Fall 2019 Stern Economic Outlook Forum

Fall 2019 Stern Economic Outlook Forum


(gentle music) (audience chattering) – Good afternoon. We’d like to get
started on time today. My name is Kim Schoenholtz. I’m delighted to welcome
you to the Fall 2019 NYU Stern Economic and
Market Outlook Forum. The host of today’s forum is the Stern Center for Global
Economy and Business, which serves the
university through outreach to the broader community, including the academic,
business, and policy worlds, as well as students and alumni. So let me now briefly introduce
our distinguished panelists. Seth Carpenter, to my left, is the Chief U.S.
Economist at UBS. He also has been Head of
Research at Rokos Capital. Previously, Dr.
Carpenter served as Assistant Secretary
for Financial Markets in the US Treasury. That followed a distinguished
career as an economist at the Federal Reserve Board, culminating in his
role as Deputy Director of the Division of
Monetary Affairs. Dr. Carpenter’s a member of The
Council on Foreign Relations and the Congressional
Budget Office’s Panel of External Efforts. He received his PhD in
economics from Princeton. Joyce Chang, on the far side, is a member of the
Management Committee of JP Morgan’s Corporate
and Investment Bank, and she heads the firm’s
global research department, which has more than 900 analysts located in 26 countries. Reflecting her
number one ranking in many analyst surveys
over many years, Joyce was inducted in 2014 to the Fixed Income Analyst
Society Hall of Fame. For the past five years,
“American Banker” has named her one of the top 25 most
powerful women in finance. She also is a member of The
Council on Foreign Relations. And finally, in the middle, Constance Hunter is the
Chief Economist for KPMG LLP. Prior to KPMG, she held
high level positions in asset management, including
as Chief Investment Officer for nearly two decades. At AXA, for example,
she helped manage more than $500 billion
in fixed income assets. Today, Constance
serves as President of the National Association
of Business Economists. Last but certainly not least, Constance received her
undergraduate degree in economics and
sociology here at NYU. That deserves a little bit of– (audience clapping) So please join me in
welcoming our panelists. Seth will now begin
the presentations, followed by Joyce and Constance, in that order, alphabetical. After their brief
initial remarks, we’ll begin the Q and A session. Thank you, Seth. – Just stay sitting or use the podium?
– There’s a switch right here. Whichever you prefer. – Yeah, I’ll stay here,
make it more informal. – Okay, let me bring it–
– There we go. – Yup. – Excellent, well, thank
you very much, Kim. I am extraordinarily happy
that Kim invited me to come for now my second time
here to address this group. After I finished my
PhD, for two years, I was a professor
teaching economics at the College of
William & Mary. And I think just about every
day miss being in the classroom so this is just a little bit
of that coming back for me. So five minutes
to start off with to give a little
bit of an outlook of the things that
we’re talking about with our clients
about the US economy. And I necessarily had
to narrow it down. There are 1,001 things
one could talk about, but one of the things
that I don’t think a single day goes
by, probably not even a single conversation goes by where we’re not talking about
our outlook for the US economy and importantly, how that’s
affected by the trade war between the United
States and China. One phrase, sentence that I have said many, many, many,
many, many times over the past year
and a half is that the US economy is strong
but for the trade war. At some point, boy,
that’s gonna be like being in the middle of
the winter in Michigan and saying that it’s
really, really warm except for the frigidity. So there’s a saying, which
you wanna get across to an audience, that numbers numb
but stories store, so I will get the
numbers out of the way, ’cause everyone does wanna
know what the forecast is. And for us, we see this
year, a GDP growing at something like two to 2 1/4%, but next year much
slower at about 1.1%, and in particular, the
first half of the year, we think the growth is gonna
slow very, very sharply to just under a half
a percent per year. And then when it comes
to things that matter more directly than those
sorts of numbers, people, the unemployment rate,
we have that rising over the course of
next year, up to 4.3%, which is kind of remarkable. I’m old enough to remember
when 4.3% was a good number, but it turns out that’s not
going to be a good number next year, given
where we’re starting. And finally, thinking
about the Fed. We have the federal funds
rate in our forecast coming down to 1% by
September of next year. So those are the numbers,
those give the outline of the forecast, but
what is the story? And for us, the story
really is tariffs. And so the title of our
current slide deck is “Tariffs take us to
the brink of recession.” But what does that mean? Last July, the
beginning of July, changed our forecast
for 2018 and for 2019 and said that the US
economy is going to have a massive slowdown in Q4 that is going to be
induced by the tariffs. And we had any number of people throw rotten tomatoes at
us, metaphorically speaking. We had people telling us
that not only are we stupid, that we’re also not
very good looking and we probably have
relationships with our siblings. (crowd murmuring) But in the event, as you
can see from the chart, we went from a very, very
strong middle of 2018, the blue bars, our
quarterly GDP growth rates, or sorry, private
domestic final purchases, so all of the spending
that goes into GDP that’s domestic spending,
a massive slowdown, a massive slowdown
that persisted into the first
quarter of this year. The black line is the
unemployment rate, which had been falling
over the course of this very, very long expansion, the unemployment
rate peaked in 2009 and had been falling ever
since, started to rise in the fourth
quarter of last year and into the first
quarter of this year before resuming the decline, and then the economy
bounced back in Q2. That pattern was precisely
what we had written down for the pattern for the
economy and economic growth and employment way back
in July of last year. And it was because
of the tariffs. The tariffs applied so far, if we exclude what
happened on Sunday, so tariffs kicked in on, the new round of tariffs
kicked in on Sunday, but until then, most
of those tariffs had been on intermediate goods. Capital goods,
inputs to production, bits and pieces that firms take, combined with other bits and
pieces that produce output. One of my favorite analogies that has nothing
to do with tariffs, but I think illustrates why
we were convinced for so long that there was going to be
an outsized reaction is Ford. So Ford’s single most
profitable vehicle is their F-150 pickup truck. It produced F-150s in four
different assembly plants in four different states,
and one auto parts producer out of the hundreds of
auto parts producers in the United States,
let alone the world, had a fire, couldn’t produce
air conditioning units. And so Ford’s production across
four different facilities for F-150s, their
most profitable model, went from full capacity to zero because of this one
auto parts supplier. And it stayed at
zero for three weeks, and then it went right
back up to full capacity. Now, they didn’t make up for
lost time ’cause it turns out you can’t produce more
than full capacity. Otherwise, it wouldn’t
be full capacity. But that kind of non-linearity is exactly what you should
always expect to see when you see disruptions
to supply chains. And so what happened
in Q4 of last year was that a lot of manufacturers who were importing
goods said, “Wow. “I just can’t pay 25%
more for that input, “and so I’m gonna
wait for awhile. “I’m gonna suspend
production for awhile “until I can find a
cheaper supplier.” Turns out, when manufacturers
suspend production, their workers go on unemployment
insurance for awhile until they go back to work. And sure enough, at the same
time we saw unemployment rise, we saw applications
for initial claims for unemployment insurance rise. But eventually, we
started to see businesses find other sources
for these inputs and we got back in
Q2, a bounce back, just as we had always
thought would happen. But the ways of
tariffs are astounding. Overall, if you think about
all the goods under tariffs, I just love this chart ’cause
it looks like I made it up, those are all imports
at a monthly flow rate, all imports of goods from
China that are under tariff. And just 13% average tariffs, through the data that
are available here, saw a 40% reduction. So how do people
normally model tariffs? They usually say,
tariffs are taxes. You know what
happens with taxes. Taxes push up prices,
and higher prices, you move along the demand curve. And if you assume
unitary elasticity, blah blah blah blah blah blah, and they’re just wrong. First of all, the direct effect just on what’s bought
is much, much higher than those assumed
unitary elasticities. And second, you get
these non-linear effects from the disruption
of production. For all of those reasons,
these tariffs have been massively disrupted,
massively destructive. We got a bounce back in Q2, but then we got another
wave of tariffs. And so just to keep people
up, we got more tariffs in September, in May. We got more tariffs
just on Sunday on, mostly now, this time, on
finished consumer goods, and then we’re gonna
get another increase in the tariff rate for things
that already had tariffs in the beginning of October. And then we’re gonna get
another wave of tariffs in the middle of December. That is a problem. Oops, that last chart is
actually just for Constance. That is a problem. Why is it a problem? It’s a problem because
this type of disruption is gonna happen again
and again and again, and that’s why we think that
the economy is going to slump in the first quarter
of this year, and as a result, the
unemployment rate is
going to drift up. But for the trade war,
the US economy is strong. We are now in the longest
expansion on record. It could have kept on going, could have kept on
going for a long time. And so the last
thing I wanna say is, how far could it have gone
but for the trade war? And my answer is, quite
a long ways further, and I’m gonna wrap up
with this last thought, which is, one of the
questions that came in that Kim shared with us is, shouldn’t the economy have
been coming to an end, the expansion have been
coming to an end soon? Aren’t we going to run out
of labor in the labor market? Aren’t we going to hit
resource constraints? And my general
view on that is no. And so we have the labor
force participation rate in this chart, which is,
for the aggregate economy, is the black line. The blue line is just
prime-age workers, people between the
ages of 25 and 54. Why separate out the entire
population from the prime age? And as an aside, over the
next four or five years, I’m gonna hate the
phrase prime age as I exit my prime apparently. But the point is, it strips
away the demographic shift as the American
population gets older, it masks a little bit
of what’s going on. But what I want you
to take away from this is the cyclical behavior of,
especially the blue line. Every business cycle,
you see an increase in labor force participation. The longer the
expansion goes on, the more people stay
in the labor market, join the labor market. The early ’90s, the labor
force participation had dipped. I graduated from
college in 1992. The job market stunk. I got a PhD. Five years later, I
joined the job market just like lots of other people when you had this upward trend. The same thing has been
happening in this expansion. And not only have we not reached
the previous cyclical peak in labor force participation,
we have not even yet reached the previous cyclical trough. And so as a result, if it
weren’t for the trade war that’s just pounding
the economy, I see plenty of room for the
economy to continue to grow, to continue to draw
people into the labor force. And then I’ll stop. – Thank you. (audience clapping) – Hi, I’m Joyce Chang
from J.P. Morgan, and it’s a real
pleasure to be here. Welcome back to
school, everyone, and thank you, Kim, so
much for the invitation. I’ve known Kim since
graduate school when we both worked together
at Salomon Brothers, I hate to say it, more
than 30 years ago. But it’s great to be here with
Seth and Constance as well. And so I thought
I would just start by describing the global
economy today and how I see it. And I would say
pushing on a string. Central banks are
trying very hard. 17 central banks have eased. In total, we have 22
central banks easing by the third quarter
of next year, and right now, growth
is not collapsing. Very similar to Seth, we
have the US growing at 2.2%, but we have a slow
down to around 1 1/2% next year for the US, but
look outside of the US, and you now have nine economies
that are in recession. We’ve just taken down
our China growth forecast for next year to below
6% for the first time. We have China growing at
5.8%, but pushing on a string. And so what are the policy
tools that are left? If you look around
the world today, 42% of the global
government bond market is at a negative yield. 60% of Europe now
has a negative yield, and many of you here will
probably go into finance. I realized, as I looked around the research
analysts in my group, that 1/3 of them had not worked during a period of
conventional monetary policy. They looked at me like
I was talking about the Romans or something.
(audience laughing) But unconventional monetary
policy is here to stay. So let me talk a little
bit about our forecast. So these charts, and the
bottom right hand one is really the one
to take a look at. You have the benefits
of the tax reform. You can see PMI
manufacturing going up, but you can see that it’s
been completely eroded. And very much as
Seth pointed to, it’s not just the direct
effects, the tax effect, it’s the measures of sentiment that we’re focused on right now. The outlook for business
sentiment and global CapEx, and the question is,
is this going to erode into consumer confidence? Because you can see
in the top chart that consumer confidence has
actually held in pretty well, and we are now seeing
signs of that erosion. So after rising
in 2016 and 2017, global trade volumes are now at their weakest
level since 2010. The pain is very acute
in Europe in particular where they’re very
trade reliant. You can see that in Germany
where the new orders are foreshadowing a continuing
decline in production. And you can also see now that the hit that we are seeing
on the consumer. But central banks have been
pushing very hard on a string. But we are seeing that these
major geopolitical shocks are now turning
into economic shocks that are depressing
global economic growth. And this has brought on a broad
response from central banks. Even though we don’t
have synchronized views on the political views, we do have synchronized
central bank easing in place right now. But what we’re worried
about, as we look ahead, is that Trump’s trade
war is hastening a Japanification process. Low growth, low
inflation, weak earnings, zero negative yields
across regions. We now talk about, could you
have zero interest rate policy in the United States? If you have China’s growth
slowed down to 4 1/2%, given where their debt level
is, could you be talking about zero interest rate
policy in China? And these kinds of questions,
we were not asking ourselves even 18 months ago. So this year, China still has
the scope on the fiscal side to deliver something that
will still be above 6%, but we do have a slowdown
below 6% next year, and we do have the US in the
third quarter of the year slowing down to 1 1/2%. Some of the questions
that had come up had been about, what is the
risk of the US recession? So I thought I would spend
a minute walking through our US recession model. Now we have a higher
probability of recession than conventional wisdom. We have it at around 40 to 45%, and I think consensus has
been around 27 to 30%. So what’s in our recession model and why are we at a higher risk? We put a higher emphasis
on profit margin and margin compression. And we estimate that the tariffs have actually taken about $7
off of earnings per share. And if you put the
full tariff into place that they actually
went ahead in December that you would have several
more dollars taken off of this. But we look at a
couple of things, many of them which
Seth also talked about, the tightness of the
labor force conditions, the demographics, but
also we have seen, if you look at our
recession model and you look at where we’ve
seen a pickup in the numbers, it’s the ones where you
see the biggest jump. More than seven points
is business sentiment. And so when you do get
to the next recession, you’re likely to see
all of the central banks facing an effective
lower bound constraint, and you’re going to see
that unconventional tools, QE, the enhanced
forward guidance, are going to probably
prove much less effective as a result of the past decade’s r-star drop and also the
yield per flattening. So this points to the need to prepare for the
next recession now by putting in place facilities which many of these tools
have really been exhausted. So that’s a 12-month view,
the 40% chance of recession. If you go out two
to three years, we’re at over 50%
chance of recession. So I wanted to just
say a few things, like what kind of
recession is it? It’s the question I get. And I would say, it’s not the
2008 global financial crisis. Even had enough normalization to have that type of recession. So it is more, I think, a recession led by an
asset class sell-off rather than a
business cycle event. You’ve had, if you look
at the equity market, this current cycle
has gone much longer than the average
equity market rally. And although there
are imbalances in the US economy that are
ample, they’re not glaring, and they’re concentrated more
in the government sector. So something like household debt was 1.4 times income, and
now it’s about one to one. Because we’ve had such
low interest rates, even though you have
more corporate debt, the debt service burden
is more manageable. So I think this is more of
a asset price-led recession, more akin to what
you saw like in 2001 than it is something like a systemic global
financial crisis. But when could this be coming? Again, it’s not the
working scenario for the next 12 months. But could you see this
actually playing out, and the market pricing it in more as you get towards 2021. And that brings us
to the yield curve ’cause a lot of
questions have come up about the yield curve. And I would say
one thing is that, as we’ve looked at
the negative yields, we calculate that every 10
percentage point increase in the share of
negative yielding debt actually flattens the curve
by about six basis points. So you’ve got this record amount
of negative yielding debt. And questions about
whether this is going to actually spread
to the US, to China, to other countries
over time as well. So the yield curve has
always been a bad omen, but we are in a different
point on the yield curve than what we have
seen previously. Typically, the yield
curve inversion is a sign that real policy
rates have become too high, and that’s certainly not
where we’re at today. So this time around, the real
rates are not much above zero. Claims have been
much more resilient. So I think this is an indicator of extreme market
nervousness at present, rather, it’s of increasing
central bank action. It’s also technical factors, the sell-off we saw in
treasuries in early August. We think that that
was attributed largely to high frequency trading, which was about 80% of the
volume that was traded. This was not really
humans trading it. This was more of the
machines trading it, which led to the magnitude of the move that we saw in
treasury yields in early August. But you see that in this
chart that, typically, when the yield
curve, you have a lag between the yield
curve inversion and the actual market
peak in recession. That has, if you look at
the last six episodes, that’s been about 17
months on average. Recession, not necessarily
around the corner, but more market nervousness,
more warning signs. And then I’ll just point
to one slide on China, just to talk a little
bit about the way in which we’re trying to
monitor US, China trade. So we’ve been doing more
work with big data and AI. And so what we’ve done is, we’ve taken about
25,000 company reports, the call transcripts,
the news headlines, and we mined them to the
millions where it’s this, to try to get higher frequency
sentiment indicators. And it’s an interesting chart because you could see, in
the second quarter of 2018 that the most frequently
mentioned words were tax reform. Everybody talked
about the tax reforms. You could see that chart. Then it switched
to trade tariffs, and then by the fourth
quarter of last year, it was recession risk. And you can also see
that for the estimates of how much of the tax
benefit has been eroded, we estimate that the tariffs
have cost the households, on average, about $650
going up to about $1000, as you see the next
phase put into effect. So if you look at the estimates that every household got about
$1200 from the tax benefits, you’ve eroded most
of it already, and there’s still
talks of more tariffs. So it is a more precarious
outlook going forward, and very much, as Seth
and, I think, Constance will have some of
the same points, so we are seeing
more talks about shifts in the supply chains
and in behavior of companies as we look ahead. – Okay. (audience clapping) – [Joyce] I didn’t go
through all of these. Some of these we
saw the questions. So I did slides based
on the questions, which I can go back to. – Okay. So the benefit of going last is that I get to do a
little bit of a summation of what my fellow
panelists have said, and it’s just so
great to be here. Kim, thank you for
the invitation. It’s great to be back at NYU. So, we view it as the US economy
is at this crossroads, and very much like Seth, we believe that there is some
slack in the labor market, so I love this. Numbers numb and
stories store, (laughs) but examples excite
economists, right? So in any case, if you look at just
something as simple as the reservation wage that
people are willing to take when doing any number of jobs that one can get, either
on Uber or TaskRabbit. We can see that reservation
wage is actually below, in many cases, the
now $15 minimum wage that many people
are putting forward. And so this says to
me that there is this in addition to the data
that Seth showed us earlier about the rising labor
force participation. There is some slack
in this labor market. So we’re at this crossroads where the Fed could continue to elongate the economy or it could be worried
about inflation, and we know that there
really is no reason for the Fed to be worried
about inflation here. Any inflation we might
get from the tariffs, the Fed is gonna so
called look through because their dilatory
effects on the overall economy are gonna be much
more significant from
the view of the Fed. So let’s look at GDP and how it has been doing, and I would say that Q1 GDP is entirely a function
of trade distortion. So we go through some
components of GDP. Obviously, there’s the headline
number there up at the top. We have consumption, which
fell in the first quarter, and you may recall that we
had a government shutdown for the month of January, so that really
impacted consumption. We had business
investment decline. That was a worry. And we had the fifth
consecutive quarter of a decline in residential
fixed investment, so housing investment. Also a worrying sign to us, one of the leading
indicators of a recession. And finally, of course, because
of that government shutdown, we had a decline in
government spending, which we expected would rebound. But here’s the rub with
exports and imports. The way this works, of course,
as you know, with net exports and you can see that that
decline in imports to 2 1/2% compared with an increase
in exports, 4.8%. That caused that to
positively contribute to GDP, and it’s what gave us that 3.1%. So looked at another way,
you could look at Seth’s data around final sales to
domestic purchasers. And if we combine the first
half of the year together, so we look at the first and
second quarter together, we still see slightly
slowing growth. We see consumption holding
up, and it’s really, again, this business investment
in real estate where we are concerned. And as Joyce pointed out,
trade volumes have fallen, and we see this, both
exports and imports declined in the full first half of 2019. And so we expect a
slow decline of GDP towards potential of about 1.8 with a lot of risk
on the horizon. So let’s talk for a minute about where that risk could come from. So we have our sort of list of
essential recession signals. So, obviously, the shape
of the yield curve, which Joyce talked about,
housing investment, the tightness of the labor
market, liquidity conditions. When the tariffs first
started being applied, we thought, how are we going
to put this into our model? And so one of the
things I did was, I shocked our model
with a higher VIX, a higher Volatility Index. And what that does is,
that has reverberations throughout the entire
capital markets. Of course, it corresponds
to a sell-off in equities, but it also corresponds
to a widening out of corporate bond spreads. So the cost of capital
for firms goes up. They’re less likely
to make investment. And so we were able
to get a window into how much we would need
to adjust our cap backs and corporate investment levers in order to really get a feel for how this would begin
to impact the economy. Then we also looked, um, Joyce talked about
consumer sentiment, and what we do is we look at consumer current versus
future expectations. It looks a lot like the
inverted yield curve, actually, and it maps it pretty closely. And then, of course, we
look at global conditions. So this is the global
manufacturing PMI. It’s a heat map. It takes us from
December to now. It’s organized by geography. The top is Europe,
and of course, as Joyce mentioned, Germany
is really not doing well, but we can see, with
the exception of Greece, which, of course, is a
very small economy that, until very recently, was
doing pretty terribly, we see a lot of sort of yellow
and orange within Europe. Within the Americas,
Canada and Mexico are doing slightly
worse than the US, but the US PMI data
that just came out also shows a decline
close to that 50 number. And then, of
course, within Asia, while China is
slightly above 50, we see a lot of countries that are at or below 50. So generally, a concern around
the manufacturing cycle. Now, in the past,
when the Fed has done insurance rate cuts like
they have just started, it has actually worked
to expand the economy. And in both cases,
if we look back, we had a fall in
manufacturing PMIs, we had a fall in
industrial production, and those are both, manufacturing is a very
interest rate-sensitive sector so it responded to
this pullback in rates. It is unclear, given
the noise around trade, and I think Powell
really alluded to this in his recent
Jackson Hole speech, it’s really unclear
if the Fed tools are sufficient at this moment to have the same impact they had back in the ’90s.
(phone beeping) Oh. I set myself for six minutes, so I’m gonna wrap up very soon ’cause I know we
wanna get to Q and A. It’s very unclear that we’re
gonna have the same impact, and the Fed is gonna be
able to have the same impact as they had in the ’90s because we have all
this ancillary noise around the trade war. So just a little bit on
the negative yield curve, Campbell Harvey was
really the first person to come up with this, and one
of the things he looked at was the five-year bond minus
the three-month treasury, and that it had to sustain
for longer than one quarter. And, of course, you can see,
not only has it sustained for longer than one quarter,
but it has amplified. And if we look back, of course, it’s been an exceptional
predictor of recession, as Joyce pointed out,
and the reason for this, of course, is really highlighted in a recent New York Fed survey
that they did last November. And they asked banks, would they tighten
liquidity conditions if the yield curve inverted
even just slightly? And so for consumer
and industrial loans, 19% said they would tighten
liquidity conditions, and for commercial real estate, 40% said they would tighten
liquidity conditions. So you can see that
this reverberates out into liquidity conditions
throughout the whole economy. Now, will the Fed’s
insurance rate cut work? If we look at the FOMC
forecast, they think it will. They think it’s gonna work. This is the June summary
of economic projections and it is the August survey from the “Wall Street
Journal” and average. And you can see that
private forecasters are somewhat below the Fed. Having just been
out at Jackson Hole and having had the chance to
speak to many Fed officials, I am less certain now that we are gonna get
more rate cuts than I was, and that is because, again,
it’s this efficacy of the tool in the face of the exact
challenge we are up against, which is, what’s happening
with the trade war. So I think that there’s
a lot of questions, legitimate questions around
the efficacy of this tool, given the current environment. So if we just look at the
positive and negative factors, there are a number
of positive factors. As Seth pointed out, we
have steady jobs growth. We have low inflation. We have this Fed
insurance rate cut. We have seen a bit of
a productivity pickup, but the negative factors, residential real
estate disinvestment, which we actually think is
probably gonna turn around as a result of the jawboning
down of interest rates that the Fed did in the
beginning of the year. We’ve seen mortgage rates
come down substantially, and then, of course,
the actual rate cut. We have trade disturbances,
we have slowing CapEx. We have some labor market
tightness in certain industries. We have a possible
recession in Europe. We have China slowdown
and, of course, the ever-present possibility
of a financial market shock. (audience clapping) – Well, first, let me
thank the panelists for living up to the five
to 10 minute limit, I appreciate that, and for
excellent presentations. Thank you. This is now your turn. So just a reminder. Hopefully, Slido is going
to come up in a moment. There it is. This is your chance
to submit questions by going to slido.com, enter the join code, 2222, and go ahead and
submit questions and vote on questions. The ones that are voted up
will tend to be the ones that I try to transmit
to the panelists. One requirement, no anonymity. You have to supply
your full name if you want your
question to go through. So with that, the first question
that got voted to the top, actually, I think, it was Joyce who actually provided
an answer to, which was, what’s the probability
of recession over
the next 12 months? And I think your number
was in the order of 40%. Am I right?
– 40%, yeah. – So do you guys
wanna add to that? Do you have a different
view or how similar or? – So I’m officially at 40%, but I should say that every time the New York Fed’s recession probability
indicator gets above 35%, there is indeed a
recession, so. (laughs) – Which makes you wonder
if they don’t need to recalibrate the numbers.
– Yes. I think it’s based solely
on yield curve inversion, or mostly on yield
curve inversion. And I would just add that,
in the beginning of the year, I was the first economist in “The Wall Street
Journal” survey to say that the Fed’s next rate
move was gonna be a cut rather than the increases
that everybody was expecting. And it’s because of this
noise around the trade war just adding to so
much uncertainty, and the slowdowns we
were already seeing in residential real estate,
and then the impact on CapEx. – Oh, I think mine still works. You can keep it, yeah.
– Still works, sorry. – So I’m totally
comfortable with the numbers that Constance and
Joyce both have out. So our forecast has growth in the first half of next year down at half a percent or a
bit less than annual rate. And when you get down
to numbers that low, it basically takes somebody
sneezing in the wrong direction to tip you over into recession. But it takes something, and
so what else could go wrong? So the US is now
an oil producer. I think that’s probably,
with this audience, received wisdom, but people
our age remember back to when higher oil prices
were bad for the US and lower oil prices
were good for the US. That’s just not
the case anymore. And so if you think
about 2014, 2015, massive fall in oil prices, particularly large slump
in investment spending ’cause fracking has got this
flow of investment spending. So if the global slowdown
is enough to push what’s called WTI
below $40 a barrel, that’ll be enough to push
us over into recession in the first half of next year, and that’s not a low
probability event. – That’s great ’cause
it’s the opposite of the 1990 shock
when oil prices jumped and it tipped us over
into a recession. – Exactly. – Okay. Okay, so the next
question is really not, well, it’s orthogonal
to what we’ve discussed. If there’s a no-deal Brexit, how do you see that affecting
the US and global economies? Someone wanna jump in? – I’ve got a slide–
– Joyce, go right ahead. Your lapel mic works. – I’m the one with
the non-working one. – Oh, okay, I’m just
gonna try and see if I can pull up my slides. I don’t know if I
can do that or not or if it’ll go back to it. – [Kim] Can we get
back to the slides? That’s great. – I had seen the
questions in advance, so I prepared some slides
based on the questions. So on the global economy, I don’t think the
impact is that big, but on the UK economy, it’s big, and it kinda looks like it’s
taking a playbook from Italy. You’ve got an extension of
Article 50, early elections. They delay this. So we have the probability of
a no-deal Brexit at about 35%. I mean, the bigger risk, really, is going to be the possibility of a general election,
which we have at 40%. The implications for the global
economy are not that big. It’s the UK economy. Do you really see, I mean, look. Back of the envelope numbers. I mean, if you think
China is slowing down, we estimate that every
one percentage point slow down in China takes global
growth down by about .4%. So if you think over time, China’s growth is
gonna come down, and that means, could potentially
European growth be like .6%? The UK below 1%. This is much more about
Europe in a recession, something that all of
us kind of talked about. But what I think
will happen is that you’ll get some extension past
the Halloween, October 31st, and you see what the events
that happened to date and then this call
for early elections. And you see that playing
out in Italy as well, but just a sharper slow down
than expected in Europe. Not just on the trade issues, but just on all of
the political issues is something that I do think
you’re gonna see in the offing. I don’t think you’re
gonna see this event impacting the US
economy very much. And what we’ve done on our
recommendations is that, we’ve really taken down a
lot of the domestic companies in the UK. Just given what we see, and we
see the more resilient ones. There’s certain sectors
that are going to be more negatively impacted,
autos, for example. And there’s another one where we
use a lot of big data metrics. We actually look at what
UK companies are saying about the vulnerabilities
of certain sectors. So you have, a lot of the construction
and auto-related sectors are going to be hurt more,
but this is not something that’s impacting our
US forecast much. – All right. – No, I think we’re
in the same place. – Yeah, I definitely concur.
– Okay. Okay, this question
is again orthogonal. It’s about the volatility
of Asian markets. Now, they mention specifically
Hong Kong and India. But obviously, other markets
in Asia are also volatile. How do you see that affecting the rest of the global economy? – So I’ll just jump in quickly. And I sort of, I would put it in a
similar bucket to Brexit. What’s sort of remarkable when
I think about global linkages, you’re gonna have two
primary types of interactions, and I focus
exclusively on the US. But for any economy you can
have direct trade effects in and out, and that
can affect the economy. And then there are financial
market transmission channels, and that matters a
lot to the economy. What I find probably
much more important for the US is gonna
be the latter, the financial market
transmission channel. And so the way
that Brexit might, I mean, don’t think it will, but if it did have a big
effect on the US economy, it would be a global
pullback from risk taking as people freak out. And you see credit spreads
globally widen out. Similarly, for countries like
China or for India or others, probably not gonna have that big of a direct effect on the US
when it comes to trade flows, but if there were a
financial sector meltdown that causes the whole global
economy to pull back from risk. Here, I’m thinking
back to 1997, 1998, the East Asian financial
crisis, the Russian default. In principle, those
things should have had almost no effect on the
US and global economies, but in practice, they
had a much larger one ’cause global financial
markets pulled back. – I would just add
that, something Joyce
touched on earlier, which is the amount of
indebtedness that there is within the Chinese economy. And this is a worry if
China’s economy slows because they, if you’re spending
a fair amount of money servicing your debt and
your cash flow slows, you’re not gonna be as
able to service that debt. And so, to me, that is
the biggest concern. And we’re already seeing
global liquidity change in terms of just how
China is treating the rest of the world. So foreign direct
investment, for example, into the United
States as a result of the worsening relations is certainly impacting
industries within the US. But real estate, we
see very significantly. So these have
reverberation effects. That transmission
channel is not isolated. It starts to impact everything. And so I think it comes down to, it depends on the timing because if we’re in that place where the US economy has slowed, where this second
waves of tariffs starts to take a bite
out of consumption, is continuing to take a
bite out of investment, if we’re at that
0.5% growth rate and this type of sneeze occurs, it could push us into recession. And what I worry
about is a confluence of these events
occurring together. So if we had the timing of
a Brexit with the timing of a sort of greater disturbance within the Asian capital markets with the effects of the tariffs all taking place
at the same time, then we would be
at greater risk. – [Joyce] Yeah, and I
can go back to the slide. – Can we go back to the
slides for a moment? Thank you.
– Sorry. So again, let me just
start with, big picture, we see that every one
percentage point decline in China’s growth takes about
.4% off of global growth, but the impact on emerging
markets is bigger. So, for example,
for Latin America, we think that every one
percentage point decline in China’s growth actually
takes more than 1% off of Latin America’s growth because it’s a
commodity exporter. So for emerging Asia, you have a 1% decline
in China’s growth and you’re taking
.6% off of Europe, only .2 off of the US ’cause
it’s not as sensitive, and you’re taking about
.6 off of emerging Asia. So China slows down, the
rest of Asia slows down. Asia, this year, is about
a 1 1/2 percentage point contribution to growth. It’s about 50% of the
contribution to global growth because China is 30% of that. So when you’re talking
about a slowdown in China, you’re really talking about a
slowdown in emerging markets because you have
so much dependency because of the commodity
cycle on Latin America, because of the manufacturing
and the tax cycle on Asia. And then Europe is also
more trade reliant as well. So that really
does feed through; the US actually does have
less vulnerabilities, which is why I think
Trump has felt emboldened to go ahead with this. But when we’ve
actually looked at the real supply chain effects, how much of the supply
chain has moved? And so what the graph shows is, companies indicating that
they are thinking about shifting the supply chain. So that’s gone up to about 40%. You can’t do that very quickly. So this is more how the
sentiment, again, is changing. And I think one of
the questions was, who are the winners and the
losers from all of this? Well, there are
not really winners. You can say Vietnam is a winner, but this is pretty
small. (laughs) And Vietnam is one of the winners, but certain other countries,
like Mexico, for example, which presumably
should have benefited with a trade agreement,
except that Trump said that, even after signing it,
he could invalidate it. So you haven’t seen many
winners off of this. You’ve seen more discussion
about moving the supply chain. That’s actually
much harder to do, even if you’re
thinking about it, to actually physically
move that in a rapid way. So the effects on Asia
are very significant. When you look at Asia
overall, it’s India and China that are really about
70% of the Asia story. But when we looked at
the vulnerabilities,
the supply chain, it’s the north Asian countries
that are hurt the most, and then the Asian ones, Vietnam, to some
extent, Indonesia that
benefits the most, but you do have a severe
impact on some of the, Taiwan, and then you have,
like look in Hong Kong. you’ve just given what
has been happening there with respect to
overall activity. There’s a slowdown
that’s happening, irrespective of the particular
trade issues as well. – All right. I think you’ve just answered
the next question, too, so I think we’re gonna
move on from that one. Namely that there many be some
countries that are benefiting from a shift of activity.
– Well, Vietnam is. – But not large enough to
make a global difference. – I would just add. Some manufacturers that
are exporting to Asia, ’cause we are
exporting to China. We do export to China, and we export some pretty
specialized goods to China. And I have spoken
with several clients who are thinking about, could I shift my
manufacturing to Canada? Could I shift some of my
manufacturing out of the US to Mexico, to Canada, so
that I could export to China without having these
tariff effects? And it’s interesting because they’re not so much over
tariffs, but things like, well, we have to have a
physically signed purchase order so we can’t send a PDF. We have to print it out and
we have to FedEx it to them, and just little
things that slow down our ability to export to China. And so I think it’s hurting us and shifting supply chains
not just out of China, but also out of companies
that wanna continue to export to China out
of the US where possible. – I think when France wanted
to limit Japanese car imports, they required that
they all go through the clearance operation Poitier, which had one clearance officer. Speeds things up. So, looking at the
world as we see it with more than 40% of
government bond markets yielding below zero, what are the best safe
haven assets for investors in a world that’s as troubled as the one you guys
have described? – One thing that’s funny. When I was assistant
secretary of the treasury, I would do trips
around the world to talk to investors
who have large holdings of US Treasury
securities, and felt like a little bit of the federal
government’s Willy Loman out sort of flogging my wares. And I thought we could
get T-shirts that said buy treasuries as safe as
boons and four times the yield. And now the factor by which
they have more yield is infinite given that the
boons are negative. I think part of the reason, and Joyce definitely
alluded to this, and Constance as well, the low, long term rates
in the United States is because treasuries are
paying positive yields, lots of otherwise
safe sovereigns are
paying negative yields and so it’s starting
to pull things down. So I think, from that,
you can infer that global investors
see US treasuries as one of the best places to go. And every time we
see a risk-off event, treasuries rallying further
sort of reinforces that notion. – And the dollar, too. – Yeah, you’ve seen that
even with 1 1/2% growth for the third quarter, it’s
still US exceptionalism. – Yeah. – So stronger dollar,
gold, high grade bonds, and US treasuries
have been the winners. I mean, and the US equity
market has also held in relatively well in all of this because, still, at 2.2% growth, when you look at
the other economies that are going into recession, this is still a growth
differential that
looks attractive. The way we look at it,
the capital flows, really, are very dependent on
the growth differential. The US still is with
the positive yield with the growth differential. You’ve had, still, even with
more volatility in August, much stronger performance
in the US markets than in the other markets. So I think that the question is, when are you really sort of
running out of these tools, and at what point will some
of this sort of play out? And I think you can
see through this year, we have one more Fed cut, but we don’t have
any purge in 2020. The market’s pricing in five. So at some point, this
will come home to roost, given where expectations are. But again, you’re
very late cycle. You’re 11 years into the cycle. And that’s more than double
what a usual cycle runs, which is why I do
think it’s going to be more of an asset
price correction that will be sort of leading, rather than necessarily
seeing this huge shift in the economic
indicator so rapidly. – Are there any
other implications of having these incredibly
negative yields abroad on the economy of
the United States? One question was also
specifically about how does that
affect bank stocks? – Well, it’s certainly
a challenging
environment for banks. And Japanese banks have
been dealing with this for a number of years. European banks are having a
hard time dealing with it. And the negative
yield curve in the US, if it persists, will, of course, impact US bank profitability. But I think the
bigger impact is on insurance companies
and pensions. I’m on the Advisory
Board of KPMG’s pension, and having negative
yields around the world certainly challenges
us to figure out how were we going to meet
our performance targets without moving too far
out on the risk curve. And this is a challenge that everybody
running a pension has. It is a challenge that
any insurance company has, especially European
insurance companies where they, from a
regulatory perspective, have to put a certain amount
into government bonds. And so it’s a really
big challenge. And insurance really
is one of the backbones of our financial system. – Anybody else
wanna add to that? – No, I would just say that
it’s raising a question on whether you’re going
to have to buy more in emerging markets just
to get a positive yield. So even if you are concerned
about the geopolitics and you’re concerned
that, still, both the growth differential
and the yield differential, is that going to
push you into this? And even with everything
that’s happening in China, as China goes into
the mainstream indexes in both equities and in
fixed income markets, will just that search for yield push you into more
of these instruments? So you’ve seen a demand
for high yield instruments just because of the
negative yields, and it’s the pension gap
and the demographics, which, that gap has
just been widening, but there is also a, I think,
real question mark on just, if there’s a debate
on, when could the US actually hit the zero interest
rate yield bar as well. I mean, when you look at this, when you have the Fed funds
rate as your highest yield ’cause the long end is so low. So there is a question,
are you gonna have to actually take a look
at emerging markets, local currency debt,
including Chinese debt because of the yield. – I guess the next question
seems to be about psychology and how it’s formed. The question is whether
the media attention to the recession risk is
actually prompting people to expect a recession,
including forecasters? – Nothing to fear, but, that nothing to fear
but fear itself. (Kim laughs) There’s certainly
an element to that. And I think this is why the
trade war is so pernicious because it gets right at
the heart of the sentiment. And if you were just
basing it on the economy, we wouldn’t have
necessarily seen a slowdown in
corporate investment the way we’ve seen it. Residential real estate,
yes, we might have seen because there’s
some particularities of the real estate market, and I think that there was a
real psychological barrier. Again, for anybody
on this panel, interest rates for real
estate is very, very low, but for many people who are just entering the
home-buying market, they’ve seen rates
very, very low for most of their adulthood. And so this move up seems
very dramatic for them. But that sentiment
factor, I think, is, and, I don’t know, you guys, upon the cycles you’ve seen, but it seem so to be much more of a disgust factor
in this cycle. And I think that is because
of the psychological effects that the trade war is having. And when I say the trade war,
I don’t mean just US, China. As Joyce alluded to, or
said, that Trump told Mexico, “Well, I signed this, but I
could rip it up tomorrow.” That’s just general uncertainty.
– Now it’s tariffs on Mexico. – Yeah, yeah, just that
there’s uncertainty everywhere with regard to this
aspect of the economy, which had been growing
and expanding for so long is really, I think,
having an outsized impact. – So I took part of the meaning of the question
probably wrongly. Does it affect people like me who do forecasts of the economy? And for me, the answer
is an emphatic no, partly because I know
a lot of reporters. And so that’s part of it. But I think, on the other hand, people’s fears matter
for how they spend money. But ultimately, I suspect,
at the end of the day, the average household, if they
were to come home at night after a long day, sit
down at the coffee table. Honey, how was your day? Well, I read the newspaper, and
the “New York Times” told me that there might be a recession
and that makes me worried. And then the other spouse says, “Yeah, but you know I just got a raise,
so let’s go out for dinner.” That, for me, the actual cash
flow for most houses, I think matters more. The actual employment
prospects matter a lot more. Similarly, if the media
were to be telling everyone, everything’s great,
everything’s fantastic, and then a bunch of
people get laid off, I bet they cut
their spending a lot even though the
media is telling them that everything’s fine. So I think how people
spend their money and how much money they receive
sorta matters for a story much more than (mumbles) story. – The one thing I
would say is that, 30 years as a research analyst, we’ve had to develop
these big data, more natural language
processing tools just because, like Donald Trump tweets, on
average, 13 times per day. So if you’re trying to
track all of this stuff. You can talk about
recession risk, but then there’s just like the
sheer number of tweets that you need to follow and
that the market is reacting to. So we’ve created, we
have our trade war index, which, that was the
graph that I showed, but we also created a
geopolitical anxiety index and a populist sentiment index. And a lot of this is
just actually aggregating a lot of the
newspaper headlines, the company earnings,
and the transcripts, but you see a lot of
interesting things. It’s not just the
recession risk. If you looked at our
populist sentiment index, the most frequently mentioned
word now is socialism, which you would not have seen before the US midterm elections. But if you take a look at our
geopolitical anxiety index, it’s saying, look, 2020, US election’s a far
riskier prospect than what we’re
watching in Europe. So I think part
of the reason why, is it about the press
reporting it or is it just that the way that social media
has changed communication and the frequency of
that communication that waiting three months
for indicators to come out, you need to incorporate some
alternative data metrics into this now and other
ways in which you can get higher frequency
reads on sentiment. On top of that, the whole way
in which the market has traded also has changed as
liquidity has declined, market depth has declined as you move to more passive
investment algorithms. And the market moves
are happening in
these flash crashes. So the combination
of those two things, it’s just kind of
changed the whole way in which the market
function is playing out. – The next question
is about something you guys have all
begun to address. Namely, what tools are gonna
be available to central banks in the next downturn? And having spent an
early part of my career focused on Japan, I’m sort of, one way to pose this is, are
we all becoming like Japan? Are we going to be running
out of monetary policy tools, and what else is there? – Well, and one could say Japan has also run out of
fiscal policy tools now as well. Yeah, I mean, barring some
sort of productivity miracle, I would say that the efficacy of the
tools has certainly… We seem to be at some limits, and I think if we
ask, what’s the value in Europe reducing
rates even further and going further negative,
there are a lot of valid debates or valid arguments that say that that is not
gonna be effective. – I wanna push back a little bit the way you distorted
the question because it said officials,
will they have policy tools? And you made it narrowly
about central banks. And I might actually
take the opposite side of part of what Constance said about Japan running
out of fiscal policy. I’m not worried
about policy tools. I’m worried about
political will. This expansion went
on for a long time, but the unemployment rate
took a painfully long time to get down to a low level. It took a long time,
and, as I said before, I don’t even think
we’re anywhere near actual full employment. I think there’s a great deal
of extra slack in the economy. One of the reasons
for that, in my view, is the Budget Control Act. So we had contractionary fiscal
policy in the United States at a time when the unemployment
rate was quite elevated and at a time when the economy was only barely operating
above potential. Why did that happen? It is because of sort of
a lack of political will and lack of right thinking
among policy makers. And that just seems
to be a history of policymaking in
the United States, but also globally. So when I think
about the screams about fiscal responsibility,
fiscal irresponsibility, I think back to the last
time we had a budget surplus at the end of the
Clinton administration. That had nothing to do
with any particular virtue of the Clinton administration. It had everything to do with
the inability of government, at that point, to
spend a lot of money, combined with a really,
really, really good economy at the same time. And then, at the first chance, formally fiscally
responsible politicians decided to blow up the deficit,
and so we have it again. So I don’t worry so much about
the tools being available. I worry about the political
will being in the right place. And same thing with Japan. The fact that they’re
again contemplating another sales tax hike,
or about to implement it, is just, for me, sort
of beyond inscrutable because it’s
precisely the opposite of what you think you
might want at this point. And for Europe, I mean, I
sort of think it’s remarkable that the Germans inscribed
in their constitution a balanced budget amendment, when what might be best
for Europe right now is if the Germans
could pass a tax cut where every German
gets 5,000 euro, half of which have to
be spent on vacation in either Italy,
Spain, or Greece. I mean, if you do
that, Europe is saved. – I would add sort of two points to what Seth and Constance said. I’d say that, first of all,
I’m gonna take it back to China ’cause China’s about
30% of the contribution to global growth,
so our forecast is, actually by 2030,
this’ll come down to 20%. It’s gonna take a
lot longer for China to be the size of
the US economy. So our estimate is that, if you look at
China’s debt burden, the estimates are anywhere from
the high 200 percents of GDP to higher than that, depending on how you
calculate the debt. Our estimate is that they spend about 70% of their
credit growth right now just on the debt service. Well, there’s this whole
question on whether you’re going to go to a
Japanification in China first as growth comes down to
more of a 4 1/2% range and we have growth
coming down to 5.8%. So there’s an issue on
just slowdown in China and the implications of
that to the global economy, which has broader implications
than even the US slowdown, in my point of view, and the
constraints that they have as far as the tools. The second point I would make, I was at a central bank seminar where they asked me to give
the markets presentation. And it was one of those days
where the central bankers were sort of having a
pity party for themselves. They were like, “Why
are we getting blamed? “We’re the good guys. “We saved the global economy.” And they were like,
“Well, what do you think “the market expects?” I was like, “Look, BOJ
buys equities and ETFs. “What do you think
the market expects?” They’ve seen it. So fallen angels, that happens. You guys, look, is there
going to be some expectation that policy on the public policy side that’s
gonna have to move beyond? I mean, you’ve seen
a template with, if you think it’s
really Japanification, you know what BOJ has done. – I’m gonna skip one
and come back to it, but the Fed independence. How worried are you? – Not worried. Not worried. – [Seth] Wow. – Yeah, I mean, from
the Fed’s perspective. Everybody at the Fed takes independence
completely seriously, and they are not being swayed. – Okay. – I completely agree
with that last statement. On the other hand, I’m
very worried about it, but maybe in a broader context of the deterioration of
institutions more broadly. So, the bouts of Fed independence,
lack of independence, back and forth. there’s a long history of that. And for anyone who’s interested
in this historically, there’s a great,
great, great book by two people who were in D.C. One’s a professor at George
Washington University. The other’s sort of a
retired hedge funds manager, but about the long history
of Fed independence and lack thereof. It’s quite fascinating. But I think it gets
back to generalized waxing and waning of
respect for institutions and how government should work. And so when I think about
someone like Jay Powell. I first met Jay in 2012
when he joined the Board, and then when I was at treasury, we worked on joint projects. He is absolutely impeccable
in terms of character, and I think he sees
his job as being, to try to be independent of
all the Reserve Bank presidents and that’s where the
Fed is structured to try to enshrine that. Nevertheless, it is
impossible for a human to sort of ignore the
sort of commentary that they get on
a regular basis. And then, again, you end up
being backed into a corner. So as the economy gets
battered by the trade war, necessarily, the Fed’s
going to react to it based on their objectives to ease policy, and
anyone in markets who is now questioning
the independence can easily be excused for that because if the Fed were to
give up its independence, they would act in much the
same way they were doing if they’re just
following their mandate. So I worry a lot about it,
both because of the perception, but also as a
generalized deterioration of institutions in Washington. – I would just say that, I worry more when
the Congress says that they’re going to look into, it’s just that it’s
getting more politicized. But you look at the appointments that have been made to the Fed like the Randy Quarles
and the Richard Clarida, and they’re excellent
appointments. They have been independent
and they’ve upheld everything, but I worry more about
the politicization when you see calls for
congressional testimony that there just becomes a period where it’s just scrutinized
in a different way, even if you have
all the individuals who are really acting in
a very responsible way. And we go through these cycles. We saw that after the
global financial crisis, so this isn’t necessarily
new, but it seems like you could be getting into
one of those periods again. – Well, just following up. I think all of
you have suggested that if trade conflict
reduces demand, you’ll expect the
Federal Reserve to ease. We recently had the New
York Federal Reserve Bank, former Federal Reserve
Bank president suggest that easing in the face
of trade conflict actually encourages
trade conflict. How do you respond? – I mean, he’s not wrong. – [Kim] Do you mean by that
the Fed should not ease? – No, I mean that,
as Seth pointed out, this puts them in a bit of a, shall we say tautological box. – I agree. I think easing in the
face of trade tensions absolutely increases
the likelihood of further escalation
of the trade war, but I also think it’s the
right thing for the Fed to do. Similarly, there’s been
a lot of discussion about US direct intervention
in the FX markets. There’s no question whatsoever the treasury has absolute
authority to be able to do that. Jay, in his effort to
try to seem apolitical, did the standard dodge that every single Fed Chair
has ever done and he said, “Oh, don’t ask me about that. “FX policy is
totally the purview “of the secretary
of the treasury.” Well, the other thing that is
unfortunate in that regard is, not only is that
true, historically, every time the treasury
has intervened, the Fed has intervened
alongside of it, including times when each,
Greenspan and Volker, categorically did
not want to join in ’cause it was at odds with
their domestic monetary policy. And so now, suppose
Secretary Mnuchin decides we’re going to
intervene directly to try to weaken the dollar, it seems utterly and
completely indefensible for Powell to stand up and say, “The Fed’s not going to join
in alongside the treasury.” That’s the history,
that’s the tradition of what the Fed wants. It’s fully consistent with
the accommodative lean that he’s put in place as Chair. And yet, in an instant,
that will ratify in so many people’s minds
that the Fed is utterly and completely captive
to the administration, and they are now with
the administration, directly engaging unilaterally in efforts to weaken
the US dollar. – I don’t have much more to add to that.
– Okay, no problem. Again, a series of
orthogonal questions. Michael Burry, the
infamous fund manager from “The Big Short”,
believes he found the next bubble in
passive investments. Do you agree? – You’ve had yield. I think there’s three things that have happened
with market structure. First, you’ve had
record issuance and
growth of the market because of low interest rates. So if you take a look at the global bond
market capitalization, it’s increased by about
60% to $57 trillion. So massive growth of
the size of the market. Then you’ve had a lot of the
traditional intermediaries have been taken out because
of financial regulation. So the banks are not
holding the inventories. And then remember
that the whole point of financial deregulation was you wanted to make
the market democratic, that everybody could
own it and trade it and pay the lowest fees possible
so you could trade 24/7. So you’ve had massive inflows
into passive investment and outflows from
active management, which almost look like
the jaws of death. I mean, if you take a look
at the inflows into passive and the outflows from active. And what you are
seeing is that with the change in the market
players and the structure where it’s more algorithms,
high-frequency trading, if you take a look at the
treasury market moves in August, we estimate that 80% of that
was high-frequency trading. It was not that
fundamentals changed very much in that period, and we’re now measuring
things in milliseconds. You take a look at the
December 24th market sell-off where the equity market was
down 3% on Christmas Eve. We estimate that you had, really, some type like 90
futures contracts trade that caused that
much of a correction ’cause nobody was in. So the liquidity and the
technicals really do matter when you can look at the
magnitude of the market moves. And I think that, if you’re
going to do the analysis the right way, given the way
that market structures change, you need to be looking
at the fundamentals that we always start with
and the top down view. But you need to be able to
overlay alternative data, and you also need to look
at the market positioning, the technicals, who the
players are in the market, who the owners are, what’s
happening with the CTAs, what the positioning
is going in. The August correction,
if you take a look at it, the market depth, and
we use market depth, the market depth is different
than market liquidity ’cause market liquidity
is the simple metric of your market cap divided
by the volume trades. Your market depth is the amount that can actually
clear the market. And we estimate that
the market depth was actually worse
in August than it was during the December sell-off,
which had, at that point, been one of the worst
periods of liquidity. Now that was
relatively short-lived, but you are going
to have to, I think, treat it as a reality, that
these kinds of flash crashes are here to stay. – Okay. It’s not re-ranking
correctly on my iPad, but apparently the
leading question is about 2020
presidential candidates. Do any of the
candidates threaten significant economic
instability if elected? (Seth chuckling) – God, I would suspect
that all of them do. (audience laughing) So one of the wonderful
things about the US is, it’s not just the
presidential candidate, it’s also who controls the
various Houses of the Congress. And that was part of the
sort of bad economic outcome of having contractionary
fiscal policy when we’re below
full employment, and the economy’s only
barely recovering. I couldn’t quite tell if
part of the implication was some of the policies,
more progressive policies, would sort of lead to some
sort of overall instability ’cause there’d be too much
spending or too little spending. I guess one thing that
people often point to is, oh my gosh, here’s the price tag on any given policy proposal. That’s gonna bankrupt
the United States, that’s gonna cause
debt to go up a lot and interest rates to skyrocket. And a lot of discussion
about modern monetary theory and isn’t that sort
of the hobgoblin that’s going to sort
of destroy the US? I’ll just take
everyone back in time to the middle of 2017, or even just after
the previous election. And there were lots and lots
of people who were saying, oh my gosh, if we
have a massive tax cut and a really, really
substantial increase in federal spending, boy, that’s just gonna
explode the deficit. That’s gonna cause a sell-off. We’re gonna have super
high interest rates and cats are gonna
start to sleep with dogs and people are gonna
compose atonal music and the world’s gonna
stop spinning on its axis. And it’s true, I mean,
look how much higher US interest rates are than the
rest of, oh, wait a minute. That’s not gonna
be a good argument ’cause US interest rates are
much lower now than they were before the trillions of dollars
of extra debt were issued. So I think there’s
a bigger context that has to be considered, and
in some sense the best time, so suppose my forecast
is too optimistic and, in fact, US
goes into recession in the first half of
2020 and stays there. Then if you get a
candidate who is, in fact, a bit on the profligate side
and ends up squandering money on people who might just use it on food and shelter
and clothing, that might, in fact,
in a specific context be the right approach,
whereas it might be more harmful in
other circumstances ’cause I think it’s
very context specific. – Yeah, and I see that we
have the next question, which is, “Given
prevalent negative
interest rates globally, “to what extent would
fiscal policy be “more effective platformed to
counter the next recession?” So it ties in to the MMT idea. There’s obviously a
hot debate about this, and I think if you go
below all the hype, it is all about context. It is all about timing, context. Are you spending money on things that advance the economy, advance future generations? Are you doing things like
infrastructure spending? Are you doing
education spending? Are you doing
retraining spending? Are you doing science
and technology spending? If you think that the
federal government, after World War II, contributed
to over 70% of RR&Ds spent. And now it’s come
down substantially. Does spending on
that type of thing help increase productivity? Does it help grow the economy? There are arguments
that say yes, so I think I agree with Seth. It’s extremely context specific. – I’m gonna just pull
up one slide if I can go back to the slides.
– Can we come back to the slides? – Joyce is the person
you never wanted to have in class with
you, ’cause she’s
always more prepared for these things.
– Like I have slides for that. – One of the things
I had to do was try to put some numbers
around the Green New Deal. So I just thought
I would go through the way that we tried
to look at this. So we only dealt with, ’cause a lot of the
candidates are saying, “We want the Green New Deal.” I mean, Bidenism, but
all the Democrats, all the other Democratic,
they’re saying Green New Deal. So let’s just forget about
the universal income, forgiving the student loans. Just take the zero
emissions piece of it. Just take that. So to get to the 2030 goal of zero emissions by 2030, what would you need to see? You would have to see
overall US primary energy use decline to 1988 levels. You’d have to see solar
generation go up 11 times. You would have to see wind
generation go up five times. You’d have to see nuclear
generation unchanged. Remember, the goal was to
get rid of it completely. You’d have to see a 90%
decline in coal usage. You’d have to see electric
vehicles, EV, in the US go up to 40 to 50% from 1 to 2%. You would need to see
oil usage decline 50% due to the electric vehicles. You would need to see household
and commercial consumption cut by about 1/3 for the
intensity residential buildings. And you would suddenly
meet 40% of the goal. So some of the proposals
by the candidates do not seem
economically feasible. – Can we come back to
the Slido questions? That does suggest instability
if they try to implement. (Seth laughing) – Well, I know every
campus has a lot of people who are really
protesting on this and nobody’s tried to
work through the numbers. If you really try
to do that exercise. (Joyce laughing) – Okay, I’m gonna
digress for a minute. (audience clapping) Thank you, Joyce. But central banks are
starting to think about the impact of climate change, and is it going to
impact their mandates. So the Bank of England has done a fair amount of work on this. The Reserve Bank of Australia
started to do work on this. Bank of Canada’s done
some work on this. And so I think this will become
something that becomes part, a much more significant
part of the policy debate. – And it’s really clear
that this is an issue that there’s just such
passion around. I mean, you still look
even at the state level. I mean, even at the national, we’ve rejected The
Paris Climate Agreement. 23 states have adopted it. I mean, you’ve got the reality that carbon pricing and taxing, China looks like it’s
going to adopt something. And they’re going to
electrical vehicle usage much faster than
the United States because the pollution
problem is so bad. They could hit that–
– Right, but they also are using, they’re
also using coal. – Absolutely,
they’re doing both. – It’s not really, I mean,
from an emissions perspective, it’s not really the best choice.
– No, it isn’t, it’s not the best choice, but China on some
parts of innovation, like solar and wind,
is far ahead of the US just because it’s
such a problem. So there’s no denial
of the problem. The solution in
the Green New Deal and sticking
everything under it, it’s just one of
those things where there should be some
level of responsibility and trying to work
through numbers when you put out
these kinds of things. – All right. The next question is really,
the least I have here, is really about how
the economic outlook affects student strategies. Assuming there’s a slowdown
or even a recession coming in the United States,
and we already have it in some parts of the world, what are the best
strategies for students for managing their
own career risk? – Get a good internship. (audience laughing) – Yeah, I actually I
fully agree with that. It’s sort of remarkable
when I think about every time I hire, and
Joyce has probably hired thousands of people
over her career, I get a gazillion
and one applicants. And trying to sift through
the number of applicants just to get the
number that I can do a first level half-hour
phone call is painful. And then if I wanted to be
as inclusive as possible, then I do 10 different
half-hour phone interviews. Then I have to go from
that to try to figure out who I wanna interview in person. But if somebody I know has had somebody working
for them as an intern and can tell me, here’s
what the person can do, here’s what they need to learn. And I guarantee you that
if you leave at five ’cause you have to go to your
kid’s after-school thing, this person’s gonna
stick around ’til eight to make sure that
everything gets done, boy, that’s gonna go a long way. Not quite as long
as an NYU education. (audience laughing) I can pander to a crowd
with the best of them. But I think that
suggestion is a good one. The other one that may
have been evidenced here is when you’re making
forecasts for things and you have to do it
in probability terms, 40% probability of
something happening is really, really good because
either you’re gonna be right or you’re gonna be
wrong, but if you said, (sighs) that’s about
40% and then it happens, you were wrong, but
you had already said it’s got a pretty good
chance of happening. Whereas if you say, ah, that’s
not gonna happen, it’s 5%. You don’t wanna
be wrong in that. You wanna be on the
right side of things. So pick 40% anytime
you have a chance. (audience laughing)
(audience clapping) – I would just say, J.P.
Morgan has moved to, for our campus recruiting, the first round is
now through pymetrics. And they had some of us do the demo for it, and I have to say, I didn’t
understand some of it. How fast can you push the space
button and actually get it? (laughs) I mean, you know, maybe I’m old school. So I think that
what’s very clear is that knowing
the data analytics is going to be a
lot more important. The pymetrics is to try
to get to a broader pool so you’re not just recruiting
from the same school. So I think that is actually
a healthy thing overall. I actually think that is, I don’t understand
the exercise itself. I think the concept actually
makes quite a bit of sense. But I think that, yeah, getting as many real life
experiences as you can. And you’re lucky to
be in New York City where that’s really doable,
is the most important thing. There’s your education,
and then there’s really what you’ve
been able to establish as a work record. The other area where
we’ve been just doing, a lot of work has
been on student loans. And so when people ask me
about our recession risk model and they say, “Look, what are
you really worried about?” I said, “Look, I’m not worried “about systemic
risk in big banks, “but I worry a lot about
things like auto loans, “credit card debt, student
loans, and consumer finance.” So just to walk through some
of the student loan numbers. So you’ve got student
loan debt at 1.3 trillion. I think it’s a bigger problem than the leverage loan
market, quite frankly. Because a lot of the repayments
on the leverage loan market look more easy to be made
than the student loan problem. But we estimate
that just the rise in student loan debt has
cut home ownership levels for the 18 to 35-year-old
group by about 15%. That’s a material amount. And it’s really changed
the way that people live. Are they gonna own a car? Are they gonna own a home? What are their
aspirations compared to the previous generation? I do think just the
student loan problem. When I look at what I worry
about in the next recession is things like auto loans, our stress to show,
could you see 60 to 70% default student loans? You already have
a very high ratio of delinquencies right now. Things like the consumer
finance side of it. Not something that’s
systemic like the big banks. You haven’t had
the normalization, and you’ve had all
the regulation. You don’t have the kinds of
problems that had come about, but that’s where
I see more stress in the system going forward. – Maybe you mentioned it before. What about stress in
non-financial businesses that are somewhat leveraged?
– well, if you take a look at mortgage loans, now 80% of
them are from non-bank lenders. So when you hear that Home
Depot is doing mortgages, stuff like that. And that’s not as regulated, so I think that’s gonna
be more of an issue. – Okay, thanks, we’re good. So again, hard to
get the ranking here, but the one, well, I
see something up there. Essentially, this follows up on something that you mentioned. You were arguing that
if monetary policy
runs out of tools that fiscal policy will be
the natural alternative. And there’s fiscal space in
the United States to act, fiscal space in Germany
I think you mentioned. And you suggested fiscal
space in Japan as well. Does everybody agree with that? Is there any doubt about
whether there’s an ability to use fiscal policy in
the advanced economies in the event that, imagine
we’re all at zero yields? – No, I think you’re
gonna have to use fiscal policy.
– Yeah, I don’t think you have a choice. – Yeah, you’re gonna have to. – Yeah. – [Kim] Okay. – So I’ll just be
slightly contrary in the, you won’t
have any other choice. The choice will be for
politicians to dither and do nothing and let
the recession get worse. And that’s actually my forte. – Yeah, and then you will
have, at the state level, they won’t wanna do anything. So even, could you do
infrastructure spending? Yes, states could do it if they
authorized, but they won’t. So I mean, I don’t
think you’re gonna have that many alternatives, but
whether it will happen or not is another question. – So let me just
link it to something that’s been published
recently at Brookings. The idea of strengthening
automatic stabilizers. Have you thought about that, and how relevant would it
be in this circumstance? – No, I thought the work that
Brookings did was really good. And I think part of
the simple version, the boiled down version
of the logic is, recessions often have been, at least demand-driven
recessions, have been when
spending falls off and then people lose their jobs. As a result of that,
those people spend less. And so it builds on itself. And the idea of strengthening
the automatic stabilizers are that when people
lose their jobs, their spending doesn’t have
to fall anywhere near as much. And as a result, the
recession is more shallow. I think that’s a absolutely
sort of plausible idea that sort of works. – And it avoids the
discretion problem that you’re worried about, that there might be
policy reluctance to act. Essentially, it
substitutes for action. – I agree. On the other hand, if
you take a step back in that super game, it also
reduces the probability of it getting enacted
in the first place. – Okay. Anybody else? – And they could always undo it. But I agree. I mean, if you look at
most recessions in the US, we don’t have consumption
actually decline. We have it increase
at a slower rate. And so going back to
the financial crisis where we had consumption
actually decline for multiple quarters in a
row, that is the anomaly. So we have a garden variety,
business cycle recession that’s not the result
of a financial crisis. I think you wouldn’t expect
to see consumption decline to the extent that it declined during the global
financial crisis. So I think a little
bit of this work is anchored to that experience, and that you wouldn’t even
have to go terribly far to really help smooth
the consumption function under a normal recession. – Okay. Actually, each of you have
said something about this, Joyce specifically
just a moment ago. But it’s worth asking sort
of a longer term perspective. How are environmental
issues affecting economic growth prospects? Not just over the
near term cyclically, but medium term, long term. What’s the impact? – So I can start with that. We actually took a pretty
serious deep dive into this. And looking at everything
from the cost of mitigating the impact of a
carbon-based economy. So that’s very expensive
to do the switching, and it actually, if we were
to do massive switching as Joyce modeled out,
there’s costs to that. If you’re interested in this, I encourage you to look
at Nordhaus’ work on this. It’s very comprehensive. But then there’s also costs,
of course, to doing nothing. And those matter, and they
matter more in coastal areas. They matter more in places
that are getting warmer. So, obviously, for
some northern climates, getting warmer is actually a
short term economic benefit. So if you look, for example, of being able to do certain
types of mining in Greenland that you wouldn’t
have been able to do. The growing season in
Canada becomes longer. But if you look at
places near the equator, you’re actually having places
that are getting too hot to even function out of doors. And so, just if we take this
a little bit closer to home, if you were to imagine, and
I always get them confused. Is it Disney World
that’s in Florida? Okay. Disney World is in Florida,
Disney Land is in California. All right, Disney World,
obviously, is in Orlando, and it’s a warm
place in the summer. But if you have days where
it’s over 100 degrees, do you operate the park? Is it too risky? What kind of risks do
you take by doing that? So that’s a direct economic hit to revenue by Disney and to economic activity. So we can start to
model out these things. And so, obviously,
it’s asymmetric. The switching costs
or up front costs that are relatively high, but, of course, the cost of
not doing that switching, really, you’re looking at
very, very significant, possibly catastrophic
and unpredictable costs. So if we just think about, and this is becoming an issue,
by the way, for insurance. So there’s a coal
fire power plant that Australia wants to build, and it’s possible it’s not
gonna be possible to insure it. And if you look at
the insurance question around PSE&G and
the fires in California, this is starting to impact
current economic thinking and current financial modeling
of insurance companies. So I’m not sure if I actually
answered your question, except to say that it’s something that I think
more and more financial actors are having to take into account, when previously,
they could have said, oh, that’s in the future. It’s not in the
future, it’s now. – Yeah, I guess I
would have thought, Constance has covered
a lot of the negative and I think there
are lots of ways in which it’s very,
very bad and costly. And I think in terms
of long run growth, you’ll end up putting
a lot of spending that, and this’ll get back to the
semi-philosophical question I’ll bring up at the end. But you’ll put a lot
of money into things that are fixing problems. And so when you think about
what that means for growth, that’s not adding anything
to overall growth. And so as a result, the
engine that’s made the economy strong over time,
productivity growth, gets whittled away more and
more and more over time. If one wants to be
optimistic and see. I’m never particularly
optimistic. I can see a glass is 1/10 empty, but if one wants to be
particularly optimistic, you can think, okay,
as these problems get more and more approximate,
it’s clear that it’s dire, could lead to more spurts of
productivity and innovation. Could lead to more
rapid reduction in the cost of solar
cells, wind power, yada yada yada yada yada because it becomes more and
more clear in people’s mind that this is, in fact, a
problem that needs to be solved. And then you could end
up being off to the races in terms of productivity growth. So there’s a reason
to have hope as well. But it requires action. I think the part that’s
a bit philosophic, but leads, I think,
to the negative route of bad productivity growth. So think about the hurricane
that is in the news these days. Dorian destroyed
Bahamas, hitting Florida. Boy, if it’s my house
that gets knocked down, I feel crummy and
I feel much poorer, but then I go through and
I actually pay someone to rebuild my house. That actually gets
calculated as part of GDP. And so ultimately, I
think, as we think about climate change, actions to
remediate climate change, the question of do we care
about GDP as a metric anymore is gonna come up because
if you’re hiring someone to build a sand wall
to keep the water from eroding your
house, I mean, yes. That actually is a flow of a
service that you’re paying for but it doesn’t raise
productivity in the long run. It doesn’t do very much. And more importantly, it doesn’t really make
you feel that good. It makes you feel better than
if your house got flooded, but it doesn’t actually add to
anyone’s particular utility. So I think the question of, what do you actually care
about in terms of economics is gonna become more
and more to the front. – I would just say that,
other parts of the world are moving much faster
on what they’re doing on the whole environmental,
social governance. And so in Europe, it’s mandated. I mean, increasingly,
you have to have a clear policy in place
or shareholder activism. It’s just not investible. In parts of Asia,
that’s the case. The US has not adopted it
in a mandated type of way, but that’s becoming
more then norm, and it’s being demanded
by younger generations to have that kind of level
of social responsibility. But what we’ve been
telling companies is that you need to begin
developing a strategy around it. And we’ve kind of divided it
into three different categories like the transfer
risk, the liability, and the physical risk,
and sort of developing your own plan about it. Very much, as Constance said, we’ve looked at the
impact on insurance, trying to put into account also some of the things
that Seth has said. What is, actually, the rebuild kind of
gets you out of some of this. And so, right now,
you’ve kinda said, it hasn’t been that significant, but you’ve had so many events that have been the worst
event of the last decade, like all in concentration that, at the pace at which it’s going and that it’s becoming more
of a global phenomenon. You look at Brazil, you
look at other places around the world, the
Amazon, what’s happening. It’s getting harder and
harder to use past precedence as a way to model it. And I think that’s a lot of
the problem with many things that we’re talking about
in financial markets now, the way market
structure has changed. So you can’t really
look at past sell-offs. ‘Cause you’ve got the flash
crashes, the algorithms. You have the higher frequency
data that you need right now. You have some unprecedented
number of natural disasters. So a lot of the templates
that we’ve historically used need to be changed,
and that comes back to the point of what kinds
of skills you need. And you need to have sort
of the data science skills, and so much of the data has
been created so recently, and the higher
frequency nature of it, and to be able to
incorporate that into the way in which
you think through investment processes,
economic processes. – I hope you’ll join me now in thanking everyone on the panel for excellent presentations.
(audience clapping) (upbeat music)

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