World Economic Update

Friday, October 11, 2019
Susan M. Lund

Partner, McKinsey Global Institute

Adam Posen

President, Peterson Institute for International Economics

Vincent Reinhart

Chief Economist and Macro Strategist, Mellon


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

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, great. I think we can get going. Thank you all for coming. Welcome to this morning’s World Economic Update at the Council on Foreign Relations. I’m Sebastian Mallaby. I work here at the Council. We’ve got Susan Lund on my far-right, partner at the McKinsey Global Institute. Adam Posen, president of the Peterson Institute for International Economics. And Vincent Reinhart to my right resident cinema expert and chief economist and macro strategist at Mellon.

So the world economy, I’d say it’s fair to say, is probably kind of doing OK, but not great. Growth is forecast at 2.6 (percent) for 2019. That’s the weakest in three years. But you’ve still got full employment in most of the big economies, barring Western Europe where you’ve got still high structural unemployment. But at the same time, there’s lots to worry about. The big headline being political risk, which seems to drive markets not only—you know, most obviously in the U.S.-China context, but also in terms of Brexit and I think, arguably, in terms also of the outlook in the eurozone. We’ll get to all of that.

And since the president has just tweeted about the U.S.-China negotiations, perhaps we’ll start with that, and maybe start with Adam. So the latest Trump tweet is optimistic about the prospects for some sort of mini-deal. But I want to ask a slightly different question, which is we’ve now had several months of 25 percent tariffs, and yet the U.S. economy is still growing. There’s no recession. What’s going on? Why the resilience?

POSEN: Thank you for having me back, Sebastian. Thank you all for coming out.

The U.S. economy is a red bull economy. It’s a big frat boy lunk who’s taken a bunch of caffeinated stimulus. And while that slightly elevates the chance he’s going to keel over of a heart attack, basically he can just keep powering through. I’m not being facetious. You know, you have a big, strong body. The resilience of the U.S. economy is much better than it was fifteen or twenty years ago because of improvements in financial supervision, improvement in household balance sheets, improvement in corporate balance sheets. And so it’s basically strong. And the stimulus is we have massive fiscal stimulus and moderate monetary stimulus. So it can keep going. And China can keep going. And the euro area can keep going.

This isn’t because trade doesn’t matter. Part of the reason, I think the primary reason we have such a horribly investment-poor recovery at the moment, despite tax cuts and despite deregulation, is because of trade. I think our productivity rate will continue to be affected and driven down by lack of competition and corruption that are incurred by trade policies of the sort the Trump administration pursues. I think that diminished investment. And the investment, in turn, reinforces the bad productivity effect. So, again, the frat boy can decide to live on, you know, Power Bars and Red Bull and, God, now they have alcoholic seltzer. You know, and nutritionally in his forties that’s probably going to be a really bad idea. But while he’s still in college, he can get away with it.

MALLABY: Susan, you and your colleagues at McKinsey often look at the microeconomics underpinning this stuff. So when you look at firm-level data, what do you see in terms of the impact of the U.S.-China trade war?

LUND: Well, manufacturing is in recession. Like, yes, the overall economy is expanding, but we’ve now had several months in a row of manufacturing actually contracting. And that is to be expected, because the tariffs we’ve had so far have been mainly on intermediate inputs. And those are hard to source differently in the short term. So the global value chains that have, you know, been established, whether you like them or hate them, they are in place. And it’s quite difficult for firms to very quickly switch components when they’ve worked with suppliers to develop very specific products.

The Chinese, on the other hand, had no problem buying soybeans from Brazil overnight. So U.S. soybean exports literally just went to zero. It was an administrative deal. It wasn’t an effect of tariffs on the Chinese side, they just stopped buying U.S. agricultural products. But for U.S.—for the U.S. importing Chinese goods, it’s much harder and it’ll take more time. So this is why I think you do see an effect of the slowdown. You certainly see the point that Adam made which is a lot of companies are in the wait-and-see mode. They have shifted where they’re sourcing products to the extent they can with their existing relationships. They’re seeking new suppliers in Vietnam, and Bangladesh, and different countries. But I don’t see a lot of new investment going on in building out production, either in the U.S. or in other countries, yet. So it’s hitting the U.S. I know the goal was to boost U.S. manufacturing, but there’s no evidence that that’s happened yet.

MALLABY: Vincent, I think you present a chart in your most recent piece showing that if you track the hit to business confidence it looks like a bigger hit in China than anywhere else.

REINHART: So I want you to entertain this possibility, Sebastian, and that is: President Trump is right on trade in two respects. I’m going to say narrowly in two respects, by the way. The first is, trade matters more to our trading partners than to us. We are a much more service economy. Manufacturing’s eight and a half percent of our workforce. Thirty percentage points off the last century’s peak. And we’re more closed. And the second point is we have more cyclical momentum going into this event than our trading partners, in part because we got the boost associated with the fiscal stimulus.

What you see is that an economy that has a large trade surplus is sending more goods out to the world than it’s bringing in. By definition, if the volume is trading is slowing, it’s going to hurt them more. That’s the story about China. And, oh, by the way, if we’re 12 ½ percent of value added is in manufacturing in the U.S., it’s 30 percent in China. And so that is the lever to negotiations. And what you find, you find if you look at search interest, if you look at measures of uncertainty, newspaper interest, it’s literally off the charts in China. It feels bad here, but it’s an order—almost an order of magnitude different in China.

MALLABY: Uncertainty is.

REINHART: Uncertainty, yes. Yeah.

POSEN: Just one thing, though. I mean, Vince’s point is well-taken, but let’s not forget a huge share of U.S. services—a huge share of U.S. exports are still services. And they will be affected. And brands will be affected. It’s not—it is a little misleading to present it as manufacturing exports are the definition of vulnerability. It just takes a little more time.

REINHART: So what that is—what that says is the U.S. can weather a downdraft in its domestic manufacturing sector, and the global activity, for a time, not forever. It’s going to bleed into incomes. It’s going to bleed into financial prices. So it is critical in this exercise to resolve some of the trade uncertainty.

POSEN: Well, again, this is a great point, though. It’s not just about the uncertainty. I mean, this is the same thing. And we’ve talked about this before in this group about Brexit. The problem with Brexit isn’t Brexit uncertainty. It’s Brexit. The problem in trade and China is if we shut down world markets and we attempt to decouple. Even if we’re 100 percent certain that a President Pence or a President Warren will do that, it’s still bad.

MALLABY: Susan, you’ve looked, I think, at the sort of underlying strength or weakness of China, in particular the other official statistics, real. Is the debt burden going to catch up with them? What’s your judgement about China’s strength and therefore its resilience in an extended faceoff, if that’s what we’ve got?

LUND: Well, it’s always very hard to know. The official world is this is not a big deal. China’s doing just fine. I think Capital Economics, a consultancy in London, did some very good work. They have what they call the China economic activity index, or some such thing. And what they show is that since about 2012, there’s been a growing divergence between probably actual economic activity and reported. Remember that to achieve the goal that was stated almost ten years ago to double GDP by 2020 means China needs to grow at 6 percent this year and next year to achieve that.

MALLABY: And magically they’re saying 6.1 (percent).

LUND: And my guess would be that will be the official reported growth. But I think that when you look under the covers, I think it is biting. And it’s very much what Vince said, is that, you know, manufacturing is very large part of their country. Now, that said, work that we’ve done shows China is become more of a consumer—Chinese-consumer-oriented economy. So the share of what they export has fallen quite dramatically over the last ten years. They’re starting to sell into their own market. They’ve got a billion people. Many of them are extremely rich. Many of them are what we call consuming class.

So they are shifting, but they’re not there yet. And what they’re trying to do every time they don’t hit the target of 6 percent is use stimulus, usually in the form of some type of debt. So bank lending to SOEs, state-owned enterprises, or most recently more bond issuance by what are called local government financing vehicles. These are local governments issuing muni bonds, essentially, to fund infrastructure, shopping malls, entertainment facilities, you name it. So it’s still very much investment and building that’s driving current growth.

MALLABY: Vincent, let’s go back to the U.S. for a second. You know, the Fed has cut twice since the summer. And that’s part of what’s explaining the continued momentum of the U.S. economy, despite this trade friction. Do you think the Fed has enough ammunition to continue to protect the U.S. from a downturn?

REINHART: So you’ll have to explain to me how long the downturn is. And when you think about it, say, where we were a year ago, it isn’t just a fifty basis point swing in the federal funds rate that we got this year. It’s a much more considerable swing in where the Fed thought it would be today relative to where it is now. So that represents stimulus. In the list of unconventional policies you have guidance. The first line of defense will be the Fed will say they’ll keep rates low for a very long time. They have done quantitative easing three times. They will do it again. And they will reach deeper into the toolkit to provide stimulus.

There is a limit to what we can expect from monetary policy. And as we see in Japan, as we see in the European continent, without help from the fiscal authority, without help from your trading partners, it is—the Fed’s got a difficult job. What makes Jay Powell’s job even more difficult is his colleague central bankers, because when you ease monetary policy you want to stimulate financial conditions. Included in that is a depreciation of your currency. But what’s happened this year is all Jay Powell’s colleagues have moved down with him, because they don’t want to have an appreciation of their own currency.

The way to think about it is, a depreciation of your currency is asking your trading partners to share some of their strength with you. Nobody’s raising their hand. That makes it harder for the Federal Reserve to provide as much accommodation.

MALLABY: And, Adam, do you think that the politics around the Fed, the name-calling from the president and this strange situation, where on the one hand the Fed is cutting rates to shield the U.S. economy through Trump’s trade war, at the same time Trump’s response is to attack the Fed. How does that—does that dance matter? How does it end?

POSEN: I think it matters less now than some people feared, although it’s there at the margin. I mean, the usual response of central bankers, as Vince knows well, is when you’re under political attack you’re slightly more reluctant to give the government what they want, and the markets slightly are more likely—slightly more likely to assume that you will give the government what they want. So there’s a recent estimate that markets are probably perceiving ten basis points, roughly, lower rates due to Trump’s threats, which no non-trivial but also not a huge deal.

I think in terms of the atmosphere around the FOMC, and not just Chair Powell, I think it matters a lot that Trump has started tweeting about the Fed so frequently, like he does other things. And then it actually becomes easier, it becomes more like noise. I was at Jackson Hole when Chair Powell gave his speech. And we immediately—almost immediately after had a tweet from the president of the United States calling—saying, you know, who’s more of a(n) enemy to the U.S., Chair Powell or President Xi? And you know, Chair Powell kept it together. But that’s a very frightening thing to have said to you then. And so that was creepy.

But now that it’s just Trump—(laughter)—now that it’s just Trump going blah, blah, blah, blah, blah, you tend to tune it out. Also, more importantly, Chair Powell and the Fed since he took over has worked extremely hard to do outreach, particularly to Congress. And that’s ultimately much more important. As I think I’ve mentioned before, the Fed fears Congress. Congress fears the president. The president fears the Fed. So basically, until Congress starts coming after the Fed, the Fed can largely ignore it.

Finally, on trade, I just don’t buy the sort of story of the dynamic between Fed actions and trade policy, because if they cut Trump says, oh, you’re strengthening my hand, you got to cut more. If they don’t cut, he says, ah, the Chinese are still evil and you’re making my job harder. I think he does the same trade policy whatever the Fed does.

MALLABY: Let’s switch to Brexit. And I guess a framing question for Susan, first of all. So the news on Brexit has been very fluid in the last twenty-four hours. The odds of a deal and an orderly withdrawal seem to have gone up a bit. But the likely outcome still appears to be fairly much of a hard Brexit. So what I want to ask Susan is, you know, if that happens can you think of another example of this sort of radical experiment in deglobalization. You know, a country integrates for thirty years, or something, forty years, with its geographic neighbors. Forty-three percent of exports go to—go to this market. And then they say, we’re leaving. Is there a precedent?

LUND: I can’t think of a precedent. Although—well, you could—OK, I don’t even want to say it. But you could look at Zimbabwe. Not a good one. (Laughter.)

MALLABY: Great, that’s reassuring.

LUND: Sure, I don’t know, look at the U.S. I mean, we may or may not pass the new NAFTA. We’re threatening 25 percent tariffs on European auto imports. I mean, you know, a year or two hence we may look back and say: Aren’t we doing the exact same thing?

REINHART: So I would say one example, particularly emphasizing the global supply chain aspect, is the fall of the Soviet Union and what it did to Eastern Europe. Eastern Europe was—had a trading pattern directed toward an economy that was no longer there. And therefore, had a massive disruption in their supply chains. And, by the way, they had really bad capital, so they couldn’t integrate by turning Westward. That was a very large fall in output across many economies. So that’s lots of experiments.

On the other hand, there’s—you know, the dirty little secret in trade theory is—or trade empirics—is bilateral trade is pretty much determined by distance. They’re not going to move the island, right? And so there will still be those advantages associated with closeness. It may require very large relative prices to still get the same trade flows. And so we’re going to have this controlled experiment. How much of it is supply? And then you take the Eastern European example as being very scary. And then how much of it is about bilateral demands, in which case the prediction is it’s about prices and less about quantities.

MALLABY: So sterling depreciates, and then you retain the same relationships? So, Adam—

LUND: And then Britain is poorer.

POSEN: Yeah, Britain is much poorer.

REINHART: Yes. That’s the consequence.

POSEN: Yeah, no, I just want—

MALLABY: You guys will go to London and buy—

POSEN: Clean in economic terms, right—I just want to be clear the audience understands. Price adjustment means, like, Greece, right? It means, like, all your wages and the price of your goods has to go down a lot. So this is—this is—this is not—I’m not saying Vince meant otherwise. I just want to be clear everyone gets that that’s what he’s saying.

MALLABY: But you’ve been, therefore, shopping in London recently.

POSEN: Oh, yes. Oh, yes. Absolutely. I am a substituting consumer. So I was in London last week. Partly talked Brexit, as I gather Susan was recently. And so I see—rationally, I see the tariffs on British cheese coming. So I picked up a huge chunk of stilton at Neal’s Yard and brought it back. And I did the calculation afterward. It was 38 percent cheaper than at my current Whole Foods.

MALLABY: Thirty-eight percent?

POSEN: Yeah.

MALLABY: And did you buy stilton, Susan?

LUND: No. I went for the Gucci purse. Thirty percent discount if you go—

MALLABY: Thirty percent?

LUND: Thirty percent from what you pay in the U.S. right now. So all of you interested in designer goods, Heathrow Airport is your place.

POSEN: See, we’re doing our bit for Britain. (Laughter.)

MALLABY: And we’re offering you, you know, practical, real-life economics here. Sorry, I interrupted you, Adam. So—

POSEN: No, no, no. I was just going to say but the other thing that’s different, I think the Eastern Europe and the Zimbabwe examples, frankly, are reasonably apt. I hadn’t thought of Europe—Eastern Europe. And I think Vince is right to raise it. But just to say that, again, the services aspect matters a great deal. So the U.K. is disproportionately, even by rich country standards, a services economy. Media, law, business services, obviously finance. Even the North Sea oil stuff has all now turned into—or, mostly turned into services for the energy industry.

And the barriers we’re talking about, Vincent’s absolutely right about the geography. It’s called the gravity model. You tend to trade with those closest to you, and historically you’re closest to. But, you know, if you have nonagreement on recognizing people’s qualifications, nonagreement on contracts, nonagreement on regulations, those service barriers go up awfully fast.

MALLABY: Do you think—would you apply the same red bull thesis to the U.K. economy? In other words, you know, there was prediction back in 2016 that if the referendum went in favor of Brexit there would be a near-term economic shock. That was cushioned by exchange rate shifts, by accommodating monetary policy, by strong global growth at the time. We’ve now had one negative quarter of growth this year in Britain, but the most recent quarter looks like it will be positive. So what do you think, if we do get a hard Brexit, what happens in terms of the economy?

POSEN: So I don’t want to use the red bull analogy for the U.K., just partly because I don’t want to overuse it. But mostly because, I mean, this is actually, in a sense, echoing Vincent’s point. The depreciation—the sustained depreciation of the pound is what should have happened with the economy is going to be fundamentally less competitive for the foreseeable future. And so that is part of the adjustment. And that’s not what we’re seeing in the U.S. case. It’s not a self-ingested stimulus. It is these other things. I don’t know what the right analogy is.

In terms of the damage, most of the careful studies that have been done—and we published a summaries of these—a lit review of these studies at Peterson, including some updated ones from the Bank of England and others, suggests that the U.K. is probably down 2 percent of GDP versus what you would have expected over the last couple years. Two percent of GDP is real money. It’s not a horrible recession, but it’s real money. So there is still a harm there. And I can talk about all the ways this is a robust number. There are a lot of ways you can get to this number, and it’s about right.

And so most of the literature and the simulations we look at is anything approximating a moderately hard Brexit, meaning not a cliff but something like what apparently Boris Johnson and Leo Varadkar were talking about over the last couple days, should take off on the order of 5 or 6 percent of GDP over a couple years. Now, that’s an actual recession. You can then debate how much of this 2 percent we had already should come off that. But we’re talking chunky numbers here. This is big.

MALLABY: Let’s switch to the eurozone, Vincent. We have a situation where, you know, Christine Lagarde comes in as the new head of the European Central Bank November 1, I think. And she’s walking into more of a sort of stormy situation than one might have guessed when she was named to the job, because the latest round of doubling down on unconventional stimulus by Mario Draghi has produced this rather strong backlash with seven members of the committee voting against Mario Draghi, with the—one of the German committee members resigning. You know, more than normal pushback in the German press about the evils of quantitative easing and negative rates. Lagarde is famous for being a politician. How do you think she navigates this?

REINHART: So first part is the beauty of the ECB setup is they don’t take a vote. Somehow Mario Draghi looked in the room and he said, I see a majority for these policies, even though it probably was not a majority GDP-weighted when you get everybody—

MALLABY: That’s right, yeah.

REINHART: —everybody who objected. So that’s the first part.

The second part is, we’re talking about a consummate politician. And that’s Mario Draghi. The president of the ECB—it’s always hard to head a monetary policy committee. But there’s a sense of shared interest and also an understanding in most cases you are accountable to the same politicians and therefore you have to deliver the same thing. In the ECB case, it’s fractured. You’re trying to get a committee together but they’re not accountable really to the same set of political betters. And so there’s got to be an element of political management by the president. And what Mario Draghi was quite successful with was falling forward, suggesting an idea that the majority of his committee would not accept in a speech, getting that into a press conference subsequently, and then going to those same people and saying: It’s built into expectations. If we don’t deliver it, then it will be a colossal failure. And, oh, I look out and I see there’s a majority of the committee for it.

And if it is—has that political element, then Christine Lagarde is well-poised to—and even more than Mario Draghi is probably willing to call the political master to the member of the governing council, because she does have those finance ministers, she does have those prime ministers’ phone numbers in her Rolodex. Recognize that in the—in the meter between politician and economist Lagarde is much more politician than economist. That does also imply that there’s there going to be a more reliance on the staff of the ECB—i.e., more reliance on your chief economist Phil Lane, who’s a dovish guy.

MALLABY: So that suggests that the dovish chief economist Phil Lane, combined with the politically adept Christine Lagarde, sort of sticks with the Draghi program, notwithstanding all this pushback in the German media. And so then the question becomes, if that is the path, and maybe Adam can comment on this, is it—how well will it work? I mean, are we at a point where negative rates and QE, you’ve got an environment where I think three-month government bonds in Greece now attract negative interest rates. In Germany, long-dated debt, negative interest rates. How much is it possible, or even good, to continue to keep rates on the floor like this?

POSEN: I think, Sebastian, that notwithstanding the, by ECB standards, fireworks around the last meeting that you and Vince went through, the real story is that former President Draghi, President Lagarde, and the overwhelming majority of the committee, including the German and Germanic members, believe that they are at the end of ammunition for central banks. I mean, Mario Draghi’s valedictory statements were very clear about that. And so picking up on Vince, the idea about the political role of Christine Lagarde, the term of art nowadays is fiscal monetary coordination. This is essentially convincing those finance ministers in her Rolodex that it’s time to do more fiscal stimulus as things get worse in Europe, rather than rely on monetary policy. And I think, despite these atmospherics, there’s actually a very broad consensus on this.

What’s been fascinating over the summer and over recent weeks is you’ve had almost everybody in Germany who’s a public figure on this come out in favor of some form of shifting fiscal. They may blame it on Mario Draghi and the evil ECB, but, you know, Axel Weber, the former Bundesbank president who runs UBS, he’s obviously talking about the interests of UBS, but nonetheless he’s coming out publicly for tax cuts. Wolfgang Schäuble, the former finance minister of Germany during the euro crisis, still big in the European—I’m sorry—in the Bundesrat, the German parliament—Bundestag, excuse me, German lower house of parliament. He’s come out somewhat for fiscal. You’ve got distinguished, supposedly, right-wing monetary economists in Germany writing that it’s much better than QE or further negative rates.

The Dutch government which, if anything, was even more fiscally orthodox and conservative that the German government, they’ve publicly come out and said: OK, we’re going to do a Green New Deal, but we’re ready to issue debt to do that. So I think that that is actually the major change going on. And Madam Lagarde will be important in facilitating that, but there’s actually a surprising, to my view, amount of consensus behind this shift away from the ECB towards the finance ministers.

MALLABY: But just to clarify, in terms of statements from the German government, the commitment to zero deficits remains, right?

POSEN: It’s a little complicated. So there’s both what they call the schwarzhandel and the schuldenbremse. The schwarzhandel was the commitment that they were going to try to keep the budget basically at zero. They have backed off that. And even Merkel has not explicitly said it, but they are—Olaf Scholz is speaking here at the Council, I guess, next week. When he spoke at Peterson last year he spoke about readiness to move off that if needed. The issue is more what they’re calling the schuldenbremse, the debt brake, which is written into the constitution and puts all kinds of weird limits. My bet is that as Germany has a major slowdown, assuming Germany has a major slowdown for all the manufacturing reasons Susan and others have talked about, is that they will find a way to finesse that. They will create an investment budget, or a green budget, or a green investment budget and get around that.

MALLABY: Yeah. Yeah. I want to put one question to Susan before we go to members for questions. And this is really about something which perhaps underpins—we’ve been talking about the political situation and its impact on growth. But underpinning those politics is I think something you’ve been working on to do with the geographic distribution of growth in the U.S. So talk a bit about that concentration of growth.

LUND: Yeah. So we’ve looked at what’s happened since the Great Recession over the last ten years, and project forward. We’re interested in what is the impact of autonomation. But just when you look at history, what you can see is that every county in the U.S. lost jobs during the Great Recession. But coming out of the Great Recession, there are large parts of the U.S. that didn’t see any rebound in employment creation. Sixty percent of the jobs that were created were in just twenty-five cities. And it’s the ones you would guess. It’s Seattle, Denver, New York, Los Angeles, et cetera, Austin, Texas. And then there are some niche cities around that are manufacturing hubs. Or, like, Provo, Utah, or Reno, Nevada are up-and-coming tech hubs. But by and large we can name, and you all know, the cities that have created jobs in this country. And vast swaths of the rest of America, whether it’s small towns, rural areas, former manufacturing sites, have seen very limited and even negative employment growth. And as we look forward, absent major policy changes, it looks like this could continue.

I think it’s particularly concerning because U.S. mobility and the rate at which Americans move across country lines is about half of what it was in 1990. And that’s for a whole variety of reasons. It’s two-income families. It’s taking care of aging parents. It’s—we’re older. We own more houses. That’s a limit. But it’s a big problem, because it means people aren’t moving to where the prosperity is. When they do move, they tend to stay in the type of county they were leaving. So if they’re in a low-growth and rural area, the number-one destination will be another county in a low-growth rural area. So this really speaks to an economic divide, but it clearly has political and social implications a well. And I think it deserves a lot of attention on how do we promote prosperity?

Adam, I watched the video of you with Jonathan Gruber and Simon Johnson.

POSEN: Well, more Simon Johnson than Jonathan Gruber, yeah.

LUND: OK. Flip that order. They have a—I forget the name of their book. But anyway, they’re looking at the same phenomenon. And they come out with a policy proposal on, like, how do you spread innovation and growth to other parts of the country. And I think this is a big challenge. Nobody’s talking about it in the election cycle, but to me this is fundamental unless we want to see a continuing diverging America.

MALLABY: OK. Let’s go and see if there’s any questions from members? Who’s got a question? OK, yes, right over here. Remember this on the record. I should have said that, yeah.

Q: Thanks very much. Nelson Cunningham, McLarty Associates.

This is a question I guess for Adam, but the others would be welcome to jump in also. You would have counseled President Trump not to get into this trade war with China. But now that we’re in it, what’s the right way to unwind it? There are clearly things that we need the Chinese—we’d like the Chinese to do. Clearly changes in their system we’d like them to do. What would you say to the next president, whether it’s a Pence, or a Warren, or—my favorite—Biden? They take the office. What’s the first step with China?

POSEN: Nelson, thank you. And I’m obviously interested in what my fellow panelists have to say. My view is very simple. This is—this is the economic equivalent of the Afghanistan War. And so there is—there may be huge sentiment for it in halls of Congress, there may be pockets of sentiment for it in parts of the U.S. where people feel they felt losses because of China and they have to strike back. But ultimately, it’s pointless. The amount of our ability to change the internal structures of China or the Chinese economy is extremely limited. I also think the amount of their ability to do us genuine damage instead of perceived damage is extremely limited.

So politically I would be walking into presumably the third-level advisor to one of these people, whoever’s president, and saying to them: Look, I understand politically you may feel you have to continue this, but the best thing to do is to move this into a symbolic plane and get it off the economic plane. Start with a ceasefire. Maybe that is what President Trump’s going to yield today is negotiations, which would be a ceasefire, which I then expect Democratic candidates to attack as being soft on China, frankly, which shows the problem. And then have very narrow, specific national security goals.

Friends of mine who are experts on this much more than me talk about a very small yard with a very high fence. So there are very specific technologies, very specific practices that you try to go after in an extremely potent way. And otherwise, you have to let it go. Now, again, people are not going to want to hear that, but I just—literally, it’s just a waste of treasure and blood, in the form of jobs.

LUND: Yeah, I would just add, I think many people—because this has come in so many different rounds, I think many people don’t realize actually what a dramatic shift we’ve had. So the start of the trade war, U.S. average tariffs on Chinese goods was somewhere in the neighborhood of 3 percent. Average Chinese tariffs on U.S. goods were 8 percent. If we get to December, the end of December, and all announced tariffs go through, we’re at 25 percent on both sides on 100 percent of goods traded, more or less, right? That is a—(laughs)—we went from 3 percent to—I mean, this a very large tax. I think it’s important for any administration coming up to realize that. We know taxes are inefficient. They’re distorting. I mean, we need to try to walk this back and go beyond just a ceasefire. And, actually, I think Adam has it exactly right. And then be very targeted about the places that we really care about and want to do something about.

MALLABY: The only thing about that analogy of the small area with a high fence, is that if you were to include 5G in your small area, the area becomes quite big. I mean, there are—technology, to the extent that it, you know, is key to national security in a cyber world, and key to the economy, means that it’s tough to—

POSEN: But I actually—sorry, Sebastian. And of course, I agree with Susan. I’m going to push back on this, because fundamentally if we are vulnerable because of 5G and Internet of Things-related things, then I might trust the Chinese least with that. But I’m not sure I trust the U.S. government with that. I’m not sure I trust Facebook with that. I’m not sure I trust Amazon with that. And so the answer may be not to say we don’t want Chinese 5G. It may be, as European Union contemplates in various areas, regulating the heck out of these things so that we’re all not vulnerable to corrupt use and bullying through our information. And so I don’t—to me—and, again, maybe this just sounds naïve—but to me, I don’t view that as a China problem. I view that as a technological control problem.

And fundamentally also, when we talk about these tech wars, in the end the ability of China to threaten the U.S. is about their ability to run various systems integration, high-end military capacities. We can deal with most other things, it’s just if they suddenly had ten aircraft carriers on a part with the USS Enterprise, then we would be worried. At present, they have one and one under construction. Again, I defer to Adam Segal, you colleague here at the Council who does great work on this, but just the history of this is every time—go back to the Cold War, go back to the U.K.-German rivalry before World War I, you can even go back to the Napoleonic era. Everybody’s always trumping up, there’s some new technology that makes it much more dangerous than it was before. And in the end, that’s not what determines things. So I just fundamentally see it differently.

REINHART: Let me just say two things. One to Susan’s point, and I think it goes back to the earlier conversation about trade policy and trade policy uncertainty. There’s scope for improvements associated with a partial trade deal, not because it’s going to significantly narrow the uncertainty about trade. We might wind up not doing two bad things, two more rounds of tariff increases. And eliminated, a negative is a positive. The second thing, my answer would be just despair, that things have been said that can’t be unsaid. You should view President Trump as enabling, that CEOs of tech companies, of chemical companies, were very much concerned with intellectual property rights. But then they said, you know, 1.4 billion potential clients—customers, we can’t go into there. That there were people in the security apparatus that were concerned about the rise of China, but they were pushed out by the conversation of the original logic of the WTO accession. They’ll become a market economy and become integrated. That didn’t exactly—that part was oversold.

POSEN: Oh, it was oversold. The reason I’m making a face, Vince, is, as you know well, it wasn’t one conversation with one intellectual mistake. It was that there’s inherently—and many of the people in the room have experienced this; Nelson’s experienced this—that there are always both econ types and security types in the room. And there’s got to be a yin and yang. And you fight this out all the time. And what I think is—and now, where I completely agree with you is the Trump people have essentially taken the economists out of the room, the civil service economists out of the room, and replaced them with economic jihadists, like Navarro.

And so it’s not that there’s some cosmic realization, oh, China—we blew it with WTO accession. That’s the cover story. It’s in that in a series of interagency internal meetings there’s nobody pushing back against the security types whose goal is always to say terrible things are about to happen.

REINHART: And when you are on the BIS restricted list, you’re on the on-fly list.

POSEN: Right.

REINHART: And well what’s also striking is that’s the—Bureau of Industry and Security in Commerce Department—is how much that apparatus is slow-walking applications, who is sending them back for more comment. It’s basically enabled those who were always suspicious to actually act on their suspicions.

POSEN: Yeah. Yeah.

MALLABY: Let’s go for another question. Yes, right here. Yeah.

Q: Grace Gu, Dracaena Capital.

So question for the panel. I have two. First of all, do you see a 2020 recession? And the second one is, what are some of the major macroeconomic implications to an Elizabeth Warren presidency? Thank you.

MALLABY: OK. Let’s do the first one as a probability. Can you each give a probability of a recession in 2020?

REINHART: I wrote down a third last time we wrote—this week, when we wrote down our forecasts.

MALLABY: One-third probability of 2020 recession.

POSEN: Twenty-five percent of less.

LUND: Twenty percent or less.


POSEN: And just baseline, remember, in an average year the chance of a U.S. recession is 15 percent. So we’re all saying elevated, but none of us are saying that elevated.

MALLABY: Right. That’s very clear. Elizabeth Warren presidency. Who wants to comment on that for the economy? (Laughter.)

LUND: I’ll pass. (Laughter.) Well, there’s, right, Elizabeth Warren, but then there’s also the politics of the whole thing. And then who’s controlling Congress? If you have a divided Congress then, not—I mean—

POSEN: Yeah. So let’s—let me put in terms of policies. I’m not going to put it in terms of an individual, because for all the reasons Susan said I have no way of assessing. In terms of policies, the odds are, I fear, going back to Nelson’s question—(laughs)—that on China relations, both in security and in trade, there’s very little difference. I think there could be a sea change in relations with the EU over trade, and in how much you rely on the WTO and other means. So on trade, even given Warren’s weird video about wanting to defend the production of number two pencils in the U.S., literally—(laughter)—you know, I think—I think we get a lot of progress on some fronts and not.

On environment, whoever’s the Democratic president would do massive 180 on environmental issues and energy issues through executive orders, just as Trump has done it through executive orders, and appointments, and slow-walking equivalents in the various agencies. So you’d see a complete turnaround on energy and environment. On health care, it always comes back to Congress. Most likely thing is you either—if you don’t have a divided Congress you get Obamacare-plus, you get a slightly expanded—a restoration of Obamacare, attempt to get the individual mandates to clear through the courts, and the slight expansion of the public option. If divided Congress, you try to go more to the state-by-state situation and make those states’ individual Republican governors have to make the choice about whether to expand Medicare or not and suffer for it.

Budget deficit, it probably makes no difference, but it makes a difference on who benefits from it. You would have a shift in the incidents of the tax code. You’d have a shift in how much infrastructure spending is green infrastructure spending. So some differences, some not.

REINHART: I’d just add two to the list. One is finance. That will be a considerable difference, and one in which there’s lots of scope for executive action. And while—

MALLABY: You mean regulation of finance?

REINHART: Yeah, re-regulation of finance, in particular on consumer protections and the like. So that’s going to be a big difference. Second point is, yes, divided governments really do matter in terms of the ability to execute these programs. But what we’ve also seen with President Trump, but with President Obama before and Bush before that, is an increasing reliance on executive action. So the next president is going to material in terms of the direction. And it could be quicker if it’s a unified government, but the president—who’s in the White House matters.

MALLABY: The other announced difference, whether or not it translates into a real policy difference, would be the attitude towards big tech—break it up or don’t break it up. I mean, we see a clear—

POSEN: Oh, yeah. Absolutely. And that’s something that—well, traditionally in recent decades that’s something that’s more a matter—exactly what Vince said—about executive action, about who you appoint to the FTC, about who you appoint to the federal courts, what you prosecute. However, if you go back nearly 100 years, you can go back to the Sherman Antitrust Act. So if for some reason Senator Warren was instead a leader in the Senate, or had someone in the Senate—if she was president, had someone in the Senate who she felt she trusted on this issue, you could imagine major legislation on the big tech. You’re absolutely right. That’s another difference.

REINHART: Yeah. And in that regard, I would draw you attention to the American Prospect’s latest issue had something called their day one project, where it was the thirty things the new president can do on the very first day. And it was a very long list. (Laughter.) And it was very encompassing. So it is—and then the second thing is, within that conversation, I would clearly advise President Xi not to try to wait out President Trump, because a Democratic president most likely will be at least as hostile to trade, and a multilateralist in that approach. He might actually be more effective in finding friends.

LUND: Yes.

MALLABY: Question at the back, I think. Yes.

Q: Thank you. Frank Finelli from the Carlyle Group.

I’d like to extend beyond the discussion on negative rates. I understand there’s approximately sixteen trillion (dollars) in sovereign debt trading at negative rates. What about the debt, though? You know, we had 984 billion (dollars) in deficit in FY ’19. That by ’20 is projected to be above 1.1. (trillion dollars). CBO says ten years from now it’s thirty-five (trillion dollars), and thirty years from now it’s a hundred trillion (dollars). And that’s with, quite frankly, some pretty liberal assumptions. And that’s just the on-budget debt. That doesn’t include the unfunded liabilities. Does debt ever matter?

POSEN: Yes. But I think the honest answer has to be, it matters less for large sovereigns, like the U.S., and even some small sovereigns who belong to the euro area than people thought. And my colleague, Olivier Blanchard, has done some of the key analytic work on that, but it’s just people’s lived experience. You cannot claim—you cannot make a debt boogieman that tomorrow or the prospect of tomorrow debt shooting through the roof is going to cause death and destruction. It can cause waste. It can be unfair to future generations—which is a very key issue. It can be a source of diminished discipline on government not to be wasteful, the sort of healthy version of the starve the beast argument. You know, there are a lot of things you can say about excess public debt.

And then you run the risk that someday the interest rate will jump. And you run the risk that if we have a bad recession and monetary policy’s at the floor, you don’t have as much on hand as you would like. But the bottom line is there is a genuine reason. I’m not saying this is what motivates Congress. But there’s a genuine reason why a lot of people have scaled back their doomsaying about public debt, is because it’s just the facts. And the reality is if you’re Japan, or the U.S., or Germany, you know, you can—you have these very large deficits. But as you and others in real finance more than I know, you know, only a small percentage of your total outstanding debt comes up for a rollover every year. And so this is what we’ve seen with Italy.

Italy, you know, has an enormous debt problem. It has enormous tax collection problem. It needs to do better things with its money, all these things. And it’s hurting Italy. But in terms of sort of debt crisis, you know, it’s only occasionally when there’s been what’s called a sudden stop does it become a problem for Italy. Otherwise, they can just roll over small parts of their debt. So it’s one of these things where in public life, you know, it would be more convenient to sort of lie to people and say this is really bad, we have to do something about it right now, instead of saying: This is not good. It would be better if we didn’t do this. And that may not work. But if you lie to people and say there’s a crisis right now, you may end up having to eat your words.

MALLABY: But, Adam, surely the—

LUND: Let me add—

MALLABY: Go ahead, yeah.

LUND: Let me add, though, debt matters—private debt is very different.

POSEN: Right. I thought he was talking about public deal.

LUND: OK, right. Right. Private debt does matter. And public debt matters if you’re a small country and you’re issuing in somebody else’s currency.

POSEN: Absolutely. Absolutely.

REINHART: We didn’t have our conversation about Argentina.

MALLABY: Yes. I was going to bring up Argentina. But that is exhibit A in debt matters.

REINHART: But let me just say one thing here. And we’ve talked a lot about the trade in goods and services, and that President Trump has put that trend on a disquieting path. There’s a counterpart, which is capital flows. And when you think about those budget deficits accumulating to debt stock, we will increasingly rely—have to rely on the international investor to be willing to purchase our securities. And we’re not making friends. And so if you’re talking about a thirty-year path, that should be concerning.

POSEN: Yeah. I mean, this isn’t a free pass on debt. As colleagues of mine at the Peterson Foundation—which we’re independent of, and are obviously a little more concerned about debt than I am—one of the things they say, which I agree with, is, you know, just because you have a home equity loan, just because you have a credit card with a high limit doesn’t mean you spend all of it every time. And it doesn’t mean that you spend it all on junk. You know, and I think we have to have an adult conversation—I’m not setting you up as a strawman. I know that wasn’t your point of view. I’m just saying, we have to have an adult conversation. That those are the kinds of things why it’s stupid. It ruins your credit rating over time, literally and figuratively. But it’s not tomorrow. The big number today doesn’t mean tomorrow.

MALLABY: Let’s go over here. There’s a question. Yeah.

Q: Steve Lahorn (ph) with Deloitte.

I’d like you to tell them—I have five children in university—tell them that debt that doesn’t matter. That would be just awesome. (Laughter.)

I’d like to go to a more—somewhat of a more mundane, but I think it might be important. You can tell me if it’s not. Susan Lund, you observation on labor mobility seems to be a very fundamental issue to me, I would think, for whatever kind of long-term structural recovery we’re going to have. Labor productivity has been revised upward. It hasn’t been all that bad. In manufacturing, though, it’s gone down, I think 2.3 (percent. Non-pharm went up by 2.6 (percent), so there’s a net increase. So how serious is the labor mobility issue that you cited, in your view, or anybody’s view?

MALLABY: In terms of the productivity impact.

LUND: In terms of the productivity effect? I’m less worried in terms of the productivity effect. I think there are big questions about U.S. productivity that we didn’t talk about. Why has it been so low? There’s been an uptick, but is that going to last? Will the next wave of automation and artificial intelligence being adopted by companies change that? You’re shaking your head. I’m an optimist there. But I think, look, the mobility issue, yeah, it could help somewhat. I think it’s more important because it had big ramifications when you start to think about public subsidies to some of the rural areas. It matters also a lot where you’re born. It means that if you’re born in one of these places, if you don’t have the ability to go to college and move—by the way, I can’t believe you. You have five kids in college? How is that even possible? Anyway. (Laughter.) At any rate, I would say, you know, there are big social and political implications. And if you’re born outside of one of the big cities, like Washington, D.C, your prospects are much poorer. And that’s not fair.

I think that there is something—there are many economists who say, look, promoting mobility, telling people to move, is actually bad. You’re tearing apart communities and family structure, and that’s not good. I think on the other side of the coin, though, some kind of information and even incentives or people who want to move but maybe can’t afford to relocate, maybe affordable housing is an issue in the place they want to go. I think policies to address that piece of the—or, segment of the population who want to move, and make it more possible for them, I think would do a lot of good things.

MALLABY: I’ll take one last question, right here.

Q: Thank you very much. Hani Findakly in the Clinton Group.

A follow-up on the question of debt. Since we have three economists talking about the global economy, I wanted to get your perspective on the future of inflation. Is there something in technology, in the structure of the economy, in labor force that gives us some sense of where inflation’s going to be in the medium-to-long term? Because that impacts debt. It impacts fiscal policy. And it impacts the interaction between fiscal and monetary policy.

MALLABY: Why don’t we—each of you can talk about that, and then we’ll wrap up. Quick comment. Is inflation quiescent forever? Does it come back?

REINHART: So if you run a—if you stretch resources, ultimately it shows up in costs and it shows up in prices. We should think about another consequence of that secular change away from manufacturing. We’re 70 percent a service economy. We don’t measure that stuff very well. And we don’t—and so I think there’s a(n) element of a secular trend leading us to a less-volatile, lower-inflation economy, but that supply and demand still matters. And if we run excess demand for long enough, inflation will go up. However, we all have central banks committed to low inflation. They may sometimes be part of the problem, if they’re asymmetric in that pursuit of low inflation. But I wouldn’t be worried about the medium or longer-term prospects of high inflation.

POSEN: So when most of us of my generation, roughly the same generation as the other people at this table, were trained, we were trained that the last thing Vince said was the most important determinative of inflation. What mattered was central bank credibility, and how anchored were expectations, was always the story. And this was seen as partly a reaction to the 1970s, that you had the—not only the running the economy hot so that you got wage inflation, but that it kept spiraling up, and it was hard to get under control, and this was seen as proving this point about expectations.

And so coming into this period of what turned into very low inflation, there was a tendency to dismiss what we’ll call real-side factors, demographics, labor bargaining power, Amazon effect, globalization, as determinants of inflation because it was really supposed to be all about the central banks. And just as there’s been significant, but not 180, change on fiscal policy, I think there’s room to have a significant reevaluation on monetary. So again, not to misrepresent Vince but I think largely agreeing with his thrust, these real factors are having some underlying effect, pushing down inflation over an extended period. And so therefore I worry about it less than I would have, coming out of the ’70s or ’80s.


LUND: I mean, I would agree. It’s, like, I‘m not a forecaster, but I think that the impact of globalization, of technology, of slowing demographics, of shift not only to the service economy but to really the intangible economy. I think these are all factors that explain lower inflation for longer than we would have expected. And loss of bargaining power. Certainly, we’ve seen anemic wage growth, despite historically low unemployment. There’s something going on there. And I think at the same time, you know, when you think about interest rates, they’ve been falling more or less consistently since the early 1980s. So I don’t have the answer. We need to understand inflation better, but just like we’re in a very long-term structural shift in supply and demand for capital, something similar could be going on with the way we think about and measure inflation.

MALLABY: OK. We’ll leave it there. But thank you to Susan, Adam, Vincent, and to all of you for coming. It’s been a good meeting. (Applause.)


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