commission, the capitals in Berlin and Paris—may view this slightly differently. They’re in a situation where they’re very worried about intra-European credibility. And they, I think rightly, take seriously the fact that the current parties, in particular the Lega in Italy, are leaning towards the Orbán evil Polish twin side of the fence. And that’s something they want to stand up against. They want to show there’s no reward for populism. So, again, I’m not that worried about a market breakdown in Italy, the way some of the issues colleagues have raised about other things, or in EM. But I do think that somebody is going to have some interest and some explaining to do when the Italian government is less ambitious in spending than they promised.

MALLABY: Yeah. OK. So we didn’t get to Brexit or a couple of other things, but we’re going to go to members. So if you have a question, please put your hand up. Yes, right here. And remember, this is on the record. I should remind you.

Q: (Laughs.) OK. Thanks very much. I’m Barbara Slavin from the Atlantic Council.

I was curious for the panel’s views on sanctions policy under the Trump administration, how disruptive that policy will be, whether recent moves by the Europeans to find ways to continue to trade with Iran, for example, threaten sanctions as a future tool of U.S. policy? And also, any thoughts on oil prices, how high they could go and what impact that’ll have. Thank you.

MALLABY: Who wants to take that?

POSEN: All right. (Laughter.) I’m the one with the staff, so I get to do this. My colleague, Jeff Schott, is, of course, one of the world’s leading experts on this topic and he’s one of the State Department advisors on this. So let me—I’ll take responsibility for what I say, but if any of it makes sense it’s due to Jeff.

The sanctions history is very real because the—it’s not credible that the Trump administration is going to be able to enforce the kinds of sanctions that they had been able to enforce in—previous U.S. governments, I should say, had been able to enforce given the combination of greater political legitimacy, lower oil prices, and less importance, frankly, of China and Russia, for a temporary period. So in that world, the U.S. ability to get solidarity on the sanctions—whatever you think of the sanctions—vis-à-vis the Iran deal was much higher. And so it’s not credible that China will just stop buying Iranian oil. It’s not credible that—in a political context—that German or Japanese or a number of other European companies are going to just quickly give up.

You mentioned the underlying systemic issue, which is the U.S.—largely because of its financial system and the payment system, and everything being invoiced or financed through dollar accounts—has leverage and can say, well, if you—even if you’re not a U.S. company or you’ve got some kind of weird trading arrangement, as long as you’re touched by the U.S. financial system, we can get you. And this, again, goes back to something I said in my article six months ago, which is the U.S. as chair of the club gets certain privileges by being chair of the club. But if it overuses them, then there’s a chance you may cease to be chair, or at least lose those privileges.

And so the question is, when do we reach a tipping point that the U.S. has done enough of overutilizing, in others’ perception, the access to the U.S. financial system? I think we’re a long way from there, frankly, because it’s very difficult to create a substitute. It’s possible they can jury-rig something very specific for Iran. But to more generally create a substitute I think is a far way off. But let me just highlight one—I don’t want to talk about oil prices, because I’m always wrong. (Laughter.) I’m wrong about other things, but I’m not always wrong. On oil prices, I’m always wrong. (Laughter.)

But one other thing I want to highlight. So along this issue of sanctions and technology transfer, don’t forget that the U.S. has—Congress has now essentially reinstituted, rehabilitated export control regime. And that’s as much or more about technology transfer to China as it is about anything else. And so I will at least flag the possibility that—again, this wouldn’t be just Trump. This would be with widespread support in Washington. That some companies could be subject to sanction-type regimes or punishments if they’re seen as transferring technology to the U.S., or if the U.S. decides to take a—the U.S. government decides to take an aggressive view on that.

I would watch that space. As Soumaya said, there are common complaints from EU, Japan, U.S. on tech transfer. So it doesn’t necessarily have to be a conflict. But if it’s seen as unduly—U.S. unduly punishing foreign companies, then that adds to this problem.

REINHART: Can I just say the extra-territoriality of U.S. enforcement has been an arrow pointed up for a while. And in particular, you had mentioned earlier the CFIUS process tightening. We are less—we are more hostile to international cooperation and international trade and international finance. And we have been using that privilege since we first seized Iranian assets in 1979. That’s a real risk. And I think that—and as an advertisement, I think Paul Tucker’s book on some of these issues is, I think, instructive.

Oil prices, the dollar’s not appreciating. That is a—is a risk. We are a large and responsive producer. And that is another downside risk. But the world’s a risky place. And there—Venezuelan crude production is pointed in only one direction, and that’s to zero. Iranian oil will leak out into the global market, but it’ll take a—take a while. And so for now, we view Brent as in a trading range. And it’ll probably be there—be there for a while. That, by the way, creates an enormous incentive for production in the United States, and manufacturing in the middle part of our continent, because WTI is $10 below Brent. And so that is a large subsidy to—and one of the reasons we think that manufacturing productions is going to be well-maintained this year.

MALLABY: All right. You may well be right, but we can predict that somebody else will take credit for that.

REINHART: Yeah. I would also point out that—to Adam—if you’re always wrong, you’re actually a useful signal. (Laughter.)

POSEN: That’s why—that’s why I keep getting invited back, actually.

MALLABY: But not necessarily wrong in the same direction.

POSEN: Thank you.

MALLABY: Another question. Anybody, a question? I got plenty of questions, but—OK, I can see a question right here.

Q: All right. Jack Goldstone, George Mason University.

We’re now looking at United States budget deficits, a trillion dollars into the foreseeable future. Is that going to make a difference? And in particular, is it going to make a difference if China, losing some of its exports, no longer becomes the main purchaser of U.S. bonds? Is there going to be any issues, disturbances to the global bond market, if we issue more, China buys less?

MALLABY: Vincent, why don’t you have a crack at that. Or—

KEYNES: No, no. You go first. (Laughs.)

REINHART: So a couple issues. My wife, Carmen, and Ken Rogoff and I wrote a couple papers on debt and growth, and among other things, that economies with very high levels of debt relative to their GDP grow more slowly than their own history for when they have lower debt loads. So it’s, you know, sort of a first order big picture. It is a source of concern about our medium- and longer-term growth prospects. But I think you’re right to note the interaction of the conversation thus far. The U.S. has an argumentative approach towards both the trade in goods and services and capital. May be abusing its privilege in terms of the clear and settle of transactions in its currency. But we also expect foreigners to continue to add to their purchases of treasury securities.

Which economy in the world has the biggest twin deficit? It’s us. We don’t have a balance sheet mismatch, because we just issue in dollars. But we’re forcing a balance sheet mismatch on everybody else because of that. So over the medium and longer term, this should be a serious source of concern. And it goes back to—you know, Sebastian was looking for that market discipline on Italy. Maybe we should be asking where is the market discipline on the U.S. treasury if the ten-year treasury is below 3 percent?

MALLABY: It’s just interesting that, you know, after 2008 there were a lot of commentaries to the effect that this would finally break confidence in the dollar as the anchor currency of the international system. The Chinese central bank governor famously put a piece on his website about how you had to create the renminbi as an alternative international currency. And yet, here we are ten years later. And we’re still discussing the continued propensity of emerging markets to borrow in dollars. I mean, it’s a very sticky form of power.

POSEN: It’s very sticky and it’s so sticky we can use the term structural, right, because you have so many things going in this direction. So to try to be responsive to your comment, I—it’s something where economics is not a morality play, right? So for all the reasons Vince said and others have argued, you know, the U.S. is running about as irresponsible a fiscal policy as you could possibly imagine right now. I mean, there’s no good reason to be doing what we’re doing. And we’re just throwing money away, OK? So that’s bad. But the fact remains that in a world of least-ugly contests, the dollar far and away is the least ugly currency. I mean, in a China that is going the way it’s going, you cannot imagine putting safely your assets into China. And even if you thought you could, there are several hundred million Chinese who are zero percent diversified out of Chinese assets. And if they were given the chance, for at least a while they would want to diversify out.

Europe, I may be not as worried about Italy as some, but there are fundamental issues. And so we just say, I guess it was Juncker, just came out and said, well, maybe we should have a global euro. Well, I edited volumes on that literally fifteen years ago, and ten years ago, on every anniversary of the euro. And, you know, five-year anniversary, ten-year anniversary. And every year it’s just more clear, that’s just not credible. Now, again, that doesn’t mean they can’t keep borrowing in their own currency. It doesn’t mean that these aren’t useful currencies. But just we have this gap. The U.S. is in this position by historical legacy, by being less-bad than the others. And you can end up with a world in which, as we’re seeing now, to use a term of art, there’s a scarcity of safe assets. Part of the reason the dollar is overvalued, some people would argue and I agree, is because there just aren’t that many places to put it. And when you get conflicts and emerging market problems, even more money goes into the dollar.

And so the market discipline Vince was talking about may end up just being unfairly applied. It may be the rest of the U.S. economy at some point in the near future. Spreads will widen. Corporate bonds will default. Credit conditions will go down, but Treasurys will keep getting funded.

KEYNES: Yeah, just—so my two cents on this is that—so when the U.S.-China tariff war was heating up, there were lots of questions of, well, you know, how are the Chinese going to respond. And there was one school of thought that said if they respond with tariffs that’s actually quite good news, because they’re being very transparent about how they’re responding. And everyone was worrying about whether they would essentially weaponize Treasurys. And it was my understanding that they—so far, they haven’t—it’s not clear that they’re trying to do that. And I think that there might be steps before they tried to do that. But if—I think if we’re in that stage where the U.S. administration perceives them to be weaponizing that, then we’re in much, much uglier territory than we are now. So that’s kind of maybe tin hat time, and we’re not quite there yet, I don’t think.

MALLABY: So before 2008 my colleague here, Brad Setser, wrote a long study of weaponizing of Treasurys and the prospect that the Chinese could sell them. And at the time, I was persuaded that this was a—not a likely thing, but at least a plausible weapon that we should take seriously. But then we had a QE. And the Fed would—you know, if the China dumped all the Treasurys, the Fed could buy them.

POSEN: Some of us were skeptical about that, even in ’08. (Laughter.) No, I’m sorry, I’m not trying to be cute. I think—let’s remember two basic things. If somebody weaponizes Treasurys, they’re driving up their currency against the dollar. Usually that’s not what countries in economic conflicts want to do. Second, if you’re weaponizing Treasurys, going back to what I said about safe assets, you may be upsetting some influential people in your economy or, say, the keepers of safe in China, who have a few trillion dollars in U.S. Treasurys, which is the people’s money. So, again, it’s not to say there won’t someday be a reckoning. It’s not to say there can’t be another currency. It’s just very hard to see it from where we are right now.

REINHART: Yeah, it’s not a credible threat to say: I’m going to create enormous capital losses on my balance sheet. (Laughter.) And I think that’s the argument against. I don’t worry about the decision by bureaucrats in China to say, let’s stop new purchases or let’s start selling. What I worry is attitudes towards the U.S. as a safe asset will change over time, and we’ll think of other alternatives. But that’s the slow bleed. That’s not the sudden death.

POSEN: Agreed.

MALLABY: Yes, Doug.

Q: Thanks. Doug Rediker, Brookings and International Capital Strategies.

When you went to the audience questions, you noted that you didn’t have time to get to such issues as Brexit. So my question is, Brexit? (Laughter.)

MALLABY: Thank you for taking the hit. Soumaya, tell me how you—tell me how you see it.

KEYNES: Yeah. I’d say—so, I’d say Brexit means Brexit, still. But, yeah, we’re nearing a deadline here. And I think it has probably sent most people to sleep by now who were vaguely following it. But—so, two kind of misunderstandings. The first one is, I think, from the outside world, that this is—that there will be a deal, and it’s worth being very precise about what they’re actually negotiating over now. So they’re negotiating over the terms of their exit, not the final deal. So supposing we get some big announcement, it’s only going to be on that interim stage. We’re going to have many, many more years of bedtime means bedtime.

And I think the crunch issue that is the most important one is the same one that it’s been all along, which is the Northern Irish border. And so what’s going on now is that Theresa May is trying to get assurances from the EU that no matter what happens—you know, if all—if all else fails, then essentially there won’t be a border either within—on the Northern Irish border, or between the mainland and Northern Ireland. But the problem with that is that she’s essentially seeking some assurance that no matter what happens she’ll get the benefits of being in the EU after Brexit day, without giving the kinds of assurances to the EU that they would need, which is that they will, you know, follow all the same regulations and rules.

So there’s this kind of fundamental tension that hasn’t been resolved within the U.K. And I think from the European perspective, it looks like the big problem is that Theresa May hasn’t yet won over the Brexiteers. It’s not clear that there is any version of a resolution for the Northern Irish border issue that will actually please them. And that means that it’s very difficult, because they don’t know who they’re negotiating with. If I had to make a prediction, I would say that although in theory everyone will say, we really, really need to resolve this in the next few weeks, I would say that probably it’s going to be a question of how far can they fudge it so that the hard Brexiteers are comforted? The EU says, oh, of course, if—we’ll give you a political—sorry. Hold on. We’ll give you a political assurance that we won’t have to add to this kind of Armageddon, awful situation. And then the question is, is that enough legal certainty for the British to say yeah.

So this is all going to come down to—

MALLABY: It’s almost about the interim, isn’t it?

KEYNES: Yes.

MALLABY: Because you could have—if the—if the exit agreement is, how much does the U.K. pay into the EU budget? Answer, probably about $50 billion, but to be filled in precisely. Secondly, how do you treat EU citizens in the U.K.? You know, answer, probably fine. But—and thirdly, Ireland, which as you say is unresolved and difficult. But fourthly, what trading arrangement exists the day after March the 29th between the U.K. and Europe? And they won’t have negotiated the end state, you know, customs union not customs union. So what’s the interim? And it seems to me that that’s where there’s quite a high chance that the interim will be: We’re not cutting you some special deal. The British want to be in the single market, but not in it. They don’t want freedom of movement of people. That seems to me the under-emphasized risk in all this. But maybe you’ve got a different—

KEYNES: Yeah. And—sorry, I said that there were two problems. And the second one is that there are still people in the U.K. who are writing in—you know, who seem to hold the belief that a no-deal Brexit would be fine, which it won’t be, obviously. And that, I think, heightens the risk of a no-deal Brexit, because there’s this—you know, the politics could overwhelm, essentially.

MALLABY: You two? Adam, you’re sort of a Brit.

POSEN: Yeah, actually, with you in this room a couple of times I’ve spoken about Brexit. My view, starting from a month or two before the referendum, has remained unchanged. And it seems to be right, that it was always going to be a bimodal outcome. It’s either hard Brexit or it’s what some people would call capitulation or Brexit in name only. And there’s essentially nothing in between, because you can’t get a coalition in the U.K. for anything in between. The EU, for the reasons Sebastian noted, doesn’t want to be seen as cutting a special deal, especially now that there are anti-EU parties in so much of Eastern and Southern Europe. And the Irish issue, which certain people in the U.K., in London in particular, tend to think they can’t really be serious that the Irish issue—they care about the Irish issue. No. No, not only the Irish care, you know. This is real. And as Soumaya said, there’s just no whole solution.

So, to me, it’s always been a much greater—fifty, sixty percent chance—of Brexit—hard Brexit than not. The hoped-for scenario, I guess, has to be that Keir Starmer and the supposedly reasonable wing of the Labour Party and a bunch of other people manage to get an extended transition—going back to what they were saying—that sort of papers things over. But it’s not—absent a general election in the U.K. or another referendum—it’s very hard to see politically how the EU would grant that. If you got another referendum, or you got a general election, whatever the outcome, I think the EU leadership would be very—perfectly happy to see the British officials come to them and say, can we have longer to make up our mind? But absent that kind of real political change, I don’t think the EU can do that.

 MALLABY: Another question? Yes, over here.

Q: Doug Ollivant, Mantid International.

Following up on Brexit, this conversation has been largely internal, about what it means for the U.K. and for Europe. We can see kind of what it means to us. But for those who aren’t Atlanticists, what does this mean to Seattle, to Singapore, to Dubai? How does this impact those who aren’t closely connected to the EU and to the Atlantic—the greater Atlantic, I guess?

MALLABY: Quick answer, someone?

REINHART: The U.K. is about five percent of world GDP. The effects may be large, but it’s multiplying into a pretty small base. And it is part—another manifestation of a bigger phenomenon, and that is the growth of world trade is slowing. And it’s not going back to where it used to be.

MALLABY: OK. Karen.

Q: Excuse me. Karen Johnson, a consultant.

Productivity growth is often the positive force that allows economies to solve lots of problems and just make other problems go away. We have been somewhat disappointed, most recently anyway, about what productivity is doing. And certainly the anecdotes that one hears about productivity make it sound as if those things that are sort of on the horizon will be very strongly labor-saving, which will produce challenges to everybody to sort of adjust to this new world. Can you give us some of your thoughts on where you think productivity fits into the story about the outlook for the global economy?

POSEN: Karen, you have, as usual, the finger on the underlying important issue. And you’re absolutely right. we’ve lost, in a sense, both the easy way out and the best way out of our economic problems, which would be sustained productivity growth. I’m just going to say that I think it makes sense to continue to expect productivity growth to be poor. Meaning, our trend will continue to be much lower than the previous trend used to be. That’s getting—the amount of support for that position has fluctuated over time. And there are a few signs, if you choose to read them, in the last couple quarters in the U.S. that maybe things are a little better. I know that you didn’t take a position on this. I’m just pointing it out.

My view is, since we saw a simultaneous slowdown in productivity across the rich world that it started before the global financial crisis, though certainly was made worse by it, and that for all the sort of—we see—we see genomics everywhere except in the—in the productivity data. That’s a classical tech reference to Bob Solow, for those of you who follow it. You know, we’re just not seeing it. I mean, the—it’s very hard to come up, in my mind, with an easy response to the Bob Gordon sort of point of view, that there’s something fundamental, supply-side. Maybe you can extend it and say something demographic reinforces this. And you can look to what’s happened in Japan.

But all I can say is I totally fear what you say, Karen, that this just makes things harder and worsens the political economy. And if we happen to get a wonderful deus ex machina of some of these technologies panning out in a big way in the next few years, that would be great. But I’m not holding my breath.

MALLABY: So, Vincent, in your new Foreign Affairs piece—

POSEN: Oh, you have a new Foreign Affairs piece.

REINHART: Just out a week ago.

MALLABY: You point out that the slow growth following ’08 was only to be expected, that balance sheet recessions have this quality. And part of that, presumably, is very low productivity growth, because investment falls off a cliff and you’re not having—without cap ex, you’re not going to—so, do you share the view that in fact this goes back deeper before ’08?

REINHART: Oh, certainly. Yes. A severe financial crisis. We shallow out the human and physical capital stock. It takes a long way to dig your way back out of that hole. And if there’s a certain amount of denial and accepting the capital losses and sharing them among your citizens—i.e., Italy and Greece—you will have a situation in which, according to IMF forecasts, they will not be back to the level of GDP they had in 2007 by 2023. And another feature of the WEO forecast is, if it’s right, is this is the year that Europe—euro area nominal GDP reaches the level it had back in 2007. So crises are serious problems.

But, as Adam points out, productivity probably inflected down in the early 2000s. And it is across industry. It is across industry when you control for the factors of production. It is also across economies. Six out of seven of the G-7 economies have seen their potential output growth marked down. If you look at vintages of World Economic Outlook forecast, they have a five-year ahead forecast, which is basically trend. You have no reason to say there’s interesting cyclical dynamics five years from now. Over the last four years, the IMF staff has marked down trend growth in two out of three economies, across 190. So this is significant.

However, I’m not usually optimistic about anything, but I would point out that when Solow famously said, we see computers everywhere except in the national official accounts, that was 1987, which was just when output begins to inflect up. You might be able to plausibly tell a story that we are in the S-curve one more time. I believe you devote a good bit of your book about Alan Greenspan where he correctly identified where we were on the S-curve in the late ’90s. Right now, we are tripping over ourselves to invest in projects—technological projects in which you’re either first or you’re out of the business.

And so early on you’re not going to be very productive. You’re not going to get a heck of a lot of output. But when you are first, you really will be adding a lot to output. That, by the way, will then introduce lots of issues about concentration. It will also introduce lots of issues about using labor because the biggest lie we learned in graduate school is lump sum transfers are available to make everybody better off. It’s the choice of verb that’s really useful. We kind of hear lump-sum transfers will be—but it’s not the case. We’re terrible at dealing with workers who are displaced by either globalization or technological improvements. And that’s going to be a big challenge, even if the optimistic case unfolds.

MALLABY: Last words, Soumaya, on productivity. Might it come back?

KEYNES: So, having just been at Jackson Hole, where the big—the theme was—of the conference was concentration. And this was obviously—you know, the question was, is the rise in concentration somewhat responsible for kind of weak performance? And so if I had to take away anything from that, it would be that it’s the dispersion in productivity that we should be really concerned about. And that this is a very, very broad phenomenon, but the other thing when thinking about this I would definitely want to do is—there was—there was a paper basically showing that there are actually really interesting differences between different sectors.

So there’s one idea, which is that the idea of intangible capital—IP, patents, et cetera—means that the biggest and most productive firms are more able to sort of sit on their high productivity, and for that not to diffuse to smaller firms. And in sectors like health care, for example, there was evidence of both a very marked rise in concentration and also a very large rise in markups above productivity. So I think—I think some answers in terms of, you know, are there policies that we could think about to help with this. Some of the answers could be gleaned by looking at particular sectors and such.

MALLABY: OK. Soumaya, Adam, Vincent, thank you very much. And thank you to the members.

POSEN: Thank you. (Applause.)

(END)