Surveillance: Dollar Centrality Up Since 2008, Mallaby Says

the global economy. This all according to the International Monetary Fund, who want that overall market participants appear complacent about the risk of a sharp tightening of financial conditions, jointing us to discuss I please to say this morning in our studio here in New York is Sebastia Malaby, CFR, Senior Fellow for International Economics. Good morning to Sebastia, and great

to be with you. So let's get to that line from the i m F. Do you think investors are under appreciating the risk that financial conditions could tighten and what that could mean for the global economy? But if we focus on the US, I don't think that's true right now, because when you've got growth at four percent,

that can mask a lot of financial fragility. But if you project forward and you say, okay, this fiscal stimulus from the tax cat in December is going to be wearing off next year and into twenty by which time the Fed world have hiked a little bit more, and you've got a very fragile corporate credit situation. It's that interaction between the likely growth slowdown in and a highly

leveraged corporate credit picture. That's what worries me. Even if you didn't get a recession in because of the wearing off of the fiscal stimulus, and you just had a growth recession in other words, growth down at one percent, that's enough to start kicking the fault rates up and and and and credit could react. It's almost none austerity. Let's review this. I think this is important. Back eight years, what we learned about British austerity or Germanic austerity or

austerity austerity. What was the lesson learned? Well, first of all, it produced populism small detail, which is quite a big detail um. And second of all, it didn't really drive debt to GDP down much um. And so it's a struggle. You really need growth to be generated by productivity changes, which means technology and so forth, and we don't have a magic one for that. Um. So I think those

are some of the lessons. The trend, overwhelmingly for developed economies has been for debt to GDP to climb throughout the last ten years. Sebastian, I just wanted to what extent this sort of curtails some of our abilities to sort of respond to the next downturn, whether it be

financial or economic across Europe. In the United States, yeah, I think that's a profound issue that last time around, in two thousand and eight, there was enormous ammunition to respond, both in terms of fiscal stimulus and in terms of enormous monetary intervention. If you think about the next time, there are different constraints in Europe in the US, but

they're big in both cases. In Europe, the issue is that you might have a different central bank chief, not Marry a draggy but somebody more kind of a Northern European cautious persuasion could be ends vitamin of Germany, could be somebody else. Um. And secondly, on the other side of the table from the central bank in Europe, there might not be Maria Monty, who was a responsible, technocratic

Italian leader. There might be the kind of populous leaders that you have right now in Italy, and that would change the equation Sebaston when you think about the constraints. Though, at least here in the United States, there is some spere capacity and monetary policy to respond to a financial or economic downturn. In Europe that does not exist, both in fiscal both in monetary policy. And also I think something that doesn't get a lot of discussion is the

regulatory response. In two thousand and two thousand and nine, it was every country for themselves bail out the banks. It's gonna be very different if we have a banking crisis in Europe again. The ability see if some of these countries to actually do what they did last time. It's just not going to be there, is it. Yeah, And that's fundamentally why I worry more about Europe and particularly a flash point like Italy, than I do about

the US. I mean, in the US, there's a legitimate debate about the way that the Dodd Frank reforms curtailed the FEDS ability to act as lender of last resort. But hopefully a big dose of monetary easing combined with further fiscal stimulus, if you really had to do it is something that US can get away with it. Because of the dollars reserve currency status in the world, you can assue more. Dad. I mean, that's a really important

point in my conversation with Mada re Guard. This came up the part of Asia to finally move the exorbitant privilege over to China. I mean, that's a backstory in Bali as well. But through all of the Sebastian and frankly through all of your writings, we go back as you started staying in this idea. There is something special the dollars ascended. Do you see any change in that? No, I see absolutely zero post a fact of changing that.

I think the dollars centrality in the global system has gone up, not down since two and and this is so important. From Barry I, Canna Berkeley, and from Joseph Harvard, they agree with Mr Mallaby. But there is a real debate about this now, debate about they're just saying no where right. Dalio is weighed in on that debate as well quite recently as well. Sebastian and I just wonder whether the deficit actually matters. With this in mind, if we go from five percent to ten percent here in

the United States, do we just assume it keeps getting funded. Yes, I think we do. I mean the reason is that we ran an experiment in two tho eight, two thousand nine where the Chinese Central Bank governor put on the website a sort of declaration of trying to make the remand b international, trying to make the reman be a global currency. You know, ten years later, has the dollar been dethroned. No, it's actually more dominant. Why is it

more dominant. It's because fundamentally, countries around the world, and especially corprates, want to issue debt in dollars. And if your corporate sector has lots of dollar debt, the central bank needs to protect itself by having dollar reserves. And that isn't changing. And so central banks will hold dollars, and private wealth managers will hold dollars because the markets are deep and liquid and they have rule of law,

and because that's what the liabilities in. So if you're trying to cover against a run on your banks or on your corporates, you need dollars as your safeguard. Look at the use of dollar swaps after the two eight crisis. Everybody was screaming for dollars. So I think people are going to want to hold dollars and that gives enormous rope with which the US can continue to kind of hang itself and strangle itself in terms of budget deficits. Is that more true in a period of risk aversion?

We're still going to see this situation where it becomes by treasuries, by the US dollar when we go through a sustained period of risk aversion. Well, I mean that's exactly the paradox. You know, the US can create a financial cry, this a No. Eight and everybody's response is they want to hold more donnas. And I don't think that's going away. I think the U s can be irresponsible to create, uh, you know, some kind of panic and the response would be we want the US currency.

It's ironic, but it's the truth. Special Malloby, thank you so much, And I really can't say enough about a careful read of Mr Maloby's article in The Atlantic Magazine on growth in the latest Nobel Prize, roner Paul Rohmer of Stanford Quieter Markets today, we really like you can almost truncate back the data checks Brazilian Royle three point seven one yet to trade a day around that election, and John, I would suggest we've been exceptionally Asian centric

today with Bali, I m f all the China news and of course the guests we've had Lord Patton, the former governor of Hong Kong, and s Aston Mallaby and such. You know it Europe and there's I'm sorry and the crush of the news flow. There's a lot going on in Europe right now and I'm sorry all centers back

to this turmoil over populism, migration and such. I thought the comments from Matteo Salveni were absolutely amazing, like like essentially essentially essentially telling the market here's the line in the sand. It's four basis points over Germany and we don't think you're going there, which I just think is staggering that it's the one oh one of how not to communicate the financial markets at a time when you

are going through some serious stress. Um. I want to bring a class Fistess and Pantheon macro Economics chief euros Own economists to weigh in class, what did you think of those remarks from the deputy Prime Minister in Italy. Oh look, Jonathan, I mean, you have the nail, and I completely agree. This is really really bad. I mean,

right now Italian politicians are picking fights with everyone. And so even though you know, I could sit here and say, look, we could sit here and talk about you know, you have a current count surplus, you have a primary surplus.

This is not two thousand twelve. It's not that the macroeconomics are much better, but I mean, at the moment, seriously, with this kind of comments coming out, you know, the market is just going to poinst them over and over again, and and it's not clear to me how and how and why they step back. I mean, he also said something like, well, when we hit four hundred basis points, you know we're going to take actions. Oh who the easy beat? Now, this is we're in a very bad

equilibrium at the moment. I think we're going to snap out of it eventually, but at the moment, it's it's difficult. It's difficult. Let's talk about what four hundred basis points actually is. It's Greece. That's where Greece trades fo hundred basis points over Germany. And do you think you could

get that bad class before it gets better? Well, I mean, I think you know once I think, I mean, I think we have to we have to go with with the with the sort of the tenor of of of your first comment, namely that once you give a market something to aim for, they might get there. Now, I think that's a massive miss pricing Italian bondy's currently bondmarket

is currently are miss priced. I mean two yr yield shouldn't be above one percent um and and certainly I don't think ten yea yields should be should be as high as they are. But it's it's almost like they're welcoming in, right politicians. Is that if we're in a situation now where where the more they push and the more they think that it boasted their domestic political capital. So it's like they like, it's like they welcome. Right.

That is not a good idea. We had a wonderful magesterial conversation yesterday with Janice Vera Facus who's got an acquaintance with crisis in real time and particularly negotiating with Germany, the Netherlands and France, the other core countries and one of our basic themes was Greece has got to be

different than Italy. And he was fascinating about how Italy could mess this up from a pantheon economics basis, do they have the structure in Italy not to mess this up the institutional linkages of politics, economics, society in their banking system is Italy not Greece. Um No, Italy is not great, And I think and sometimes mess of our funck is he He was right when he said that what they should do is to use the fact that Italy is the third biggest economy in eurosine so they

pull some weight in terms of the rules. But obviously they've jettisoned all that by now. So now, unfortunately, we are in equilibrium where you know, you play tis chat with the with the Commission. The e c B had already abandoned you because you know they can't help you. So now there's a risk that you know, this escalates.

I mean, what I will say about Italy is that you know, the macro economics are just much better, right, I mean, it's like this is not we should not this is not a stable equilibrium from a macro economic perspective. We should not get here right, two point four percent in two thousand nineteen, you have a primary surplus at one point five If you are growing and unemployment is falling, your external accounts are and surplos. I mean they should

not be as bad. But I mean, once we're in this overshooting environment, you know who knows right, so and then and the next year to dou will be the rating aggies. They will come in and some of them will jump ready to be. It's so frustrating from the outside looking again when you see the European officials and

the Italian government essentially arguing over tens of basis points. Literally, I have fifty basis points at a budget deficit and probably not even This is what the argument essentially comes down to, Klaus, And they're risking another crisis for it. Is it worth it? Yeah? Yeah, no, no, it's not worth it. And you know, some of the blame has to have to put be at the EU as well.

I mean, it's odd, right that every time we have one of these negotiations between a southern European country and the EU, it always ends up like this, and there's no reason. And by the way, the Italian people will pay right because I mean, let's just let's go run through the economic year. This will start to hurt next year with a lag like you have two year yeards one Rachel will go up with a lack banquets bankalown rate. Of course they will. This is like, this is just

one of one. We know this, but the first half of next year Italy. Italy could be close to recession if this continues, because it growth is al really very low. I mean, it's just amount of time before just make that conclusion. So how does Mr Drug respond to this? We have an historic headlined out of the Bloomberg that they're going to keep rates where they are until I don't know, on the edge of freezing over I guess late summer of next year. Can that be derailed by

this tumult in Italy? No? Uh well the rates maybe not chewy, but yeah, I'm fair of the rates next year obviously, yes, I mean in some sense if Italy falls, really if the Italian economy retakes a knock on the basis of this, this is obviously going to feedback through to the Ecbach reaction function. Growth going to be lower. So yeah, that that that could be through. But then

again we're playing for time here, you know. We we don't have to have that discussion until at some point in the first half of next year, but not a

queys ending. And at the moment, the ECB has been paced into a corner, as it did with Greece, in the sense that when you have a faceoff like this between the EU and and and a government needs to be just have to kick back from So I think some people would also argue that the e CP have put themselves in a corner, and they did it several years ago, unto John Claudritie, when they were responsible to some extent to introduce read denomination risk into this market

because they didn't behave like a normal central bank. Are they going to continue to behave like a normal central bank now? Well, I mean I think I know, I see your point. I mean that that that big, that that that that great high. But I mean what the ECB can do right, What we can do is the ECB can help the Talian bond market if there's an

actual miss pricing. But if that miss pricing because Italy is flirting with the idea of leaving the Eurozone, or if markets believe that that's true, I mean you're you're gone. I mean, then you don't have the ECB anymore by definition when you leave the Eurozone. So one, the fact that we still have this debate, which is incredible to me, that just means that that the e g B is really just I mean, listen, the e g B should come in hard on Italian two years, you'll say. In

my views, they should just smack that down. It is a violation of the e CBS forward guidance. Yeah, it has. The Italian two yields has no business being one point. But there are two Eurozone happened crisis hangovers. Class as you know, there are two Eurozone crisis hangovers that still exist today, and one is to do move between the banks and the sovereigns hasn't gone away. You see it

in Italy. The other for me is that Italian peripheries, and just peripheries in general, sovereign debt in Spain and Italy, Portugal, Greece still trades like credit. And to what degree when it trades like credit, does that curtail the populist ability to really take this fight and have this fight for a sustained period of time. Oh no, it does in some sense that that again really is a really good point. The fact that the bonds trade like credit obviously in

some sense empowers the EU and empowers the EP. Just all right, let them run. Oh yeah, we'll see how far they get, because at the end of the day they end up with having to pay the pride. And I mean, I'm very clear in my base case. If we start to see growth slowing and bank loan and variable mortgage rates time to go up. Let's see how the balls do and the first time make year for Salvenia and Demo Claus. Thank you so much. Close Festal

with Pantheon. Really good update there with us right now a gentleman that certainly within banking and finance and banking legislation needs little introduction. Michael Mayo as this week as wells Fargo as well. Before we get the banking earnings and all that. H ARE four one zero five is an attempt to bring Mike Mayo sensibility to Washington. What is it and is it gonna work? So this is HR four zero one five the Core Governance Reform Act, also known as the Mayo Act. Well it's the Anti

Mayo Act. This is the Corporate Governance reform. Having covered the banking industry for the last three decades, seeing the abuses that have taken place. As you know, Tom, I've written about this in my book. You've been fired over this, continue exactly and you know I testified to Congress over this. So if you hear Corporate Governance Reform Act, I have

great ideas for this. But what this act would do, it's it's cracking down on those advisors that advise shareholders on how to vote and so the so it's proxy advisors, it's Institutional Shareholder Services, Glass, Louis Egan, Jones, a couple other small ones, and what they do is they advise shareholders to vote when the main questions for every annual meeting. And now the um you know, the this bill as we're going to crack down these proxy advisors. We're gonna

make because that's what the big banks want. Right. Well, I'm not I'm not saying big banks or other banks. I'm just saying for me, as someone who represents shareholders, I've done that for the banks, and this applies to all industries. What this would require is that the proxy advisors, before they publish their research, they'd have to show that research to the companies, and the companies could say, hey,

this isn't quite right. The companies still agree, then the company view would be listed alongside the views of the projects. Come to the chases. This act good for Jamie Diamond. Well, you know, I say I change it around. I say, does this pass the city group test that? Well, by by that, I mean so if a proxy advisor wants to conduct research talking about city groups pay, then they'd have to check with City Group. If they want to conduct research saying we should separate the CEO and chairman job,

they'd have to show that to the city group. If they say we want to have a shareholder value committee to get these are already shareholder proposals that they're giving recommendations on. So if they want to give recommendations that

they have to show their research. So for City Group, for the last two decades, the CEOs over two decades have gotten paid for um, sorry, I've gotten paid an average of twenty million dollars a year, four million dollars while the stock's gone down, While the stock's gone down by at a time when the SMP has got up two to threefold. So you know, if if I assess or Glasslows wants to write about the pay at City Group, they'd have to show that research to City Group before

doing this. This is the anti Mike Mayo by all means, Ferre scrim over times in England gave him a lot of time. Has gone a bit of a rant, didn't we It's okay, it's as a friend of Oz, he can do that. But you know, if I'm ad Egan Jones, do I need to show my research at whatever bank before my imagine we can we talk about the earnings that come this week. A bit of a rant now about some of what is going gone down in Washington day see with the regulation still bullish City City Group.

It is our number one idea you have. I think that the main course for City and all the banks should be decent. I mean you have good cause control, good credit, good cath return. If there's a concern out there, it's that you don't get that dessert, the extras of you know, extra margin increase, extra long growth, extra capital markets, the extra animal spirits that should come after the tax cuts. I prefer having a little bit less revenues today and

much more sustainable growth. In a way, it's the the opposite before the financial crisis from people celebrated revenue growth only for banks get hurt later. Now you have a little bit less revenue growth, but it's sustainable. You'll really bullish on the structural story for banks in America. Can you just build on that framework, because we've got a bit of time with you this morning, and then we can get deeper into some of the stuff you concerned about.

Just why is the structural story for banks right now so favorable for the longer term with a much longer time a rising here. Well, I appreciate that question. There's too much short termism. And so when we look at the banks, despite you know, to be some cyclical softness, you have um the cost uxture at banks. If you're reaching a twenty five year structural breakout for the benefits of scale. It was when US banks were first allowed to expand nationally. You're seeing the benefit of that. There

was the scale. Now you're seeing a structural reduction in risk. That doesn't mean loan losses aren't going higher. That doesn't mean there won't be problems, but you've seen incredible de leveraging and de risking. And so we think while lawsuit will go higher, they won't go as high as in the past. And then lastly, capital RETURNE. You have record capital return at the bank, So I guess you could you know, called this the three cs, credit, costs and

capital Very good. That sounds like there's no research report. Michael Mayo with well, let's talk about perhaps detail or lack thereof when it comes to some kind of divorce settlement between the United Kingdom and the European You and you're sterling up. Yes, perhaps a deal in the making. Amanda slot Brookings Institution, Senior Fellow in Foreign Policy Center on the United States and Europe. Amanda Slote, what do you know about a potential deal? Well, all eyes are

certainly on London and Brussels at the moment. Next week there's a meeting of the European Council, which is all the leaders of the European Union, including the British Prime Minister. The hope had been that next week's meeting was when a Brexit deal was going to be finalized. People are increasingly pessimistic that it may not be finalized next week, but may require another special session in November to wrap things up. What are the specific sticking points is it

still the border with northern Northern Ireland and the Irish Republic. Yes. Absolutely. A lot of people have been coming out and saying about eight of the withdrawal Agreement that divorced settlement is complete, but the continued inability to determine how to handle the border with Ireland remains the major sticking point and actually

could still prevent a deal from ultimately being done. Now there is a report that David Davies, who is a Member of Parliament and has now stepped up an assault on Theresa May's Brexit plan, says that the Conservatives the Tories would lose the next lession election unless Theresa May's exit plan is scrapped. Is that just politicking? Well, there's

lots of politicking from all sides here. Theresa May has to get a budget through Parliament at the end of the months and so some are threatening not to support the budget if they don't agree with her brexit deal. She held snap elections after she became Prime Minister following the resignation of David Cameron, who lost the bregsit referendum

was disastrous for her. She lost her majority in Parliament and is now dependent on the Democratic Unionist Party is the hardline unionist in Northern Ireland and they are actually making it much more difficult for her to get a deal through Parliament as well. So lots of different political interests from lots of different political parties, and John Bayner had a way to do this under the US system.

Are Kitty Donaldson and Jessica Shanklman have a smart article Amanda today about how the Prime Minister has to go find labor votes. I think this is something our our American audience and certainly I miss all the time. A party leader, a Conservative party leader in this case, doesn't just wander over and get labor votes, do they. No, there's certainly a massive whip effort that's underway to try

and get agreement. I think there's people within the Labor Party that we're not supportive of the idea of Brexit, but they recognize that a no deal for the UK is going to be even more disastrous than UH something that they might not fully support. So you raise the point there's a question of whether the UK and EU can reach agreement on a deal, but then the UK Parliament has to accept the deal and it's possible that this could fall apart at at that point as well.

But but the key thing for Americans I think is Prime Minister May. Can she go get labor votes? And if she does it, does it? Is it political suicide? You know? I think there's there's likely to be some sort of election after this anyway, you know, you've got

lots of of churn over this. The problem for some of the Labor supporters as Labor is led by Jeremy Corbyn, who's a Democratic Socialist and so one of the things that keeping people in line is the idea that him as Prime minister might be even worse than Theresa May as as prime minister. So with all of the jostling in the UK cabiniche, with all of the unhappiness by David Davies and others, people have to be very cognizant of what the political alternative could end up being. Amanda.

No matter what we describe today, something will happen by March of correct, Yeah, something will happen. There either will be in agreement, there will be no deal in the UK will crash out of the EU and have to return to w t O rules. Or third, people are continuing to talk about whether you have snap elections. There's a continued push for a people's referendum, but those things

seem seem less likely at this point. Okay. The reason I ask it in that way is that there is going to be lingering feelings on both sides of this issue, and many of these politicians are still going to be politicians. And I want you to focus, if you can, on Scotland for a second, because the word is that Nicola Sturgeon, the head of the Scottish Nationals Party, says this is going to make independence for Scotland unstoppable. I think you're

absolutely right. This not only is having implications for the UK's relationship with the EU, but it's having domestic consequences across the UK. People in Scotland voted overwhelmingly not to go forward with brexiti of them wanted to stay within the EU. There was a referendum in Scotland on independence in which failed, uh and there's been questions about whether

or not this makes Scottish independence more likely. Opinion polls have not so far shown a massive swing, but there certainly is a feeling that if Scotland gets a bad deal coming out of Brexit negotiations, particularly in terms of where powers from the EU that are being repatriated to the UK land. Uh, it is possible that that sentiment could grow in Scotland for another independence referendum. Recently we heard that Unilever has decided to maintain its headquarters or

dual headquarters in the UK and in the Netherlands. Is that the exception that proves rule that many companies are looking to leave the UK. I think a lot of companies have been caught in a really difficult position because even now, as you said, less than six months away from when breggsit happens, is very unclear what a deal looks like. And so I think a lot of companies have taken the decision to hedge and so for some

of them that has been to relocate their headquarters. For others it has been to to open multiple headquarters, keeping one in in London and one in elsewhere. And so this is is creating a tremendous amount of uncertainty for for businesses. Okay, you came out of Lansing, I get it, and then you went to the gorgiosity of Edinburgh, Scotland, right, that's why about scott I know. But the bottom line is is people want to live in Edinburgh. People want

to live in London. Right. The real issue here for companies like you and Levers, that's where people want to live, right Sure, where people want to live, but I think also where they're able to get economic certainty on what the rules of of the road are going to look like. I mean, London certainly is going to remain a significant financial center, but there is so much uncertainty at the moment about what the future relationship between the UK and

the EU looks like. What everybody has been negotiating right now is the divorce settlement. What they also need to come some ways towards within the next couple of weeks and then hash out during this twenty one month transition period after next March, is what the future relationship between the UK and JUST looks like. Do they have a trade agreement? Uh? Does the UK follow EU customs rules, regulations rules? What? What does that look like? Amanda, Thank

you so much, Amanda Slope with Brookings on Brexit. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at I'm Keene. Before the podcast, you can always catch us worldwide. I'm Bloomberg Radio