Surveillance: Possible Outcomes of Trade Talks With Spence

and I and Johnny has three Bloomberg terminals. But there I was on television this morning, and you know, I'm frantically dealing with yields in the yields lower in Europe. I don't even know who sits down next to me, so of course look into the TV camera and go and with this. Christopher Varone and dr was was was sitting next to me, A confused. I was a little bit confused. He leans over to me and says, you'd never do that to own center. Let's bring in Chet

and I shall wait more. Instanley's chief economist and clubiz doctor. Good morning to Chatting right to have you with us on the program, my pleasure. Let's just talk about it. The headlining you like this research piece, Policy dominates the cycle, which trying to get a hands around the next policy move from China. How do you frame that at the moment, Well, we think China is right now already implementing quite a sizeable fiscal stimulus that's about two billion dollars in size.

And if this straight tension thing escalates, we think they will probably do additional fiscal stimulus, and this time the fiscal stimulus will actually be more focused on public expenditure. What we saw the last round was a mix of tax cuts and public expenditure. But if pay tensions escalated, they'll probably not do more tax cuts, They'll do more

physical stimulus in form of spending. Why more focused on the public sector, because you know what had happened, and a lot of people are ask me, you know, did China always plan to extend this trade tensions for longer? My immediate answer and first impression is no, because you know they actually this time very much focused on the

private sector. Try to do these tax cuts, which supports the private sector, but now these trade tensions, if it escalates, it actually affects the confidence and so people will save that tax cuts and not spent. And so if you see the trade tensions are escalating and you want that growth number to look up, they will actually have to take control and do the traditional style more public expenditure. So many people are trying to understand where the China

is pushing on a string at the moment. And I'm wondering, if you control any kind of distinction between the debt cycle and the public sector and the debt cycle in the private sector, are we seeing two different tracks there, two different things happening. Well, actually, you know in China's case, um, you know, because there's so much of public sector in every part of the economy. When you're looking at debt sustainably, you just look at the overall debt to GDP and

they actually did have a control on that. In two thousand and eighteen, total let to GDP decline by five percentage points, corporate debt to GDP declined by eight percentage points, So they were actually able to achieve some success towards that. But I agree, if you do see trade tensions and an around of stimulus, you will see some compromise and

debt to GDP will rise somewhat. In two thousand ninety the Morgan Stanley Global call on slower GDP a tendency to lower yields has been extraordinary, almost a synthesis of what you and and Ellen Center and others have done there. Bring that over to what everybody knows on the street is your cautious equity call as well? Can you ever more with the news flow the last two weeks, Lincoln an equity market caution to I see a US two

year at two point one seven. Essentially the call from the equity side and fixed income strategy side is that, you know, even while we have some kind of stabilization in global growth, the reality is with this trade tension as the risk to the outlook askew to the downside, and so what they think is that the market is going to I saw this downside risk and that's why they are cautious on the markets. They're cautious on the markets,

and you have to be cautious on a slowdown. Is the FED aware of our quickly we're moving towards a rate cut call? Well, I think as of now things are fine, and I think the FED is in the right place. I wouldn't say that they are actually behind the curve and not observing this downside. I think they will come through very quickly if you see these trade tensions escalating for longer and it shows up in the

financial conditions UM index. So our view is that as of now, it's fine, but the financial conditions tight and the FED will come through very quickly. And we've got to work out the external inter internal forces affecting some of these economies. And I want to focus specifically on China. It's been quite hard to draw distinction between what China engineered themselves, the slowdown we have seen over the last year, and the slowdown off the back of the trade dispute

between the United States. How do you draw that distinction at the moment, Well, I actually have been different from consensus as its consensus has been saying that china slowdown was because they were doing tightening. So I don't think it was policy driven slowdown which they enforced on themselves. It was more really trade tensions that was the biggest problem for China's growth outlook in the second half of

two thousand eighteen. Let me explain what I mean. So if you see the credit growth, which is the most important policy variable we watch, it was slowing already from middle of two thousand and sixteen from your on your number of sixteen percent to twelve and in those six quarters until second first half of two thousand eighteen, its GDP growth was fine six point seven six point eight percent year on year. So the only time you saw that slow down was in the second half one straight

tensions escalated. So we think the private sector confidence took a serious not just only in China but everywhere in the world, and so it was really trade tensions that has caused the big story. This is really important because China's credit impulse is just starting to inflect up again. The provision of credit is a percentage of GDP just starting to flex time and some people look at that as a leading into cadfory economy. Are you saying it's

not this time around? Well, it is, but to the extent to which you if you don't get trade tensions solved, then that credit growth recovery will still not bring net net recovery in China GDP growth. So, as I was explaining to Tom earlier on the TV show, that there are two forces at play here, policy stimulus and trade tensions. Which one wins depends upon the duration of how long

the trade tension lasted. Trade tensions last for longer then we think policies similars will increase, but even that will not be enough to actually drive out And you went right where John Williams was in our conversation with him, Zurich, I think it was twenty four hours ago. Which is a loss of business confidence? Is Morgan Stanley observing right now? A lessening confidence which means less investment, less animal spirit among business. Absolutely, that's exactly what is going on right

now in the capex numbers that we see. So for for me, you saw that Germany today, John. And if you cat another transparent indicator, which is you aggregate global capital goods import from the trade data that you get, and that's contracting on a year on your basis, in the first three months of the calendar year, it's down three percent. You're on your versus one percent growth plus one negative three. What does that do to a leguard like global GDP number? Do we go back to a

three handle on global GDP? We are expecting global road to be three point two percent in the first quarter, down from four percent. Let me translate that, folks, that's low that's not three point two, is not three point eight? Found a question for your channel, how they manage the FECTS channel in China. We've seen some weakness come through. Is that weakness engineered or largely out of their control? I think it is more market oriented at this point

of time. I don't see a case for China to actually use this as a tool as a you know, point to discuss or debate on this trade at tension. So we think it is pretty much market oriented. Look, they don't run big kind of account surplus is now. So when you get this sort of market declines, you will see capital outflows, portfolio outflows, and that's going to drive some cut and sea weakness. So we think it is just that right now is the outlook on capital flows.

Thank you so much. He is with Stanley, head of Global Economics, and thank you unto all your team who are with this almost on a daily basis, it seems Morgan Stanley with I will suggest as a summary and more cautious call John. It's it's just exceptionally important to understand that the Washington capital's lost. So we really don't care what Appy Joseph Cohen thinks, and so we need to have somebody here who understands we are destined for

Bruins Blues Stanley Cup final. Yeah, this is Glenn holl And goal in a guy name or goes across the top, and only our next guest understands the importance of Ruins victory. Just just killed the Canes last night. It was such a big game. Took a resk. It just just fantastic. Okay, great player? Do you like that? Do you like my baseball? Sort of like lipool? I'm joking, I'm so good at one in you are honestly ice hockey in Boston. I

get it all right. I mean, as we can only talk to one gentleman from Gorman, David Coston, Goman, Sex's chief US equity strategist. Did you think we'd open a conversation like that? David? Uh No? But nothing here surprises me? Is that? Is that an insult in me? Or a tom? I think it's a group effort, is that? David? Let's talk about something I think is dominating the conversation, and I know you and the team have been focused on it too, input costs and how they're managed as the

year grows older. Just walk me through some of the conclusions you've come to us some of the research. Even the guys the team have been doing well. One of the biggest topics in the investment community right now is the rising input costs. Now, tariffs are the top of mind, but there are other aspects of the cost structure of corporations, one of which would be labor costs. Uh. And so from a social point of view, that is a good thing. People make me more money from a margin pressure. However,

that's the downward to squeeze on some margins. That's the one particular aspect that we're focused on a lot. You think the typical company, uh, something in the order of fourteen percent of its sales are devoted to the cost of labor. That's fully low. Did you think about healthcare costs, medical benefits, their salary, their compensation, all that's about fourteen percent of sales. And so there are some companies where that's at the low end, maybe five percent, and there

are other companies where it's the high end. Something like percent of the revenues are consumed by by labor. So I would say that's a sort of front and center. The tariffs are just a complicating factor or another attribute

of that. So as a investor, you want to think about it those companies that are goods producing as compared with service providing and if you have an option or not option, but if you would want to tilt a portfolio more towards companies that are services providing because they have less exposure on the on the labor class side, they have more stronger, less variable margins, they have better balance sheets, and most importantly, they are not going to

be subject to tariffs. When I say not subject to, they're much less affected by by tariffs, both the actual tariffs as well as potential retaliatory terrorists in the part of China. And when you separate it up that why service providing US is good producing, do you also find that the service providing companies are able to pass those kosts on instead of absorbing it through the maunchion. It's

not what you're finding too. Yes, And if you want to think about some of the companies that are in the industry, the industries that are there are more representative in the services categories you look at, software and services, media, entertainment, retailing, banks would be examples of service providing companies and the

goods producing sides. You'll see that in pharma. You look at the capital, goods, technology, energy, those will be on the other side, and they have more UH downward pressure on their in their business model simply because they're more goods producing. If you look at that another way of thinking about it, of the revenues of services companies are domestic, whereas the goods providing and something like and so that's non us, which is which is another challenge on the

tariff side. They cut their way out of this. I mean, I have heard about margin compression since Nixon was president, and you know maybe it was before that. That was around the time Bobby the Bobby Or scored that great goal you were faring to various Robert Or in his studio. You can see where this is great. You're like going, we got to get old Vetchkan back with having really the perfect cast for you. It is thank you, um, David Uh. We've been talking about margin compression for years.

It's finally here you claim what's different this time? What's different now? And why can't an industrial shop in the Midwest cut costs like they've always cut costs? Well, the biggest issue is UH on positive point where three point six unemployment rate the lower fifty years UH, which which is a positive from a social social point of view, but it does put upward pressure on wages vector on wage growth high. My colleague is our chief economist at Goldman Zax is also of the view and his forecast

would be that UH wage inflation is accelerating. And if you look at the quarterly conference calls, right, we just finished the quarterly conference calls in UH in the first quarter results and companies were enumerating and discussing the labor and this goes back to Chairman Paul I did the chart John while we're on the break talking about Bruins, No blues, Bruins were doing it. And if you take

trimmed mean like Cleveland mean. Yeah, I'm sorry, these are higher inflation numbers than a lot of the stuff that's being quoted. Can we talk about where consumer stiples fits in here, because some of the big consumer staples companies actually were quite successful passing through higher costs to the end consumer, lifting prices and actually getting some revenue growth as well. Where did they fit into old of this? UH?

The consumers stables area is certainly more exposed than a lot of others in our view, in our research, and so the preference would be h til portfolios more towards technology, particularly software. And if you think about the fact of the last fifty years, remember where the lowest unemployment rate

in fifty years. You think about over the last five decades, only one year have you had negative growth in real spending on software in this country one time in fifty years, and that is that took place right after the two thousand and one, right after the tech bubble collapse. Other than that, real spending on software in this country has

increased for for five decades. And so that would be an area very strong revenue story behind it, and they're able to absorb, uh, the increased labor cause this is one of those sencular growth stories. Is that essentially what you sang well. Secondly growth stories. Also, if we're concerned about the what impact triffs may have on the business models of a number of companies in terms of their their call structure, some companies are trying to diversify their

supply chains. That's one tactic to combat the potential risk of tariffs. Also addressing the issue of higher input costs. That's uh, that's the strategy we're focused on. Let's get back to the index level just quickly as we round out the interview, the work cous for narn ex recession in the United States? Have we seen the worst? Was Q one the worst? And can we avoid that? David, Well,

there were earnings recession. We're basically had positive two earnings per share growth for the first quarter year of a year. Expectation is you'll have modest growth this year, somewhere between three and six percent positive earnings growth UH in two thousand and nineteen. And that's reflective of the fact that you're going to be somewhere between one hund and one and seventy three dollars of earnings per share for the SMP five hundred. That would lead us to an endex

level to end of the year around three thousand. How does David Coustan define scale every C class officer, Now, we have to find scale, scale this scale that this is a roll up frenzy that we're going into. Well scale us offer the prospect of better margins instead. The big topic of on the investment community right now is which companies or which industries are able to increase those those margins. A lot of we talked about this morning.

So many companies are having downward pressure on their their margins. David constant us. It was a surprise. It was very happy with David just dropping bout a studio. I was shooting a video there. What I was doing was shooting Mr Costs just annoying. That's what coming. No, no, and then I came over you and then with with the video camera that we've got it. So the same thing that using Game of Thrones, I went through you and over you, just like Robert or going over Glenn Hall.

You know how you fail. It's very bruinsible when the youngest is running around the apartment driving you crazy. That's that's how I feel every morning, doing right. That's how much fun it is. John joining us now as a boomber Brexit editor. Emma Ross Thomas. Emma, So the timing is awkward right for the Conservative Party, because so she says she's going to bring this back to Parliament in ju ahead of that, we have the European elections. How will the Conservative do and how will Labor doink? The

timing actually is almost in her favor. She's she's one of the good things about the European elections, if you like, if you want to seek a silver lining, is that the Tories are almost certainly going to get wiped out by the Brexit Party, founded by Nigel Farage, the veteran Brexit campaigner. He's polling about thirty the Tories, and some polls are done at ten percent, coming into the fourth

or fifth place. So Jeremy Harten, the Foreigns actually said yesterday that maybe if they get a real drubbing, that that will send a message to his colleagues to just jolly well deliver Brexits. That does seem to be the sort of the main hope, if you like, is that the message from those elections will be you've got to get on with it, deliver Brexit, startling about something else. Um and the certainly inside the Tory Party has a view that the Brexit Party is the next essential threat

to the Tories if they don't deliver Brexit. If they do the didn't Brexit, then they can they can live with. But if the Brixit Party, which frankly it's just very clear what you're voting for, which is brexit It, if they win big in the European elections, does it not give inputs to for example, a Conservative Party, you know, possible leader that is that is pro Brexit to say, actually, Theresa may move out of the way. We don't even

like this deal. We want something much stronger in our divorce deal with the Yeah, I think it's very likely that the next step, if you like, is certainly the leadership race to reason mas deal. Probably I'm not gonna put numbers on it, but it's not very likely that it goes through. It's not very you know, people have become increasingly entrenched over in their positions over the last three years. Um. You know, I suppose that when I say that about the European elections, that's kind of the

only hope if you like. Oh, of course that she does actually offer the Labor Party what they want, which is a customs union and also a confirmatory vote. Again, very unlikely, and it would, you know, she would end up being killed by her party. So looking ahead to a leadership race, yes, probably Exeter is gonna is going

to win that race. But then he is stuck or he or she is stuck with the same parliament, a parliament that has voted repeatedly against No Deal, and so you know, it's not too hard to imagine that beyond that leadership race, you're then looking at a general election if they are going to want to renegotiate that deal. Emma, thank you so much. This morning, we'd like to have a three hour discussion with the Laureate Michael Spence of New York University. We can unfortunately not get you for

three hours, but we could fill it effortlessly. At well, we might point out that we celebrate with Professor Spence his new efforts as a special adviser to General Atlantic, which is, I know, uh, an investment shop that is always pushing the information in education envelope. Michael Spence, what a day it was when you won the Nobel Prize sharing it with the gentleman from Stanford and there's only one George Akerloft. I think Professor Taylor would agree with

that statement. And a guy named Stiglets from Columbia as well, and so much of Spence Stiglets Akerlof was what we don't see out there? What are we not seeing right now in the information flow of our brands spanking new trade war Well, I think we're confused, tom uh and we refused, confused mainly because we can't see what the objective function of the current administration in the United States is. And we have similar difficulties figuring out where where the

Chinese want to end up. So, for example, it's there's a group in Washington that would like to decouple our economies. There's a group that's concerned with national purity and defense and related things, and they might be sympathetic to the decoupling and a little insensitive to the economic costs of that. And then there's another rather large group, bipartisan group, who thinks, you know, that the thing hasn't been fair. We got a level of playing field, and otherwise we can have

normal economic relationships. And what we can't see I don't think it's possible to see now is sort of where we're gonna end up on that spectrum. Let's fold in Michael Spence with Jonathan Spence of Yale University, and of course no relation, right, no relation, no relation with the giant Jonathan Spencer, true scholar, our original scholars, some would say on China, uh, if we fold in the two Spences,

the mystery is how did the Chinese respond? And do they respond culturally and behaviorally or rationally and economically, which will it be. That's part of the uncertainty. That is part of what we don't know. So we think we we Jonathan and others who spend a lot of time in China think they're as as is true in every country. Groups. So there's a group that want the state to be a major part of the economy and that creates clashes

with interactions with our system. Um. There's a group that that wants reform and would be quite happy with some of the things that are being proposed and bandied about in the trade. And it's not clear you know, how that balance is going to come out. I mean it's pretty what. One thing is pretty clear is the old assumption that they would evolve and become more like a Western economy in terms of governance, the role of the state and so on. That's not going to happen, at

least not in the near future. Um. But there are great uncertainties. There's the I sometimes say the Chinese have gravitated from correct behavior, which was what the atic corruption campaign was about to correct. Thought, there's more uh willingness to intervene and prevent people from expressing diverse views on things.

So Professor from your perspective, what do you think as a reasonable deal at the end of the day, given you're not your understanding of the limitations on the Chinese government and what they can do, and given certainly our political limitations here, well, I think a reasonable deal is to pick off the stuff that's relatively easy. The Chinese, in order to achieve economic performance, do not need to

have theft of intellectual property. They don't need significant degrees of protection, and I don't think they need for the most part um to protect state owned enterprises and other parts of that as apparatus. So I think that, you know, if we can get over this, you know, you get to lower your tariffs and we get to keep ours or the right to keep ours kind of back and forth that we're seeing now, I think there's a reasonable deal in that area. Now, what what all insightful commentators

say is that's not the whole story. That we'll still have friction and surround the way technology moves around the world and between the two countries and so on. But but there is a deal to be struck that's mutually beneficial in that area. So it's interesting. The one of the issues seems to be UM enforcement that has always been a major issue here are is there any room for breakthrough and actually getting real enforcement of whatever is

agreed to? Well, for the enforcement issue comes from a long history of China agreeing to terms uh and then sort of ignoring them when it was inconvenient. Going back to the w t o A session, I think the Chinese realized that's not a long run productive way to

interact anymore. Um So, I my best guess is the way this is going to go is there aren't really hugely reliable enforcement mechanisms, but both sides are going to reserve the right to react to misbehavior on the On the other side, I've got to rip up the script and and go somewhere where I think it's surprising we

would go. Many of you may not know if you're just joining us, Michael Spence with us the laureate of New York University and a nodding acquaintance without to get from Palo Alta to the airport a few years ago. It's Stanford. You arguably invented modern graduate school, thought provoking

academics out at Strand Stanford a million years ago. I I would be honored to know your thoughts on people spending a jillion dollars to get their kids a fake sailor, or fake tennis player, or a fake whatever into these elite schools. How did you respond when you saw what parents would do to get their kids on the undergraduate gravy train of many of our our most spensy and institutions. My response was, I suspect the same one that most

Americans had, which is completely inappropriate behavior. What do we do with athletics at these schools? I mean, the heart of the matter is athletics was the vehicle the catalyst for this, this behavioral function of desperate parents, Well, it

was certainly the vehicle for it for it. So so you think of it as a vulnerability and the admissions in the integrity of the admissions process to UM and I think that the the universities and colleges in the United States, a vast group of very great institutions, will move to close those vulnerables. Stanford moved immediately, I mean,

you know, full disclosure for Stanford, they moved at light speed. No, that's true, but they But the secondary effort needs to be to introduce a sort of monitoring and control system so it doesn't happen again. They did, They did move right away. Can we also have an understanding, Professor Spence, that there's a select number of a jillion schools out there that can provide exquisite educations away from the thirties select schools. Yeah, that's my view of American My grandfather

called it Harvard on the brain. You know, that's what you know if my kid doesn't go to Harvard, you know, I mean Gates and Balmer where you're we're in your graduate class. They didn't even show up to class, did they Not very much? But they did rather well in the course. That's a that's a that's at the tale, the right tale of the distribution that the brain. How do we get ourselves away from this pressure to send a kiss to seven schools that you know are deemed correct? Yeah, no,

I I think this is very important. Um. My answer to that is I view the great strength of American higher education as the as the size of the really top flight institutions that I don't mean the thirty, I mean the three D five hundred, and they are state schools as well as colleges, teaching colleges and so on. I think part of the answer is we just keep repeating it and and tell and telling stories. I mean, there's lots of successful people, you know who who didn't

go to Harvard and Galel in Stanford and etcetera. Uh and and so I think we've just got to get the message. I like your effort is saying keep telling it. In a major shot at the Jonathan Cole of Columbia University, who was just truly definitive on this, Michael Spence, thank you so much. Laurd of New York University. Uh there on trade wars, and we'd like to get your back in to finish up the three hour conversation at some point.

I'd 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 Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio