The Global Economy in 2019 and Beyond

what we should be worried about. Welcome to Benchmark. I'm Scott landman and economics editor with Bloomberg News in Washington. Joining me as guest co host is my colleague Peter Koy, who is the economics editor at Bloomberg Business Week magazine in New York. Peter, glad to have you on. Thanks for having me. Now this is a good time to take a break from politics and look at the global economy. We're fortunate to have someone with deep experience doing just that.

Katherine Man, chief Global Economist for City Group, position she's held since February. Before that, she was chief economist at the Organization for Economic Cooperation and Development. She has also held positions at the Federal Reserve Board, Council of Economic Advisors, World Bank, and Peterson Institute for International Economics here in DC. She's in our New York studio with Peter right now. Catherine, thanks so much for joining us on Benchmark. I'm really

pleased to be here with you, Scott and Peter. All right, well, let's start with the US now, just to get this out of the way. Did you make any adjustment to your outlook after the mid term elections? We haven't done that yet. Um. The schedule for our outlook actually goes into a twenty nineteen review, and there are a number of issues that need to be addressed that actually aren't

related to the outcome of the mid terms. In particular, there is this question about the so called fiscal cliff that is actually in the data, but it becomes an issue in So what that's all about is that because of the budget rules, when the budget was originally passed in the early part of this year, there were some rules that with a certain number of votes that were cast, there had to be caps put on spending and those

caps bind in. Now, what that means is that, according to our current projections, the US growth would be two point eight percent in and then would drop to one eight percent. That's why we call it a fiscal cliff. Now that's predicated on these caps binding. Now, one of the things that we've learned is is that on a bipartisan basis, when caps like this bind, both parties agree they don't think it's a good idea for them to

bind in a presidential election year. So we are currently reevaluating the trajectory for US growth that goes for the rest of this year, of course, but also into and the trajectory could be different depending on whether or not we see the fiscal cliff binding, or whether we think the fiscal can will be kicked down the road related question, would you then think that the US is likely to be an engine of growth for the world economy in and and what about Well, the thing that in we

of course still have quite a bit of the fiscal stimulus, both the tax cuts and the spending those are still playing a very important role in the driving US growth in and whether or not that becomes an engine for global growth depends a little bit on the configuration of trade policy. It also depends a little bit on what might be happening with financial markets and potential turbulence and financial markets coming from normalization of monetary policy. In other words,

what the FED decides to do well. Then let me jump right to a FED question. Do you think the Fed will be able to keep the expansion going by preventing overheating without accidentally causing a recession. So there's a lot of fiscal stimulus in in the U. S. Economy next year, as I as I said, and so the risk of overheating is a little bit more than the

risk of recession. And even if the Federal Reserve keeps on the path that we think that they're going to do, there's still plenty of momentum in the U. S. Economy. I think one of the things that's most important when thinking about the challenges that the Fed faces is that, on the one hand, UH, they need to move on the path of moving the policy rate, that's the so called Fed funds rate. It's uh, that's the thing that

they more or less control. It's the thing that they talk about at each one of their meetings, and they need to increase that rate sufficiently to ensure that risk is properly priced in financial markets. Right now, when we look at the financial markets, we can see, for example, very risky investments UH that are that don't carry extra return. The way it's supposed to work is that if you're it's a risky investment, you get a little more return for it. And right now we just don't see that

happening UM. And so the financial markets have not yet priced in UH the full range of policy moves that the Fevrual Reserve says that they're going to do in UH. There may be turbulence associated with the repricing of risk. That's also it could be in the equity markets, it could be in the high old bond markets, it could be in exchange rates. There are a number of different places where we might see a repricing of risk. But

but that could cause financial turbulence. And what matters is from the standpoint of what the FED has to worry about is does that financial turbulence feedback into the real side of the economy. So so we've already seen some of that in the last few weeks. Is that do you do you think that's actually going to happen or do you see how much of a risk is it? So we've we've certainly seen some financial turbulence. That's absolutely true.

And one of the things that that we look at very carefully is will that financial turbulence feedback into the decisions on the part of businesses to continue on their path of investment, and will consumers look at financial turbulence and say, Wow, I'm not sure I want to open my pocketbook for Christmas. So this, this response of real side business investment and consumer to decisions to financial turbulence, is a key element of something that the FED pays

attention to. It's something that we're looking at, Now, what do we do and what have we seen? So what we've seen by looking at the data is that consumers by and large are ignoring what's happening on Wall Street. They don't most of us don't have large wealth portfolios, and so when you know, the stock market goes up, they don't feel richer. When the stock market falls, they don't feel poorer. So what they care about mostly is do they have a job. Are they getting a good wage?

And of course we can argue about whether or not the wages are high enough, but certainly employment conditions are very good, and so consumers buy and large are feeling pretty good. Sentiment is pretty good, and they are spending business investment. We can also make some distinctions between firms that are domestically oriented and basically don't care about Wall Street because maybe they borrow from a bank, but that's about it. And those businesses are feeling better now than

they have for a decade. UH. They see the demand around them, they see that they're having trouble hiring workers, so they're they're investing. They're investing in capital that either complements the workers that they hire or substitutes for the people that they can't hire. So that group of business is continuing to invest. The wild card, UH is the businesses that are globally engaged and so they're very worried about trade, and they're also financially market engaged, and so

they're very worried about turbulence. And so watching that set of firms really carefully about do they pause their investment decisions or do they power through what is a turbulent external and financial environment. That's really the key for the prospects for the US economy going forward. Catherine, let's turn to the trade war. You mentioned it briefly. What's it doing to the U s economy and what's it doing

to the Chinese economy. Let's talk about China first, because what we've observed is that the Chinese economy was slowing before the trade war started to heat up. Uh. Now, part of the slowing and the Chinese economy was expected. The policy makers there were undertaking a strategy of trying to clean up the financial system and to consolidate the state owed enterprises that consolidate them at least a little bit, and so we expected and they expected that h fixed

investment would start to decelerate. What they had hoped was that the consumer would boy up the economy, So investment we decelerate, consumers would accelerate, and that that would rebalance the economy towards a more consumer oriented um economic growth rate, which is thing that they've been intending to do and

wanting to do for a while. Unfortunately, what happened was that consumers started to look at their wealth portfolio, looking at real estate in particular, and they saw that real estate prices were coming down, so they said, I have

a wealth shock. Secondly, the constraints in the monetary trying to control the monetary side of the economy was hurting small businesses relatively more than the state owned enterprises, and those small businesses were starting to shed workers, were starting to fire workers, and so consumers, rather than boiling up the economy, were concerned about employment, and they were concerned about their wealth, and so they decided to decelerate consumption.

So instead of consumers buoiling up the economy, they also were decelerating. So you layer on top of a decelerating investment climate a decelerating consumer climate, you will are on top of that a trade war. And so Chinese economy has got problems. Now they have implemented a wide range of policies to address both the investment side as well as the consumer side, and some special policies to try

to deal with the trade side as well. But it is the case that the economy is slowing and they are working hard to uh to change their trajectory to resume growth. And what about the U. S. Economy on the and the trade war? Right so on the on the trade war for the U. S. Economy, what we've seen is is that the impact on the growth rate in the U. S economy is not is really almost irrelevant. On the one hand, the there is some substitution. In other words, instead of buying an import, you buy a

little bit more of on the domestic production. But on the other hand, you know, there has been trade retaliation as well, and so what that has done is has tended to unwind any benefits that might come from the from the trade war. It's also the case that frankly, the U S economy is much more of a closed economy buying and selling internally, and is much more services oriented,

which primarily is locally produced. So on the sort of the GDP side of things, there's not a lot of evidence that the trade war has had much of impact. Now on the other hand, on the inflation side of things, we are seeing an impact of the tariffs coming through UH, particularly the intermediates. Remember there's a lot of tariff put on steel and on aluminum. We are starting to see some of the impact of some of the other tariffs that it were more recently put on the ten percent tariffs.

With the prospects for the tariffs to be put on the two fifty billion dollars worth of Chinese imports, we are starting to see um some pressure coming up on inflation. And the question going into is how much of that bubbling up of inflation that we see coming up through the costs of production. When will that start to emerge on the top line in core inflation and headline inflation. And we think that coming into the first of the year that one of the important changes from eighteen to

nineteen is that in companies had a tax windfall. They got this big tax cut and it wasn't expected, and they're able to use that tax windfall to protect their margins this year. Next year they'll have a lower tax rate, but they won't have a tax windfall, and so they'll have to start making a decision do I pass through these tariff increases, this tightness in the labor markets? Why passed that through? And they certainly have been talking about

it a lot. You can read the Beige Book, earnings calls, UH surveys, there's a lot of talk that firms are testing the waters for do I have pricing power? Really tight market situation that they're facing. UH, that's one that is conducive to having pricing power. Katherine China. Going back to China, its currency keeps falling. Can China afford to let you want to appreciate you above seven to the dollar? In well, there are a couple of different ways of

thinking about this that that I think is important. One is that a lot of the Chinese products are invoiced in dollars, the trade products there and the imports and the exports are both invoiced in dollars, So the red men B doesn't really affect that, okay, And the red men B two dollar is not the only exchange rate that the China should care about, because of course a major customer is the Euro area, and so when the r and B depreciates against the dollar appreciates against the euro.

So there's a little bit of a of a wash there. And as they said that the invoicing also essentially offsets some of the exchange rate effect. The other thing to consider, though, uh and it's certainly irrelevant and probably more relevant question is how does the R and B dollar affect the financial side of the economy. The Chinese enterprises have borrowed a lot in dollars, and so when the RMB dollar changes, that is a direct hit on the financial side of

the economy. And so if we think about the balance of risks to the Chinese economy, the risk coming from the financial side and the much more costly servicing of dollar debt in the face of a depreciation of the R and B that financial risk offsets whatever they might get on the trade side. So a lot of people think that seven you want to the dollar is sort

of a red line? Is that so that that sort of has been put out there as an important watershed for many people the view of the our our folks in in in who are closest to the situation there is that, uh that not that shouldn't be thought of in so strong as terms. Yeah, all right, And then one other question again on China. You talked about how it's slowing down, but how much will it slow down?

Will China's Chinese leaders put de leveraging on hold next year to keep growth from falling below six Well, they've already started to sort of dial back some of the things that they were doing directly associated with trying to clean up the financial sector. So that has already um

kind of the trans lsstination on that one. So and they're and they're definitely trying to focus credit allocation more to the private owned enterprises, the ones that have been constrained the most by the policies that they had in place to try to again, the objective was to clean up the financial sector, so there's a little bit, there's definitely a dial back on that. And as I say, there's also a wide range of what ends up being

fiscal policy. U tax cuts to promote consumption, and consumption support through various other types of taxes, and then some relaxation of constraints on bond issuance by local government. So these are all fiscal policy measures that are also being put into place. The view is is that these are going to be sufficient to offset the deceleration that's coming from investment and consumption. And we shall see, we shall see. They have a range of policies that they've been able

to implement in the past. I think, I think we all I'll appreciate that the effectiveness of those policies tend to be less effective, as you know, as you use them over and over again, and so there is some concern about the effectiveness of the policies going forward. Would your estimate be that China will maintain growth of six percent or better in twenty nineteen, at least reported that's that's we certainly have, um, we certainly have better than

six percent. Okay, Katherine, The US and China obviously the two biggest parts of the world economy, but I did want to try to hit a few other places before we wrap up on our podcast today. Quickly on Japan. It still is the third largest economy. Are they on the road to revival or are they going to be stuck in low growth, low inflation for the foreseeable future. So the economy has been doing better, they have achieved more positive rates of growth, they've achieved some positive inflation

um sort of gotten out of the deflation slump. One of the important ingredients to getting to them at to getting to that point is the Olympics. The Olympics have been an important driver of business investment. Now we are hoping and and they are having in place the policies to make that catalytic, in other words, not just one off shot to to do investment for the Olympics, but to catalyze more generally positive rates of growth. Of course, face a big challenge associated with their desire to put

their fiscal accounts on a sustainable trajectory. Of course, a component of that is the value added attacks increase. And now the plan is to put into place a variety of mechanisms and other fiscal policies that would um offset to some degree the consequences of the value added tax cut. But of course if you do that, then the sustainability of the fiscal trajectory is also put at risk or or not improved so much so they definitely face some problems going forward to achieve um a path out of

their current fiscal situation. Staying in Asia, what do you make of the clash between Prime Minister Modi of India and the nation's central bank. The Indian Central Bank has really achieved quite a bit of independence over the years and that's been an important and are to support the

growth in India. And the lessons that we've learned from a number of different episodes over the years is is that it's important to have a good relationship between the government and the central bank, one that respects each other's sets of policies, and that the independence of the central bank is it is an underpinning of a stable macroeconomic

growth trajectory going forward. So you know, it's it's one thing for politicians to kind of comment on on central bank independence and central bank what the central bank is doing there? Should you know, communication is always reasonable, But but you don't want to undermine the independence of the central Bank. All right, Let's go from one hot spot to another, over to Europe. A couple of issues weighing on the European economy, Brexit and Italy. What you see

as the percent chance of a Brexit that produces no deal? Uh, you know what's going on right now and what what kind of result do you see happening um for both the UK and the broader European economies. From day to day we get different pieces of information about what the prospects are for for bregsit. It's it's a little bit like watching glasgrow. So it might have even changed while

we're while we're talking right now, Yeah, exactly. It's when I described the shape of the distribution of uncertainty about Brexit, it's a flat distribution. In other words, it's how do you make a bet because you have no idea exactly how it's going to end up. So it's a slow burn. It's a slow burn, and then there will be an outcome. Now, of course, the outcome might be we stop the clock

at eleven fifty nine and allow for further consideration. And I think that there is definitely that possibility because nobody, I don't think anybody Frank really wants a hard Brexit and they want to have some resolution of what what a new relationship might look like, and that puts the higher probability on Italy. Italy and the European Commission are butting heads over Italy's budget deficit. Will there's two sides

find a safe face saving way out of their conflict. Well, I think the the the avenue that provides the best opportunity for both saving face but also, of course, much more importantly, having Italy returned to some to return to growth, which of course is critical for them to achieve any kind of debt reduction. Is you have to have growth. It's the denominator and all the ratios that everybody cares about debt to GDP, deficit to GDP, So you have

to have growth. So the way you get to both growth, which is the most important thing, but also saving face is to have a discussion about what's below the top line.

In other words, the fight is about the top line, meaning the deficit to GDP ratio and um that number is not nearly as important as what are the policies that are below the top line, because some policies are going to be more effective in helping the economy grow than others, and I would like to see more discussion about those set of policies, the ones that will satisfy both some of the political issues but also will ultimately get the economy to grow, because no politicians going to

win on an economy in recession. Catherine, let's go back across the Atlantic to Latin America. Two key economies in this hemisphere, Brazil and Mexico. They've both just elected new leaders in recent months. Mexico's is on the left, Brazil's is more on the right. What does that mean for the economic outlook in those countries. Well, I think we're still seeing how things are developing UH in terms of the approaches that these new leaders are taking in their economies.

There is um somewhat of a the Mexico side of things, somewhat of positive in the in the sense that you know, next door to the United States, the United States doing relatively well, but there is some concern about the most recent initiatives to to roll back the construction of the airport UH and whether or not that might be viewed as a bell weather for some of the other policies

that might be put into place there. So so there is more concern about about what might be the pathway for for growth for Mexico and in particularly how the financial markets might react to that and therefore that feedback into the domestic economy or GDP in the economy. UM. For Brazil, even less information really just you know, the government really just starting to be formed. Of course there's

the honeymoon period. Um. Definitely some talk about making some some of the fundamental changes on the fiscal side that are necessary to have the fiscal side of the things being stable. I'm talking about the pension reforms or mini pension reform that have been well known across very even before the election that this was that was crucial for Brazil. So we're getting you know, we're getting some some initial thoughts about that coming from the administration, but it will

depend on how things work out. I think with Latin America in general, not just those two countries, but also more broadly, different parts of the of the region are more associated with the United States, Others are more associated with the dynamics in China, and because there's so much of a divergence between what's happening on the top line GDP range of things for the US versus China. That that's going to create a divergence of growth rates in

Latin America as well. At something to watch emerging markets. So we see falling currencies, surging interest rates, what is the outlook for the next twelve months for the emerging markets. I'm not a believer in aggregates. I think that's I sort of talk about the top top line versus what's underneath for the Italian budget. You know, divergence within the Latin America. And so the emerging markets are exactly the same. They cannot be bulked up into one unit. And and

the problem is that they have. There's the ms C I M and so you know, somebody says, I want to take exposure to the emerging markets in my portfolio, and so they buy into the ms C I M and so that means all the money goes in and then all the money comes out. And what want is it? Just to be very specific in terms of thinking about how might the trade shock affect different countries in Asia, Well, it affects the different countries very differentially depending on how

they are linked. Step to China through the global value chain. That's sort of the first way of looking at it. But then secondly, which countries might be a source of supply if buyers can't buy from China anymore. So that's a second round. And then a third is, of course, who's most exposed to dollar appreciation? Uh, it's a financial

side of things. So so the emerging markets are really a heterogeneous group based on trade relationships, based on their exposure to principally dollars in terms of their obligations, and so it really warrants a much more, much more disaggregated view of countries in order to decide who's going to do relatively better than others. Katherine, we've covered a lot of ground here. What's the bottom line? Will be a good year or a bad year for the global economy?

I think I know what your answer is going to be. Well, I've recently wrote a piece um that was titled some basis for optimism question mark. Yes, but the financial turbulence and the external accounts through trade remain the dominant narrative, and we do see sources of domestic resilience, particularly in the United States, sources of domestic demand. Those internally oriented firms, the ones that are really powered by a strong consumer,

that's low unemployment rates, rising wages. That source of domestic demand we actually see replicated in a number of countries, uh In in Europe and and even and even in Japan. But you know what really matters, You know that that's if that's extremely important. Those are sources of optimism. But the trade turbulence and the financial turbulence do remain the dominant narrative into and so the prospects are um not

as not as hopeful as as we might think. All right, Katherine Mann, chief Global economist at City Group, Thanks so much for being with us. It was a pleasure. Thanks very much. Benchmark will be back next week. Until then, you can find us on the Bloomberg terminal, Bloomberg dot com, our Bloomberg app, as well as podcast destinations such as Apple Podcasts, Spotify or wherever you listen. We'd love it if you took the time to rate and review the

show so more listeners can find us. And you can find us on Twitter, follow me at Scott Landman, Peter You're at at Peter Coy, and our guest Katherine Man is at c l M a n n eCOM benchmark is produced by Toford Forehead. Francesca Levy is the pet of Bloomberg Podcasts. Thanks for listening, See you next time.