Fall 2018 Stern Economic Outlook Forum

Fall 2018 Stern Economic Outlook Forum


(music) Good afternoon. Like to get
started. My name is Kim Schoenholtz.
I’m delighted to welcome you all to the Fall 2018 NYU Stern Economic and Market
Outlook Forum. Since 2012, this event has
become a Stern tradition at the start of each semester.
The host of today’s forum is the 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. We’re especially pleased today
to have here today- have here students and faculty from all
over NYU, as well as a number of Stern alums. Thank you
very much for joining us. Today’s program will last about
80 minutes. It will begin with presentations of 5 to 10 minutes
by each of our panelists about economic and market
prospects, followed by audience Q&A. We’ll finish by 6:30 PM. Please note on the screen, thank you, please note on the screen that
you can submit questions to the panel using your smartphone by
going to the website www.slido, S-L-I-D-O, .com, entering the code number “3333”
in the box labeled “Join,” and then submitting your
question or voting on others. Your votes will help us
judge the issues that are of greatest interest to you. Let me now introduce our
distinguished panelists, starting from the- close to me:
Seth Carpenter is the Chief US 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 received his PhD
in Economics from Princeton. Michael Feroli is the Chief
US Economist at JP Morgan. Before joining the bank in 2006,
he was an economist at the Federal Reserve Board. Dr.
Feroli has consulted with the joint Economic Committee
of the US Congress. Today, he serves on the
Economic Advisory Panel of the Federal Reserve Bank of
New York, and as a panel member of the US Monetary Policy Forum. Dr. Feroli earned his PhD in
Economics here at NYU. (Applause)
(Kim Schoenholtz laughing) (Carpenter)
– Never been so ashamed to go to
Princeton in my life. (Laughter) It’s far away. Rebecca Patterson is Chief
Investment Officer at Bessemer Trust and a member of the firm’s
Management Committee. TPrevious Ms. Patterson worked’s
at JP Morgan as Chief Market Previous Ms. Patterson worked
at JP Morgan as Chief Market Strategist for Asset Management
and as Global Head of Foreign Exchange and Commodities for the
Private Bank. She’s a member of the Council on Foreign Relations
in the Investment Advisory Committee of the Federal Reserve
Bank of New York. American Banker has named her
one of the Top 25 Most Powerful Women in Finance.
Finally, Ms. Patterson earned her Executive MBA right here at
the NYU Business School. (Applause) Sorry Seth, it’s a home crowd. (Seth Carpenter laughing) Please join me in welcoming all
our panelists. (Applause) Seth will now begin the
presentations, followed by Michael and Rebecca in that
order. After their brief initial remarks, we’ll begin
the Q&A session. Over to you, Seth. (Kim and Seth chattering) Wow, thank you, thank you very
much for that introduction, Kim. Thank you everyone for being
here. It’s an honor to be here, letting in the hoi polloi and
the rabble from the streets to the august halls of NYU. So, what am I gonna
talk about today? So, we just have a button –
you don’t have to read everything –
sort of all of what we think about the US economy at UBS in a
few simple bullet points. The- there are two things that
I’m gonna to want to touch on in the 5 to 10 minutes before
I overstay my welcome at the podium. The first one is
-and it lines up with some of the questions that we got a
sneak peek at before, our view is the underlying US
economy right now is actually very, very strong and things are
going great, but there is one serious monkey wrench being
thrown into the works, and that is trade policy. Two months ago,
we changed our view that we were engaged in a trade skirmish and
upgraded that to a trade war, and our view is that that’s
going to have a massive and meaningful effect on the US
economy, and I’m gonna talk about that in just a little bit.
The second thing that I think is also potentially interesting,
and I, I think I saw it on one of the questions, but it’s also
on lots of our clients’ minds in at UBS, is about the Fed and
unconventional monetary policy and the unwind of the balance
sheet, and I’m going to say something there. I always like
to talk about it because in 2002 or thereabouts, when I
was at the Fed, my boss came into my office, closed the door,
and said, “I’ve got an opportunity for you to excel,”
which is bureaucrat speak for “Shit flows downhill.” (Laughter) And it was, “You get to be the
person over all of monetary policy at the Fed, to be in
charge of the Fed’s balance sheet.” Boy, was
that an honor in 2002. Turns out it’s kind of
interesting now, so I always like to talk about it.
So this is the two things that I want to talk about. Our bullet points though is:
“Trade war escalation is gonna slow growth in the fourth
quarter,” so where are we in terms of trade negotiations?
I want you to think about trade and trade- possible trade
war in two camps: China and everything else. Right? Everything else is in our
view more or less a side show. You hear lots- lots about NAFTA
and there’s lots of ink spilled. It doesn’t matter from a macro
perspective. You hear a lot about interactions with the EU
and automobiles. Our view, the way that
is going to turn out probably won’t matter as a macro
development either, but when it comes to China it matters a lot.
The current state of affairs is there are tariffs of 25%
on $50 billion at an annual pace of imports from
China already, but those were very carefully picked to
not matter very much. Those are in categories of
goods where the US imports from all over the world,
and the Chinese share of US imports is 10% or less. The next round, and we think
this next round is coming in maybe as soon as tomorrow
but most likely next week for the formal announcement,
is on $200 billion. And there, if you rank all the
different categories, there are a whole bunch of cats and dogs,
but there are a few categories where China is 40, 50, or 60%
of US imports, and a lot of those are intermediate goods
to production, especially for a lot of manufacturing firms. The tariffs on those are either
going to be 10% or perhaps 25%, with the risk
to 25% growing every day, given the rhetoric coming
out of Washington, and we think that will be sufficient to put a
serious crimp on the US economy. In particular, the US
manufacturing sector is actually quite strong, underappreciated.
Over the past year manufacturing has added more jobs to the US
economy than at any point since the mid 1990s. A lot of those firms are new
firms, and notoriously, new firms fail a lot. Census
estimates on average that something like 10 to 20% of all
new firms fail in the first year because they
experience a cost shock that
they had not anticipated and they go out
of business. These tariffs will be such a cost shock but
more than what is normally anticipated and we think it’s
going to cause an abrupt crimp in hiring and capital investment
especially in manufacturing but there’ll probably be some in
retail as well. Retail was going through an existential moment
last year because of all of the competition from online sales in
one form or another. They’ve rebounded a bit with the extra
spending from the tax cuts but they’re still on- in a tenuous
situation, so you probably lose some jobs there. We see fourth
quarter GDP growth at 1.6%, coming off of 4.1
in the second quarter, 3% we think in the third
quarter, so that’s a very very sharp slowdown, and so in
terms of what that means, sharp slowdown in the economy, the
market in our view is not fully priced for it, and the Fed is
going to see this, and the way the Fed thinks about the economy
is they have a forecast what’s going on, and then they compare
the data to what their forecast was. And this slowdown is going
to be much sharper than the slowdown that they would have
thought the tariffs would do.
And so they have to confront the question of:
“Are tariffs having a bigger effect on the economy than we
thought?” That’s a bad outcome. Or “Is something else that’s
not even on our radar,
in addition to tariffs causing the economy to slow
down?” Boy, is that a worse
thought. And so, in December when they’re making
the decision to hike rates or not hike rates, the way the Fed
makes these decisions when there’s uncertainty is to say,
“If I hike what happens if
I’m wrong? And if I don’t hike, what
happens if I’m wrong?”
Because if you look for the worst case scenario, if
they hike as predicated on everything being just fine,
and if they turn out to be wrong and the economy stinks, they will regret that decision
for many a month. Quarter. Year. If they don’t hike and it turns
out- if they don’t hike it’ll be predicated on the idea
that the economy is slowing and they’re worried, but what
happens if they’re wrong and
everything is just fine? No one will care.
Jay Powell’s gonna give 8 press conferences next year, they
themselves only think that they’re gonna hike three times
next year, so making up for one
skipped hike is no big deal. In the 15 years I spent at the
Fed, I don’t know how many, a couple dozen FOMC meetings
that I went to, and that kind of risk management is part and
parcel of how the FOMC works. Jay Powell, despite being a
relatively new Chair of the Fed, grew up intellectually in terms
of monetary policy within the Fed, so he thinks about these
things very much in a standard, mainstream Fed sort of way. So I
have no doubt that that kind of logic is also his logic. So that’s our macro story. The
US economy is strong, tariffs are going to be a spanner in the
works, if in fact we get 10% tariffs on the next
$200 billion of- of imports from China, and it doesn’t
escalate from there, we’d get a hit to the economy in the
fourth quarter, but then things start to recover, and we’ll go
back to roughly where we would have been otherwise, and it will
have been a very bad quarter, but the US economy will be able
to muddle through it. If instead escalation leads to more
escalation, as is often the case with these sorts of things, we
could see an even bigger hit in the extreme. If you get
tariffs on all the goods and services – which is really
just the goods because we don’t import services from China
– on all the goods and services we import from China, and it’s
at 25 or 30%, boy that’s probably enough to bring
the US economy to a standstill. So those are the risks at hand.
I think Wall Street is only just now starting to appreciate how
imminent the next round
of tariffs is. I think Wall Street has not
fully internalized how big
the risk is for a further escalation, and
that is what we have in store. So that’s the first thing
I wanted to talk about, and
that’s the bulk of it. The second thing is a little bit
nerdy and dorky and if I can get to it quickly I will, which is
the Fed’s balance sheet. Boy we went through a massive
experiment with monetary policy in the United States and around
the world with the expansion of
balance sheets. We went from a balance sheet
that was about $770 Billion, which sounds
like a large number, to one that was 4.5 Trillion. So
this is the expansion of the Fed’s balance sheet. On the left
are assets, on the right
are liabilities. Convenient thing about balance
sheets is they balance. Otherwise they’d just be sheets. (Laughter) Wow. I- can I- can I
get a degree from NYU? (Laughter increases) So here- here’s what we think
this happens in numbers.
The last column is where we think things
end up. We think the Fed’s done unwinding its balance sheet in
May of 2020 at a size of $3.5 Trillion. What that looks
like in pretty charts though is the following, and this is the
one point that I want to make and we can get into it
in Q&A later. On the top left are total assets in the Fed’s
balance sheet. So the size of the balance sheet went from 770-
something before the crisis if you measure it from Wednesday,
August 7th, 2007. That’s the starting point for
me. I got up to 4.5 Trillion, and then it’s going to come off,
and that’s with the dotted line projection is. And what they’re
doing is they’re letting treasury securities that they
own mature without being fully reinvested, and they’re taking-
they’re letting mortgage-backed securities that they own prepay,
which is the MBS fancy word for, essentially, “mature,” without
being reinvested, and so that’s what you see in the top right is
what’s happening to those asset classes. Now the funny thing
that happens is the Fed’s balance sheet is going to shrink
and shrink and shrink and shrink until the middle of 2020, and
then it will start to grow again. It has always grown since
essentially 1914, when the Fed was created, till 2007. It will start to grow again when
everything is back to normal, and the answer is very very
boring, which is physical
paper currency. Paper money, liability on the
Fed’s balance sheet – balance
sheets balance – so if a liability is growing, so will
the assets. That fact, I think is only now getting appreciated
widely. The Fed’s going to shrink its balance sheet, but
then it will start expanding it again, and it will expand it
in line with currency, but the amount of treasury securities
that they will buy – and this is
my very last point – is something like $20 to 25
Billion of treasury securities each month, starting in May or
June of 2020. $20 to 25 Billion per month. That sounds like the
kind of asset purchase program or colloquially, “QE,” that some
central banks have been doing, and I think that fact, once it
fully sets in in people’s minds, will be a bit of a revelation.
Thanks. (Applause) (Seth Carpenter)
– Wait, hold on the disclaimer.
It’s great. (Kim Schoenholtz)
– The disclaimer is fantastic.
(Laughter) (Michael Feroli)
– I got a longer one.
(Laughter) Alright, so I’ve been doing this
forum for several years now, and I actually went back and
looked at some of my old presentations, looked at one
from 2013, where we looked at the- kind of the economic
landscape then, and we kind of concluded as we looked at
everything, that in 2013, the economy then really still
bore the scars of the- of the Great Recession. So I thought – and that was
particularly unusual given, you know, we were almost five years
out of the recession – to still have a lot of the scars in the
economy. So I thought we’d take an update of that and, like,
take a look at where we are now in terms of the economy. And the first thing to note is
that in 2013, when I was here, the unemployment rate was 7.5%. Now it’s 3.9%, so I think it’s safe to say, in terms of the labor market, things have definitely healed. That was not the case five years ago, so if you’re about to graduate, it’s a much better
forum to be sitting in
than then. The other thing that I think is
a lot more normal now is the
federal budget. At least until a year or two ago we had seen a pretty good improvement in the deficit situation. That was not, again, the case in 2013, when we still had very large deficits to support the economy, which at the time was still rather weak. Another thing we talked about
then was the housing market, which in 2013 was still quite
depressed, and that was pretty important because housing
was at the center of the
Great Recession. Now housing has pretty much recovered. It doesn’t look like it’s recovered, but the demographics are different than they have been in decades past. And I think when you adjust for
that, most people would say housing market is now
back to normal. And then, finally the last thing
we looked at back then was equity markets and financial
markets in general. Whether you were looking at
price earnings ratios or the equity risk premia on the
right-hand side here, there was still a bit of fear evident in equity markets, and in fact at 2013, the equity risk premia was at the very peak of that chart on the right, so I said at the time,
“Equities look cheap.” There’s a record of that, Kim,
so I’m not just…
(Laughs) What you did with that
information, you know,
is up to you. Now arguably, equity risk premia
still somewhat elevated but not nearly as elevated
as it was then. So all these things that we
discussed in 2013, which still bore the scars of the recession,
now look like they have fully recovered. So I think it’s, in
one sense, you could say things are back to normal. On the other
hand, if you look at some other- just sticking with the topic of
equity markets – if you look at skew in the S&P futures, they indicate that there’s still a lot of concern about downside risk, actually record levels of concern about
downside risk. If you look at household
behavior, what I’ve plotted here is a little bit- takes some time
to talk through it. What I have plotted is
basically, the blue line is net worth, the wealth-to-income ratio, so this is how wealthy households are, relative to how much they make. The orange line is a saving rate It’s inverted, and generally what happens in the past is when wealth goes up, i.e. when stock prices go up and house prices go up, people feel more comfortable reducing their saving rate. What you’ve seen lately is a- kind of a breakdown in this relationship. So we’ve had great equity
markets, we’ve had house prices go through… are doing very well, and yet
saving rates remain relatively elevated, so households seem
to be unconvinced, or just more cautious than they had been in
the past when it comes to this wealth that we’ve actually
generated over the past several years. So, consumers seem to be
a little bit more cautious. And then finally, if you look at
business behavior – I don’t know what happened to this chart – but you can still get the idea which is the orange line is corporate profits as a share of GDP or GDI, same- roughly the same thing, and the blue line is business investment spending as a share of GDP. Now in the past these two tended to co-vary, and I’m not saying
this is the perfect model of capital investment spending,
but generally thinking, it’s not too unreasonable to think that
when profits go up, firms are gonna want to invest more,
and what we’ve seen lately is a disconnect. For whatever
reasons, firms seem to be a bit more cautious about or reluctant
to invest these profits. So what I would conclude and
again I guess this is more of a big picture view than Seth’s,
kind of more near-term outlook is at least compared to when I
was here in 2013. The physical scars, if you will,
of the Great Recession have healed. Right so when
unemployment is down, spending seems to have
recovered. Fiscal position is in better
shape. But in some ways the-
emotional scarring is still present and I think you see this
in a number of behavioral shifts and how long those-
behavioral shifts persist. I don’t think anyone really
knows but I think coming back to this issue the of saving rate I
think what we do know is that people who lived through
the Great Depression, their saving rates
remained elevated generally for the rest
of their lives, so I think people who lived through the
Great Recession, I think you probably will see behavioral
shifts that persist. Probably for quite
some time. That’s it. (Applause) (Rebecca)
I have less disclosures. Great, so I don’t want to
duplicate what’s already been said extremely well, so what I’m
gonna try to do is go very quickly through US thoughts and
then do a little bit more of a global tour and also take where
we left off with monetary policy and the economy in a little bit
more into market implications and I think at the end of the
day, the economy drives the markets but the markets can also
influence policy and the economy so it’s- I think it makes sense
to be discussing both. There’s my- look at that!
It’s so little! It’s great being on
the buy-side. (Laughter) Okay. So first quick comment, first quick comment: don’t
worry about the numbers here and if you’re color blind, my
apologies. This is a heat map looking at business
confidence surveys. And we focus on them a lot because they tend to be, generally, leading indicators of actual economic activity. And what you see in the red box
is a period of time where we had very
synchronized global growth almost every country
producing a PMI, a business confidence index,
was above 50, ie., the economy
was expanding. Now when we get to
the last few months, partly because of trade,
partly because of some EM shocks I’ll talk about
in a minute, you’re seeing a little less synchronization,
and that helps explain why the US equity market is
outperforming the rest the world
so much a bit. And it also has impact on
companies. If you’re a big US multinational, obvious…ly if you have synchronized
global growth, you’re gonna be getting revenue from more
sources around the world so, synchronize/non-synchronize does
matter, but overall the global economy is doing fine. If you
look at the August PMIs, which just came out, and thanks to JP
Morgan because they put together a really nice all-industry PMI
aggregate. It suggests global growth is still
growing around 3.1%. Now, while we’re staying on a
happy note – because I may get dark in a few minutes – so those of you who are legal
can go out and have drinks when we’re done. But I’m staying
happy for a moment, so we’re Goldilocks still, so you have decent global
growth led by the US, which in turn is led by
deregulation in fiscal stimulus and then you have this gorgeous
picture on the left which is inflation, which is positive but
still very much under control, which means that central banks
can go gradually. So financial conditions don’t tighten too
fast, they don’t choke off the economic expansion, and they
don’t hinder equity market. So this is a good thing, and I have
lots of clients who come in and say, “Why is the market up? The
market should be down. Trade wars! Anxiety!
OpEds! Aah!” But at the end of the day, it’s
not the rhetoric that drives the markets. It’s the underlying
economy that does, and the underlying economy is about as
good as it gets. You have strong global growth and you have tame
inflation. Alright that’s the end of my happy notes. So when I think about how to
invest my clients’ capital, I’m looking a lot at the economy and
then I’m always thinking, kind of like Seth
mentioned with the Fed, “What can go wrong?”
You know, it’s risk management, and there is
such a long list right now, there’s always a long list, but I wanted to touch
on a few and I’m- I’m anxious to be making any
comments about the Fed in front of this little group here, but
one of the things that you’re reading about a lot in the
press, comes up a lot is the curve. Right? So on the left you have a chart.
You can see that we’re nearing inversion, and I can promise you
as a former journalist that the day we invert, every newspaper,
every business TV channel is going to be going absolutely
batty over this. They’re gonna be
screaming about it. “The end is nigh! Get out!
Get out! Get out!” So just a friendly reminder that
there’s a lot of dispersion around inversion as a signal in
an actual economic influence, and when the- the world turns,
and it got cut off here, so it’s kind of like a puzzle. The
bottom line is that historically if we go back to the ’60s,
after the curve inverted you had usually another year before the
equity market peaked and another half year or so before the
recession started. There’s all- again though a lot of dispersion
around that and every cycle is different. I think you had
Williams talking today up in Buffalo about this and saying
the curve isn’t a big deal. It is different this time. So it’s an important
signaling effect, but it doesn’t mean you need to jump
out of the pool right away. The balance sheet: you know,
Seth talk to- and- and Michael both mentioned balance
sheets. Seth especially. I love your 2002 story. And this is- this is a tough
one. I mean the New York Fed committee that I’m part of, we
spent a lot of time saying, “Well how much does this matter
to the equity market? How much does this matter
to financial conditions?” And we don’t really know,
because we don’t have a lot of
experience with this before. The chart I’m showing you is just
the balance sheet and this isn’t just the Fed. This is the Fed,
the European Central Bank, and the Bank of Japan, and it’s a leading indicator
for global equities by a year. But to me that’s kind of
intuitive, right? If you are draining liquidity from the
system, if financial conditions are getting tighter, there
should be some effect. To me, the
question is just: “How big of a deal is it?”
And I think we’re gonna know sadly in this case in
retrospect. There’s a lot of great academic work predicting
how much it matters but I think we’ll find out when it happens.
But it’s another risk to watch- medium term, not imminent. Trade
we touched on a little bit, To me, the trade war is: “When do we see it in
the data?” And just now you’re starting to see a few
bits and pieces, you’ve got German manufacturing orders. We
just got new data on that out this morning – it was actually
worse than expected. And Germany is 50% exports. If
you’re seeing their manufacturing sector hit and
exports hit, it’s gonna affect their overall economy. In the US it tends to be
in sentiment more than actual data
at this point, but you know if Seth’s right, – and I really hope you’re wrong
on this one, I’m sorry – but if he’s right, we’re gonna
see it start showing up in those PMI surveys, probably
more in some of the PPI, the intermediate inflation
numbers in the coming months. And that certainly could
affect equity markets. Our own view is that the longer the
uncertainty lasts, the greater a probability that it feeds
through to the economy. And you are seeing it in CAPEX already.
People are deciding to buy back stock rather than
invest, in part because of the uncertainty – in part. So going overseas for a minute,
if we want more to be scared of, so we have this lovely Italian
government of – full disclosure I lived in Italy in the 1990s,
and as a journalist followed Berlusconi around when
he first ran for office, and I will go on the record saying he
didn’t hit on me. I wasn’t his type. (Laughter) Darn! So my point here is that we have
a new government in Italy formed by the league and the Five Star
Movement – very populist – they aren’t quite sure what
they’re doing yet. Are they going to have
fiscal expansion or not? If so how much?
What’s- unnerving the market and you see in their ten
year yields starting to rise is that they’re talking about some
fiscal expansion which would go against the growth and stability
pact in Europe. Right now it’s not a big deal because the ECB
is buying all their debt and you can see that in the chart on the
left but as of January next year guess what? Quantitative easing
in Europe comes to an end. They stop buying assets. What happens
to Italian bond yields then? How does it feed through into their
equity market and their broader economy? I don’t think the
market’s giving that enough credence. It’s possible this new
government won’t go that route but if they do it could get
nasty around the end of the year in particular. EM. We’ve got two issues here:
cyclical and idiosyncratic. On the cyclical side as the Fed
raises rates, all else equal, that tends to lift the dollar.
Currencies trade in pairs. If the dollar goes up,
other currencies go down. It’s pretty easy. So you have the Fed raising
rates, dollar goes up pretty much
against everything. So that’s the cyclical. The
idiosyncratic – there’s a whole bunch of stuff. There’s inflation overshoots
in places like Argentina. There’s policy uncertainty
in places like Venezuela and Russia with sanctions.
There’s countries with large current account deficits
that our oil importers – Brent Crude is back to its highest
levels this year. Places like South Africa, Turkey. And so you
have these idiosyncratic and these cyclical elements coming
together, and the result is a good old fashioned EM crisis that we’re starting to see play
out. Argentina raised interest rates
to 60% last week trying to fight this. It hasn’t
worked yet. The chatter in the market right now is that Turkey
is going to raise in the next few weeks five
hundred basis points. It’s not helping. This is
a problem for economies because as you
get weaker currencies, it passes through to inflation. The
central banks react by raising rates to try to stabilize
inflation. Higher interest rates choke off the economy, which
makes investors not want to be there, which weakens
the currencies more. And you get a little bit of a
death spiral going. I don’t think we’re done. Turkey in particular I think is
underappreciated, not because of economics but because of geo-
politics. Remember on the map where it lies, right? You go
over the bridge in Istanbul. It’s East versus West. It’s also North versus
South. So if Turkey’s economy implodes, you’ve got a whole
bunch of problems there. You have NATO bases, you have US
airforce bases. Erdogan is threatening the US bases. Turkey
has promised the EU it won’t let the migrants through if they
get six billion Euros. They’ve only gotten three, reportedly,
and they’re now threatening if they don’t get financial
aid that they might open the gates again. That was fine in 2015
but it’s not fine today. We have an election in Sweden
this Sunday and there’s a good chance you’re gonna see
a populist, far-right, anti-immigrant party get
more seats than it ever has before because of
this issue. Turkey has a lot of leverage
right now. If they don’t get the help from Europe, they
could go to Russia and Iran for it. Europe doesn’t want to see
Turkey go that way. I would pay a lot of attention to this one. Last but not least – I told you
I was getting dark – so at the end of this year
– November – we’re going to get the sanctions on Iran
fully implemented. And oil prices are
starting to go up now in anticipation of that
terrible time of year for people to have to pay more to fill
their tank. Because they want to buy holiday gifts for their
family and friends, and so you can see oil obviously a big
chunk of overall consumer prices so oil will lead CPI, which
affects the Fed’s thinking. At the same time, and I apologie
the chart on the right is a little hard to follow,
but trust me when I say that higher oil prices on average
will tend to weigh on consumer sentiment and it hurts
consumer spending. A lot of Americans spend a good chunk
of their disposable income filling their tanks and heating
or cooling their homes. So if we see oil continue to go up on
Middle East because Turkey makes the Middle East / North Africa
situation worse, Iran implementation is stricter than
expected, this is another shock that could affect the US
and affect the Fed’s thinking. Because it would be
stagflationary right at the turn
of the year. I’m gonna leave it there, and we
can say more happy thoughts during Q&A. (Applause) (Kim Schoenholtz)
So now our panelists are ready to answer
your questions, so I’m going to ask everybody, once
again, to go to slido.com, S-L-I-D-O.com, join at 3333,
that’s our event, and enter your questions and
vote on the questions that are there, and unless the questions
have already been answered – and some of them have been in the
discussion we’ve had – I’m going to be led in posing those
questions by the ones that you select, so audience
participation matters today. Let’s start with
Paul Wachtel’s question. This is a bit of a long run
question, but it’s a question about the labor
market: Wage growth in the United States
has remained rather low, despite the fact that unemployment-
the unemployment rate’s below 4%. How do we explain this? What’s-
what’s causing this pattern? (Michael Feroli)
Well I think- one thing I
would say is that you would think that normally in
a economy operating at full employment, where everything is
humming along nicely, is that wage growth should equal the sum
of productivity growth and the inflation rate. Inflation rate
should be around 2% and is lately running around 2%,
so you’d say normalized wage growth should be 2% plus
whatever the growth of productivity is. I think when
a lot of us grow up, we thought growth and
productivity should be running around 2-2.5%, so nor- normal wage growth
should be around 4-4.5%. Over the last 5-10 years,
productivity growth has been more like 1% at best if you can
find the right comparison. Seth might argue that in this
kind of new normal regi- regime where productivity growth
is slower, that normal wage growth may be more like 3%. Right now we’re running 2.7-
2.8 depending which measure you look at, so we’re still
under-performing I think what we should be doing and particularly
since the economy is probably operating a little bit beyond
full employment. But maybe we aren’t under-
shooting as much as we would think given mindset that was
formed a few decades ago. (Kim Schoenholtz)
Anybody else want to jump in? (Seth Carpenter)
Yeah so I completely agree
with Mike’s characterization that part of
the- the vast majority of the puzzle but not all of it is that
people tend to be comparing wage growth to the wrong
measures. Some people when the- the variation that I get as a
question is: “The last time the US economy
had an unemployment rate of 3.9%, wage inflation was
much higher. Boy aren’t we missing by
a couple of percentage points?” And the answer is in
large part “no,” for the reasons that- that Mike posited.
So the puzzle is much smaller than it first appears. I would
add to that part of the resolution of the puzzle is a
slight difference in- in the take on the data. From Mike’s statement that
the labor market has fully normalized, just there are still more people who
are working part-time who would rather work full-time than there
had been in the past when the unemployment rate was this low. So part of that scarring,
I suspect, is still there. Moreover, the unemployment
rate is a reflection of how many people have jobs relative to the
labor market but one also has to consider how many people are
choosing to be in the labor market, or more importantly when
the survey from the Bureau of Labor Statistics comess around,
check the box that says that they’re in the labor market, and
what we have seen over the past two and a half to three years is
that people between the ages of 25 and 54 years old
have actually been increasing their labor force
participation. So whatever measure the unemployment rate
one has in mind, it may be in fact overstating just how tight
labor market is, or overstating how much clo- how far back to
normal we are. And so I think those other bits go a
reasonable ways to explain the puzzle, and then we’ve just been
this very very low inflation environment for a while and- and
people are a little bit afraid to ask their boss for a raise.
Raising your hand saying: “Hey I’d like a raise” is also
raising your hand saying: “If you need to fire somebody,
I’m right here.” (Rebecca Patterson)
I’m good. (Kim Schoenholtz)
Good, okay. President Trump has been
criticizing the Fed for hiking interest rates. If that criticism continues,
this will run counter to Seth’s expectations for Fed policy
later this year, but if that criticism continues, how do you
think it’ll affect financial markets and the economy
and the Fed? (Rebecca Patterson)
I- I love studying history and
if people are into this, I would highly recommend- there’s a-
I believe it’s a New York Times article in their archives that
talks about President Johnson. And that was the last time we
saw the Fed chair criticized in this manner and if the reports
are to be believed, and this is more hearsay than factually
confirmed, but there was a point where the President might have,
at his ranch in Texas, actually physically touched him – not
in a happy friendly way – so it doesn’t happen often. I’d
say where you do see it happen overseas, it absolutely does
affect financial markets. I mean, look at Turkey.
In this case, Erdogan has basically made a relative
in charge of policy, and he’s not letting him
raise rates – so far. It’s not going well. Where you see a lack of
independence between the Fed and the government, it doesn’t tend
to end well. I think right now because of the President’s
pattern of commenting frequently and often changing his view, the
market’s sort of looking through it and believing it’s more of
the same. It’s just bombast. It’s not something to
really worry about. But if it were to continue,
and the threats grew, it might be. And it’s certainly
not positive. I think the Fed’ll do whatever
the Fed thinks is right, regardless. (Kim Schoenholtz)
Anybody else? (Michael Feroli)
If I just add for those who aren’t familiar with
the institution that, the people who run it
cannot be removed by the President, right? And they have
very long terms. So this could be a lot of noise, but the
substance I think is gonna be not much. Unless the mark-
market makes it substative. So, the people who are in there, the
President cannot fire. He can tweet about, but that’s-
that’s about it. (Kim Schoenholtz)
So the message is: if Jay Powell gets invited to Mar-a-Lago,
he should think twice. (Laughter) (Seth Carpenter)
But the other message is if he gets invited to Mar-a-Lago, I
think the effect on the Fed to two decimal points
is zero. (Rebecca Patterson)
Yeah. (Kim Schoenholtz)
Okay. So, what do you think are the
economic effects of the White House tightening immigration
policies, both short term and long term? (Seth Carpenter)
Yeah- (Michael Feroli)
I guess the only thing- oh- (Seth Carpenter)
No, please. (Michael Feroli)
The only thing I would add
is that I think- so, most mes- and it’s obviously
hard to measure undocumented immigration for obvious reasons,
but I think most measures we have suggest that it really
flattened off quite a bit in 2008, and has been very
marginal since then. So it may be a lot less and-
even if- so first of all, it’s not clear
he’s actually done anything or is able to do anything,
beyond you know what you can do by executive power, but
even if you were to do something more it’s not clear that’s gonna
have a big effect on on labor supply. Prior to 2008,
undocumented immigration had been a big source of- of labor
supply and growth in the work- force, but that really hasn’t
been the case over the past 10 years. So I would agree with that. I
think the bigger issue is more what goes on with the
immigration reform debate more broadly. So there was – I forget –
five years, ago six years ago, a bipartisan bill that passed
the Senate to reform immigration to allow more immigration and
especially among higher skilled, higher trained workers, and the CBO score of that
was that it would raise potential GDP growth by
3/10 of a percentage point. One can quibble with all
sorts of details of the- the analysis but nevertheless,
3/10 of a percentage point, a potential GDP growth,
3/10 of a percentage point or anything remotely like
that, essentially in perpetuity of faster growth is a massive
increase and the general well- being of United States and
that’s what we’re leaving on the table. (Rebecca Patterson)
And just anecdotally,
I’d add that some graduate schools
– not this one – professors and administrators
I’ve talked to have suggested that they’re
now losing extremely well-trained immigrant students,
who are going back to their home countries because they feel less
welcome. I think there can be, over time, a economic impact
from that and if you think about immigration policy abroad, you
know part of the reason China’s loosening up on its one child
policy is they desperately need population to- to underpin GDP.
And without having the population growth, because it’s
not going to change quickly enough, they have to rely on
other sources to boost GDP which either- either is capital stock-
which is dead which is an issue- or it’s “Made in China 2025.”
It’s a technology-focused industrial policy. They
have to do this because they don’t have the immigrants or the
domestic population. And that’s where we could be headed. The next question is about the
the ri- big risks in the emerging markets and Rebecca you
touched on that a lot especially about Turkey. Did you want to
expand perhaps about other parts of the emerging world that might
be worth looking into in a little bit more depth?
Argentina as an example. Just a couple years ago people
used to look back at Argentina and say “This is a model of how
you’re supposed to behave for the government that was aiming
at structural reform,” and yet they’re in a crisis, raising
interest rates to 60%. How do you manage that? (Rebecca Patterson)
Yeah, I mean, as a
rule of thumb, I try to invest or focus on emerging
markets that have current account surpluses or very small
deficits, and that don’t have… …huge… …policy issues. I prefer countries that aren’t
completely cyclical, tied to commodity cycles unless you’re
being thoughtful when you get in and you also want liquidity. You
also want to look at foreign holdings of local assets. So a
country like Indonesia right now one of its challenges is that,
I’d say probably more than 50% of its local debt today
is held by foreigners. And so when foreigners get spooked and
they take the money out, the markets are so illiquid that it
has an exacerbated impact on the underlying markets, which can
cause the currency to fall and that spiral to happen. So a lot
of it is sentiment-driven. If Americans are feeling confident,
if foreigners are feeling confident they put money
overseas. When they get nervous, they bring it home. I think the
whole ETF phenomenon has exacerbated that, right? Because
now you have more and more ETFs which are an EM ETF, and so
you have money that flows in and flows out en masse, even if
their underlying companies within those countries that are
very very sound and that can make the problem faster and more
exacerbated. I- I don’t know if this is going to have contagion
back to the developed markets. I think that risk is greater if
the trade war gets worse and/or when the fiscal stimulus in the
US starts to wear off. And I- I don’t have a
strong view if we see the stimulus impact wearing off in
’19 or ’20. Part of it I guess will depend on the
interplay with the trade war but this doesn’t feel like- I lived
in Singapore right after the Asian crisis – this doesn’t feel
like that to me. But- because the holdings are
not as big, you haven’t seen as much flow go into emerging
markets this cycle, so there aren’t as many
positions to leave, but it certainly can have a
feedback loop to the US. The one watch is China. China’s
the- it’s- it’s basically EM and China, even though China is an
emerging market. And they’re subsidizing as much as they can
to get through this trade war. If they can hold up with GDP
relatively steady, I- I’m not so worried.
If you start to see China cracking, then we’re going to
have a much greater risk of a global recession. (Kim Schoenholtz)
Okay. Well the next question is about
a Fed-induced recession, but let me broaden that. I just ask your
judgment. What are you- How do each of you see the odds
of a US recession over the next two years? It’s- our take on it has been
evolving pretty heavily with the trade wars. So as the probabiliy
of full-blown trade war tariffs across everything we import from
China and the probability of a recession from that
source goes up, if we can abstract from
the trade war side of things, we thought there was a
meaningful probability of a recession in 2020,
and probably going up a bit in 2021,
and the logic is we have the fiscal impulse
starting to come off a bit at the end of 2019 and
then very sharply in 2020, and any time you see an
economy decelerate very rapidly it leaves itself vulnerable to
other shocks. So just the unwind of the fiscal stimulus in and of
itself, in our view, is not going to be enough to cause a
recession, but then suppose against that backdrop something
else happened. So bad things happen to good economies
all the time. I’ll actually quibble a little
bit with the role of oil prices on the US economy. Absolutely
higher oil and gas prices are a drag on the US consumer. That I don’t disagree with
in the slightest – however – the US is now one of the largest
oil producers in the world. The amount of production in the
US is going up at a staggering rate, and all of the increase in
investment spending in 2017 that we saw came because
of the energy sector. As long as oil stays
above $45 or $50 a barrel, there’s going to be a net boost
to the US economy, unless and until it gets
about something like 125 or more dollars a barrel,
which case the drag on the consumer is going to outweigh –
and the drag on the consumer is- is real – but the boost to
investment spending and the boost to extra employment from
the energy sector is not to be underestimated. We think it’s
adding something like 35 basis points of real
GDP growth this year. (Kim Schoenholtz)
Mike? (Michael Feroli)
You know so we’ve been hearing
a lot about the 2020 recession as people have been calling it,
and you know, I think it’s a reasonable story that,
you know, the economy, labor markets are tight,
the Fed’s gonna have to keep tightening, and
then that’s usually how things go into recession. You know, that being said the
Philly Fed has been surveying professional economists going
back to the 1970s. One of the questions is: “What is the odds
of a recession in the next twelve months?” And they’ve never gotten it
right. They’ve, you know, those odds have never got- gone above
like 30% 12 months before a recession. (Seth Carpenter)
Shh! We’re professional
economists. (Laughter) So to think that we’re
going to get it- We’ve never gotten it
12 months in ahead – that we’re gonna get it
24 months in ahead, you know, I think we should treat,
you know, these… with some – humility and some skepticism.
Again I think the narrative makes sense. But you know, we’re not great at
forecasting recessions. The other thing I’d note
is that: there’s no sort of cosmological
constant that says the economy has to go into recession after a
certain number of years. A lot of people have recently
been pointing to the example of Australia, which is in 27 years or something
of expansion. Now what they have had is a period of two
basically soft landing slowing- slowdowns that- the pause that
kind of refreshens. It’s possible that we could have
something like that here. I don’t know. Or it’s possible
we could have a recession in 2020, but we’re not trying to push that with too much-
too much confidence. (Rebecca Patterson)
And I have the view that at- at
the end of the day the equity market is heavily tied to the
economic cycle, and so while I agree it’s almost impossible to
predict when the recession is going to start, I think if you
can get close on the probability and you see the probability
rising, there’s a greater chance equities are going to roll over.
And if you have equities falling 15, 20% the sentiment shock
can take you into a recession. So we spent a lot of time
trying to understand the probability of a recession
over a certain period, most institutions, I’m sure both of
yours, the Federal Reserve, everybody has probability models
for recessions. Ours is now saying over the next year and a
half about 60%. We haven’t seen- (Kim Schoenholtz)
6-0? (Rebecca Patterson)
6-0. But that’s not surprising,
right? I mean, if the Fed continues tightening,
the curve inverts, we’re at full employment… a year and a
half- that’s, you know, late 2019, early 2020, so
yeah. But what we’ve seen historically is equity markets
didn’t tend to roll over til that probability got to 75
or 80%, so 60% might sound high, but
historically it wasn’t an inflection point. (Kim Schoenholtz)
Okay. Well actually it’s related to a
couple of other questions that are out there if- the most
popular one is: “How long do you think the bull equity market is
going to continue?” (Rebecca Patterson)
April 3rd, 2019, 2:30
in the afternoon. (Laughter) (Applause) (Kim Schoenholtz)
We can sell the equity market
forward exactly on that date. (Rebecca Patterson)
We wish we knew. No one knows. (Seth Carpenter)
Wait, but why would I wait
’til the afternoon? (Rebecca Patterson)
I don’t know. I just made
that up. I mean but that is what I mean
it’s such a silly ques- it’s not a silly question, I’m- I
appreciate whoever asked the question, but it- no one knows.
Again, it’s th- the world is not that easy. If it were there’d be
some really successful people out there who would own islands. It’s all about probabilities and
you look at valuations, you look at flows, you look at the
underlying trends in the economy and policy and when you feel the
probabilities are tipping or not you probably should take some
money off the table. That’ll do. Very different
kind of question: In this university, we spent a
lot of time teaching people about data skills, using all kinds of new
techniques to access big data, variety of data. To what extent
are you finding it useful to use unusual data sources, broad data
sources, in the work that you’re doing and looking out? (Seth Carpenter)
So I wanted to jump in on data, whether it’s big data,
alternative data or not and first just make a point – and this might actually
resonate which Dick, who used to run the office of
financial research – so one of the hats that I wore
at the Federal Reserve, is I ran entire Federal Reserve system’s
Statistics and Reserves function – so all of the collection
of data – from all the banks in the
country get processed and the reason that I was in charge
of it is much like the earlier stories, talking about the
balance sheets, I was the only one around that day, but one of the things that I
would frequently tell the analyst – so at each of the 12
reserve banks they have statistics functions where there
were analysts getting the data in and they would run edits over
them to ensure the validity of the data: “Do these make sense?
Do the balance sheets balance? Is the change in this category
larger than anything we’ve ever seen? Call the bank back an- and
get quality assurance on the data.” So, you know-
but then they’d hit send, it’d go off in the
ether, so what- a part of my job was to buck up
the spirits of everybody and one of the things I tried to tell
them to understand what they were doing
and why it mattered with data is that there is the job that they’re doing – and then
they’re checking to make sure the data are accurate and
they’re checking with the banks that submitted the data to make
sure they made any sense because there is a massively important
distinction between data and information. And so the best example for me
that I would always give these analysts to show why and what
they were doing was important is that as we got into the
beginning of the financial crisis, which I date to
2007, not 2008, there were all of these stories
and anecdotes about a credit crunch, about banks pulling back
on access to credit and lots of firms not having access to
credit and there was a series of articles written some by
otherwise highly respected and respectable economists saying
that is just complete hogwash look what’s going on with C&I loans, and business loans, they’re actually running up,
they’re booming, well, as it turns out,
all of the staff around the Federal Reserve system who
collect these data from banks who submit them called them back
and said, “This is going up more than we would anticipate. What’s
going on?” And the answer was: “Well, we had a bunch of
contracts with our customers where there were pre-
committed lines of credit. They never used them
before, because boy were they getting credit
everywhere else, and the only reason they’re coming to us is
because they can’t get credit anywhere else.” And so you saw
this surge in business lending precisely because other forms of
credit were no longer there. And so if all you’re doing is
looking at data, you may well be missing a huge amount of very
useful important information. I think the same sorts of lessons
need to be applied to big data. I think they can be incredibly
helpful if you know what you’re looking for and so anytime you
ask a student, “Hey go get some data and then compute the
summer statistic,” you will get an answer, but boy, isn’t it important to know
what answer means? (Michael Feroli)
Yeah we’ve actually been using big data now for a few years
there’s JP Morgan Chase Institute which has access to- Chase is obviously a very large retail bank that has, I think,
40-some million customers and so they’re using that data to
better understand trends in the economy, for instance, “What happened to
consumer spending after Hurricane Harvey?” Because
retail sales data we only have nationally so we can use some of
that data to kind of drill down and get a better look at those
things. So we have found some promise
there in terms of some of that. (Rebecca Patterson)
And I would just put in a plug
because all the data that they have is made publicly available,
and so- and it’s clean data. It’s interesting to play with. (Kim Schoenholtz)
Cool. Rebecca made the point about the
yield curve attracting a lot of attention on the day that we
hit flat, to what extent- let me pose this question
a little differently. To what extent have you downgraded
the importance of the yield curve and your judgments about
the economic outlook and the market outlook? Sure, so one of… part of my dissertation thesis
here at NYU was on the information content of the yield
curve as a predictor of future output growth and even back then
and I wrote that in 2002, it was already evidence that
its power was diminishing somewhat in the ’80s and
’90s relative to prior decades. So it’s already been… perhaps not quite as informative
as it had been the past, there is this other issue
regarding a decline in term premia, which
is basically how much extra compensation you get paid to
hold longer term debt, that may be messing with the signal
a little bit, that said, you know we
definitely don’t want to totally downplay it or diminish
it and I think what it’s saying is something pretty
obvious which is that this cycle is not young. It was maybe in 2013
but it’s not now and so I don’t think it’s
inconsistent with I think most people’s common
sense intuition. I think when it does invert, then you’re gonna have to say,
is that some sort of, you know, critical point or does it have
to invert more so than it did in the past before we really get
worried, and I think that’s an unresolved debate but
a pretty vigorous one right now. (Seth Carpenter)
My general answer is I- I can’t dismiss it outright, on
the other hand, listening to historical evidence is
essentially drawing conclusions off of a small
handful of observations without being able to control for
everything else that’s going on, so we get to a point where the
yield curve is five basis points steep or negative five basis
points inverted, sure are we looking at the real data and if
I get some negative signal from the real data, I may pay more
attention to it but if the yield curve is inverted by five basis
points and we’re printing 300,000 new jobs a month
and investment spending is accelerating… a bit and consumption spending
is- is holding up at, you know 2 and 3/4 to 3%,
I’m not going to take that as an imminent sign of a
recession and moreover just something to keep in mind when
people say, “Look every time the yield curve has inverted we’ve
had a recession.” It’s also the case that everytime the
economy’s been in expansion it’s been followed by a recession. You can look that up
in the data. So, whenever there’s an expansion,
just be really cautious because there’s- there’s a- there’s a
recession coming. (Rebecca Patterson)
I would just quickly add that
one thing that I think is new this cycle relative to the past
is the influence on global flows on the long end of the curve,
because we have had negative interest rates in QE
around the world, and you’ve had more
investors in other countries trying to put money
here in the US to pick up a little extra
yield and that has pushed down the long end of the curve,
perhaps more than has been historically, and so it’s a different- every
cycle’s different but that’s one of the influences that this time
around is relatively new and much more pronounced- it’s not
new but it’s much more pronounced this time around,
so to your point yeah there’s meaning there but
you don’t want to over-emphasize it. (Kim Schoenholtz)
And I’ll just add a quick
anecdote. I’m reminded of- I’m old – so I’m reminded of the Greenspan
conundrum of 2005, when he was worried that the Fed
was raising interest rates, but long bond yields haven’t risen
for at least a year and a half, the yield curve was flattening.
I think at that time if you looked at a whole variety of
financial conditions, equity market conditions, yield spread,
etcetera, you would have found that the yield curve was the
anomaly, it wasn’t really a clear indicator even among a
whole variety of financial conditions leaving out the real
economy, so I’m sort of careful about it. Okay, FinTech is a big subject here
at NYU – at Stern – and the question is: “To what
extent is FinTech and AI likely to continue to shape or
reshape the financial industry and maybe the broader
job market? (Seth Carpenter)
So, my take on that, when I
was part of the administration there were lots of work streams,
policy streams being done on FinTech. My view then is like
now, only a couple years in the future which is in 5 or 10
years, no one’s going to talk about FinTech, they’re gonna
talk about the financial servics industry. They’re utterly and
completely inseparable in my view. Well over 90% of the
transactions that take place in the on-the-run treasury market,
so the market for trading the most recently issued treasury
security is done electronically. So there- there is no
distinction, almost the entire sort of most recently issued treasury
market is- is- is electronic and financial and taking place at
the speed of nanoseconds or faster. So, I would take the
question and say you didn’t go anywhere near far enough. It
matters, it will continue to matter more and more. It will
matter so much to the point where it’ll be indistinguishable
from just every- every part of daily life in the financial
services industry. (Michael Feroli)
I totally agree. I was actually
shocked to learn that my company now employs more programmers
than Google does, so I think tech and finance are very much one and the
same right now. (Rebecca Patterson)
And I don’t think it means that
there aren’t jobs, they are just different kinds of jobs and it
doesn’t mean everyone here has to code although it’s certainly
helpful to understand it, I also think it means that EQ still matters or perhaps even
matters more because you have to take the data, you have to take
the results, to be able to explain it to someone on the
other side of the table from you and understand what they’re
trying to achieve, what their problem is, how can you
help them. And so I think there
is a role for humans here, even in this
advanced technological age. (Kim Schoenholtz)
Let me just extend that
a little bit, the last decade has seen a
really big increase in regulation and compliance costs
in the financial industry. To what extent is technology
helping to cut those costs, RegTech, so to speak? (Seth Carpenter)
My sense is it’s not there yet, when I think about, and I
hope I’m not airing dirty laundry, when I think about some
of the interactions with clients and so our sales people are
trying to get more business with our clients and they dangled a
shiny object which is the Chief US economist, and I’m like, so
how much do we trade with that person and the answer is very
frequently, and I’m curious if you have the same thing, well it’ll be a lot soon but
we’re still sort of signing all the documents to make sure that
we have all the regulation in place, and you know, if you take a good sized hedge
fund, it’s not an entity. It’s a bunch of different entities and
they have different funds and to be able to do transactions
across different ones then the- each investment bank has to have
an agreement- has to have a document signed with each of the
different individual ones and then depending on the security
being traded and blah, blah, blah, then you multiply that by
all the different investment banks, that still seems to me
to be a borderline inscrutable sand in the gears for the
financial services industry. So I don’t think it- I don’t think
we’ve seen anything like what it’s capable of. (Michael Feroli)
One thing I’d just kind of add
to that is: at least when it comes
to a standalone FinTech, one has to be cautious as to
the degree to which it’s just regulatory arbitrage, right?
Before FinTech we had financial engineering, that’s now
a dirty word, but they are very similar
sounding actually if you just say them, but I think we-
now realize that a lot of financial engineering was ways
to get around some of the capital constraints that were
being imposed. So I think that’s something that, I’m not sure that the regulators
are well prepared to address but it is something I think that we
should be thinking about. (Kim Schoenholtz)
Okay. This one is about the US… I assume it’s the
Federal deficit and debt, to what extent, or is the
debt likely to affect US economic growth prospects? (Seth Carpenter)
Boy, there’s so many really
simple models that give you a very strong conclusive
“yes” to that, the deficit is galloping higher
and higher and higher, and yet, in longer term, you know, ten
year rates are still at 2.9, so it hasn’t shown up through
the normal crowding out method that most people would think
about higher interest rates leading to less
investment spending, moreover, the short run/long
run version of those sorts of things is always a bit confusing
lots of basic models will tell you that expansionary fiscal
policy, which pushes up the deficit also can stimulate the
economy, so you have a short run versus long run tradeoff.
I think the things that I worry about… most are- are- are two fold
for the near to medium term. First is we were talking about
EM before and I’m firmly of the view and I think our strategists
are of the view that part of the stress that you’re seeing in EM,
though by no means all of it because I think the fundamentals
are absolutely clearly there, but the US Treasury Department
is issuing a lot of debt, it’s issuing a lot of short term
debt as short term interest rates continue to rise. And so
somebody is thinking about where to deploy capital you’re looking
at emerging markets where you used to get a much higher return
relative to Super Save US Treasury debt and now that
return differential has diminished, and in risk adjusted terms, boy
that differential is probably diminished so much that it may
be going the other way. And so this very large increase and
super safe, super liquid debt denominated in dollars is
probably contributing to the- to the stress of financial markets-
and in emerging markets. I think the other place where
I’m little bit worried is cyclical behavior and
the inimitable wisdom of the US Congress, so if you think back to
2009, there we are facing the worst
recession since the Great Depression. The worst recession
literally than anyone alive at the time it ever seen, and we
were able to muster the political will to have the
stimulus package of $780 Billion. Boy, we have to be fiscally
responsible! And then we got to the expansion that was kinda
weak, and we went through this need for fiscal austerity as a
political artifice to sort of rein in government spending and
so now when the political winds shift and we blow up the deficit
what I’m worried about is the next time we end up in a similar
situation, those very same cries will be given lots and lots and
lots of credence by lots of very respected and respectful
mainstream economists who say: “Well, you know the deficit
is going to have bad, long run effects
on the economy,” so you can’t expand the deficit,
and it’ll be the reason why once again we will have not counter
cyclical fiscal policy but pro cyclical fiscal policy making
the recession worse and making the expansion less robust. (Kim Schoenholtz)
Okay. I think it’s ten years ago today
the treasury put the Fannie and Freddie into conservatorship and it’s only ten years plus, a
little less than ten years since Lehman failed, so the question
is are we in a safer place today can we withstand shocks that were as big as those and
not suffer the same kinds of consequences? (Rebecca Patterson)
I think they’re safer, I think the banks are a lot safer, the
regulatory crackdown was large. You all of hired thousands of
compliance officers and done a lot with- with your capital, so
that’s a good thing. I think the consumer is safer and we saw
that some of the charts earlier where I see, I constantly look
for where are the excesses, where are the vulnerabilities,
and the one- and I think the IMF has done a nice job with this
and its global financial stability report is the
non financial corporate debt
and we’re seeing non financial corporate debt back up to pre
crisis levels, we’re seeing covenent lite loans back again,
we’re seeing all those same sorts of behaviors, and to me in
a surprisingly large amount of US companies today, they’re
barely able to make current interest payments with current
revenue and that’s before the Fed hikes three more times next
year, maybe once or twice this year, so I think we’re safer on a lot of
fronts, I think where the excesses build up is the
government debt and then the non-financial corporate debt. So I don’t- I think generally
were probably safer but not completely. I guess also think
about where the capital moved. When the banks couldn’t make the
loans as easily anymore, people still want loans so they went to
nonbank loans, so private equity shops, hedge fund shops that
aren’t regulated the same way. A lot of people who work there
maybe didn’t go through ’08. What’s going to happen when we
hit the next recession and you have a lot of entities who have
a lot of liabilities and maybe don’t have the experience for
the regulatory supervision, so I think that’s another area where
we might have a few surprises. (Seth Carpenter)
Very sympathetic. I would have
said we’re absolutely safer for exactly the same shocks that you
mentioned but for what the next version of shocks is it’s a
little bit less obvious. I think it… It is important to distinguish
between systemic risk and just lots of leverage that could
cause people to lose money or even potentially
cause a recession. Think the non financial debt build up is there
and has the possibility of being one of the things that could
cause a slump, seems harder for me initially to think about it
being the same systemic effect, but the less regulated, unregulated
financial system, you know those crazy entities that only have
one page disclaimers? (Rebecca Patterson)
Yes, I know, I know. (Laughter) (Rebecca Patterson)
Touche! I mean, but in the- but I think
this also ties to Mikes point about the phrase FinTech verses
financial engineering. There are lots of different ways to get
something that looks a lot like leverage but doesn’t always at
first glance appear to be leveraged to whoever’s
inspecting the books and I think that therein lies the issue is
that whatever is going to be the problem might not be something
that we identified very clearly the last time around. (Michael Feroli)
Yeah I’d echo the comments earlier, I think
the banks are not only better capitalized, they are more
liquid, they have more stable funding and I’d also say that
the non bank or the shadow banking sector is either better
regulated or out of nonexistent parts of it. So you
don’t- you no longer have large standalone… investment banks like Lehman
Brothers for example that were basically unregulated. The money
funds now are have face some regulation. They were big source
of systemic risk so I do think that the financial system itself is much more sound. I’d
agree with- we’re getting a little concerned about
corporate debt. I don’t see that as like a
financial crisis risk I do think that in the next downturn that
could be a headwind to a speedy recovery afterward. (Kim Schoenholtz)
It sounds like most of you were
answering that question in a domestic sense. You could argue
that the last crisis was sort of a North Atlantic crisis, US, Europe, I don’t want to overdo it,
I don’t think Canada really suffered that much, but what about Europe, is Europe
safer than it was a decade ago? (Rebecca Patterson)
I’m- I’m already thinking about
what I wanna write at the end of the year because EMU will have
its 20th anniversary on January 1st, and I was in
London when the EMU started when the Euro was born, I was one of
those people that did all the arbitrage trades between the
Italian Lira and the Spanish Peseta, was a lot of fun. Lots of currencies, was definity
more fun. I do think in Europe when you take it as a whole, the
size of the economy is close to the United States, when you put
it in aggregate. So it can have a meaningful impact on
the global economy. And I think it’s a low
probability but when you look at things like the Italian
government with its troubles the Swedish government possibly with
the political shift this weekend Angela Merkel holding on
to her coalition government by the fingernails and if Turkey
were let immigrants back in that could be a tipping point for
her. I mean there’s a lot of weaknesses there not to even
mention Brexit and the impact that may or may not have on the
rest of Europe, probably more in the UK, but at some point next year. So I
do think there’s some vulnerabilities there and as the
IMF always says, fix your roof while the sun shines, they
haven’t fixed their roof enough. They’ve still got some serious
holes in the roof and I worry that as we lose demographically
the leaders that understood why EMU was built, you know EMU
is a political construction to keep them safe and out of war
and as those people die and you don’t have that memory, the
populace doesn’t care as much about the project. So would they
be more willing to consider a breakup because it means
something different to them. So I do think there’s relatively
greater risks around Europe both kind of politically and socially
the next time around and then China. I mean you think about
China’s integration in the global economy today and it’s
just continued to grow over the last two decades if China hits a
pothole we’re all going to feel it more than we ever did before.
The correlation between Chinese and US stocks, while certainly not perfect,
has been trending higher since they joined WTO. We used to not care about
Chinese PMI, now we look at it as much as we look
at US, so I think an overseas trigger for a global recession
is a much higher probability today relative to what it’s been
in the past personally. (Kim Schoenholtz)
Seth, I think this question in
some sense is directed to you, because you spoke about trade
as being a serious source of risk for the US economy, near
term, but you distinguish between China related issues
and everybody else. This question is about
Canada and the US, if you can’t reach
a deal soon on extending the Mexican agreement
to Canada and having a new NAFTA in some sense, what are the-
what’s the implication for the US and for Canada? (Seth Carpenter)
Yes, so my baseline view there
is if Canada doesn’t get to yes to the bilateral
agreement such as it is between the US and Mexico, that will not
trigger the abrupt end of NAFTA, instead it will push off the
negotiations for another bit of time and then our baseline view
is that something looking very similar to the
status quo ante comes out in about a year because the
differences just aren’t really that- that big. So from a
macro perspective we don’t actually think there’s going to
be that much of a difference. If you actually got to the
point where NAFTA was completely torn up and we went back to
having tariffs against Canada like the tariffs we have against
China, which to me sounds absolutely implausable
politically as much as anything else, I mean that’s just
disastrous for the US economy, the amount of cross
border trade is mammoth and throwing a 20%, 30%
wedge into all that is just staggering. (Kim Schoenholtz)
Next one’s about the fiscal
policies of the last year or so. Mix of tax cuts and- and- and
expenditure increases most of this started 9 months
ago. That’s still short term, what are we seeing as the impact
today and what do you expect the impact going forward? (MIchael Feroli)
I mean in terms of the- the
tax cut, or the Tax Act, we think the
impact is about so far as expected which is to say we
thought the most notable thing would be, it would increase
consumer spending because it was about a $120 Billion
reduction in the federal tax burden on
the household sector and almost on cue you saw in the
second quarter consumer spending galloped ahead at about a
4% pace and it looks like it’s doing pretty well in the
third quarter as well. We’d expect going forward that
incremental consumer spending growth will kind of dissipate. Then the other big element of
the tax cut or the Tax Act, whether it’s a reform or
a cut, people debate it, was a big reduction in corporate
taxes as well as a change in how some other elements of the tax
code including the treatment depreciation credit and we were expecting that would
have a pretty marginal impact on positive but- but small impact on
investment spending. It’s hard to tease out exactly
you know how much that’s affecting things. So far the big
lift to capital spending in the first half has been in the
oil and gas sector which we think is probably unrelated to
the tax reform, but you know we’d say so far it
looks like it’s doing what we thought it would do which is to
add to growth this year about a little less than
0.5%. In terms of the other element of
fiscal policy, the bipartisan budget act which went into
effect in February, we were thinking that would
start to show up in the data and the economy in the third quarter
so far we haven’t really seen it in a tangible way so maybe it’s
yet to come later in the year. (Kim Schoenholtz)
Great. I think the first question is
really about the technology competition between
China and the United States. China’s unusual in a lot of ways
but one way which is unusual is that it- it has companies that
are at the technology frontier despite having a relatively low
per capita income compared to wealthy advanced economies. So
how do you see that tech frontier technology competition
playing out over time? (Rebecca Patterson)
I went over to China in July
this summer to meet with folks and just spend time on the
ground and talk to people
because you can read and you can talk to
experts when they’re visiting here but I always think you get
something from going on the ground. I think my my favorite
day there was in an area called Qushi which is about three
hours west of Shanghai at some high tech, I’m probably mis-
pronouncing it, I’m sorry, at a high tech manufacturing
plant and it was like the global supply chain right in front of
me. You had Korean chemical inputs, Japanese
robots, Chinese workers producing auto bumpers,
spoilers, grills for BMW, Mercedes, Land
Rover, GM for sale in China. And they have auto production
facilities here in South Carolina, in Detroit, in Mexico
with American workers, so again I think the- the
technology push there, the Chinese government- just think
every government leader has the same goal. They want to stay in
power. And how do you keep in power? Well you make the
population happy. How do you make the population happy? You
make sure there’s money in their wallets and that they have a
better quality of life, so in China’s case, if government debt
has grown so large that the government can’t simply keep
churning out money to get the growth, and you don’t have the
demographics there, technology is another tool they can use to
support the economy and keep the growth so the population is
happy therefore President Xi can be a leader for life. Well, it’s effectively what
he’s doing and- or could do
if he chooses, so technology is an important
economic tool for them. It’s interesting I was looking I know
Kim that you are the Japan expert in the room, but I was
looking at the trade war in the 1980s and it was
interesting to me that in 1983 President
Reagan instituted our own industrial policy to improve our
technology which is called Project Socrates so we’re saying
China shouldn’t be allowed to have a technology industrial
policy to help their own domestic economy and yet we did
the exact same thing a few decades ago because we were
afraid at the time that Japan was going to take over and that
we might be at risk from the Soviet Union. So those two fears
caused us to do something quite similar to what China’s doing
today. I think the difference with China and the US right now with the BAT verses
the FANG, there’s pros and cons we have a culture of innovation
we have a deeper research, R&D culture and bench which is
obviously a huge positive for us they have less government
regulation and no privacy rules so if the government says I want
all your data so I can look at it and try to get smarter off
it they have that advantage so I’m not sure- I’m not sure where
it ends but I’m- I’m happy to be looking for opportunities to
invest in Chinese technology just like I’m happy to look for
opportunist invest in US technology. (Kim Schoenholtz)
Great, okay. This one’s also a long run view.
How do you see the economic policies of the current
administration affecting climate issues and what do you think it
means for future generations? (Seth Carpenter)
So my day general take on these
things is two interrelated things are really really bad for
the climate: Unregulated economic activity
because if there are ever externalities they tend not to
be internalized unless there’s some sort of government force
to do so and we’re seeing a roll back in that sort of
regulation and then so that’s regulatory policy as much as economic policy, I think for the
other part though just the general economic policy if you’re not creating all the
right incentives for- for technological innovation that
sort of thing which is the sorts of, in my view, solutions
that could curb the longer run climate issues, if instead
you’re going for short term gains because of you know, short
term stimulus, you’re probably slowing down the process of
getting that technological innovation
to get there. I guess I would have thought
the first is probably worse so it would just be the outright
degradation of environmental controls, unfettered economic
activity that’s not internalizing longer term cost,
but the other probably matters somewhat- it is a bit more
pernicious. (Rebecca Patterson)
I’ll say something hopeful. I
think that the private, I mean, I’m saddened to see what’s
going on with policy around the climate in the US, personally I’m not speaking for
my firm, but I am encouraged hugely by the amount of private
sector corporate activity that’s going towards having greener
businesses, more sustainable businesses and I think as long
as that aggregate private sector activity continues and grows,
that this is maybe a setback but not necessarily a game
changer, especially for the short run. (Kim Schoenholtz)
Okay. We’re seeing a number of the
questions pop up again but
here’s one that’s sort of interesting: Do you have
the sense right now that virtually all asset classes are
expensive today? (Rebecca Patterson)
Venezuela’s cheap, man! (Laughter) (Kim Schoenholtz)
Compared to what? (Rebecca Patterson)
I wouldn’t buy it, sometimes things are cheap
for a reason. You know, equities, if, a lot of people talk about
cyclically adjusted price earnings ratios Schiller’s CAPE,
and if you look at that metric today it would suggest US stocks are very expensive. We’re
at the highest CAPE if you will cyclically adjusted P.E. ratio that we’ve seen since I
think around 2001, it was quite a bit higher at the
peak of the dot com boom, quite a bit so we’re not at
unprecedented levels, but we’re high but again it kind of goes
back to intuition. If we’re this late in the cycle and we’ve had
years of economic growth and we have strong corporate profits,
you would expect that valuations go- go up so yeah they’re
expensive but they’re expensive for a reason. We look at valuations as a
predictor for equity returns in over a 12 month or even
24 month view. It has zero telling power over a 5
year, 7 year view. Valuations today when they get extreme tend
to correlate with longer term returns because if you’re late
in the cycle the probability is you’re gonna have a recession
there which is going to impact your returns for a few years. So
your average annual return over that period will be lower. So I
think it’s fair to look for lower equity returns over the
next five years because it’ll be a recession in the mix. Is every
asset class expensive? I mean equities globally are more
correlate, so they’re all little more expensive and you want to
be careful looking for the outliers in emerging markets for
some of the reasons we already discussed. (Seth Carpenter)
One thing I would just
add into that, what’s hard, you know,
PE ratios, you’re always gonna be
discounting earnings by somethin, usually something
like ten year Treasury or some sort of longer term safe
interest rates and there I think the jury is still out as to what
the long run level is but if you take the Fed at face value they
think the long run equilibrium level of the federal funds
rate is about 2 and 3/4%. And then the term premium that
Mike alluded to before so the extra bit of interest that tends
to accrue to the longer term yields relative to short term
yields that’s just been trending down over the past 40 years literally, so for the
sake of argument say that the new equilibrium value for that
is something like 30 basis points or 40 basis points, not
the 120 that it was before. And then you add those together, 30 plus 275 is 305,
and then you keep in mind that, you know,
more often than not the short term interest rate is a
little bit below equilibrium rather than above, you know
3% is in fact the new long run equilibrium, 10 year, or
perhaps something lower, then I think what people are used to in
terms of valuation looks a bit different because you’re gonna
be discounting by something much lower. (Kim Schoenholtz)
So I think this could be the
last question, we’ve talked about a variety of political and
and let’s call it geopolitical risk, talked about Argentina,
talked about trade policy, are there other political,
geopolitical risks that you
would want to put on the list for people to think
about – and Turkey obviously? (Michael Feroli)
I’m not a European expert, but
Italy really worries me. I focus on the US but that is
something that concerns me, I still think the- the European Currency Union is
fundamentally unstable. (Seth Carpenter)
So, I worry about what I started
calling the- the convexity of political economy so, bad economic policies often
lead to bad economic outcomes, but bad economic outcomes cause
people to be afraid, worried and insular, which tend to lead to
bad electoral outcomes, which tend to lead to bad policy,
tend to lead to bad economic outcomes which tend to lead
people to be afraid and insular and defensive. And that for me is the kind of
cycle that that really starts to worry because it’s hard to know
why and when that spiral stops. (Rebecca Patterson)
I touched on that a little bit, but you know, the- it feels like this isn’t a US phenomenon, but a global
phenomenon, and this goes to your fear and insularity,
that the unease of around technology and globalization
that backlash creating a fear of foreign, foreign anything,
foreign trade, foreign people, foreign workers and if you look
at the demographics of the world that’s not going away,
so where does it end? You know we’re not having as
many babies in the west and China has a slowing demographic.
Their working population is shrinking, so how do we get out of this
feedback loop that Seth just described? It’s a longer term
issue it doesn’t affect your investments today but it’s out
there and I don’t see policy being focused
on it as much as it should be. (Kim Schoenholtz)
It’s a great point and if you
look at what standard demographic projections look
like, more than 90% of all the population growth on the
planet for the rest of this century will be in Africa. And people really just don’t
seem to know those basic facts so it’s a big deal. So I hope you’ll join me right
now in thanking our panel. (Applause) And we’re just putting up
for you on the screen the four additional events are going to
occur that the center is sponsoring this semester, so we
hope you’ll join us for at least some of them. The next one
that’s coming up on Friday the 21st, the second annual David
K. Backus memorial lecture. Darrel Duffy is a
distinguished Stanford professor is going to talk about a topic
that I think we’ll find some interest: No Longer Too Big to
Fail, so hopefully we’ll see some of you there, thank you
very much for coming today. (Applause) ♪♪♪

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