Meeting

World Economic Update

Wednesday, January 29, 2025
Kai Pfaffenbach/Reuters
Speakers

Co-Chief Investment Officer, Bridgewater Associates, LP; CFR Term Member

President, Peterson Institute for International Economics; CFR Member

Managing Partner, International Capital Strategies; Non-Resident Senior Fellow, Brookings Institution; CFR Member

Presider

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 and is dedicated to the life and work of the distinguished economist Martin Feldstein.

MALLABY: Well, good morning and welcome to the World Economic Update. This series is held in honor of Martin Feldstein, who was a friend and mentor to many of us. I’m Sebastian Mallaby, for those who don’t know me. I am here at the Council. And we have an audience which is streaming, as well as you hardy warriors who’ve actually shown up in person.  

So we’re in one of these split-screen moments for the world economy, where if you look at the data on the surface—you look at the latest World Bank update, for example, global growth for the next couple of years is projected to be exactly what it was last year, 2.7 percent. But under the hood there’s plenty of turbulence, a lot of uncertainty around the baseline forecast. We all know by now that two big things happened on January the 20th: President Trump’s inauguration, but also the release of the DeepSeek-R1 model. We also know that the market freakout on Monday was maybe the biggest freakout, or one of them, since the post-COVID freakouts. And, of course, this was also caused by a leak from a Chinese lab. But joking aside, the point about January the 20th is that you’ve got these—you know, it’s sort of an indicator of the two of the big reasons why underneath the 2.7 percent steady forecast you’ve got this huge uncertainty—the geopolitics stemming from Trump’s, you know, arrival in office and the uncertainty around how technology and specifically AI plays out.  

So with me to discuss all this and more we have three of our favorite people. Right next to me, Doug Rediker, who is at Brookings and also the managing partner of International Capital Strategies. Then Adam Posen, who is the president of the Peterson Institute for International Economics. And then Karen Karniol-Tambour, co-chief investment officer at Bridgewater. 

So we’re going to start with the geopolitical shock, specifically with trade. And I thought I’d get Doug first to explain—you know, we have a situation where, you know, every day you get some statement from the administration, you know, most recently the new Treasury secretary saying one thing about a tariff outlook which is sort of different to what the president then says later in the same day. So what is actually going to happen with tariffs? And how do you even think about that? 

REDIKER: Well, thanks, Sebastian. And thanks, Mike, and all of you for being here.  

So you’ve asked the question that obviously there’s no definitive answer. But let me frame it by taking your question and breaking it down. You said, every day we hear something else from the Trump administration, dot, dot, dot. So let’s ignore everything you hear from the Trump administration and focus on what Trump says. Because I think it is hard to say that Scott Bessent, or Kevin Hassett, or even the press secretary speaks for the president on this issue or anything else, but specifically on this issue.  

So we’ve had—since Trump’s election campaign but then after he was elected and then during the transition—we’ve had a series of market perceptions that it’s all going to be OK because the famous take Trump seriously not literally mantra comes in. He’s checked by a fear of a negative market reaction. Stock market is what he cares about. Therefore, he won’t do anything stupid and counterproductive. He’s pro-business. The question is about sequencing and whether he does tax cuts and deregulation before he layers on tariffs. All that stuff gives a certain segment of the population, the financial markets and others, a comfort that Trump’s not really serious about tariffs. And then you hear the Washington Post leaks and the Bloomberg leaks that Bessent is telling him go slow, and everybody gets very comfortable. So when I talk to my clients and institutional investors there’s one camp that believes that, wholeheartedly.  

There’s another camp that listens to what Trump himself says. Remember, Trump never said: I’m going to do tariffs on day one. Trump said, I’m going to do tariffs. He said, I’m going to do some other things on day one. But he didn’t say tariffs on day one. So the comfort that he didn’t do tariffs on day one is not a promises made, promises not kept. It’s just people read into it, it was going to be day one. And when it wasn’t, they exhaled. But there are a lot of people who then believe he’s going to do it. Now, why do they think that? Because he keeps telling us that he’s going to do it, as recently as this past weekend when he said February 1. You know, there’s the old saying you can use a number and a date, but don’t use a number—sorry, number or a date, but don’t use a number and a date. Well, Trump used a number and a date, 25 percent, February 1. Whether he adheres to that or not, we don’t know.  

But there’s another big chunk that believes he’s going to go big on China and Mexico, in particular. Maybe—sorry—Canada and Mexico, and maybe China. Obviously, the Colombia thing is a separate issue entirely. But that tariffs are his favorite word. He’s going to do it. It’s going to be 25 percent. We don’t know if it’s going to be for negotiating purposes or as an end unto itself, but that he’s going to do it. And my big concern is, I think that both sides—the he’ll never do tariffs and the he’ll definitely do tariffs—both believe with certainty that they are right. And both believe that the markets have priced in their view, which means there’s going to be someone, a lot of someone’s, who are very surprised when he goes either one way or another.  

My view is he’s going to use IEEPA, which is the only tariff tool—and I say tariff tool. Tariffs are not actually built into IEEPA, but the expectation is it can be interpreted to allow him to impose tariffs. But he gives him unilateral discretion with almost no judicial or—there’s a congressional check, but it won’t be used. So he can do that on a dime, any way he wants to do it, effectively, simply by declaring an emergency, which he is prone to do for anything or everything. So I think he’s going to do it. I think he’s going to do it relatively aggressively. I think he’s probably going to build in some optionality. So he might say: I’m doing this but it won’t be implemented for thirty days, sixty days, ninety days, something like that. Which gives him a chance to walk back if he needs to.  

But I do think he’s going to go forward. I do think there are going to be some big surprises on the people who think he’ll never do it. And I think we’re going to have to see how that plays out in terms of negotiating with the individual countries, because I don’t think they’re all going to just suddenly capitulate. 

MALLABY: Yeah. Adam. 

POSEN: I want to add one dimension to Doug’s excellent portrayal and rightful discounting of some of the chatter. Our view at Peterson has been throughout that he was going to go heavy tongs after Mexico and China, and then the rest would be negotiated. The Canada is a bit of a surprise to us. We still think, once the election happens and he gets a more favorable government in Canada, he will drop a lot of that. But the main point that I want to add to what Doug said is the fiscal aspect of this. You’ll hear a lot of discussion, including from Bessent, Hassett, but even from the president, about the idea that tariffs can be a significant source of revenue. And this is true under one side of affairs, which is they do what are called across-the-board tariffs. They put up 10, 15, 20 percent across a very wide range of countries and industries.  

And if they do that, then they are talking about one and a half percent of GDP a year in revenues, which is real money. Not enough to cover the tax cuts they’re planning, but it’s real money. The key point is that, because of what’s called, as many of you know, the reconciliation process—which is the only way you can pass a budget with fifty-one votes instead of sixty votes in the Senate—is that you have to—if they want to count that as revenue, they have to have it legislated so the CBO can count it. But if they have it legislated, and this goes to Doug’s key point, then the ability of President Trump to use discretion on a bilateral basis—and say, I’m doing this to you, you’re nasty, I’m not doing this to you, you’re not nasty, I’m doing this on steel, I’m not doing this on plastic—is constrained.  

And so I agree with Doug. There are these two camps. But I think there’s a third camp, a third risk, which is—I think it’s low probability, but I think it’s rising. Meaning it’s, like, 25 percent probability. That they put on 15, 20 percent across-the-board tariffs for the sake of revenue. Bessent and Hassett say, this is a step to creating a consumption-based tax system instead of a corporate income-based tax system. And then Trump tries to use discretion on top of that. Now that’s a nightmare scenario. But I think you have to actually price that in as a risk scenario as well. 

REDIKER: Can I just—without getting too wonky on this—but I just want to make sure I—so Adam’s point on legislating tariffs is really important. But one of the second-order issues on that is what’s called PNTR. Again, I’m not going to make this into a trade law seminar, but PNTR is basically most favored nation trade status, which every member of the WTO grants to every other member. And the U.S. granted that to China by law in 2000 or 2001, when we accepted China into the WTO. There’s a move on the Hill to now take that away. When you hear Trump talk about 60 percent tariffs on China, that derives from the average tariff on China, if you took it away, would be 59.5 (percent). So let’s assume that’s where Trump gets his 60 percent.  

The problem with that is, if Trump is the big deal maker, the one thing you can’t do when you’re cutting a deal is say: I will negotiate those tariffs up or down, even though I have to go back to Congress and get a vote for them to redo what they just undid. The Chinese are never going to negotiate that. So I think when you hear talk about these massive 60 percent tariffs, rolling back PNTR on China, it’s a very big talk. In terms of the legislative benefit, it’s about $4(00) or $500 billion for the budget, as Adam referenced. But the costs of that, in terms of negotiating leverage with China, are just astronomical. 

MALLABY: So I want to go to Karen. So, I mean, I think what we’re hearing is that, you know, one of Trump’s central policies—a thing on which arguably he’s the clearest in terms of his history on a policy issue—is actually super unclear in the implementation details, how you would do it, do you go to Congress. But notwithstanding this confusion in his central policy, Karen, you were just at Davos. The atmosphere there, I’m told, was super bullish on the U.S. How do we reconcile these two things? 

KARNIOL-TAMBOUR: Well, look, I think that, first, if you just step back and look at the U.S., right, if you take Trump out of the equation, pretend Trump didn’t exist, you’d be looking at the United States and saying, pretty much growth is pretty good. Inflation has come down a good amount. It’s not at the level where it’s worrying policymakers nearly as much as it used to. And you have a Federal Reserve that really, really wants to believe that it can continue to at least ease a little bit and it would take a lot to convince it to tighten. So if that’s all you knew, you would say, this is a great time. Like, how much better could you ask in terms of a macro backdrop for investors?  

And the only thing that would kind of temper some of your enthusiasm would be that valuations are already pretty high. Markets already think this. And, you know, on Doug’s comments of what’s priced in the markets, I feel pretty sure that very high tariffs are not priced into the markets. If you really compare at company level companies that would really be affected by high tariffs versus ones that won’t, you don’t see a big mispricing the way you did, for example, in Trump one, where companies that would really benefit from tax cut versus those that weren’t, very quickly that pricing started getting into the markets and saying, this thing is about to happen, and it’s going to differentiate companies. OK, so that—was ignoring Trump, this should be a pretty good environment.  

Then you bring in Trump and I think it’s mixed. I think when you look at what he does to the outlook of the economy, it’s mixed. You know, you look at the fiscal side, and you basically say, here’s somebody who wants to not just extend tax cuts but increase them. And for companies in the stock market obviously there’s a disproportionate positive effect from lowering the corporate tax rate, right? You look at what he’s saying on deregulation, and there’s certain areas where it’s just talk, and certain areas where at the market has to say, this could be meaningful.  

I would say that my personal impressions is that the breadth of CEOs across industries that something regulatory under Biden was a big issue for them and they are relieved that is off the table is much broader than I sort of appreciated. Because people, I think, under Biden didn’t want to be talking about the issues that they were having. But I’ve been surprised by what a breadth of industries have sort of said, no, something regulatory was in my way. So Trump doesn’t have to necessarily deliver huge deregulation that’s positive as much as take off a bunch of the stress and uncertainty the different sectors were feeling on regulation. And his team definitely believes they could also do positive on deregulation, certainly in energy but also potentially, you know, well outside of that. 

Immigration is obviously a negative and inflationary. People don’t really know how to size how big of a deal that will really be. And then you bring in all the tariff issues. And one important thing to note about the tariff issues is that the Federal Reserve, I think, would really rather see—whether they should or they shouldn’t—I think they’d really rather see any inflation shock from the tariffs as a one off-shock that should not make them tighten monetary policy. So that sort of puts you in a place where you say, well, if the worst effect of tariffs is inflation, and that doesn’t cause a tightening in monetary policy, you’re not going to end up with a very damaged economy as a result of that.  

And then you go to all of these conversations you guys were having, the uncertainty about, like, what they’ll actually do and when. And I would say, look, I think, like, the prolonged uncertainty about what will happen on tariffs basically benefits the United States. Because businesses just say, in this environment of uncertainty on the margin I should probably just manufacture in the U.S. I don’t know exactly. I don’t know how bad this will be. But I don’t want to certainly set up new things that are going to harm me.  

But you look at companies—like, you have identical, almost, European automakers, people like BMW and Stellantis, that made choices years ago that today they’re probably sitting there being like, wow, I had no idea the consequence of those choices. Whether they chose to say every single SUV in the world is made in America, and we’ll send the other SUVs to other countries. Or, no, no, in America I set up to make every car for Americans, and then that means I have to double do every type of car manufacturing around the world—I’m sure they have their own choices. They each made different choices in terms of efficiency. But I don’t think they ever imagined when those choices were made what it would mean under a tariff policy like this. And so on the margin, I think the uncertainty makes you say, maybe invest in the U.S.  

And then I will say, when you take the rest of this conversation, probably the most important thing I would keep in mind is that it’s a lot easier to get around bilateral tariffs. It’s a lot easier. So it can harm the one country you’re doing the bilateral deal with, but it’s a lot easier to get around. When you do across-the-board tariffs, you just don’t have the same degree of getting around it. So I think the market is now pricing a very high probability of very difficult to get around tariffs, in other words against everyone, and very broad, like against every single product in the world at the same time.  

POSEN: Can I just— 

MALLABY: I want to move the conversation to the Fed. 

POSEN: Yeah. Can I just make a couple quick points on that? So, reinforcing what Karen said, I think there’s two key points. The flipside of what she said about the lifting of regulatory fear and threat perception under Biden versus Trump is there’s a lot of pent up deal flow, particularly in financial services, somewhat in healthcare, obviously, energy. And this is an environment where—it was implicit in what Karen said, but just to make explicit—Europe ain’t doing so well. China ain’t doing so well. So you potentially have a multiyear boom even if the Fed raises rates, which we’ll get to in a second, where this pent up deal flow, and change in circumstances, and desire to be in the U.S. further feeds that.  

The second thing I would say—and again, it just reinforces something Karen said—it’s not just I’m worried about tariffs. The Stellantises, the BMWs, the Toyotas, the Hondas, everybody saw the environmental wave that’s coming. That the U.S.—and particularly under Trump—the U.S., environmental standards are going to be completely different and lower than Europe and a lot of other places. And so this idea that you’re producing differently for the U.S., or you’re putting heavy, dirty industry in the U.S. and not elsewhere, is going to be reinforced. So just underscoring what Karen said about a short term sort of rotation into capital market activity that I think is strong. 

MALLABY: Would you come back to the Fed now, Adam? So a few months ago in this same forum you made a call on the Fed. And we know we have a meeting, obviously, today. There’s not that much uncertainty, I don’t think, about today’s particular decision. But stepping back and looking at the next sort of six to nine months, A, do you think the Fed will have to go back to tightening? Is that still your view? And, B, how do the sort of politics of that play out with the Trump administration?  

POSEN: So thank you for having me back, Sebastian, despite my Fed call. (Laughter.) And some of you, I think, were here for that. And what I said in June, and I’ve been saying consistently, is if Trump won 80 percent chance the Fed would be hiking by the end of third quarter 2025. And I stand by that call. And the markets moved a lot in that direction, but not all the way yet. So Karen said, Doug said, I say, basically, you can—Kevin Warsh did an op-ed, Scott Bessent did testimony saying, tariffs are not necessarily inflationary. It’s always fun when practitioners start parsing monetary theory. It is correct that, in theory, tariffs—there are certain circumstances under which tariffs are not inflationary. In a world where you’re close to full employment, even now, in a world where companies are—not greedflation, but do have some pricing power, in a world where you are—there are certain goods that you cannot easily substitute for, tariffs will be felt. And certainly migration restrictions will be felt as inflationary.  

Now, what Karen pointed out, and I very much agree with, is the Fed may choose to try to duck this. They can say, oh, it’s a one-off and what matters is the second round. And, conveniently, the second round of price effects are sometime close to when Jay Powell will be succeeded by someone named Kevin or Kevin. (Laughter.) And they can wait. I think this is a mistake. This is why I think, in the end, they’ll be forced to raise sooner. I think that also relates to the underlying strength of the U.S. economy, that the Fed underestimated and they overestimated how much their tightening was doing in a world where financial conditions were not tight. So ultimately, I think the Fed either is hiking six, seven months from now, maybe eight, nine months on the outside, or is wimping out and ends up behind the curve, which if, as Kevin Warsh said in his op-ed, you know, you think the Fed lost some credibility on the inflation front, is not a position you want to be. It’s not irretrievable. Think of it as ’85 Volcker after ’82 Volcker. You’re slightly behind the curve. You didn’t fully kill inflation the first time around, so you have to kill it even harder.  

Now, the politics. A lot of people are very concerned about this and watching it. I think they’re—I’m worried about the Fed choosing, out of a self-preservation for the institution instinct and for the economic reasons that Karen mentioned, to err on the side of wanting to keep easing. And I think that’s a bad risk. But I don’t think, in the end, Trump will be able to force it to do anything. And so I think the scenario is they ease maybe once more, probably not, and they sit tight until they’re forced to hike.  

MALLABY: So, Doug, I think you have a slightly different take on the risk there.  

REDIKER: No, it’s not a different take. It’s a, what happens next? Last night, apparently, Trump, or the Trump administration, fired some senior officials at the EEOB (sic; EEOC) and the NLRB. Apparently—and I haven’t done the detailed work on this—but apparently, in contravention of the law, which says— 

MALLABY: Just to spell out, these are— 

REDIKER: Sorry. The National Labor Relations Board and the Equal Opportunity Employment— 

POSEN: Equal Employment Opportunity. 

REDIKER: Thank you. And he’s not supposed to be able to do that. So apparently the law says, you got to defer to a Supreme Court decision which says they can only be removed for malfeasance or some other technical term. And they weren’t found guilty of that. They were just fired because Trump fired them. What I was talking to Sebastian about earlier is it would not surprise me if Adam is right, then Trump says, I don’t care whether the law says I can fire Powell or not, I’m going to fire Powell. And the only check on that would be the market reaction would be terrible. But it would not surprise me if Trump says, I want the Fed to do what I want the Fed to do. I don’t care about this monetary policy BS. So you’re fired.  

And, you know, that’s a risk that I think most of us took off the table because Trump realizes there would be a very negative response to that, and legally he’s on extremely thin ice. But what we’ve seen in the first nine days of this administration is whether you have the legal authority or not, explicitly or by deriving from a Supreme Court decision, Trump doesn’t seem to care. And, you know, that is an uncertainty that I’m not saying is my base case, but it’s certainly more heightened today than it was yesterday for me.  

MALLABY: So just to sort of sum up where I think we are here, we’ve got all the good reasons why, certainly on a relative basis, the U.S. is kind of poised for a boom, as Karen laid out. At the same time, we’ve got confusion and uncertainty around the tariff policy. We’ve got some sense that, you know, the market may not be fully pricing Adam’s logic about monetary policy. We’ve got a potential confrontation between the Fed and the administration. And now I want to add in another thing, which is fiscal. And, Doug, I think you’ve been tracking this closely. Talk about the fiscal gap that you see emerging. 

REDIKER: Yeah. So this gets into Washington inside baseball stuff at one level, but it’s enormous, and macro, and just existential at the other level. Because what we’ve seen this week is Trump hosted House Republicans in Florida. And the reports were that if you added up everything that Trump told them he wanted them to do, it reached around $10 trillion.  

MALLABY: And this is a ten-year window. 

POSEN: I would think.  

REDIKER: Yeah. Yeah. That’s hard to reconcile with what is coming out of the House Freedom Caucus guys and the Ways and Means and Appropriations people, who are all saying they want a budget resolution number to be showing a deficit tightening of between $1 (trillion) and $1 ½ trillion. So if you’re going to spend 10 trillion (dollars) more, but your idea is to get the deficit either neutral, as a worst case for those guys, or to tighten it, something’s got to give. And it’s not going to be because he fires or gives early buyouts to the federal workforce.  

One of my favorite statistics—I think I mentioned it last time I was up here—is the entire salary structure of the United States federal government is under $400 billion. So if you fired every single one of them, you’re not coming close to what it is they say that they want to achieve. So when you get into this, you know, inside baseball thing of one reconciliation bill versus two reconciliations bills, and everybody’s eyes glaze over, it’s really important. And it’s really important because there is a very real scenario in which the fiscal hawks say, no. Remember, in a 217, 218 kind of margin of one to two House seats on the Republican side, you can’t lose the two or the three fiscal hawks who really mean it, because you can’t pass the bill.  

So for them to get anything done they’re going to have to square a circle in a way that seems pretty hard to square. One of the tricks that they’re using, and I know this is going to sound very wonky but it’s worth making a note of it, is there are two ways you can score budgets. One is on what is called the current policy baseline. And the other is the current legal baseline, right? The current legal baseline is the Trump tax cuts expire at the end of this year. So when you look at 2026, tax cuts aren’t there. That’s your baseline, right? That’s what the law says.  

But if you go on the current policy baseline, you ignore that. You say, well, if we extend or don’t extend the tax cuts, that’s insignificant to the deficit because we’re just going to go on the current policy. So what that means is you can basically mask over $4 (trillion) to $5 trillion of additional deficit if you go on the current policy baseline, as opposed to the current legal baseline. Now, Congress thinks they’re too clever by half, in my view. And they think everybody’s going to just ignore this. And maybe they will, because in past instances it’s an inside baseball thing, nobody knows what I’m talking about. So fine. The scoring says zero, so we’re going to say zero.  

But if you’re Chip Roy, who’s the leader of the House fiscal conservatives, or if you’re Moody’s, or Fitch, or S&P, or if you’re a bond market investor focused on the debt and the deficit, you might say, wait a minute. You’re just going to write away $5 trillion here because you’re using the word “policy” instead of “law”? And I’m worried that this—the only way they’re going to square the circle, whether it’s 10 trillion (dollars) or 4 trillion (dollars) or 5 trillion (dollars) of what Trump wants and what the budget can actually produce is by using these little tricks.  

And I’m just worried that somebody is going to wake up and say: We’re not buying it. And you’re going to actually end up not only with the one bill versus two bill dilemma, which is—you can’t get the tax part so you have to do the other part and then kick the tax part down the road to the end of the year. Or that the markets are going to just simply see through this and say, we’re not buying it. And then you end up with the focus on the deficit and the debt, which is a legitimate concern for everyone.  

MALLABY: So on the debt, Karen, you know, if Doug is saying that there’s a risk that fiscal deficits will be much bigger than expected because of an attempt to, you know, use these inside baseball tricks to not admit to how big they’re making it. And then in addition, you’ve got some risk that, you know, Adam, shock, horror, is correct, and interest rates will be higher than people think now, that brings into the frame the question of the total debt stock. And, you know, all over Europe they’re waking up to the fact—in France, a bit in Britain, and so forth—that they have a major, major fiscal problem they don’t know how to get out of it. And the politics just don’t let them. I’m wondering whether you see, because of the exorbitant privilege of the dollar, that this is still not an issue for the U.S.? Or what are you telling people when they ask you?  

KARNIOL-TAMBOUR: I mean, look, it’s a great question. And at the end of the day, there’s no magic number, right? There’s no debt number that you hit it and suddenly it’s not sustainable anymore. Like, the IMF and so on have tried to make lose guidance for different countries around the world, but the truth is the limits are when you have debt that starts creating an inflation problem or a currency problem. You need an inflation problem or a currency problem for it to actually become a problem. As long as the market basically says, we don’t have a currency problem, we’re willing to buy all this debt, and you don’t have an inflation problem, you don’t really run into issues. And all you have to do is look at what’s happening with the U.S. dollar and how strong it is to know we are very far from a currency problem. And there are a lot of structural reasons why there’s so much inflow into the dollar, but it just tells you how big of a shift would have to happen for that to be the case.  

The other thing is, yes, the markets are giving tremendous credibility to the idea that the U.S. is able to keep its inflation under control. If five years ago you told me that inflation, core inflation, would get to where it got to over COVID, and basically bond yields or the inflation priced into bonds—what’s known as break-even inflation, or what’s the inflation expected over five or ten years—would basically not move, I wouldn’t have believed you. And we’ve modeled this for years. And we would have assumed that if you get that big of an inflation shock at least some probability that the U.S. wouldn’t be able to control it, you’d get higher inflation for longer would be in the markets. And people really believed that the Fed would have it under control, and they still do so. They’re giving the Fed a lot of credibility of being able to keep inflation under control at the same time.  

And obviously, when you look at other countries, they do run into limits a hell of a lot faster than the United States does. There’s a lot of reasons behind it. But the reality is the United States is far—another way of looking at it is that if you look at the difference between the cash rate and the bond yield, in other words how much people are demanding to get in risk premium to even take this debt stock out, it’s not that much. And I think there’s good reasons for it to be a larger spread between these two things, just to earn a normal risk premium to even buy these bonds. I think one of the reasons is that we’re in a very weird expansion where the private sector hasn’t borrowed that much. That borrowing basically got, you know, kind of shut out of the markets during the time the Fed raised interest rates. And so in many ways the government’s the only borrower in town. There’s no one, you know, kind of, competing with them. But what is clear is we are far from hitting those limits today. But that doesn’t mean that there isn’t a structural problem down the road.  

The last piece I’ll say is that the Trump people really do believe—some of them, at least—that productivity is the way out of this, right? Like, if we just get more productive, the debt stock basically melts away. And it’s a very hard argument to know where that’s going, right? That productivity is very rarely debated in these forums because it’s so structural. But all you need to do is look at something like the Draghi report in Europe to be able to say, look, over a ten-year period that’s actually what matters. Over a ten-year period, whether or not your economy is getting more productive, that’s actually the thing that matters. And the United States has radically beaten every other country in the world, especially Europe.  

But, I mean, look, the United Kingdom basically shot themselves in the foot with Brexit on productivity. The United States has really beaten everyone on productivity. And the outlook for unleashing more productivity with what’s about to happen with AI, maybe with a little deregulation, it’s a very challenging one to really call one way or another. But I definitely think the markets are giving some probability that this debt stock is also manageable from that perspective. 

MALLABY: I’m going to open up in a minute, but one last comment from Adam. 

POSEN: Yeah, sorry. Just the macroeconomic evidence and theory is that productivity is—growth gains are great for real incomes, but broadly neutral for debt sustainability. Because the neutral rate on bonds goes up roughly one for one with your productivity growth rate. So if your G goes up and your R goes up and R minus G doesn’t change, basically it’s neutral on your debt sustainability. So I’m all in favor of the Trump people emphasizing productivity. And they may be right that they’re going to get productivity gains. But that doesn’t solve the fiscal problem. It just slides it. 

MALLABY: Hmm. OK. Who has a question? Great. Andrew, microphone coming. 

Q: Thank you, Sebastian. 

Doug, and also Karen, to your point, why isn’t the break in that tension between serving the bond market and $10 trillion the midterm elections, where they all expect to lose the House and then pivot Treasury third year to bipartisan deficit reduction. Why can’t they just spend—figure out the tricks—the bond market’s not going to be tricked. They understand what’s going on. They get through what they need. This is all about tax reform this year. Next year they’re going to do the G-20 at Mar-a-Lago and focus on currency reform. Curious what you think about that. But why can’t they solve the issue in the third term about bipartisan debt reduction? 

REDIKER: Sorry. If I understand the question you’re asking, you’re saying if the midterms result in the House going to the Dems, there would be a bipartisan, fiscally responsible outcome?  

Q: (Off mic.) Which is the outlook if you—(off mic)? 

REDIKER: Well, first of all, my fear in any kind of a bipartisan setting is that nothing gets done. I cannot say—and if anything does, it’s fiscally profligate, where each side says, fine, you get what you want, I get what I want, and they’re even more irresponsible. But I think it’s a luxury in January of 2025 to be looking to 2027 for your fiscal responsibility to be emerging. I think that that’s two years of uncertainty that I wouldn’t want to put any money on. But more than that, you—the reconciliation process, the two bills would be for fiscal ’26—sorry—’25 and ’26. Those are the ones where the tax cuts for the next up to ten years would basically be entrenched. And since you’re not going to get anything meaningful on a bipartisan basis, the only thing that’s going to be embedded in the system is whatever gets done on a partisan basis under reconciliation, which is going to be the baseline to look at for the next, you know, could be two years, could be four years, could be ten years. 

MALLABY: Another question. Right here, great. I’m going to remind you all that we’re on the record here. 

Q: Hi. Thank you for a robust discussion. Munish Walther-Puri, Institute for Science and Technology. 

I wanted to ask you about something you mentioned at the top, around DeepSeek and AI. Been thinking a lot about the supply chain of AI and how we don’t really understand it that well. I would be interested to hear from all of you how you think about not just DeepSeek specifically, but the various aspects of AI supply chain—semiconductors, the software, all those different pieces—and what sorts of indicators you’re watching to see, you know, what kind of effect that’s going to have. Thank you. 

MALLABY: What do you mean by—what kind of uncertainty about which part of the supply chain? Can you be more specific? 

Q: The complexity and the depth. We barely understand our physical supply chains. I don’t really think that we understand our digital supply chains. I think we understand chips now, but when it comes to software and some of the other aspects of it. 

MALLABY: Yeah. So I’m going to take your question and sort of build on it slightly, and hand over to Adam. You know, one clear thing from DeepSeek is, you know, the first number they put out for the cost of training the model on closer inspection was meaningless. So that’s one kind of uncertainty about, you know, trying to understand what we’re dealing with. Six million dollars was not, not a real number. Second thing is, there’s uncertainty about what actual chips they used. And it seems like the first round of reports were wrong, that they were sort of an older generation of Nvidia chips. Now it seems like it was a slightly newer one. It was the so-called China chip, which was deliberately manufactured by NVIDIA to exploit a loophole.  

And all of this gets to a policy question for the U.S., which is whether to decide that the export controls that the Biden administration placed on semiconductors are, A, ineffectual and should give up and just repeal them. Or, B, they had a few loopholes at the beginning and now you should double down and do them more seriously, because DeepSeek shows you what happens when there’s a loophole. Adam and his colleagues are working on a piece which is not yet published but I think it deals with this. And maybe you could give your view on that.  

POSEN: Thank you. Thank you for the opportunity, Sebastian. So, unashamedly, because it’s good work, let me tout the work of three of my colleagues at the Peterson Institute—Mary Lovely, Chad Bown, who just rejoined us from the State Department—Bown, B-O-W-N, not Brown—and especially Martin Chorzempa, who’s the lead author of the piece that Sebastian just mentioned. And they’ve published some stuff. 

Without fully channeling their work, the basic message is—that Martin, Chad, and Mary have been giving for a long time—is if you can’t make export controls work in the semiconductor space, it’s going to be really hard to make it work anywhere else. Because in the semiconductor space—you’re right about supply chains in some ways. But we know that Taiwan and Korea are the only places that do certain things. We know that Netherlands and Japan are the only places that do certain inputs. We know that all four of those, to varying degrees, are foreign policy military allies of the U.S. So if you have a known set of choke points, all of which are in allies, and you still can’t really control what’s going on, it tells you how daunting this is.  

Now, Chad, Mary, and Martin have more nuanced views about therefore what’s the net-net benefit and cost. My more shallow view, not knowing enough about technology, is it’s all a waste. That’s me. But I think one of the points that Martin is going to make is that you really have to get into the weeds with this stuff. You really have to be on top of it. And despite the fact that Congress—talk about some of the stuff, Doug was talking about, appropriated money not being spent. Congress passed stuff under Trump one that was supposed to beef up export control monitoring at the Commerce Department, where six, seven years later and they still haven’t staffed up fully. And even if you staff up, then you got to maintain it, and execute it, and oversee it. So just to say, this is a very hard slog.  

Now, if we go over to the stuff CFR sponsors on the national security side of the house, they’ll tell you, you know, I heard Rush Doshi speaking, not this week but previously, at a China event, basically agreeing with those who said: If we lose the high end of IT, it’s game over. So, you know, if it’s that serious—which I’m not in a position to assess—then you have to try. But I think the warning and the result of our research, and—and one of the things Mary and Martin did is they have a very comprehensive list of all the measures the Biden people took; it’s on our website if you want to go through it—is that it’s really hard. 

MALLABY: And another question. Right in the back, yeah. 

Q: Thank you. Elise Labott. I am the Edward R. Murrow fellow—press fellow here at the Council. Thank you for the discussion. 

Doug, you just kind of briefly mentioned Colombia at the top, but I was wondering if you could expand that. It does seem that the president intends to kind of use tariffs as a threat or a weapon across the board, even, for instance, with Greenland, which would open up kind of, you know, more of a EU—if you read some of the reports—the EU kind of rallying around Denmark. And I’m wondering if you see any kind of market volatility if the president continues to use—if he doesn’t use across-the-board tariffs, but tries to use them as a geopolitical weapon what the kind of market consequences of that could be over the long term. Thanks. 

REDIKER: So I don’t know what the market response is going to be. I think Colombia is a story that has yet to fully be told. You know, immediately after the crisis was averted in real time, the story was Colombia—this is from the White House, right?—Colombia acquiesced to everything Trump demanded. And then we’ve got press reports in the next twenty-four hours that actually the opposite was true, and that most of what Petro demanded was what Trump agreed to give. So we don’t really know what happened, and as a consequence we don’t know what the lessons learned will all be. 

I think one of the lessons learned is, if I’m Colombia or Panama or anywhere else, ally or pivot state that’s not aligned, I am probably, counter to what Trump wants to see, thinking about cozying up more to China rather than less, because I realize I have a volatile president in Washington willing to use tariffs and other economic tools in a very heavy-handed manner for reasons that are warranted or not, and I better have a hedging strategy built in. So globally I’m worried—and I say globally, but I mean specifically in Latin America, which is supposed to be this—you know, the renewed Monroe Doctrine they’re talking about. I think we might see the exact opposite, where countries are actually saying the U.S. is not a trustworthy ally or trading partner, so we have to hedge our bets. 

On Greenland and the EU, I don’t know if Trump fully appreciates the fact that tariffs against Denmark mean tariffs against the EU, and that because the way the trading system in the EU works you can’t do one without the other. So I don’t know what to make of that. I do think Europe has been a little bit quiet. I had expected Trump to be more vitriolic about Europe because we know from history he just doesn’t like Europe and he likes to pick on areas like Europe, which are liberal democracies that are governed by consensus, because he just doesn’t like any part of that, but we haven’t seen that. But I would not be surprised if Europe rears its head as a trade adversary in the coming days and weeks, and we hear more, whether that’s Greenland-specific or not. Particularly the political weakness in Germany and in France and elsewhere means they are ripe for Trump’s aggressive tactics, and I think tariffs will be part of that. 

MALLABY: Another question. Yeah, so—go ahead, yeah. 

KARNIOL-TAMBOUR: I was going to, quick—your comment, because it is, when you step back in our conversation, surprising how little—not at all we’ve talked about Europe, which is that I think that a lot of attention will be paid to the day to day of how Trump handles the conversation with Europe, and the fact that he doesn’t know how to handle the fact that it’s so split up, right, and it’s—there isn’t, like, one phone call he could make that can make all the Europe deal together and is going to solve, you know, Denmark, and this, and that, everything together. 

But the big picture on Europe, I think, shouldn’t be missed, which is that, look, you know, the three largest economies in the world are undoubtedly U.S., China, and Europe if you take it as a bloc. And Europe simply is in a spot where China’s had protectionist industrial policy, a mercantilist perspective on the world for a long time; the U.S. very clearly does now. And that started under Trump I, but has not really gone away under Biden, is going to accelerate now. Europe just can’t survive as the lone big economy that sort of refuses to think in these terms and is just kind of thinking in the old world, pro-globalization way. They can’t be the only major economy that doesn’t do any of these tools. It’s just not going to work fundamentally for their economic model. They’re under too much fire from the two sides. And how they handle that challenge, and even their awareness that they need to do something to handle that challenge, something needs to change. 

That’s the big thing. And the risk for Europe is that they got caught—they get caught up emotionally about how could you do this to us on Greenland rather than dealing with the big issue. 

POSEN: I just have to put down a marker for future discussions: This is the first thing where I completely disagree with Karen. I think if the Europeans try to do what the Chinese and the Americans are doing, they will bankrupt themselves and spend a huge amount of money to absolutely no effect. And even though it’s a lousy outcome, they’re better off leaning into globalization because, remember, there’s a lot of the world that isn’t China and the U.S., and China and the U.S. are making asses of themselves, and you get all kinds of opportunities that flow to Europe. Again, it’s a bad outcome. I’m not disagreeing with Karen’s characterizing— 

MALLABY: Adam, I suspect where you both agree is on the point that, you know, it would be bad for Europe to be distracted—oh, and for analysis of Europe to be distracted by the idea, oh, how is it going with the Trump bashing. 

POSEN: Oh, yeah, yeah, yeah. 

MALLABY: You know, because they have their own issues laid out very clearly in the Draghi report from six months ago. And since that report came out, nothing has been done, and in fact negative things have been done. And you know, they’ve got their own hole to stop digging themselves deeper on. 

POSEN: Yeah. 

KARNIOL-TAMBOUR: And Sebastian is thankful that we don’t always agree on everything, having us on the stage together. (Laughter.) 

MALLABY: Let’s go over here. 

Q: Paula DiPerna. Thank you for the thoughtful insight. 

Just since we’re in the uncertainty realm here, what about the environmental uncertainties, pricing in the fact that environmental science, climate science—Potsdam is telling us it’s six out of the nine planetary boundaries have been breached, meaning they’re in red alert status, meaning their resilience is very much under question. The reinsurance/insurance industries can’t cope with things like the wildfires in California. I mean, these are externalities, but is the—is the macroeconomy just blind to the fact that these environmental resources are really on the edge? And there’s—you know, there are supply chain issues, workforce issues. And to talk about deregulation, I think it’s decivilizing, some of the movements away from prudent management of natural resources let alone prudent management of capital. So my question really is, where do these externalities finally show up, or will they never show up in our lifetime? 

POSEN: I mean, to be very, very sad but very provocative is at a macro level, if it’s a universal shock, you can’t—you can’t diversify around it. So at a macro level, it probably drives up volatility, drives down growth rates, does terrible things to human beings and living things, but there’s no market thing because it’s not like crypto suddenly becomes safer, given its energy needs and given chaos, than anything else under climate. And you can say that about almost any asset class. Karen may have a very different point of view. Doug may have a different point of view. 

The other thing that’s very sad, but has echoes of Jared Diamond, is if you think about the parts of the world that are fortunate enough to be in the right latitudes, it’s China and the U.S. As bad as things are in China and the U.S., from a climate point of view they’re much less bad than South Asia, Africa, various places. So, sadly—and this is part of the reason we’re getting such bad non-response to the very real things you’re talking about—is because, relatively speaking, U.S. and China come out on top in this world even more. It just reinforces that trend. And unless you have global solutions, you know, you can—maybe you want to short or buy a particular reinsurer; I’m not fit to talk about that. But from a macro perspective, a global shock doesn’t change things. It just makes things worse relatively evenly. 

MALLABY: Right. It might increase the volatility of— 

POSEN: Increases the volatility. It reduces returns. It’s horrible in human terms. It’s horrible for living things. But as a macro forecaster— 

KARNIOL-TAMBOUR: Also a very classic collective-action problem. The best probability you have is that you get a tipping point—these can be very hard to foresee—in public perception of how important this environmental issue is, right? This already happened in Europe, and it has not happened in most other places that matter. It certainly has not happened in the United States. But these things are very hard to foresee, and so you could get a tipping point where suddenly the public kind of says. Wait a minute, we don’t like these outcomes. These outcomes are not acceptable to us. 

The issue is you have a very tough collective-action problem where even if the public, for example, in India realized—I mean, India is a good example because some of the worst damages will be there, right? Like, there will be just number of days of the year that people can’t work anymore because it’s too hot, et cetera, et cetera. You take an India, which is an OK-sized economy; even if people there all really, really realize this and made this a priority from a, you know, kind of public policy perspective, it’s a real collective-action problem of what their capabilities are to change the trajectory of environmental degradation on India and global warming on India with just their action. Very, very challenging problem. And sad is the right word. It’s devastating. 

POSEN: It’s devastating. It’s—but the sort of good news of what Karen said, which I do completely agree with, is it’s—ultimately, it’s a political problem. It’s got nothing to do with markets. If you count on, whether Mark Carney’s, you know, the banks are going to save us, or Mark—that’s not it. It has to be a political agreement at an international level, and it has to be a political awakening and ideological shift, not a market shift. 

MALLABY: Mike. 

Q: Thank you for this. Two comments and then a question. 

First, we’ve just finished a two-day conference in Washington at the Council on China which was really quite remarkable in a number of ways, a bunch of the country’s leading China experts. Two things, without me violating the attribution rules, I think I can say coming out of that. 

One is that China doesn’t worry so much about tariffs; they worry about technology constraints. And they feel they can manage any tariffs that we put on them, either through transshipments or other means, or just passing on the cost to U.S. importers. 

Secondly, there was an observation—and it goes a little bit to Doug’s point about how do we cut through the noise in the administration—that the president has been really quite soft on China in his comments from the inauguration over the last week; much more vitriol towards Mexico, Canada, sometimes even Europe than China; and the view that, actually, he is not a hawk on China, maybe more of a hawk on Taiwan tariffs than on China tariffs, and that we may end up seeing fewer tariffs imposed on China than more as he seeks to cut some kind of broader kind of phase two trade deal. 

Second comment, just on Europe, to reinforce the points. The Europeans are tying themselves in knots because they are ideologically much more committed to free trade and the WTO than the U.S. has ever been, and yet they understand that their auto sector in particular is about to be hollowed out by Chinese electric vehicles, and they see the market share going very much down for their cars in China and up for Chinese cars in Europe. The big difference between Europe and the United States on this one is that, even as they wrestle with imposing various trade remedies and getting comfortable with them, they’re more open to China investing in Europe and building EVs in Europe than the U.S. appears to be. And so they’re sort of thinking, OK, Volkswagen may go down the drain, but at least we’ll have an EV sector here that’s owned by China in Germany. And that’ll be an interesting thing to see how it plays out. 

My question for you—and this is just a very basic question—on tariffs, either—if one of the purposes of tariffs is to drive production of things that we’re importing to the United States, it strikes me if tariffs work you’re not going to collect much revenue, and if they don’t work then you’re going to collect more revenue. What’s the dynamic there? When you talk about the, what is it, $400 billion or something that might be collected, what are you assuming in terms of production being shifted domestically that is currently being imported? 

POSEN: So we’ve done at Peterson some modeling work on this. I mean, my colleagues may want to come in. And we’re in the midst of a very new rush project with the Tax Foundation and the Peterson Foundation to try to—watch this space. So for the next few weeks we’ll have some fresh estimates. 

But conceptually what you say is right, Mike. And again, it goes to the across-the-board versus the specific tariffs. If you do across the board, you can’t really substitute except by domestic production. And domestic production is inherently constrained because there’s real economic logic for the most part why you’re not producing domestically. So we don’t produce rare earths, not because don’t have rare earths but because most American workers can’t be paid enough to do the really dirty, unpleasant mining, and their communities can’t be paid enough to do the dirty, unpleasant mining. Physically, of course, we could produce rare earths here. And you can do that same exercise from pencils all the way to chips. 

And so the assumption is— Kim Clausing and Maury Obstfeldt had a piece on this about ten months ago. The basic assumption is that there are certain industries, certain goods where it is a matter of just time; you can substitute. There are certain industries and certain goods where it is unbelievably expensive to produce it in the U.S. And there are certain goods where, yeah, you can move it. So, ultimately, the revenue, if—the revenue forecasts generally have a decay. So if you’re doing a ten-year window, like, for Congress that’s going to average 1 ½ to 2 percent of GDP in the first three years, as you get to the out-years it starts going down towards 1 percent of GDP. 

But, again, there’s limits. And there’s a very good book out last fall by my colleague Robert Lawrence called Behind the Curve, and Paul Krugman in his non-New York Times latest thing cites this and talks about this. There’s a limit to how much manufacturing you can create in the U.S. because there’s a limit to how many workers you’ve got who can do those jobs. And especially if you’re not importing migrants, there’s an even tighter limit on how many people can do those jobs. And so you can turn your entire economy upside-down trying to make that work, and then you’re into, like, Soviet days where you insist that this particular industry has to product N million staple guns and rifles inside the Soviet Union, and we will reallocate whatever it takes to get you there. And that’s really not good economically. 

So, ultimately, there is—it goes back to something Karen said. It’s very different whether you’re doing country-specific, industry-specific, or not. If you do across the board, the revenue stays up longer but there’s much less substitution because there’s no—there’s no relative price effect, essentially; everything just becomes more expensive. 

MALLABY: Doug. 

REDIKER: Just, Mike, thinking about another aspect of your question, I mean, I always say, you know it’s either an end or a means to an end. And I don’t think Trump has figured out which it is, but it can’t be both at the same time. 

But Adam, in reference to an earlier conversation, you know, talked about something being in the weeds on the export-control stuff. Let’s just posit this is not an administration that is very comfortable with getting into the weeds. We’ve seen that in the first eight days. They’re not detail oriented. And when you talk about across-the-board tariffs, one of the problems is under IEEPA you have to declare a national emergency. If the national emergency is we’re running a trade deficit, the problem is we’re not running a trade deficit with everyone. So even if, as I said earlier, there’s a lot of reasons to believe legal challenges against a presidential declaration under IEEPA would not be successful, there’s also a fairly good argument that if you declare that we are declaring an emergency because we have a trade deficit against every country in the world when in fact we don’t have a trade deficit against every country in the world, those countries with which we have a trade surplus have a pretty good case to make that they are being unfairly targeted. 

So just in terms of projecting out revenue from tariffs, if it’s across the board there’s no certainty whatsoever that that’s actually going to be sustained, independent of the economic forces, just in terms of the actual implementation of what the president seeks to declare. There’s a whole lot of uncertainty built into that just in year one anyway. 

POSEN: Unless you pass legislation, you don’t use IEEPA. But for all the reasons Doug said, there’s—(laughs)—there’s difficulties passing legislation. 

MALLABY: One more question? Anybody? 

If there isn’t, I’m going to ask anybody who wants to to comment on the following. So we have a(n) upsurge in online gambling. We have a return of crypto mania. We have a sense, I think, that there’s just this sort of, you know, cultural speculation roaring back, which feels different to—again, it sort of exacerbates this difference between, you know, the mentality of Europe and the mentality of the U.S. at the moment. Do any of you have a thought on why now? Why is something that—you know, online gambling in the U.S. was illegal until not that long ago. Why is all this coming back, and what does it mean? 

KARNIOL-TAMBOUR: My quick thought is that if you just said, Karen, can you list me all the things that would make the most ripe environment for the formation of financial bubbles—(laughter)—not for the destruction of them, but for the formation, for the phase of blowing them up—you’d say, you know, we’re doing pretty well, right? (Laughter.) So we’re doing pretty well on the kind of environment that would create formation. 

You know, I like looking at 1998, which is a case where, you know, you kind of could say, oh, a lot of these tech companies seem kind of highly valued. Obviously, in retrospect, they don’t seem very highly valued relative to what happened at the peak of the bubble, but there are already some concerns that some of the valuation seemed high, just not as high as they got. You had an easy Fed for reasons unrelated to that at the time that don’t look a lot like today’s reasons, but you still have a Fed that’s, you know, leaning on easy in that environment; you know, the economy kind of chugging along. And then you had a lot of corporate spending and desire to, you know—when you hear the tech leaders today, I mean, they’re going out of their way—I think they’re going to go out of their way to tell us don’t worry about DeepSeek; just because they did AI computation for cheaper doesn’t mean we need less compute. We still want to spend as much as we can. We’re still in a race for our lives. And so that’s a lot of kind of ingredients for saying there’s going to be a lot of spending, and a lot of speculation, and a lot of blowing up of a bubble; it’s not a lot of ingredients for a popping of the bubble. So— 

MALLABY: OK. So all the more reason to look forward to the next World Economic Update. (Laughter.) Thank you all for coming. Reminder, this is on the record. (Applause.) And it will be on the website, I think. The video will be up on our website. 

(END) 

This is an uncorrected transcript. 

 

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