World Economic Update

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: OK. Good morning, everybody. I’m Sebastian Mallaby. I work here at CFR. And we are doing the back-to-school meeting. It’s early September. I was told by Doug just now, you know, the year kind of really kicks off not with Labor Day but with the men’s final at the U.S. Open, right? (Laughter.) Apparently, that’s visible in the trading data even.

So welcome to today’s Council on Foreign Relations World Economic Update. This series is dedicated to the life and work of the distinguished economist Martin Feldstein, who was a mentor and friend to many of us.

Since the start of the year—I would say, as a sort of framing thought—since the start of the year geopolitical and political uncertainty have definitely not abated. Arguably, they’ve gotten worse. We can tick off the obvious things. Peace has not broken out in the Middle East. Peace has not broken out in Ukraine. In Europe, populism; AfD in Germany, Nigel Farage’s Reform Party in the U.K. are very strong in the polls. So that problem is still there. And maybe most strikingly, if we look within the U.S. and think about the gap between what people expected nine months ago and what we see today, we’re seeing more uncertainty, I think. More attacks on institutions, including the Federal Reserve. More tariff uncertainty, both new tariffs being announced and new rationales for tariffs being announced, not to mention the court challenge to the legality of the sanctions, which introduces a whole nother kind of uncertainty.

So we’re in a very uncertain world. And yet, the markets are happy. The economy is OK. And, indeed, if you look at the latest IMF World Economic Forecast, the July forecast was more upbeat than the previous one in April. So the question is, what gives? And to discuss this dissonance between political uncertainty and sort of relatively sanguine economic data, we’ve got Alexis Crow, partner and chief economist at PWC. Next to them, Adam Posen, president of the Peterson Institute for International Economics. And next to me, Douglas Rediker, managing partner, International Capital Strategies.

So I’m going to start with Alexis. And on this dissonance I was talking about, Alexis, I know you’ve been studying fiscal data across the world, particularly the advanced economies. So I’m wondering to what extent you think one of the reasons we don’t see the kind of trouble in the economy we might have expected is simply that governments are stimulating with big budget deficits.

CROW: Thanks so much. And thank you very much for having me here at the Council.

I think, Sebastian, just to go back a bit, I mean, we’ve had economics defying geopolitics, that theme, going back to the first Trump administration, where actually global growth held up remarkably well, in spite of rising protectionism. And even at the start of this year, prior to the inauguration, we had protectionist measures across goods, services, and even creeping in in capital, at record highs. But, again, growth has held up remarkably well. I think part of the reason for the exuberance today, and we’ll get into this, is AI driving the boom in U.S. equity markets. And so that’s one piece of it.

The fiscal support, I think we’re in a moment where the calculus is going to start to shift. And we’ve seen this with the pressure on the long-dated bonds, going back to May the pressure on the Japanese forty-year note, U.S. thirty-year note, which has prompted some intervention from the administration and other kind of central banking policies in advanced economies. And I do think that calculus will start to shift. One important thing to point out is, when you speak with European regulators and policymakers, and we talk about the American exceptionalism in terms of our economic performance, they will often chide, OK, a lot of that has been deficit fueled. Whether or not it’s just been spending—going back to the pandemic, and supporting consumers and households, or, again, very generous packages like the IRA.

There’s one other component here which is that the American consumer is very durable amidst any kind of political uncertainty. And I think that’s a key driving force of our growth. And we really have to think about, looking at a recession risk, where the consumer sits. And of course, we know that 70 percent of our GDP comes from consumption in America. Over 60 percent of that is driven by the top two quintiles. So I think those two quintiles and their spending might have been a little bit scared after liberation day, but once April kind of was in the rearview mirror, I think that consumer is quite durable as well.

MALLABY: Doug, would you add anything to this explanation of why there’s been market and economic resilience?

REDIKER: I think if you go back over multiple cycles, you’ve got a real question about whether any individual impact, geopolitically, is meaningful, longer term, in terms of market reaction. And over time, that market reaction has been shorter and shorter. The difference is when it’s structural then it really ought to portend a different way that markets think about—or that investors think about the markets. And I think that is warranted now. And clearly, the markets don’t. So I would argue that there’s a once every seventy-five-year kind of structural shift that we’re watching play out in real time. That does mean people should take a step back and rethink some of their basic assumptions.

But the markets disagree. I’m not going to disagree with their disagreeing with me, other than to say I think there’s a wall of money. There’s a mindset that has been beaten into investors that, over time, equities outperform every other asset. Whether that’s true or not, depending on whatever time frame you want to look at, I’m not going to pick up on. But that is the mindset. So if you’re a twenty-eight-year-old fund manager who has been brought up believing interest rates should always be zero or negative and that equities always go up, then this is a blip. I would argue that’s not the right way to look at it longer term, structurally, but that’s the way the market seemed to be reacting.

MALLABY: Adam, Doug just said, “a once in a seventy-five-year kind of shift.” That’s quite a big statement. I’d love to hear your take on this dissonance, but also maybe take us into the prospective look, which would be, you know, might we be approaching a point where the stability in both the economy and the markets ends? Because, you know, if, for example, with tariffs initially you get a lot of front-loading of trade to get the trade done ahead of the tariffs, you’re putting forward activity that would boost your numbers. But then you’d expect to see the sugar high end afterwards. So there could be mechanisms like this that would lead us to now see trouble.

POSEN: Thank you, Sebastian. Thanks for having me back in the series.

I want to emphasize a slightly different set of things, as Sebastian says, moving perspective. As I wrote in the new issue of Foreign Affairs, there’s the new economic geography. And people are so focused on the trade and the tariffs and some of the drama that they don’t see the big picture. There is a shift in the underlying picture that will go against the U.S. in the years to come. And that kind of parallels some of the things Doug was saying. I’m pulling together a particular version, where the world is losing the U.S. as a global insurer and gaining the U.S. as a protection racket.

And that leads to self-insurance. I’m just back from Europe. And for all the badmouthing Europe, people there have agency. Investors have agency. Businesses have agency. Governments have agency. And they are making adjustments. The euro is still in better shape now than it’s been at any time in its history. And the European Central Bank, the governments are more prepared to have the euro play a global role than at any time in its history. Not as much as perhaps warranted, but more than people think. So there’s a lot of things moving.

In terms of the economic outlook, though, the thing to remember—and here I’ll pick up on Alexis—geopolitics almost never affects a major economy in the short term, unless that economy is literally being invaded. If you look at the millions of lives we spent and hurt in Iraq and Afghanistan, us getting through 9/11, these do not show up in the economic data. This is true even for Europe, with Ukraine on the border. So it is sad. It is unfortunate. But it is a forecasting error to try to map from geopolitical uncertainty to macroeconomic outlook. It just doesn’t happen.

What instead I would emphasize are three things. First, as I think we all agree, AI is exogenous, in the Robert Solow exogenous growth sense, that there is just this new technology. It’s there. The big productivity gains won’t be felt until it diffuses and people figure out how to use it throughout the economy. That may happen fast. That may happen slow. But the kind of investment numbers we’re seeing, that Alexis referred to, are for real. And it’s a big economy. And that’s big enough to balance a lot out.

Second, fiscal. I think we are in trouble. I think, echoing all of us in a different way, we have a governance problem in a way we didn’t before. That it’s not credible that the U.S. will raise taxes or cut spending if it needs to. It used to be—and this is now documented econometrically as well as historically—it used to be there was this essentially mechanism since the ’70s, roughly every ten to twelve years there’d be a bipartisan presidential commission, congressional thing. And you wouldn’t fix the problem, but you’d get back on a reasonable path for about a ten-, twelve-year horizon.

For a variety of reasons that didn’t happen in 2005 to 2008, when it should have happened. And because of the politics since then, it hasn’t happened since. And now, with Congress abdicating responsibility, I think it’s right for people to reconsider the fiscal outlook. So, bottom line, U.S., we’re going to get inflation. We’re going to get higher interest rates. We may get growth nonetheless. And in fact, despite the fact people keep saying fiscal policy is neutral to tight, I think that’s wrong because I think there’s going to be tariff evasion, tariff exemptions. We’re already going to be past peak tariff revenues, I think, as Summers and Sarin have documented, if you undercut the IRS and don’t fund it revenues fall off.

So I think we’re going to get a half a percent or more net stimulus over the next twelve months from fiscal policy. And I think there’s a backlog of things where the Biden administration did screw up, including excessive anti-dealmaking in the FTC, in the health care sector, in the financial sector. And there’s a huge backlog of deals. Some of which are genuinely useful, some of which maybe not. But that’s another piece of this. And so the issue isn’t that there’s a disconnect between equities and growth. There’s always a disconnect between equities and growth. The issue is there’s a disconnect between the yield curve and what’s going to happen on inflation. And that’s where I would expect people to be disappointed in the coming months.

MALLABY: Yeah, Alexis.

CROW: So just two more things to add in support of this. The CBO actually forecasts in their projection for the deficit that we have no recession, one. Two, we will also have a large rollover of debt that matures and we’ll go back at higher rates. And so I think this is something that’s an acute focus of the administration.

Alexis, one other thought here, of course, is—I know Adam is just saying inflation pressures are real. We’re going to get inflation. And yet, pretty much everybody expects, after the last jobs number, that we’re going to get a rate cut at the next meeting. In your view, A, does it matter? How much would that really move the needle? Because people are putting a lot of weight on that. And, secondly, would that be a mistake, given underlying inflation pressures?

CROW: No, it’s an excellent question. Thank you so much, Sebastian. I think this was very clear at Jackson Hole as to whether or not Fed participants should be focusing on which side of the dual mandate. And in our forecast, it will—like, we will see inflation from tariffs, but it was likely to come through Q4-Q1. In which case, if we start to see that pass through on goods, like you saw it in PPI, will that pass through into wages? Will that pass through into the rest of services? We’ve started to see supercore edge back up. So, services less housing. So I think that’s important. So one is, inflation could be on the outlook.

The second is, how sensitive is the labor market and hiring to the interest rate environment? And from April 2022 to August 2023, the Fed jacked rates by 500 basis points. And we actually saw hiring respond in kind. So if you do twenty-five basis point cut in September, twenty-five in December, is that really going to move the needle on the labor market? And it is that piece. And then there’s last year we already saw what happened when the Fed cut 100 basis points. It didn’t really move the needle, but we didn’t have all of this additional uncertainty surrounding tariffs, the sort of vacillation back and forth on policy, as well as new fiscal issues.

MALLABY: So, Doug, in the spirit of a tease, you know, Adam is saying that, frankly, political uncertainty doesn’t tend to make much impact on markets. Your job is to advise people on political uncertainty making an impact on markets. (Laughter.) So either he’s overstating, or your presence here is a mystery. (Laughter.) But stipulating that the truth may be in the middle, you know, since it is your job to weigh political risks and advise investors, I wonder if you could enlighten us on which of—let’s say, we’ll take, you know, attacks on Fed independence, tariffs, and maybe we can throw in things like the government taking a stake in Intel. You know, which type of political risk keeps you awake at night?

REDIKER: Well, I’m going to answer the last part of your question without actually opining on whether I’m actually relevant here at all. (Laughter.) So—

POSEN: Show not tell. (Laughter.)

REDIKER: So, I mean, you gave me three options as to which is the more important. They’re all part of what Adam and I and Alexis are talking about, of this, you know, structural shift, however you want to define it. I always say, you know, markets think it’s a return to normal. That’s why they buy the dips. And the question is, what if normal becomes the new normal? It’s not the normal from before? That’s where this whole, you know, intermingling of everything we’re talking about comes together for markets. As long as things return to normal, sure, buy the dip. It’s everything you believe.

If there’s going to be these structural changes—and you mentioned three of them, right? Tariffs, Fed independence, and industrial policy, and suddenly the U.S. government taking 10 percent stakes in Intel and the like. All three of those are not normal. So I’m not sure—I will answer your question as to which one I think is the more daunting—but all three of them pose very real considerations about whether you’re returning to normal. And I think the answer to that is not. And if you’re not, then all of this does matter. Whether it matters in the micro, you know, day-to-day trading or not, that’s different than just more broadly.

I’m still more worried about tariffs and trade policy than I am the others, even though I’m enormously worried about the others. And that’s because I think structurally when you get into a world in which everybody realizes that Donald Trump believes that tariffs are a tool of economic policy, of foreign policy, of ego, of personal grievance, of whatever it is, that means it’s uncertainty on steroids. But it’s uncertainty that people have to react to at some point in time. You just—you can—in the case of questioning the Fed’s independence, I’m a believer that the institution and the markets as a catalyst for this will actually emerge in a healthy way. I don’t think an FOMC or a Fed, even if it is tortured under enormous pressure by the president, is going to end up having its core independence compromised long term. I do believe, though, the tariffs, as President Trump is imposing them, are and continue to be a risk, regardless of what the Supreme Court does, likely to upend the basic structure of the global economy as well as the geopolitical landscape. And that scares me a lot.

MALLABY: Adam, I enjoyed, once upon a time, visiting you in London when you were the central banker at the Bank of England making policy, and I was the visiting American—(laughter)—which was a fun—a fun role reversal.

POSEN: It’s true. It’s true.

MALLABY: But, you know, honoring your experience in central banking, I wanted to put it to you. You know, Doug was talking there about threats to Fed independence. It does seem to me, as somebody who’s written about central bank history, that this is—this is the biggest threat since Nixon in ’71-’72 attacking Arthur Burns. And I guess, though, you know, on the other hand, when I read the commentary, I’m struck. You know, the president says, we’re going to try and get a majority of the seven governors, which obviously betrays an ignorance about how many people actually vote on interest rates. It’s twelve not seven, because there are the Fed presidents. And trying to get a majority of twelve feels, on the face of it, like, very, very, very hard. I mean, he doesn’t control the mechanisms of the regional Feds, and how they appoint presidents, and so forth.

On the other hand, you could argue that just by intimidating Lisa Cook, as he’s doing, that threat—that we will go through your financial records—might be enough, without having to replace people, to actually swing people. So, anyway, how seriously do you take these threats to Fed independence?

POSEN: Yeah. I’m old enough now that I wrote my dissertation thirty-two years ago on central bank independence. And I spent most of this summer at central bank summer camp of various sorts. So thank you, Sebastian. Let me try. Here, I’m actually much more worried. Not so much because I disagree with Doug about rankings, but more about—I disagree with some of your characterization, actually, Sebastian. First, just to note, Lisa Cook is not intimidated. They are attempting to use the state power to intimidate her. And any reasonable member of the committee has to be scared by that. But she is showing—whatever she’s done, she’s showing great courage in not being intimidated.

But, secondly, more importantly, I think, again, we’re missing the picture here. The likeliest outcome of this is some set of Supreme Court reinforcement that the carve out for Fed independence on monetary policy, very narrowly defined, will be preserved. But there are going to be two changes, both of which I think are ultimately destructive. The first is, they are going after the reserve bank president reappointment. Legally, it’s always been that the—excuse me—the Board of Governors can veto people nominated to be—or nominated to be reappointed reserve bank presidents.

But the reality has been, at least for decades, that quietly the boards of the individual reserve bank send the Board of Governors a short list, and the Board of Governors would quietly send back, saying this one person is unacceptable, but you can pick whoever you want for the remainder. And that’s basically how it has worked for decades. But in the letter of the law, already the Board of Governors can basically block reserve bank president appointments. And in fact, the two Trump appointees and the prospective possible Trump appointee, Jim Bullard, when he was Fed St. Louis, voted against or abstained from the appointment of Austan Goolsbee as Fed Chicago president when he came up a couple of years ago. And that was unprecedented, at least for decades.

And so a majority on the Board of Governors actually means they can get rid of two, three, four of all the reserve banks, because in some stupid design flaw all the reserve bank presidents come up for reappointment simultaneously. They all come up at the end of February. And so if—it’s bizarre, it’s stupid, but it’s the law. And so in reality, if they replace Lisa Cook and they replace Jay Powell, they have four out of seven. They can decide to get rid of any two or three reserve bank presidents, then they have a majority in the FOMC. People should be very scared because this is not, strictly speaking, illegal. But it means that this—everybody keeps saying, it’s OK. The FOMC is going to be OK because of the majority. Not so much.

The second reason people should be scared is to remember that there’s a whole bunch of policies having to do with bank supervision, bank mergers, access to the discount window, bailouts, definition of who’s a bank, including crypto firms—

CROW: Swap lines.

POSEN: Swap lines, which is what I was talking about in Europe last week. Which are under the control of the Board of Governors, not the FOMC. And if you get a majority loyalist to Trump—not just have different views than the current majority, but are taking coordinated orders from the Trump administration—you will very quickly see an enormous shift in regulatory supervisory policy, probably unleashing a further huge, irresponsible bubble in cyber assets, where the Trump family, according to the New Yorker’s forensic reporting, has over three billion (dollars) accumulated in assets since January. And this could happen incredibly fast. All they need is the four members and they’re there. So we should be very scared about the attempt to grab two seats on the Board of Governors, if they’re—if those people are loyalists in the sense beyond what it should be.

MALLABY: I think in that answer we see why in this particular World Economic Update it feels like the American economic update, because so much is happening here that has global consequences. And the delta in one’s global outlook is coming from changes and how they play out in the U.S.

But nonetheless, I want to turn to Alexis for a question on Europe. Because today in France—we have—I haven’t—last I checked before walking on the stage, this hadn’t happened yet, but we have the very likely fall of the prime minister and his government in France over a budget standoff where, you know, they’re running a deficit of 5.6 percent of GDP. They want to just trim that. And it’s just politically impossible. To lose one prime minister and a government in a year is unfortunate. To lose two would be careless. But it looks as if Macron is about to do that.

And therefore, it feels like it—I mean, I think Adam said earlier you can’t necessarily sit there and assume that U.S. fiscal policy will adjust in the face of need, because of politics. In France, that’s even more clear, and in Europe generally. And so you kind of wonder, well, why are funds still flowing into Europe a bit? And Alexis, I wonder whether you could comment both on the France in specific, and more generally portfolio moves that you see amongst your clients.

CROW: Sure. Thank you. I mean, it’s—what is the locus of what we’re facing in France today? I think you can go back to the Gilets Jaunes back in 2019. And this is really firmly set within the mindset of what was quite a centrist, and even fiscally hawkish, administration, for Macron himself. The fact that we’ve now had four prime ministers in the space—since 2022 is a record for the Fifth Republic. Added to that, you’ve also had changes in Bercy, at the finance ministry as well. We have Eric Lombard now, the finance minister, actually warning that you could have an intervention from the IMF. Which for France, as a G-7 economy, is pretty remarkable. So absent kind of Russia invading Poland, I don’t think you’re going to see anything but a vote of “no” by about 7:00 tonight, French time.

So in which case, France starts to look—France, I think, in a fiscal position has always looked a little bit Southern European, a little bit Northern European. But it’s been looking a little bit more southern European, of the old days, because Spain, Portugal, and even Italy, under Meloni, have been surprising to the upside on fiscal. Portugal, I think, is the notable one there. Nevertheless, you actually have some dynamics underlying all of this governance uncertainty, the debt markets. Labor force participation rate in France continues to hit historic highs. So we see clients continuing to invest there because you’ve actually got—what Macron has done in the orange economy has been very, very positive in terms of entrepreneurship. Not going to go on the big hyperscalers, but at a smaller, micro-enterprise level. And some of that looks stable in contrast with other countries, and even more palatable than the U.K.

For Europe as a whole, I think if you break it down by asset classes one that we’ve liked is move out of DXY and dollar and into Swiss franc. So there’s a currency play there that many investors have focused on. I don’t like the euro play, for a number of different reasons. But European real estate is an interesting one, where a sort of dour or tepid macroeconomic environment has not filtered down into the microeconomic portfolio performance of a lot of commercial real estate. What we also see in the latest price data is that in the U.S., where across the commercial real estate basket we’ve been operating at a completely frozen asset price landscape. We’ve seen zero price appreciation since the inauguration.

But in Europe, you’ve actually eked out 0.6 percent growth across the real estate basket. So we’re seeing investors all of a sudden say, hey, French private equity fund, we actually want to place money from you. We never looked at you before, but it’s looking slightly better than the U.S. So I think the great British phrase of “muddling through” applies here. And muddling through is potentially more attractive for even some of the sovereign wealth and pension funds representing $10 trillion collectively in the U.S., who are starting to say, we’re overweight, U.S. We’re going to start to look at other geographies.

MALLABY: And we’re going to open it up for members to ask questions in a second, but I want to just get China on the table. And the question I’d like to ask there is that, you know, on the one hand China’s high-tech performance has been pretty remarkable—drones, solar panels, electric vehicles, now AI; strength across the board. The official data show growth of 8.9 percent last year in high-tech manufacturing. They’ve patched up their relationship between the government and the high-tech leaders, to some extent. The handshake between Xi and Jack Ma about a year ago was a big deal in that respect. And so they look like they’re on a roll in terms of high tech.

But what happens in China, of course, is that when the government pushes something—like, you know, we want to conquer these strategic industries, the subsidies come in. There’s overcapacity. And so if you look at the corporate level performance of BYD or other famous tech companies, they’re actually not doing that great because there is this overcapacity. And so it feels like yet another example of China either going all in on exports, and just doing too much of it, and getting a backlash from other countries who can’t take that much capacity being dumped on them. Doing real estate, too much capacity, it crashes. Now doing high tech. Maybe too much capacity, maybe it’s—you know, it feels like yet another of these cycles.

And so I’m wondering, Doug, whether you see it that way, and maybe Adam can come in on this as well before we open it up. But, you know, is it just one more of these overcapacity cycles? And will the Chinese ever manage to shift towards more of a consumer led model?

REDIKER: So starting by saying I’m not a China expert. Dan Rosen, who’s in the audience, is a China expert. So, Dan, you nod if I say something right, and you, you know, the other way, right?

Look, first of all, it’s not overcapacity anymore. Now it’s involution. So let’s just change the syntax here and—

MALLABY: Yeah, this convolution of involution. What does it mean?

REDIKER: Overcapacity. (Laughter.) But, you know, we live in a world in which words matter, apparently. Look, I think China is taking the long game. They’re not panicking. They’ve got some real problems, as you mentioned. I mean, you could go line by line on property sector, youth unemployment. The local debt—it’s not just the debt—the involution phenomenon means it’s not BYD. There are hundreds of EV companies in China, each of which is a regional champion, if not a national champion. And they’ve got to do something about that. But by doing something about that, it’s not just simply saying you’re in, you’re out. That has consequences at the local level, at the political level, at the employment level. I mean, it’s a big, complicated mess.

Having said that, Donald Trump’s policies are giving them an enormous opening to get the benefit of the doubt globally on alliances, on economic relations, where normally you would say these are really deep, unfathomably difficult problems to overcome. And yet, we are giving them an out in many ways. One of the things that we should also not overlook is China’s real growth is over 5 percent. Its nominal growth is below 5 percent. The only way that works is if you’re in a deflationary environment. And deflation is not good for consumer sentiment. It goes to the core of your question, when are they going to shift to a consumer-led economy, which everyone acknowledges is what they need to do?

If you’re in a deflationary cycle, if you’re providing less than certain social benefits for the future, Chinese consumers are simply not going to open up their wallets and spend and change their behavior. So while I am actually bullish on their overall technological central planning efforts, of the sectors that you mentioned in your question, I think overall the structural impediments to them getting over the hump and becoming a 21^st century economy that’s firing on all cylinders are very hard to overcome.

POSEN: Three quick points. Well, point zero is, like Doug, I deferred to Dan Rosen, Rhodium for the latest on the Chinese economy.

But point one, I think we got to be a little careful here about the “high-tech” term. A lot of the sector, Sebastian, you mentioned that people focus on EV, solar panels, even to where they are in chips, are actually medium tech. And there is a question whether that matters or not. And in different sectors, it matters a lot, both for a national security purpose and for an economic purpose. And my colleague Martin Chorzempa at Peterson has written about some of these issues. And so they’re going with a commoditized version of AI, which may, in the end—speaking as a macroeconomist—may actually be better, because it will mean broader diffusion and adoption of it, versus U.S. companies who may be focusing on having the absolute world’s best, trying to have sentient HAL, for those you old enough to get the reference. (Laughter.) You know, and that may prove to be actually smart. But I think—and then it has different national security issues, which I defer to many in this room to deal with.

Second point, picking up on Doug’s thing about the consumer. I wrote in Foreign Affairs two years ago. I think part of what’s gone on with the consumer is that Xi fundamentally shifted to a(n) expropriation regime. That became apparent to normal Chinese, normal Han Chinese, around COVID. He has, however, as you described, really backtracked on some of his anti-private sector. And so my colleagues at Peterson, Tianlei Huang and Nicholas Véron, have a tracker of the private versus public sectors of the Chinese economy, and what’s their valuation in the stock market and how much credit they get. And after reaching a minimum for the private sector two years ago, it started to rebound. I think in the end, for a tug of war, having your consumers fearful, as I’ve argued, as Doug just said, is actually more of a problem, gets you these deflation, than having your private sector less fearful. But having the private sector less fearful is still an improvement.

Third and final point. And here I’m back to the new economic geography. If we’re in a world where national identity of investors becomes more important, for a variety of political, safety reasons, self-insurance reasons, geopolitics. And again, I’m not against taking geopolitics, or Doug, seriously. I’m against calling it risk. If we’re in a world where that’s the steady state, we probably see a breakdown in the flow of the savings glut from China to the U.S., and the West more broadly. And there may be people in Abu Dhabi, or Zurich, or Singapore who think they can mediate it, but fundamentally if you’re Chinese and you’re scared you’re not going to be able to get your money out of the U.S., or you’re American and you’re scared, you’re not going to be able to repatriate your profits in China, you’re going to segment it.

And in a segmented world, where there’s less savings coming into the U.S., U.S. will have higher interest rates at the same time that we’re trying to sell more bonds to fewer savers. And China will have more deflation because you’re bottling up things that used to get higher returns abroad at home. And so that’s another piece of the big picture that I think people need to be aware of.

MALLABY: OK. Let’s open it up. I want to remind you that this is on the record. I see a question right at the beginning, front. The microphone just coming. Please identify yourself and all that.

Q: Thank you. Tara Hariharan from NWI Management.

Could I invite the panelists to opine on what they think the near-term outlook for dollar strength or weakness is going to be? You mentioned many cross currents already. I just want to add two more. One, of course, the possibility that the Mar-a-Lago Accord comes back in and there is a deliberate attempt to weaken the dollar. Additionally, the fact that some of the traditional safe havens—the yen is not looking so hot anymore, and Europe is questionable right now, although the euro is strengthening. And if I can just, finally, mix that in with the outlook you think for EM, emerging markets, based on your views on the dollar. Right now, we have started to see some, you know, nascent stabilization, at least in some emerging markets economies of inflows. Do you think that will last? Thank you.

MALLABY: Who wants to take that? Alexis.

CROW: So our forecast is that you see DXY come down another 10 percent by next May. So lose central banking independence, I think that is—that’s where we’re starting to see the pressure. It’s not in equity markets. It’s in currency markets. And in which case, I mean, we’re advising our clients on how to hedge against that and what to do. Still, like the Swiss franc play. I think the euro one is questionable as to whether or not Madame Lagarde actually wants the euro to strengthen to a certain degree, because, of course, that would undermine European competitiveness in exports.

On the EMs, what’s quite remarkable, as you know well, Tara, is that emerging market, developing economies, central banks in Asia, after the Asian flu, have responded in kind with moving from fixed to floating exchange rates, bolstering foreign exchange reserves, successful inflation targeting regimes. The central bank of the Philippines tested that out in 2018 after the trade war. So, by and large, many of these central banks are in a much firmer position. A good example of that would even be Vietnam, where, you know, the government’s recently announced what I call a stimulus package with Chinese characteristics. (Laughter.) So insulating themselves from the shocks of the tariff winds. And the package is the sum of 10 percent of GDP. And they have the space to be able to do that. So I would actually say EMDEs, particularly in developing Asia, are looking in a much better position.

POSEN: Tara, partially agree with Alexis, partially not. So I agree. I think direction of travel and dollars down. I think we are seeing that in exchange rate dynamics. Don’t look at the level. I’m sure you don’t. But as my colleague, Maury Obsfeld, has written about, as many other economists done in various ways, we’re essentially seeing a reversed reaction to the shocks in the dollar market. When there’s bad news in the dollar, you see currency down, interest rate up—which is not what generally has happened for years. And I think that’s very telling, and the central bank independence further underscores that.

I do think, however, that the EMDE, I would break it slightly differently. I think the major EM economies—India, Indonesia, Brazil, Turkey, contingent on trade deals, Mexico—are on a completely different path than the rest of the EM and developing economy world. And the geopolitics and the nature of the situation reinforces that. So you want to diversify out of U.S. You want to hedge on dollars. You don’t want to be in some frontier economy that either China or the U.S. is going to play ball with or ignore. But Brazil, India, Indonesia, Turkey, and maybe Mexico, are big enough geopolitically and economically to do this.

And this trend was already underway, going to similar history to Alexis. I mean, the Fed raised 550 basis points in this tightening cycle, in a very short amount of time. There was no financial crisis in any of those countries. I defy you to find another Fed tightening cycle in which at least not at least two of them had a financial crisis. The world already was changing but I think the change in geography reinforces that. So it’s not good for international development, but for investors it may mean long India, long Brazil, against—long Turkey, against dollar maybe.

REDIKER: Just to throw one very short. I think it’s going to be interesting to hear from investors and others coming to Washington for the IMF, World Bank annual meetings. Because when we last all convened in April, the mindset then was, oh my God, we’ve got to get out of the dollar. It was not a run for the hills, but it was a—we’re exposed in the dollar in so many different asset classes, right? Private equity investments denominated in dollars. Equities? Dollars. Treasurys? Dollars. They were looking for a way to hedge.

And then there was this sort of summer, late spring, well, we looked around and it turns out there’s nothing better than the dollar. So maybe we should stick with the dollar. And now we’re in this—you know, let’s see in six weeks—but I agree with Adam and Alexis that clearly the direction of travel on the dollar is down. The question is, into what and by how much? And I’m not smart enough to know, but I’m looking forward to hearing from the assembled masses of experts who are going to actually deploy those funds in the next six weeks.

POSEN: I’m not smart enough to know either, but two additional points. One is, people—going with what Doug said, and a number of market people coming—people are hedging in a way that they were not hedging the dollar previously. They’re spending real money to self-insure. And that includes sovereign wealth funds. That includes large pools of capital. Second point is just on Europe, picking up on something Alexis—I spent part of last week at the ECB with the European Systemic Risk Board, including President Lagarde. They are openly discussing and recognize that they need the euro to rise to make this work. Whether the finance ministers and the prime ministers will accept that, I don’t know. But I think there’s a very clear movement in the Governing Council of the ECB, on the record, that they recognize this as part of the safety—(inaudible).

MALLABY: Sorry, the euro needs to appreciate because why?

POSEN: Because, in the spirit of what Doug said. You know, everybody is so overexposed to dollars in so many ways, and you can’t count on nonpolitical access to the various insurance, liquidity, swap lines that you used to. And so therefore, no, you’re not—like Doug said, you’re not dumping it, but—

MALLABY: Of course, some people think the answer to Doug’s question is gold and Bitcoin.

POSEN: Oh, yeah. Yeah.

MALLABY: I think Joe had a question here in the front.

Q: Thank you. Joseph Gasparro, Royal Bank of Canada.

This past summer really ushered in a new era of direct state investment in key industries—MP Materials, Intel, Nvidia, revenue sharing. One camp bemoans this. The other camp says this is how we outcompete China’s state capitalism. Would love to get your sentiment. Is this a net positive? Is this a net negative? Thank you.

MALLABY: State capitalism. Who wants to make the case in favor? (Laughter.) I challenge all three of you.

REDIKER: I’ll—OK, so, first of all, it’s a great question. I made a little reference to it earlier. I think it’s one of the major structural changes. The U.S. does not do state capitalism well. It’s hard to find in history where it does go well, or at least better than a more innovative, creative free market system. Having said that, national security is a real thing and there has to be a balance. I actually think one of the things the Biden administration did well was try and strike that balance. Clearly, that’s all been, you know, undone and thrown on its head with the Intel transaction, and the reversion of the CHIPS Act, and some other related issues.

I’m somewhat pessimistic. I think the U.S. government doesn’t do ownership of strategic assets well. I think this particular administration will do it even less well than the baseline. And so I’m actually pessimistic about where this leads. But I don’t see that the trend is in the direction I’m, you know, worried it is.

MALLABY: It seems like there’s two levels of the question. One is, can one make a case for state capitalism in some circumstances? A second one is, are we observing state capitalism or crony capitalism? Because the latter seems plausible.

REDIKER: Just the CHIPS Act itself—the Wall Street Journal did a good piece on this about two weeks ago. The CHIPS Act itself does have provisions that allow the U.S. taxpayer to benefit on the upside from CHIPS Act money. It is just not through a 9.9 percent equity stake in return for what was supposed to be grant money. It’s just—that’s bad. Are there times when state capitalism has, you know, upside, not only economically but strategically? Absolutely. I mean the blind belief that free markets are always going to be the best thing for everyone in every context is wrong. We know that. I’m just saying that this is not the way to do it.

MALLABY: Adam, have we provoked you sufficiently? Would you now? (Laughter.)

POSEN: I think I would spin it a little differently than Doug. But I like very much, Sebastian, your distinction between crony capitalism and state capitalism. Making a limited national security case that, whatever the economic cost, it’s important to have assured supplies of X is fine. And it’s not just fine. It’s wise. However, that doesn’t usually mean getting assured supplies of X is not codetermined with how much production you have at home of it. Those are not the same thing. And these, under both Biden and Trump, are treated as equivalent. That’s a mistake.

REDIKER: Can I just say, because the question is from the Royal Bank of Canada, right? The amount of strategic interlinkage we have in the U.S. with Canada on strategic industries at the defense level is well beyond what the public understands it to be. So the fissure between the two countries right now is a real strategic economic problem, that goes to what Adam was talking about, which we are not talking about and we should be talking about.

POSEN: Agreed.

MALLABY: OK. A question right behind you.

Q: Hi. Thank you, as always, for a riveting discussion.

Wanted to ask you with AI—

MALLABY: Could you just mention your name?

Q: Oh, I’m sorry. Pardon me. Munish Walther-Puri, IANS.

With AI advancing productivity, do you see that colliding with intensifying U.S.-China competition? So it’s accelerating advances, and there’s productivity gains, and policy friction is increasing costs. Where do you see that creating surprises in the market, either in sectors or, you know, asset classes that investors are overlooking right now? Thank you.

MALLABY: Who wants to take that?

CROW: Happy to take part. I mean, I’ve written on this in the past. I just—where we are now in the world of LLMs I don’t see a massive unleash of productivity over a sustained period of time. I do think that some of the biggest gains that will happen will be in trade industries, like electricians doing diagnostics better, science, drug development. So I’m not seeing it happen in the white-collar business and professional services jobs yet.

In which case, if it starts to look a little bit like what Robert Gordon looks back in economic history is the nine ebullient years—so when we had this big productivity uplift related to basically the laptop, which meant that I wasn’t in some random business center in the basement of a hotel in Serbia doing an application, I was out with my laptop. So that was that one moment. That’s kind of where I see it. So as we saw, you know, one particular report from MIT coming out that shook markets slightly back in August, given the fact that 95 percent of the businesses that they surveyed didn’t show ROI, I think those—you know, more data points like that that are substantive I think could shake market slightly.

MALLABY: Another question. Right here. Microphone coming.

Q: Hi. Good morning. Samrat Karnik from Houlihan Lokey.

Maybe I’m reacting a little bit to the journal article this morning on the U.K. bond market, but going back, Alexis, to your point. The long-dated bonds. And you said it’s unclear when we start to pay the full price of our largess on debt and borrowing from the future, effectively. But do you sit here and look at triggers that would basically have the capital markets asking for a higher price to lend to these governments? Because clearly they’re coming to a point where they cannot. I mean, when you’re spending, you know, more on interest rate than defense, like in the case of U.S., you are getting to a tipping point where you can’t sustain the borrowing costs. So do you look for triggers when it just becomes U.K. paying 6, 7 percent—basically emerging market rates—for their bonds?

CROW: We’re there. I mean, I think we’re there in some economies. What I think is important is to also just point out what Adam mentioned on just—you know, in the first—in the initial weeks of COVID we were the only advanced economy to take our debt ramping up to 110 percent of GDP bond yield strength and currency fell. So I think that’s where—or, currency strengthened and bond yields fell. So that’s where I would say that kind of a pressure point is interesting. And still, I think the British pound is OK.

I would actually look at what Tara hinted at, is do we have a major debt restructuring moment? That’s a likely trigger point as to what investors will ask to hold on long-dated bonds. The other one, of course, is a governance moment, which will hit in France tonight. And does that prompt an intervention of an IFI? So I think those are the two key trigger points. There’s a debate in Japan, for example, that, like, what’s going on with the forty-year note doesn’t really matter, and that you should really only focus on the ten-year. And investors are still pouring into Japanese equities and fixed income because they see this as a safe haven. So I think it’s going to be a relative bet.

POSEN: I’ll just piggyback, if I could. Behind you is Michael Peterson of the Peterson Foundation. He’s not the whole foundation, but anyway. Just to say, one of the things—and he’s heard me say this before—I admire is, the last few years one of their key messages has been the idea of, whatever you think about the debt, if you’re spending more and more on interest as a share of government expenditures, that’s bad. And for both economic short- and long-term reasons, that’s right. And so I think, both as a governance trigger and as an economic markets trigger, that’s essentially what I would focus on—is when you have escalating interest share of government budget.

MALLABY: I would say, though, that, you know, when it comes to the thirty-year bond, or its equivalents around the world, we’re discussing a world in which AI is going to be AGI. We can debate whether that’s in 2027 or 2029, but, I mean, it’s coming. And the productivity diffusion effects will take a while. Alexis is right. I agree with her. But it’s going to—you know, eventually it’s going to arrive, right?

POSEN: Yeah, but that’s fiscally neutral. So we published a book on the slowdown in productivity growth at Peterson’s a few years ago. And this is actually a general result in macroeconomics. It’s good for growing things to have more productivity growth, but for fiscal balances it’s generally neutral. Because you have higher growth rates, you have higher returns on capital. So R-star, the base rate on interest rates, goes up. And so your—on net, your fiscal position does not consistently change if you get a productivity growth jump, unless you, basically, tax the gains from your newly productive, increasingly productive sector in an aggressive way—which you normally do not want to do.

And this, to me, is ultimately the real problem in the U.K. Is that they are boxed in. They have had terrible productivity growth since, roughly, 2012. So I got that call wrong when I was at the Bank of England. I expected productivity growth to rebound. I was completely wrong. It catches up with you. And so the problem in the U.K., as opposed to, say, France or the U.S., is they can’t figure out a path that gets them back to higher productivity growth. And so it’s not that that undercuts the fiscal directly, but that makes the wage developments unsustainable politically. And then that has repercussions.

In France, for all the terrible things that are going on, economically—you know, and I was talking about this at the Banque de France a couple days ago—you know, you can do like the U.S. You raise the retirement age a couple years. You cut this benefit a bit. You raise this tax. If you do a sum of small things, you can get it back on the road. Now, politically, it’s impossible. And I’m not making light of that. But just to say these are very different situations.

MALLABY: I don’t know. I mean, I think that if you have, you know, really deep, deep change in all kinds of different technologies, the way that production happens, people speculate, maybe crazily, when is the time when, you know, JPMorgan will have one employee? (Laughter.) You don’t have to buy that, right, but you could—you know, you just have to say, would it fall by 5 percent or 10 percent—

POSEN: What would?

MALLABY: The head count of employees needed to run a bank like JPMorgan, or whatever. And, you know, yes, there’s going to be a difference on interest rates as well as just a difference in growth, but how that nets out surely—my point is simply, it’s very, very uncertain. And so moves in a thirty-year bond rate in response to something like a difference of perception in the fiscal path, it just—I don’t know, over thirty years, I think the world will be so different, I find it quite hard to understand how anybody takes a view on that.

POSEN: I don’t think anybody does. The thirty-year bond market in most countries, including, notably, Japan, is overwhelmingly determined by regulations on pension funds, insurers, and other things. Well, now it’s the ten-year bond market.

MALLABY: Yeah, question here.

Q: Hi. I’m Jim Zirin.

I’m wondering, does anyone want to comment on the way forward in gold—Sebastian alluded to this—gold crypto, Bitcoin and these various monetary substitutes?

MALLABY: Good question. And let’s wrap it up with that. Who wants to talk about that?

POSEN: As a former central banker, I feel duty bound. There will be a bubble. There will be a crash. There will be a series of bubbles and crashes. And if the scenario I was talking about, about having a politically captured Board of Governors, people—captured by people who have conflicts of interest in this area, there will be bailouts to go with the bubble and the crash.

REDIKER: That’s crypto, not gold, correct?

POSEN: Yeah, gold, nobody—I mean, gold—people want to throw money at gold? Fine. Have fun. (Laughter.)

CROW: It wouldn’t be my hedge. (Laughter.)

MALLABY: OK. All right. Well, look, thank you, everyone, for joining today’s meeting. Thank you to Adam, Alexis, and Doug. And remember that there will be a transcript and a video of this meeting on CFR.org shortly. Thanks. (Applause.)

(END)

This is an uncorrected transcript.