World Economic Update

Wednesday, June 19, 2019
China Stringer Network/Reuters

Adjunct Senior Fellow, Council on Foreign Relations

Greg Ip

Chief Economics Commentator, Wall Street Journal

Vincent Reinhart

Chief Economist and Investment Strategist, Standish Mellon Asset Management


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

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: Welcome to this World Economic Update. I’m Sebastian Mallaby. I work here at the Council on Foreign Relations.

We’ve got with me this morning Heidi Crebo-Rediker over on my far right, Greg Ip, and Vince Reinhart. You have their affiliations and titles and so forth.

I’ve been chairing these meetings for a while, I guess coming up for nine years or something. And at different times, there’s been concern over different things: Europe falling apart, China’s currency collapsing, the Fed’s experimentation with unfamiliar economic tools, and now the chief concern appears to be geopolitics and specifically trade.

After China joined the World Trade Organization, there was maybe fifteen, sixteen years where trade was boring and now we are cursed to live in interesting times. So we’re going to start with this trade subject and then move on to other things. We probably won’t get to everything, which is where you guys come in because you can raise the parts of the world that we’ve rudely neglected.

So let’s start with Greg, and I want to put it to you and see what you think that in the trade wars there are basically two parallel wars. There’s U.S.-China, which is very much U.S.-China, not just Trump China, because I suspect that the roots of the unhappiness with Chinese policy go deeper than just the president. And then there’s a different one, which is Trump versus the world. And again, I do use the word “Trump” as opposed to “the U.S.” advisedly. And that’s where you have a range of different battles with the Europeans, the Japanese, the Indians, the WTO dispute settlement panel. Do you think that’s a useful way of framing what’s going on in the trade space?

IP: Oh, absolutely. It’s very much, you know, Trump—U.S. or U.S. versus China and U.S. versus the rest of the world. But I think it’s also a mistake probably to associate either of those confrontations with Trump personally. As you say, the tensions with China have been building for many years and there are many people, including some in this room, who have been arguing that some coupling—decoupling or threat of decoupling was necessary, given the different political and economic paths the two countries were following.

But to a certain extent, even the fights that have begun between the United States and its traditional allies also have deeper roots than just Trump. So if you look at, for example, Robert Lighthizer’s longstanding problem with the World Trade Organization, they are very much rooted in this U.S. tradition of umbrage at multilateral or super national organizations infringing on American sovereignty. He’s very unhappy with the fact that WTO rulings have frequently gone beyond the narrow issues at play in that particular ruling to sort of, like, generalized to U.S. trade policy overall. And he’s been trying—he has—his mission and the mission of people like him has been to claw back some of that sovereignty away from multilateral organizations to the United States.

And as for the idea that other countries have free rode on the United States, there is truth to that. It is definitely the case that one reason you see these fights between the U.S. and China and not other countries and China is that other countries are afraid to confront China because they’re afraid of retaliation against their economies and their companies. Only the United States is big enough to withstand those threats of retaliation. But implicitly, that means other countries hide behind the U.S. skirt. So the idea that this—that the tensions between the United States and its other allies and the WTO would go away with a different president I think are simply wrong.

And I think that one of the things incumbent on us, both as policy watchers and as journalists as we analyze these different conflicts, is to separate those things that are specific to this president and his style to the deeper-seated issues that are going on underneath.

MALLABY: Go ahead, yeah.

REINHART: One can imagine the deep frustration Senator Schumer had to praise the president’s initiatives with China trade. But it is bipartisan in terms of hostility. And I would point out that I think the way I think of it is the president is an enabler, that tech companies in particular were very frustrated at the inability to protect intellectual property rights, but they were worried about market share. And so once someone said it, they could pile on.

But I think it’s also the case—you’re right to put them in two different boxes—is the White House is an enabler for the security apparatus, i.e. the Bureau of Industry and Standards, the people who have been frustrated about China and now can use whatever tools they have in Treasury, in Commerce, all across the government to put impediments to what they view as the main geostrategic competitors.

MALLABY: Yes, but so my premise was that when it comes to China, Vincent, you’re right, this is deeper than just Trump, he’s an enabler. But when it comes to the rest of the trade battles out there, the president is kind of the one initiating this. And, you know, Greg is right, of course, that the U.S. has a tradition of frustration with multilateral rulemaking.

But, Heidi, you were in the State Department. I mean, it’s the case that when the U.S. lost cases in the past at the WTO, awkward legislation involving political capital being expended on things like the FSC tax rule, administrations would pay that political capital in order to come into compliance with WTO rulings. So perhaps you have a different perspective on this.

CREBO-REDIKER: So I think, you know, I would agree that this is—you know, you can separate this in terms of U.S. versus China, longstanding challenges that we’ve faced, both in terms of trade and industrial policy and IP theft and, you know, you know—you know the list. But I do think that we are, you know, we’re in a very different universe right now in terms of strategy and tactics and how do we actually achieve goals to remedy.

So, you know, while we do have bipartisan support for taking a more aggressive stance to tackle long-term disagreements and frustrations, I think that we really do—we are in a different place where we’re using—where we’re conflating the national security and the economic and trade agenda in a way that could be very detrimental down the road and it’s confusing our allies to say the least.

IP: If I could add one thing to that. I absolutely agree with Heidi that we are doing a lot of damage to our own interests by picking fights with allies like Canada, like Mexico, like Europe, like Japan.

But that said, I think that one of the things—one of the ways you look at just how damaging that can be is, is Trump acting alone or is Trump acting with the support of other major constituencies in the United States? And one of the things we saw that when he picked fights with Canada and Mexico, for example, on steel was the blowback he got from U.S. business groups, other members of Congress of his own party, and border-state governors, and so forth. And it is one of the reasons why we actually ended up—you know, fingers crossed—at a relative—at a new equilibrium, basically a new NAFTA that looks a lot like the old NAFTA. And it’s one reason why I think that the president was basically pulled back from carrying through his threats on Mexico.

So I guess what I would say is that there—we could expect a certain degree of friction between the United States and its other allies for the reasons I was citing earlier. We do have to worry exactly about the damage that Heidi has cited to our longstanding interests and picking fights that do us more harm. But I actually think it’s pretty noteworthy how little permanent damage has happened, partly because of the fact that when the president acts alone important constituencies push back against him.

MALLABY: Well, I’m the moderator of this conversation and Greg is clearly the provoker. (Laughter.) So in search of further provocation, I’m going to channel my colleague Ted Alden, who has argued to me for a while the kind of—the sort of worried case about the system being under strain the way the WTO may not recover from this period.

The death of the WTO, Ted, I think is one of your writings on this that went viral instantly around the world.

If you take the example of Mexico, which we were talking about just before we came on stage, where, you know, the U.S. negotiates a new U.S.-Mexico-Canada deal, and before it’s even ratified by Congress says, oh, by the way, we might hit you with 25 percent tariffs because we don’t like your immigration policy. Isn’t that—isn’t that a sort of a signal that no deal is a deal, nothing can be counted on to remain stable; and therefore, any company seeking to do cross-border business has to factor in a new level of instability?

And that’s new, that is Trump. That is not some American tradition.

IP: I agree a hundred percent. I think that—

MALLABY: Damn. (Laughter.)

IP: It’s definitely the case that there’s a level of uncertainty about the stability of international relationships. Is that, I mean, if you are a company that has supply chains across borders, everybody has got a plan B. I mean, we’ve had lots of stories in our newspaper and other newspapers about companies establishing, you know, supply chains across borders to deal with the China stuff. You’ve seen plans to build plants in Mexico scrapped; those plants were being built in Mexico. The costs will take a very long time to show up. I mean, it’s, you know, axiomatic that free trade benefits many at the expense of the few and one of the results is that the harm that comes to the many takes a very long time to manifest itself and we may not see it for a while.

Also, it’s not like we’re suddenly going from a world where the WTO—where it’s WTO and NAFTA uber all as to autarchy, right? There will continue to be various bilateral relationships and bilateral standards and conventions which will govern those relationships.

I would point out that even after with NAFTA in place the United States repeatedly hit, you know, Canada with tariffs on soft-wood lumber that were repeatedly declared illegal by a NAFTA panel and the United States repeatedly reimposed them. So it’s not necessarily a new thing that the United States does not feel its sovereign rights constrained by the international agreements it enters into.

And also, while the volume of actions that Trump takes under the guise of national security that violate our sort of commitments on trade is unprecedented, presidents have done this all the time. When Roosevelt went off the gold standard and declared a bank holiday, he used the Trading with the Enemy Act authority, OK. So, I mean, my experience in this town is that whether you are in favor or against it, a particular executive action depends a lot on whether you agree with the action and less on whether you think it was constitutional.

And, you know, I think in your question, Sebastian, and to continue with my provocation, you had—you had said, well, is there any precedent for a president using tariffs to get its way on immigration? I would say, well, maybe not here, but when the European Union was trying to get Turkey to basically hold Syrian refugees in Turkey, it very much connected that to Turkey’s aspirations for eventually joining the European Union.

So one of the things I take from that, and not at all to necessarily endorse the administration’s approach from this, is that the idea of border security and national rights is not—you cannot compartmentalize those things into immigration here, tariffs there, national security there. They all, in some sense, come together.

CREBO-REDIKER: I would just—I would take issue with that just on the point of really over-conflating national security with trade policy. There is a desire to want to inform one with the other. But in the case particularly of the threat against Mexico of the use of national security as a justification for tariff—moving forward on tariffs against allies and then looking at real national security issues, vis-à-vis Huawei and, you know, some of those longstanding issues that I referred to before having truly to do with the national security space, to then turn around and say, well, it’s on the table for negotiation, I think there’s a really dangerous space that you’re left in as to whether or not you have credibility when you charge that something is being done by the United States for national security reasons. And then if you’re willing to take them off the table in a trade negotiation, where does that actually leave the United States from a national security perspective?

REINHART: So I think that, you know, the reality is that tariffs are the president’s hammer and he sees a lot of nails. (Laughter.) And by conflating, you really run the risk of, one, not using the appropriate tools and, two, eventually breaking your tool.

Among the things that concern me actually is also the extraterritoriality of a lot we do on the finance side. We are taking advantage of the fact that so much of global trade involves dollars, even when we’re not a party in that transaction. And that has been an advantage to us for a very long time, but it is one that if you take too much of that advantage, we could lose that.

MALLABY: Well, I mean, the BRICS have talked at various times of creating an alternative to the dollar-based payment system. Every time Iran has faced sanctions, it’s wanted to do the same. We now have Facebook joining the game. They want an alternative to the dollar-based payment system.

But in reality, the dollar remains central and most financial institutions want to have an office in New York. So do you think that this worry that people migrate away from the dollar and create a parallel financial system, is it—is this something that could happen in three years, in five years, in ten years? How far off is that?

REINHART: So we don’t have that many precedents. Among the precedents is the transition from sterling to the U.S. dollar. And among the things you have to do is, number one, have the predecessor make a series of mistakes—the U.K.’s attitude toward a market closing during the great war, the mistake of ’24.

Number two, you have to have alternative assets denominated in the—in the new currency because people don’t hold the currency per se, they hold assets denominated in that currency. And because of the series of mistakes, New York became a very large issuer of securities, particularly for Latin America, and that then became the alternative in the—in the ’20s.

But I think right now the situation is a deep economic principle and that is you can’t beat something with nothing, that one could have imagined and in a different world the euro would have been a plausible alternative. One might imagine that the yuan at one point could be an alternative. But none of those things happen very quickly.

Deep down, part of the Belt and Road Initiative, part of the fact that China has lent more than 1 percent of a hundred countries’ GDP is to redenominate trade.

MALLABY: Heidi, tell us—we know we’ve alluded to the security angle, but Huawei is a huge, dividing kind of focal point here. It combines both the national security side and, frankly, the commercial rivalry over who gets to earn money off of the 5G deployment.

The U.S. has tried to put enormous pressure on European allies and that pressure doesn’t seem to be getting very far in terms of excluding Huawei from 5G rollout. The last time I counted, there was something like fifteen or something European countries that have done pilot projects with Huawei already.

Is there a better way of handling this issue?

CREBO-REDIKER: So I think there are many better ways of handling the overall U.S.-China trade, economic, and national security strategy. I just got back from about ten days in Europe. And I have to say that there’s been a shifting of thinking there after many years of when I was working there saying, you know, this is something, you know, that the U.S.-China relationship is something that we need to pay attention to, but also it’s an economic challenge that needs to be considered and you need to think of it as a national security potential challenge as well.

I think the Europeans are gradually coming around to that at a—at a very quick pace. And so one of the big—

MALLABY: So the Europeans are coming around to the idea that?

CREBO-REDIKER: That they should be concerned about China, about industrial policy, what it means for individual European economies as well as for the—for the EU. And, you know, so that was a very prominent topic of my conversations last week.

Whether this is—you know, whether we are approaching the tackling of the Huawei challenge or the national security challenge appropriately, I mentioned earlier putting it on the table as a—as a potential trade tit for tat is not—is not helpful in the least when you’re actually trying to make a national security case.

This is something where it’s not new as a concern. Chinese technology and the potential for national security exploitation, if it’s—if it becomes a dominant technology globally or within the U.S. system or within our allies’ systems, is not new. It’s just a matter of whether or not this was taken from a more behind-the-scenes tackling of the issues versus a front-and-center tackling of these issues.

And I would argue that we’re going to continue to see the national security/economic and commercial challenges continue to arise no matter who’s in the White House. But it will be easier to confront those challenges if we do have our close allies with us. And to the extent that Europeans are coming around to this view as well I think will be helpful. It’s just a matter of whether or not it’s too late.

MALLABY: Maybe just go down the line.

Vincent, do you want to make a substantive point? I was going to ask you it.

REINHART: I keep raising the bar for us here. (Laughter.)

MALLABY: OK. I’ll do—I’ll do mine first and then we’ll see if you—my thing was simply, do we predict that one year from now when we’re in the middle of the election campaign, will the China confrontation be sort of the same or will it have deescalated? Each of you, same or deescalated, or worse if you want?

CREBO-REDIKER: So one year from now?

MALLABY: Yeah. So when we’re in the middle of the election campaign, will Trump have calculated that we’re coming up to the election, we need to cool things down? Or will he say we’re coming up to the election, we need to help things out?

CREBO-REDIKER: So I think that there has been more—there has been a great deal of bipartisan support for a more aggressive strategy on the trade and—trade and investment front vis-à-vis China. So I do—I do think that that is something where he believes that he can turn up the dial and down the dial and not have it be, you know, not have it be a hugely contentious issue in the election.

I guess my point would be, looking beyond the one-year trajectory, that this isn’t going away.

IP: I guess I would think that relative to today it will have deescalated. I don’t base that on any great, you know, insight into the negotiating positions of the sides, but that fundamentally I think it’s in the interests of both sides to deescalate it and to achieve some kind of coexistence, which perhaps has some guardrails up around commercial relationships that infringe on national security, but to keep everything else unchanged. It’ll be better for our growth, it’ll be better for their growth.

The caveat is that that’s what I’ve been thinking for a while, but things keep moving away from that scenario. (Laughter.) And I think partly that reflects an inability to identify and I suspect even the Chinese and the Americans aren’t able to identify whether their red lines actually intersect at any point, whether the circles of that Venn diagram have any overlap. I think it was a shock to the Americans and to the Chinese and everybody else watching that things fell apart the way they did a few weeks ago.

There was an exchange yesterday I believe at the Senate Finance Committee where Ron Wyden said to Lighthizer, look, you know, there’s going to be schoolkids going to school this fall and they can’t afford their uniforms and their pencils because of your trade war with China. And Lighthizer’s response was if we don’t deal with China’s technological theft they won’t have jobs when they graduate from school. Now, that exchange completely encapsulated this debate. And there is a number—they’re not the majority, but people who share Lighthizer’s point of view that we must accept some costs, possibly steep costs today for the long-term prosperity and security of our country. That is a strongly held view by people in this administration, but it is not necessarily the majority view and I’m not so sure it’s the president’s view. But if that view prevails, then the de-escalation story I just started out with does not end up being the base case.

REINHART: I think there’s also a sense that the window is closing for that confrontation. I would say de-escalating with the caveat remember your two boxes, the security issues, the hard things will not go away, they’ll just agree not to ignore them for convenience to both presidents.

I would also say that it is not all of the White House’s making that changed the attitude toward China. We saw President Xi’s overreach in terms of term limits, the assertiveness in the South China Sea, and the sense of control internally and Belt and Road. So I think there is a bit of overreach on the China side that makes people generally nervous.

MALLABY: Yeah, that’s right. You might not have predicted seven years ago that the next Chinese leader would be this hawkish, just like you wouldn’t necessarily have predicted seven years ago that the current American leader would be this provocative.

Let’s switch a bit to the Fed.

Vincent, there’s been a slowdown in the U.S. economy. How much of this is trade related and how much of this is something else?

REINHART: Well, I think it’s the mechanisms that trade uncertainty is just a straight, dead-weight loss. Would you put a plant on, you know, on the Texas border? Would you create an LNG transshipment facility on either coast? So uncertainty is a dead-weight loss and uncertainty is elevated.

The way I think about it is, for the U.S. expansion to be sustained, growth does have to slow from the 3 percent it’s been for the last five quarters to something more like 2 percent. Last year, we thought that it would be the Federal Reserve providing the headwinds by tightening monetary policy. And now President Trump is providing those headwinds in terms of elevating trade uncertainty.

Remember, in the president’s calculus, he’s right on one score and that is trade is generally more important to our trading partners than it is to us. I mean, think of it. We have such an enormous trade deficit, that means there’s a whole lot more production coming into us than we’re shipping out and so it has an even more significant global footprint.

There’s an offset, though, and that is the Federal Reserve revised their plans. And that should be sufficient, at least in our outlook, for growth to slow sequentially. And damage done, capital not put in place, will be income not produced next year, but it is within our—it is within the Federal Reserve’s ability to support economic expansion.

MALLABY: The consensus, I guess, back in December was for two rate hikes this year. Now the consensus is two rate cuts. If Chairman Powell deliver on that, not necessarily today, but this year, Greg, will he be accused of political pandering?

IP: Yeah, but I think he would have been accused of political pandering of a different sort if he didn’t do it in the face of evidence that suggests he should do it.

You know, look, he’s in a very difficult situation. I mean, I’ve been covering Fed chairmen for quite a few years now and I can’t remember one who had to deal with external pressure. I mean, Fed chairmen have always had to deal with, like, you know, difficult congressmen and so on and, like, sanctimonious market pundits and so forth, but I can’t remember one who had to deal with such relentless mau-mauing from the person who appointed him, coupled with these veiled threats to basically push him out of his job.

And not only that, but that is a president who arouses very strong feelings on the other side so that if Powell does anything that looks like it helps Trump he will be equally accused of pandering.

So his situation now—and I’m actually pretty sure this is how he’s looking at. So basically, you know, we reported that Greenspan had lunch with him and said my advice is get some earmuffs, you know—(laughter)—just try—just try and block it all out. It’s hard to do, but I think Powell is trying to do that. And so the decision today I think will be, well, every central banker is both economist and risk manager. What do I mean by that? By economist, I mean you look at the numbers, you look at the data, you look at the forecast, and you lay out your best case for what the economy and financial markets and inflation will do over the next year. The risk manager part of you says, well, what are the probabilities and the consequences around that forecast if I’m wrong? And that’s very much sort of a judgment thing.

You know, you know this better than anybody, Sebastian, that that was really the secret sauce of Greenspan approaching these questions. It wasn’t necessarily that his forecast was better. It was kind of an almost, like, you know, lizard-like feel for where things were going that others couldn’t quite capture.

And if Powell is going to make the case for rate cuts, he has to kind of convince us that the density of risks on inflation, on growth, on trade are such that it is much riskier—it is much safer to lower rates now than to not lower rates. And I think that if he articulates this well, then the majority of people—leave aside the partisans—the majority of people will give him the benefit of the doubt.

MALLABY: Vincent, do you want to come on—I mean, so the argument, I guess, is that an undershooting of inflation is a bigger thing, and one should respond to that, and it’s worse to be wrong by being a bit loose than vice versa.

REINHART: So part of the literature of the zero lower bound to nominal interest rates is that if you anticipate weakness you should tighten—ease aggressively as soon as you can because the economy will be in a better position when that aggregate demand shock occurs.

A second lesson from Japan, from the euro area, from the last ten years in the U.S. is that it’s easier to contain inflation than it is to generate it. And so if you—if you have the opportunity to generate some, you should.

I think we are just all too impatient—that I think the Phillips curve works, that inflation changes according to the output gap, but by the Congressional Budget Office’s estimate real GDP only went above potential output at the beginning of 2018. And the average output gap from 2007 to now is still minus-2 ¼ percent. There’s—there is still a drag on domestic inflation, so we shouldn’t be surprised that it’s lower than—lower than ’07. But we are eroding that. We are running an economy above the rate of potential output in an environment in which the unemployment rate’s already low, and inflation’s a risk.

So, to your question—would Chair Powell be accused of pandering if he eased—if the FOMC eases twice this year—I think the same people talking about QT in December will be talking about political influence in this December, and that’s because easing two times is a mistake.

MALLABY: I want to come to members in the audience in a second, but one last question which I’m going to put to Heidi. We’ve had this escalation of tension with Iran and oil prices are probably going to respond. I saw that the Saudis, you know, are saying that they’re going to restrain output. Where do you see the Iran faceoff going? And how worried should one be about the economic and market ramifications?

CREBO-REDIKER: So I am worried about the escalation with Iran, but that’s for political reasons because I’m not entirely sure, given we don’t have a defense secretary in place. We have certain voices around the president that we’re not sure that that—what the ultimate response is going to be.

In terms of economics and markets, I think, you know, we’re—we’ve moved from a world where, you know, the geopolitical impact that we saw in markets was always, you know, driven through commodity prices, and you could always see a direct—you know, the most direct correlation to a place where, you know, we’re focused very much on demand and whether or not you’re going to continue to see the demand that we—that we need with new supply coming on. The advent of the shale revolution in the United States—I’m looking at Mark Finley here, who knows this far better than I do, to see if I’m getting a nod or a—(laughs)—but the way that—I think we’re—you know, we will see a response in markets, but I think we also have other suppliers who are ready to come on—come online to actually fulfill that—whatever that need is, and a lot of focus on the demand side.

MALLABY: OK. So let’s go to members. You can raise issues that we’ve rudely ignored. I see a question back there. Remember, this is on the record. Please say who you are.

Q: Hi. Steve Myrow with Beacon Policy Advisors.

On the issue of the Fed, leaving aside the question of whether or not it’s being perceived as politically pressured, one of the few things that we see that’s bounded President Trump’s aggressive trade actions has been a sustained, significant adverse market reaction. So if the—if you get a Fed put, so to speak, doesn’t that in some ways—even though being done in anticipation of a slowdown due to trade disruption, doesn’t it provide him more maneuverability to take further trade disruption?

MALLABY: Vincent?

REINHART: So I would say that however distasteful Chair Powell may find the—some of the consequences of lowering interest rates, he’d still lower them if that’s what’s appropriate for the—for the overall macroeconomy. I think that it is the case that markets are a check on policy. We’ve seen multiple case studies in which the president has pulled back when—on equity selloffs, and presumably that mechanism will work in the future. And that’s, importantly, associated with the change in markets. The Fed may elevate the general level of the S&P if they ease, but it would still sell off a lot if there was an adverse tweet that made us think that China and trade negotiations have gone off the rails.

IP: May I just address that question a little bit more directly?


IP: I think that absolutely the Fed would be in some sense enabling Trump’s policy, but they should do it anyway. I don’t think—see what choice they have. They accept the world as it is.

In 2003 the Fed was wondering whether it should cut interest rates and it was worried about the geostrategic uncertainty created by the planned invasion of Iraq. Greenspan said let’s wait till we know and then we’ll decide, but not once did he think it was his place to decide whether or not we should be invading Iraq. And similarly, it’s not Powell’s place or his colleagues’ place to say whether or not the president’s trade policy is correct. The American people elected Trump to watch trade policy, and the Fed’s job is to accept that as a given and do the best job it can for the economy.

REINHART: Indeed, one of Jay Powell’s favorite phrases is, “I’m going to stay in my own lane,” and that’s monetary policy.

MALLABY: Another question? Yes, sir. Yeah.

Q: Thanks. Irving Williamson, U.S. International Trade Commission.

I was wondering if you—farmers have been hurting, and you know, the trade policy hasn’t helped, and we’re hearing more and more about that. Still, I think—still profits are down and the stock prices are down this year. Yet, we’ve had record unemployment—record low employment. How is all this going to—are these developments going to have an impact going forward, and are we going to see increased unemployment or things like that coming from this period?

MALLABY: Sorry, from what? From the trade tension or from—

Q: From the trade tension and some signs we see of the slowdown.

MALLABY: OK. So unemployment is at 3.7 (percent); will it go up again as a result of the slowdown? Unemployment’s been incredibly low across the OECD, so I’d be interested to—on a wider answer to that.

IP: I think it sort of goes back to the question earlier about, you know, just how detrimental has the trade uncertainty been to growth. I don’t think it’s been terribly detrimental so far. I think you see it in confidence and business investment. It’s interesting that even though we’re putting—

Q: (Off mic)—the ag sector?

IP: Yeah. Well, the ag sector is not very large relative to GDP. And even within ag, the parts that are being affected by China are themselves a minority, right? So in some sense they are the collateral damage of this trade war with China.

I think that probably some of the industrial slowdown is a result of the trade consequences.

I think the biggest effect on the economy, frankly, has been through the financial markets. We have seen that there is—every time the trade war heats up, the stock market sells off, and that translates—ripples through the entire economy in terms of consumer confidence and business confidence and so forth. I think that’s the main thing that holds it back.

One of the—final point here—one of the questions we have right now, I think, is how much of the slowdown we’re seeing in the economic data is because of trade and how much was already baked in the cake either because fiscal stimulus is going away or because the Fed tightened too much? And we’ll only know that a few months from now. It may turn out to be that it wasn’t really that much trade related at all, in which case that’s really not the main story.


Q: Hi. John Colby with The Carlyle Group.

What about the impact of all of this uncertainty on the dollar? Further strengthening, or not?

MALLABY: That’s a direct question. Vincent, give a direct answer. (Laughter.)

REINHART: So an advantage of being the safe-haven asset is at a time of elevated uncertainty, even if we are the source of the uncertainty, we enjoy or have the consequence of some dollar appreciation. It’s hard to explain otherwise why the dollar has appreciated so much on net over the last couple years in an economy that has a very large budget deficit and a very large current account deficit. And that it continues even as the Federal Reserve is seen as getting out of the game of monetary policy does make me think that it matters in markets.

MALLABY: Yeah. I’ll come to you afterwards.

Q: Thank you very much. Mark Finley, recently retired.

Quick comment following Heidi’s comment on the oil market. Just I think you’re right that the market’s, you know, very well-supplied, but twenty million barrels a day of oil still flows through the Strait of Hormuz.

My question is, how does the panel see kind of near-term economic prospects elsewhere around the world, especially in China and in Europe? Thank you.

MALLABY: OK. So China and Europe. Who wants to take Europe?


IP: So I think one of the—(laughter)—I don’t know if I speak for you guys, but I think the—one of the big puzzles this year is why growth has slowed down around the world, especially in Europe. I mean, I look at the numbers coming from Germany and they’re just—they’re just horrific, and I can’t really understand why. And the experts in Germany keep saying, well, it was because of, you know, this changeover in automobile regulations, or it was China, and so forth. Those excuses are starting to wear a little bit thin. If I had a better feel for why we’ve seen some of those numbers I could answer that question with a little more confidence.

And frankly, in China I have a little bit stronger opinion, which is that they have been deliberately trying to slow the economy by tightening availability of credit, so that wasn’t as much of a surprise. And what you see on the trade front is simply exacerbating that side.

But I think what you’ve raised—I’m sorry I don’t have an answer, but what you’ve raised, I think, is a gigantic question mark that might actually be driving what the Federal Reserve did. We might be discovering that the whole world’s potential growth rate is a lot lower than it was ten years ago. Just kind of a—you know, to use an overused phrase, secular stagnation feel to growth around the world right now, that maybe we’re not going into a recession, but the idea that any advanced economy can sustainably grow above 2 percent is—that’s just yesterday’s news.

REINHART: Oh, potential output growth is slower in advanced economies. We are aging populations, growing more slowly, participating less in the organized labor force, and not adding much output per extra hour of work. And in the succession of IMF World Economic Outlooks, you look at their five-year-ahead forecast for 190 economies, in three out of four of them they’ve been marked lower. So that part’s—you didn’t include the lowness of water in the Rhine as a specific factor.

IP: (Laughs.) Yeah. Yeah, yeah. Yeah. (Laughs.)

REINHART: But if you—if you wanted a common factor, I think you would look at the fact that world trade actually—the volume of world trade shrank on a twelve-month basis at the end of the last year, and it has—and it has only recovered modestly. And trade matters more to those trading partners than it does to us. So I think that is a direct contribution.

I think you do have to have other idiosyncratic features to explain Germany. It isn’t just trade, that’s for sure.

And on the list in China, it is they wanted to slow the leveraging of the economy and they were in the midst of an anticorruption drive, both of which are disruptive of expansion as usual. And I think they’ve slowed, and they have slowed more than the official data would suggest.

CREBO-REDIKER: So there’s one other thing. I mean, we’ve touched on the both political risk and uncertainty as two—you know, two distinct factors just in our conversation today, but there has to be an element of this in—you know, in Europe in particular of uncertainty. We’re in an uncertain period of time where it will likely show up in the numbers of lower CAPEX, of, you know, decisions not to move forward with particular investments in different countries because there’s a general uncertainty. Part of it’s coming from—emanating from Washington because of the trade agenda, but also Europe has its own—its own homegrown uncertainty in the system, not least of which has something to do with Brexit but also Italy, the lack of moving forward on some of the larger objectives of European reform post-crisis, and banking union, and fiscal union, and a lot—a lot of the steps that have—that have not manifested itself yet. So I think, you know, we haven’t seen the real pickup that we’ve all worked for.

REINHART: Yeah. I mean, to put things in perspective, the level of nominal GDP in the euro area in dollar terms is projected this year to be below what it was in 2008; that both Italy and Greece will have—or, in the IMF projections, have a lower per capita GDP in 2024 than they had in 2007. And I think on the list we have to take account of the fact that Europe is a bank-centric system that didn’t effectively deal with the bank crisis, and there has been a grounding to a halt of bank flows within the euro area.

MALLABY: There was a question—yes, there.

Q: Hi. Nancy Lee. Center for Global Development.

I wanted to ask about labor markets, and how much slack there is in labor markets, which bear son the question of growth potential, at least in the U.S. So there’s this argument that there’s still a lot of labor sitting outside the market which can be drawn in. These are sort of long-term unemployed, which if there is enough stimulus could be drawn in and therefore have a response on the supply side to further monetary easing, which would suggest a diminution of the Phillips Curve. So the question is: How much credence do you give to that?

MALLABY: Yeah, so Governor Brainard said there’s no destination point for full employment, sort of a common along the same lines. Vincent, do you think there’s lots of slack left?

REINHART: Janet Yellen was right. If you run a hot labor market you will enlarge the pool of available workers. What’s interesting is that when you look at the worker flows, it’s mostly because people don’t leave the workforce, rather than people on margins of the labor force coming in. And that is very much related to the duration of unemployment. And what’s happened is the median duration of unemployment from 2010, say, where it was peaking, has fallen to something like—in the high twenties to something closer to five. And as the duration of unemployment has come down, the share of workers of—of people identified as discouraged from staying in the labor force has moved down about a half a percentage point. And that’s the extra workers. That’s what makes the natural rate of unemployment flexible. We’ve gotten to the point where the duration of unemployment is probably at friction levels. And so it’s hard to see that process continuing.

MALLABY: Although the friction itself might have come down. And that’s the argument about job matching on internet sites that make it much easier. And the time you have to spend looking for a job has come down. So in an environment where inflation remains below target, why not carry on running loose?

REINHART: I would say those same technological tools make non-market alternatives attractive as well. So we’ve got to remember that part of it.

MALLABY: What do you mean by that, non-market alternatives?

REINHART: The shadow economy, things that aren’t recorded in the data we currently collect. The fact that there are so many things we see that don’t show up in GDP is also—must be influencing labor market dynamics. I think there is a case for having—letting the unemployment rate run below what you believe to be its natural rate. But I don’t think anybody thinks the natural rate is 3 ½ percent. And so a cooling economy to something around the rate of growth of potential in the neighborhood or 2 (percent), would allow a long stretch of the labor market running hot to test your hypothesis. And would have the benefit of getting ultimately inflation back up to goal.

IP: Can I make a quick point here? So when Alban Phillips first wrote down the Phillips Curve, it was actually—he was correlating—he was comparing inflation not to price inflation but to wage inflation. So if you actually think of that original concept of the Phillips curve, it’s still alive and well. If you plot wages against unemployment, you see that once the unemployment rate dropped below 5 percent a very pronounced acceleration in wages from around 2 percent nominal to around 3 percent now. So that, to me, is pretty good evidence that if there’s slack, there’s not very much of it. And you could look at a variety of other data to sort of reinforce that story.

Now, that’s very different question from whether that absence of slack is therefore reason to tighten monetary policy. If you do not see that wages inflation translating to price inflation that could be because productivity’s picking up, which has been low for a while. It could be because the labor share is picking up and the corporate profit share is narrowing. And that too could simply be a reversion to me, which can carry on for quite a few years. And finally, if you start from a place where inflation is too low, the Fed would actually like unemployment to run below NAIRU for a while. It would like an absence of slack to prices and wages up for a while.

There’s a whole different question on the other side of that process of, OK, we got inflation back up. Now what do we do? (Laughs.) Do we jack inflation—unemployment higher? I don’t think they’ve figured that part out, but I figure they’ll cross that bridge when they get to it.

REINHART: But that doesn’t argue for setting policies to get the unemployment rate lower from where it is now. It’s something about the return to what is the natural rate. And perhaps they’ll know what it is when they get to it.

I had mentioned earlier that output moved above potential only at the beginning of 2008. Well, actually, the unemployment rate moved below the CBO’s estimate of the natural rate in the beginning of 2017, a year earlier. And we’ve seen wage inflation earlier than the price inflation. But I think the evidence that we’ve seen it in wages right when you’d expect to makes me think that we’ll see it in inflation—in prices.

MALLABY: Yes, sir.

Q: Stapleton Roy, Wilson Center.

We keep hearing that the strength of our economy is one of the bright spots in our domestic picture. But it’s an economy that’s being pumped up by nearly a trillion dollars in deficit spending. At the same time, interest rates are historically at low levels. So we’re in a situation where the ability of monetary policy to respond to a severe downturn is limited at the low end, but the ability of fiscal policy to address it is limited by the size of the existing deficits. How much of a risk is that for our economy, if we have misjudged and, in fact, encounter a downturn that is more severe than we anticipate?

MALLABY: Who wants to take a crack at that? Heidi, or?

CREBO-REDIKER: So I think that that weighs heavily on the minds of a lot of—a lot of monetary policymakers, for sure, because we are—now if you look around central banks around the world, we have, you know, very limited space to cut in the event of a major downturn. I think the average historically has been about 5 percent cut in—you know, to fend off significant downturns. So we don’t have—we don’t have the tools in the toolbox as robust as we once have had. And you rightly point out that the fiscal space—we’re actually running deficits that are larger than I think we’ve seen in fifty years, according to CBO.

So, you know, the—you know, it is going to come down to, you know, if we have any additional space, what are we going to—what are we going to use that space to do? Which brings up a whole, you know, host of questions about how do you make yourself more resilient? How do you build competitiveness? What do you invest in between now and whenever it is you hit that point where you’re going to need to have those tools in the toolbox? And I’m not sure we’re actually making those investments soundly right now.

REINHART: Yeah. And I’d actually like to add a global dimension. The mechanism by which we would share our economic weakness with our trading partners is through dollar depreciation. But the global economy is not such that we’d get many leaders to raise their hand and tolerate appreciation of their own currencies. So it isn’t just the policy is confined in the U.S. It’s a global problem.

IP: I would say that we have to lock you in a room with some advocates of modern monetary theory. And they would say that you basically believe in the wrong thing all along. Countries with their own currency apparently can print as much of it as they like, and there’s no limit to fiscal deficit spending. Now, notwithstanding that, I don’t fully buy the entire MMT Kool-Aid, it is definitely the case that if you can issue debt at a zero real rate, there’s no particular economic reason why in the next recession the U.S. could not run up a lot of—you know, could not fiscal—use fiscal space or fiscal stimulus to try and get itself out.

MALLABY: The constraint on fiscal policy to respond to a recession may be more that getting something through Congress in a timely fashion, well-designed, may be tougher. (Laughs.) It’s less that you—yeah.


Q: Yeah. Thank you. Jim Goldgeier, Council on Foreign Relations.

So there are going to be a whole slew of Democratic candidates debating next week. I don’t know how much time they’re going to spend on these issues. But, I mean, the picture you’ve just told, you know, it doesn’t seem like they have a lot of entry points to make a case for why they would handle the economy so much better. And some of the things we’ve seen—I mean, you mentioned the bipartisan support for getting tough on China. Until the tariffs on Mexico, Democrats have been pretty quiet about pointing out that tariffs are tax increases on Americans, which would suggest that, you know, tariffs—they’re OK with tariffs. So what should we be looking for in the debates next week regarding where the Democrats might try to distinguish their economic policies beyond the kinds of—I mean, Elizabeth Warren has certainly put out a lot of plans, but presumably we’ll hear some specifics from others next week. What do we expect?


CREBO-REDIKER: So you know, this is the Council on Foreign Relations. We talk a lot about global economic issues. But I think a lot of the primary focus is on the U.S. economy and domestic issues. So that is what I would expect to be the primary focus on the economy in debates, would be on issues that are very near and dear to voters’ hearts, which are domestic. There’s certainly a case to be made for looking at a competitiveness agenda, which is not all about—it’s not all about stick and tariffs, but it is about looking at what we need to build to invest in a more resilient and competitive U.S. economy. And that looks like infrastructure, and education, and skills. And lot of those—you know, a lot of those topics that we really haven’t—we haven’t seen manifest in policy over the past several years. So it’s a—you know, I would expect that to be more front and center.

Trade is going to be a precarious topic, I think, with—we’ll see—we’ll see how the conversations, both vis-à-vis U.S.-China as well as U.S. versus the rest of the world, the way we started this conversation, and the multilateral system and engagement—how that plays out. But I think the primary focus is going to be on the U.S., and domestic economics.

MALLABY: Vincent, what do you think of the wealth tax that Elizabeth Warren has proposed?

REINHART: That across countries that did impose wealth taxes usually don’t get much revenue out of them, which suggests that it is an invitation to evade. That wealth is essentially the accumulation of saving. And we have too little saving, not too much. And so you would think you’d want to encourage it rather than discourage it. So not obvious that it would work. Not obvious that if it did, you’d want it to.

MALLABY: You had a question, here?

Q: Alice Tepper Marlin, Social Accountability International.

I was—just a follow up on the question of Fed changes. And I’m wondering whether since interest rates are at such a historic low, is the market overreacting to the Fed’s possible—I mean, the Fed doesn’t—it doesn’t have very many cards to play anymore. Is the market way overreacting to expected rate lowering?

REINHART: That’s the forecast of the firm I work at. And it is because the U.S. economy actually does have a momentum, that the president’s headwinds on trade substitute for the need for tightening, but it doesn’t really make the case for easing. And it is not infrequent that financial markets overreact in one direction or the other. And so, yes.

MALLABY: (Laughs.) Simple. Ted, yeah.

Q: Ted Alden at CFR. Thank you for a great discussion.

If there’s one sort of economic goal that seems to me to unify the president’s policies—trade, deregulation, the big corporate tax cut that he signed—it’s to boost investment in the United States. What do the data show us so far? Is there any evidence that these policies have generated a significant increase in investment, or that that may still be coming?

IP: Well I can certainly tell you that what he data show, that after the tax cut—the Tax Reform Act went into place, there was a fairly significant increase in investment. But if you actually decompose that investment, you’ll find a lot of it was oil and gas related, which seems to have a lot more to do with the commodities cycle. And business investment has actually slowed in recent months. So it’s very difficult to find any proof in the data that there’s been a sustained increase in business investment.

And by the way, I would say that among thoughtful, nonpartisan economists, who basically supported the thrust of the legislation, that’s not a surprise. I mean, we know that you are dealing at the margin with a small reduction in the cost of capital. That they’re offsetting things—you know, the elimination of some interest deductibility would have had offsetting effects. And that, in any case, over a five-year period, the business cycle is a much more powerful driver of business investment than tax policy.

MALLABY: And the business cycle was positive, so.

IP: Yeah.

MALLABY: The headline number was not surprising.

REINHART: Well, but first of all, economists have a very hard time understanding the determinants of investment. But generally it’s the accelerator that wins that when real GDP growth is picking up investment tends to be stronger. Actually, we mostly move sideways. And it is not exactly a consistent investment-friendly set of policies coming out of the White House. All the discussion about trade uncertainty is—should be a—one would think is an impediment to making long-term decisions. There’s always the option to wait. And the option must be higher right now.

MALLABY: Is there another question? Doug.

Q: Doug Rediker, Brookings and International Capital Strategies.

I wanted to just throw out sort of the elephant in the room, so to speak, which is this had made me feel very nervous because you’ve all made me feel that you’re all very sanguine and complacent. So what keeps you at night? What is the one or more than one thing that happens between now and, let’s call it, the end of this year that geopolitically or economically deviates from this otherwise, well, rates might go up, rates might go down, there’s trade uncertainty, blah, blah. This is been very calming, which makes me very nervous. (Laughter.)

MALLABY: So Doug has been inadequately provoked. And we need to do more to get him worried. We’ll ask Heidi to, you know.

CREBO-REDIKER: So there’s a lot—

MALLABY: This will be the last thing. We’ll each go. One thing to be really worried about, each of us.

CREBO-REDIKER: So one thing to be worried about. I would—I would say that this administration really has not been tested by a massive external threat or shock. And I think, given the loss of capacity, the lack of filling many of the positions of authority, the fact that the president is unpredictable in how he’s going to react on any given day, our hour, or minute, I think keeps me up at night. I’m not sure that we have the levels of decision making in place and the process in place, or the people in place, to actually execute if we were having to respond to something that was not self-inflicted.

IP: I think a lot about, you know, Larry Summer’s secular stagnation thesis, which is that basically the U.S. has been able to achieve above 2 percent growth is by creating asset bubbles. And we’ve created one. You know, I mean, net—assets as a share of GDP are back to the peak we had in 2007 and 2001. And we know what happened after those two peaks. Now, the failure of imagination that Queen Elizabeth, you know, was told about, is my inability to look around and see what is a trigger that causes those asset values to revert to mean. I don’t see it. But I didn’t see it in 2007. I didn’t see it in 2001 either.

I do see housing prices in Sydney and Melbourne coming down, in Toronto and Vancouver coming down. To the extent that there is more contagion among countries than we realize because we can’t necessarily identify the links makes me worry that, you know, we could have with today’s, you know, mix of risk and financial conditions tightening, you know, started that little sandpile crumbling a bit. And once that asset world starts to revert to mean, I don’t how you turn it around.

REINHART: Sebastian would feel poorly served if I didn’t give a movie reference. And I have to repeat one. And my worry is that we are—we are playing games of chicken with many, many counterparts—with Iran, on geostrategy with China, on trade and strategy potentially with the EU, with Mexico. And the prototype of a game of chicken is the movie Rebel Without a Cause, in which teens race to the edge of the cliff to see who will be the last one to stop. And Sal Mineo goes over the cliff because his car door gets caught in the—his leather coat gets caught in the car door handle.

IP: Spoiler alert. (Laughter.)

REINHART: It happens early in the movie. (Laughter.) And so—and so the world’s a risky place. And there’s any number of things that can go wrong.

MALLABY: So, Doug, just don’t wear a leather jacket. (Laughter.)

Thank you to all of you for coming out. And thank you the panel. It’s been a great discussion. (Applause.)


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