Charting a Course Back to Normal
The Federal Reserve is poised to take action in the United States, but that’s just one step on the road to post-pandemic recovery, experts shared at Economic Outlook 2022 in Hong Kong.
- February 07, 2022
Just one month into 2022, the global economy is off to a shaky start. COVID-19 has yet to subside, supply chains everywhere remain disrupted, and the United States is facing its worst inflation rate in 40 years. In China, factories have kept up production, but spiraling debt threatens long-term economic stability.
With these challenges in mind, Chicago Booth hosted its second virtual Economic Outlook event of 2022 in partnership with the Hong Kong Jockey Club and Booth’s Rustandy Center for Social Sector Innovation. The event featured Chang-Tai Hsieh, the Phyllis and Irwin Winkelried Professor of Economics and the PCL Faculty Scholar, and deputy dean Randall S. Kroszner, the Norman R. Bobins Professor of Economics, along with economist Richard Wong, AB ’74, AM ’74, PhD ’81 (Economics), a professor at the University of Hong Kong. The event was moderated by Henny Sender, who previously served as chief correspondent for international finance at the Financial Times before joining BlackRock Investment Institute’s Asia office as managing director.
The panel shared their expert insights into what it will take for the global economy to recover from the pandemic.
Hello, everyone. Welcome to Chicago Booth’s Economic Outlook 2022. My name is Madhav Rajan. I’m the dean and the George Shultz Professor of Accounting at the University of Chicago Booth School of Business. I hope all of you are healthy and safe. Thank you for taking the time to engage with the school in this way.
Booth has a long tradition of informing public discourse through platforms such as Economic Outlook, which we began way back in 1954, as well as our Initiative on Global Markets and our various publications, including Chicago Booth Review. Economic Outlook provides a forum for our pathbreaking thought leaders to confront the future, evaluate emerging trends, and share insights that help reframe our understanding of the world to come.
This is our second Economic Outlook event of 2022. We had a virtual Chicago event two weeks ago, and we welcomed more than 3,000 viewers from across the globe to hear Booth faculty Austan Goolsbee, Raghuram Rajan, and Randy Kroszner to discuss inflation, labor markets, and the future of the global economy.
A recording of that event is available on our website at chicagobooth.edu. We are finalizing plans for an event on the Europe, Middle East, and Africa region. Please check the Chicago Booth Economic Outlook website for details in the coming weeks.
We have an amazing program today. I wanted to thank our distinguished panelists, Chicago Booth professors Chang-Tai Hsieh and Randy Kroszner and Hong Kong economist Richard Wong, for being here to share their insights related to supply-chain disruptions, risks to recovery, and the economies of Asia.
My thanks also to Henny Sender of BlackRock Investment Institute and formerly of the Financial Times for returning to Economic Outlook to moderate today’s panel.
Before we begin, I wanted to let you know about another great event that we have coming up. So the Hong Kong Jockey Club Programme on Social Innovation is hosting a virtual social impact leadership series called A.I. for Social Good. On February 16th, Chicago Booth faculty member Sendhil Mullainathan, who is a world leader in research and academic thought leader on social and public-sector applications of A.I., is going to share his research on how social sector leaders might use A.I. to advance the impact of their work.
In addition, practicing physician Paul Lee, Dr. Paul Lee will provide a local lens by discussing his health-care startup, Tree3 Health, which is a platform powered by A.I. that connects users with health-care services in a timely and cost-effective way. I welcome all of you to visit the Rustandy Center for Social Sector Innovation online for more details on this event and others hosted by the Hong Kong Jockey Club Programme on Social Innovation.
So we are obviously very excited to listen to our panelists and get their opinions on crucial matters about the economy today, particularly in Asia. It’s a great pleasure for me to introduce them to you.
Chang-Tai Hsieh is the Phyllis and Irwin Winkelried Professor of Economics and PCL Faculty Scholar at Chicago Booth, where he does research on growth and development. Chang has been a visiting scholar at the Federal Reserve Bank of San Francisco, New York, and Minneapolis, as well as the World Bank’s Development Economics Group and the Economic Planning Agency in Japan.
Randy Kroszner is the deputy dean for executive programs and the Norman Bobins Professor of Economics at Booth. Randy was a governor of the Federal Reserve System from 2006 until 2009. He chaired the Committee on Supervision and Regulation of Banking Institutions and the Committee on Consumer and Community Affairs. Randy took a leading role in developing responses to the financial crisis and coming up with initiatives to improve consumer protection and disclosure.
And we have Richard Wong, professor of economics, the Philip Wong Kennedy Professor in Political Economy at the University of Hong Kong. Richard has been founding director of the Hong Kong Center for Economic Research since 1987, and the Hong Kong Institute of Economics and Business Strategy since 1999. Richard’s work focuses on the political economy of public policy, property, housing, labor, and population, and regional economic development in China.
We are delighted to have our moderator, Henny Sender, back again. Henny is managing director and senior advisor at BlackRock Investment Institute and advises the firm on opportunities in Asia. Henny has decades of experience as a journalist covering finance and economics in Asia, most recently as chief correspondent for the Financial Times.
Thank you all again, and with that I’m delighted to hand this off to Henny. Thanks, Henny.
Thank you so much, Dean Rajan. Happy New Year, everybody, happy Year of the Tiger. I apologize to people at the University of Chicago who have gotten up at dawn in the dark. And this year I think our discussion is the most challenging ever. I’m going to start with the context, which is about two things: the monetary policy in the US, and the backdrop of the ongoing implications of COVID. And you all will know better than me how hard it is to distinguish between short term and long term, and cyclical and structural, and I am so delighted to have my panel help me parse all the conflicting and, in part, depressing data.
I am going to start out with Randy, because in 2021 the world was awash in liquidity, it was both fiscal and monetary, and the backdrop today is of a very different phase in the cycle. And I want to ask you, Randy, to start. How different will 2022 be? In 2013, five years after the onset of the global financial crisis, we saw a taper tantrum when the then-head of the Fed raised the possibility of monetary tightening. Asia, particularly countries like India, were very hard hit. Let’s start by asking you, how different will 2022 be as a result of a Fed who is being forced to take inflation very, very seriously?
Delighted to be with you, and that’s an incredibly interesting question to start off with, and a particularly interesting one today, since the Federal Reserve is finishing up its two-day meeting, and we’ll get a lot more clarity to the question that you asked in a few hours. But I think we pretty much know where the Fed is going. A major pivot from last year. Back in, if we roll the clock back to 2020, when the virus first hit, a very strong response, bringing interest rates down to zero, reviving all the programs … that we stood up when I was there during the global financial crisis of a decade ago, plus a whole lot more. In the last three months, the Fed has made it a very important pivot from saying, we’re going to keep things low for a long time, we think inflation is transitory. They’ve finally eliminated that word transitory. That should have been a transitory word a long time ago. Should have moved out. They finally moved away from that, and they’re taking inflation and the inflation risk quite seriously.
Understandably, since inflation is at 30-, 40-year record highs in the US and globally, it’s time for the Fed to be acting. And so what they’re doing is they are reducing the pace of increase of the balance sheet. And so they will probably end that by March, by the time of the next meeting. My guess is that today they’re going to lay the foundation for an interest rate increase. We’ve seen some central banks around the world already start to raise rates, both in Asia as well as in the West. I think the Fed is now going to be picking up that baton and running forward towards higher rates. They are not going to be putting out a formal forecast today of how many more rate increases they’ll have the rest of the year. They changed in December, going from maybe one this next year to three or four, and I think it’ll be at least four during this year.
So we’ll see a significant amount of interest rate increases, we’ll see a significant reduction in the additional liquidity being put out into the markets. And so what are the consequences of that? First, I think that it’ll be very important that the Fed is doing this to try to rein in inflation expectations. One of the challenges that we’ve been seeing, and the Fed was talking a lot about over the last six months, was that, well, this, in some sense it’s not our problem, it’s not a demand problem, because central banks are about demand; it’s a supply problem and central banks [crosstalk 00:09:43]
… later, in great detail.
Yeah, central banks can’t create more computer chips, they can’t make the ships run faster, but prices are going up anyway. If people lose faith that the Fed really is going to fight inflation, and we’re seeing inflation rates at 30-, 40-years highs, people start to demand higher wage increases. As they demand higher wage increases, if firms are willing to acquiesce, give them those higher wage increases and pass those along—because this is the first time in three or four decades firms have been comfortable to pass this along—you get into a very difficult situation where inflation becomes entrenched, inflation expectations become unanchored, move up, and it’s very difficult to pull them back down. And so that’s why I think it’s very important that the Fed move. And this has very important consequences for interest rates and asset price globally.
As we can see, a lot of the so-called growth stocks that rely on ... well, we’re not making a lot of money today, but we’re going to make money 10 or 20 years from now. That’s fine when interest rates are zero. When interest rates are 3 or 4 percent, that promise doesn’t look so good. So you’re seeing a change in relative prices of different assets, and you’re going to see important impacts throughout the world, particularly on emerging markets. As the US raises rates, that will likely strengthen the dollar, that will likely lead to capital flows away from some of the emerging markets and into a country like the US. And so emerging markets are probably going to have to respond by raising rates, and so that can cause a lot of tumult as capital flows across the world.
Randy, thank you so much. I’m going to turn to Dr. Chang first and then to Dr. Wong. Dr. Chang, Asia was hit very badly in 2013. Is Asia as vulnerable now as then?
Thank you for the question, Henny. So I want to say two things that I ... so the first, to your question, is Asia as vulnerable now as it was then? I think the answer is yes.
The second thing I want to say, just in response to the question that you posed to Randy is, I don’t see what the Federal Reserve is planning to do. I mean we’ll see today more details, how it solves the changes in, the fact that ... given the changes that we have seen, it’s clear that there needs to be changes in relative prices. And the question is, are you going to get the changes in relative prices by putting on pressure for some of the prices to fall in nominal terms? And here’s my worry. My worry is whether what is coming forward is a swing in completely the other direction, such that … it reminds me of, say, what happened to Great Britain in the 1920s. For those of you who know a bit about British economic history, Britain went through its great depression not in the 1930s, but it went through its great depression in the 1920s.
And I think the consensus of what brought that about was that after World War II, Britain was trying to move back to the gold standard, and the way that it did so was to basically put in place a massive program of deflation. They were successful in doing so in bringing prices down, and I think it was 1925 or so—this is something that Randy probably knows better—that they managed to bring prices down by enough so that they were able to go back to the gold standard, but at a massive cost. But the question is, there are some real changes, given the disruptions that we have seen, that whenever there is sort of ... I guess I want to come back to sort of what we know from basic Econ One, that whenever there are changes in relative demand and changes in relative supply, efficiency dictates that relative prices change. And then the question is, what do the changes in relative prices imply for changes in prices at the aggregate? So that’s the question I want to raise.
I’ll back to you both in a minute. Richard, I’m going to turn to you now, because China’s monetary policy is in a very different place. Many people think the recent slowdown we’ve seen in China is because of overtightening. That the People’s Bank of China wants to end its dependence on credit-fueled growth, that an economy built on leverage is an economy that is not built on strong foundations. The gap between 10-year rates in China and the Fed was at one point 250 basis points or something like that. It’s now come down to less than 100. Do you think that means that China has less room to ease and stimulate and counter, at least, the slowing growth in the near term in China? Do we see a very different pattern of monetary policy and therefore economic growth in China? Can China afford to ease to get its economy moving again?
OK. Henny, thank you for the question, a very good one and an important one. I think what China has been doing in the past two years is that, first of all, it recognized that given the global situation in which globalization is slowing, and the geopolitical situation, trade, trade difficulties, it has began to move a bit more towards relying on its own internal circulation, which really brings up an important issue, is that it has been a relatively highly leveraged economy. They need to deleverage in order to get consumption and investment back into better balance, so that more consumption will be spent. The difficulty is that their financial markets remain relatively repressed, making it very difficult to stimulate consumption. I think of it as a much more individual level in China’s fast-growing GDP per-capita economy, people have to save a lot for old age, and with very repressed financial markets there’s just not much opportunities to save.
And this has prompted asset inflation in many areas and leading to a highly leveraged ... so they have to readjust it, and that’s why during the past two years they’ve been doing that in a variety of different ways that are consistent with this policy—among other things, attacking property development companies, the IT sectors, doing these things. Having done some of that, the economy is slowing, right? And on the other hand, the global situation is changing. The US is going into a reverse interest rate policy, and being a little bit more internally driven as they see going forward, they’re trying to loosen up. Our inflation has been very flat in China so they can afford to have a bit more inflation. That’s why they’re going in a reverse pattern. I think this is driven largely by macroeconomics. Now this is not to say they have successfully deleveraged. They deleverage a bit, right? The term “deleveraging” is still quite significant. You can’t deleverage all the way out of a completely tank, right? So, I think this is what has happened.
Thank you. I’m going to turn to Randy again, to ask a question of him following up on Chang saying, and what’s interesting about this discussion so far is, we are talking about inflation in the real economy, which is supply driven. And we’re also talking about asset price inflation, and that has kind of fallen by the wayside in the US but I think it’s an incredibly important point. So Randy, Chang said he thought Asia would be very, very vulnerable, but we’re starting out in a world where real interest rates are still negative. Are you as worried as China is about the vulnerability, given that we’re still going from very negative real rates to less negative real rates?
Well, we’re certainly in a situation where we haven’t had a lot of experience, where we had lockdowns that caused contractions at much more rapid pace than the 1930s, and we’re seeing growth pressures and growth more rapid than we’ve seen, really, since the 1930s. So, hard to be certain, and I think it’s an important and interesting analogy to bring up what happened back then. So I think, as you said, real interest rates are still very negative, so the difference between inflation, which is roughly 7 percent in the US, and the 10-year treasury rate, which is about one and three-quarters percent, it’s been bouncing around, but that means that you’ve got at least a negative 5 percent real rate of interest. Well, a lot of projects look pretty good if you only have to return 95 cents on the dollar instead of 100 cents on the dollar in real terms.
And so that can lead to problems in allocating investment to the highest productive uses. So one has to be careful about that because there can be distortions in where money flows when you have significant negative rates. Second, the point that Chang made, if the Fed drives too quickly to try to bring inflation from 7 percent down to below 2 percent, I don’t think they’re going to try to bring inflation down below zero as the UK did, because they had a very high inflation during World War I—they tried to bring the pound sterling back to the same level that it was against gold prewar. So that meant it had to bring the price level down significantly. I think here, the Fed just wants to rein in inflation from 7 percent or so down to around 2 percent. So I think that’s less fragile, but there are different paths in which they can do that.
If they do that really rapidly, given the amount of leverage that’s outstanding—whether that’s in China, whether it’s in Europe, whether it’s in the US—borrowing costs as well as debt financing costs go up dramatically and so it can be really problematic for anyone who has a lot of debt outstanding, whether that’s in the housing sector or corporates or even for the fiscal authority, because so much debt has been issued. You also have a risk that if they don’t act, inflation starts to move up, market interest rates start to move up, and then they have to even move more rapidly to raise rates. And that’s the worst possible scenario, where they have to raise rates like we did in the late 1970s to levels of 10, 15 percent to try to rein in inflation and inflation expectations.
Final point is the very important one about relative prices. So when things are purely on the supply side, the Fed can’t do anything about that. They can affect demand and the overall price level, but let’s say you have something that happens in the energy sector and energy prices go up, the Fed can’t produce more oil. And if there’s a lot of demand for oil, Fed can’t do anything about that.
And so it’s really important that the Fed understand what it can and can’t do, but as I said I think it needs to act, because you’re seeing supply constraints so widespread that inflation is ... the headline numbers are very high, and people will lose faith in the Fed for trying to ... being able and willing to fight inflation if they don’t act.
Dr. Chang, back to you. As Randy says, this is supply-side issues. Now we’re turning to the main portion of this, and one of the reasons I love being part of your debates is how wise the questions are that we have coming in before we start. And obviously the pandemic has a lot to do with supply-side issues. Three years ago, we were all worried about the deflationary impact of technology. We were worried that technology would make most labor excess. And today we’re talking about inflation rather than deflation, and we’re talking about labor scarcity. To what extent do you think that this is simply short-term effects of the pandemic and we’ll have a very different discussion next year at this time? Or do you think the world has changed and we’re dealing with structural issues that aren’t just a result of the pandemic?
This is the tricky part in terms of the answer to your question, and it’s one of the points that Randy brought up, which is the question about expectations of inflation. Once expectation of inflation gets baked in, then it’s a really difficult thing to deal with. But if that wasn’t an issue ... so if people ... if there wasn’t this issue of expectations of inflation, it seems clear to me that it really is a transitory issue. It seems clear that the big shift that has taken place is a shift in terms of the relative demand for goods. There’s a shift in the demand for goods and away from services. So what happens when there’s a shift in the relativity demand, the relative price changes. And then the question is, does a shift in the relative price change by having nominal prices fall in one sector, or does it shift by having nominal prices go up in the other sector?
And we all know that the nominal prices are rigid downwards, and I think that is what is causing the inflation that we are seeing. So the answer to the question is, at what point are we going to go back and shift our demand back towards services in the same way that we were doing back in 2019? And when that happens, when are we going to go out as much as we used to? When that happens then this transitory shift is going to be over. The question is, by the time we get there, what is going to be the change in terms of our expectations of inflation? And I think, that is the key thing that I think monetary policy authorities are battling, because it’s not just ... because this transitory thing can have a permanent effect through its effect on expectations.
Now, the backdrop, of course, to this thing with supply chains, there are two causes before we get to the effect. One is the pandemic, and one is so-called decoupling, which means ... both of them mean that global supply chains are under pressure. Richard, do you share my conclusion that China has been one of the big beneficiaries of these two trends? In that we’ve seen China increase its share of exports because there’s no outbound tourism, its current account surplus has grown because tourists are staying at home. We’ve seen China increase its share of world direct foreign investment. Do you see China today as the big beneficiary of these trends in supply chains?
Well, good question again. I think what has happened after the pandemic, and it’s not ... I wouldn’t call it a trend, but what has happened is that as the pandemic struck, US has been expanding its money supply, right? And in a way that actually gets into the pocketbook of the average consumer, who then spends, right? As you spend, and since it’s spent quite a bit on goods, then the goods are being exported from China to the US. It has other ... and then other thing is, the pandemic itself also had uneven and sometimes unpredictable consequences on supply chains, which are not easily foreseen, that therefore results in hikes in prices. So it’s obvious that some would be benefiting from it. On the other hand exports go, but it is also constrained because these are container shipping and because truck drivers in many parts of the world are not really in service.
So whereas you can produce in China, the boxes that go to, say, for example, to the West Coast, they don’t come back. So you have rapid rises in shipping rates, container rates, and this hits different sectors in very different ways, including different countries in Asia in very different ways, with very unknown and unpredictable consequences that we are only beginning to learn about it after the thing, after the event. There’s no ability to predict. So in some ways, yes, because China has been in ... had a COVID-zero policy, they’ve been able to basically shut down the external impact of the economy, so their manufacturing sectors have been able to produce.
So yes, they have benefited from it, but then a lot depends on what happens to the pandemic around the world, which will gradually change all of that. And certainly with the Fed policy, US money supply I presume will slow down its growth, although the ... well, I’ll leave that to my US colleagues to see what about other stimulating policies. But I would think that the ... as the pandemic gradually subsides, the opening-up policy will actually have an enormous impact on how China’s exports will perform, especially throughout Asia.
So I think probably we will ... whether this pattern of the past two years will continue remains unclear.
Trade policy hasn’t … trade tariffs and all this hasn’t changed at all, that part is actually the most predictable part, right? It’s the pandemic that’s unpredictable.
I’m going to cut you off now to turn to Chang before I go back to Randy. And that is, one of the things you hear a lot more about when you’re living in Asia than on this side of the Pacific is RCEP, and that is a regional trade deal that ties China much more closely to Asia, including allies of the US like Japan and Korea. So I wanted to ask you, Dr. Chang, how significant is RCEP, before I go back to Randy?
The truth of the matter is that I don’t think it really matters that much. I really don’t think it matters that much. If you think about sort of the major ... so I will maybe illustrate that point by just bringing your attention to, say, Phase One of the US-China trade agreement that was implemented in the last two years. I’m not sure how many people noticed this, but Phase One of the US-China trade agreement, there was nothing in the trade agreement about changes in trade policy, nothing. So there wasn’t a single line in the US-China trade agreement about any tariffs, about any tariffs or any non-tariff trade barriers, anything that needed to be changed. That it was all about a list of products and a quantitative number on how much China was to purchase.
So if you think about sort of the ... so let me just raise the question: What is the nature of a trade agreement in which there is nothing about any trade policy instruments? [inaudible 00:34:42] Then the question is, how is China supposed to implement a trade policy agreement when there’s nothing that stipulates what is it about trade policy that it has to change, right? And the answer, I think it’s clear that it’s about that the way to implement that trade agreement is that you have to use ... the only way to do it is to use nonmarket mechanisms in order to do it. And then you can ask a question about why was it that the US chose to do it this way?
One answer could be that it was never about trade policy, it was always just about ... it’s just sheer mercantilism, that’s what it’s about. Or you could also say that, and I think there’s a lot of evidence of this, that if you look at the run-up to the trade agreement, so if you look at what happened in 2018 and 2019, very little of the battles that were taking place, at least on the Chinese side, was about using trade policy instruments. And I think that the evidence that you are seeing is that the Chinese would retaliate by using tariffs whenever the US would do something. But then I think what would happen was that they would find out that the tariffs were just not enough to have the same quantitative impact as the effect of US tariffs on Chinese goods.
So they found that they needed to resort to other things in order to achieve the same damage, I would say, and the thing is that this damage is ... there are instruments that are being used that do not involve tariffs. So here’s the question, that any trade policy agreement, right? Or things like RCEP, how does it deal with the major tools that are being used? Which are things like, you’re going to send your stuff to us and then we’re going to let that stuff rot in the port for the next two years, right? And the things that ... there are millions of things that can be done. There are millions of things that can be done, and how do you write a trade agreement in which you address all the possible instruments that can be used?
That’s very helpful. I’m going to turn to Randy now. I’m going to share with the audience, Randy, something you said on our call the other day. And that is, in context of supply chains, that just in time has become just in case. There are a lot of people in the US who have woken up to the fact that the US is not a huge manufacturer of semiconductor chips. So this concern with efficiency is now yielding to concerns about resilience, but how do you separate out that resilience segues into self-reliance, which segues into protectionism?
And that’s a very, very important issue and it gets back to one of the things that you were just talking about with respect to trade policy, and Chang mentioned mercantilism. So it’s perfectly reasonable to say, well, in normal times, just in time makes a lot of sense, because you want to minimize inventories, you want to minimize costs, and you just have everything perfectly organized. We’ve made enormous progress in the ability to track goods, the ability to move goods, and so why not rely on that? Well, we found out sometimes why you might not want to rely on that, because there can be disruptions, whether it’s due to geopolitics, whether it’s due to weather, whether it’s due to just an accident, like what happened in the Suez Canal. These things happen, and there are enormous consequences of that. And I don’t think people fully understood the amount of risk that they were taking by doing something that was just in time.
So thinking about insurance, thinking about having multiple sources of supply, thinking about having domestic and closer sources of supply is just a natural consequence of thinking carefully about a better insurance model, because we now realize that there are a lot of things that can be disruptive to the supply chain, and to that just-in-time approach. The question is, sometimes things that are motivated by better insurance really are just a cloak for some sort of protectionism. And that’s something that we have to be very, very careful about because that’s not going to be very helpful for anyone in the world economy if it’s just that. If you’re making supply chains more resilient, totally sensible. If you’re doing it just to protect some particular groups, in the long run that’s not going to be helpful to anyone, even ultimately to those groups, and that’s one of the policy challenges that we see today.
Randy, I’m going to ... there are two questions from the audience, and because they’re mostly US I want to turn to you. One of the questions refers to fiscal debauchery and long-term inflation expectations, and will financial weaknesses be addressed via monetization. And the other one has to do with the service sector and prices in the service sector and inflation there. And that syncs into technology and the quality of jobs everywhere, which is an important thing. And I wonder if you can talk about whether you think the Fed policy in the last two years was to support consumption in the US, which of course is very different than China, where it’s much more supporting growth through state-owned enterprises, etcetera. Can you talk about how you see these fiscal policies and what their long-term impact is in the US? And then we’re going to segue into a discussion both of the impact of technology going forward and the impact of demographics going forward. Thanks.
Great. So let me focus on the first question, and I think Chang and Rich will be great in focusing on the second. So fiscal debauchery. That’s quite a term. Certainly I think the initial response globally was a very big fiscal response in 2020, and I think that was completely sensible. We really didn’t understand exactly what was happening. Some of the other policies were shutting the economy down, and so making sure that people didn’t starve was something that made sense. But then the question is, how much more do you need to spend? In the US we spent a trillion dollars last December, a year ago. People have kind of forgotten about that. A trillion dollars now seems to be trivial amounts of money. In the old days it used to be a significant amount of money.
And then there were a number of spending packages that Biden got through and then wanted even more. And so the US economy not only in 2020 ... well, it started in 2020, spending about 15 percent of GDP in an initial response. And then another 15 to 20 percent of GDP being spent, and it’s not at all clear that that was necessary, in order to stabilize the economy, and also in order to stabilize people’s lives and livelihoods. I think one of the things that we’re seeing now is so much demand coming because checks were sent out to people, they didn’t have anything to spend on and they couldn’t go out. And, exactly as Chang said, they’re buying a lot more goods, and that’s putting a lot of pressure on prices, so you’re seeing more demand than you otherwise would.
And some people have argued, oh, well, there’s all that fiscal spending in the last year and a half, that’s all going to fall off this year. I don’t think that’s exactly right, because a lot of the fiscal spending continues over time, and a lot of it went into people’s savings accounts, which are still relatively high, and people are eager to go out and buy things right now, mostly goods. And then as Chang said, probably more services down the line as we make more progress against the virus. And so I think the fiscal issues are ones that are very important.
I think that’s one of the reasons why we’re seeing significantly higher inflation in the US than we are in Europe or in Asia, because there was so much more of a fiscal impulse. And I think it’s really important that we rein that in, because that’s also an important part of what’s going to be affecting people’s expectations. But I’ll defer to Richard and Chang on the demographic issues, which I think are super important, because China’s population is aging more rapidly than Japan’s, and I think the technology issue has very important relative wage impacts and will affect different sectors very differently.
So Chang is going to take the second part, I’ll start with Richard on the first part. China’s aging population, its birth rate keeps getting lower. To what extent, in a world where technology will at some point replace a lot of jobs, is demographics a curse for China, that it will not have enough people to support productivity and economic growth or otherwise? You look at China’s take-up of robots, for example, and robots today are far more affordable and far more flexible than in the past. China is doing a lot of interesting things to optimize the combination of capital and labor. How do you see this issue in China, especially against the backdrop of what you and I refer to as a very incomplete social safety net?
Yeah. Well, this is a very involved issue when you talk about demography. First of all, we should not fall into trap because birth rates are low, therefore the productive labor force necessarily declines as a share of the population.
Because China has a very early retirement age, they can through policy change that, right? Of course this will be widely unpopular, right? That’s another issue, right? But it is doable because in the state sector retirement age is 55, right? So, it’s really very ... and health-wise they can continue to work. So, that’s one, but it does call into question many different aspects of this. It highlights directly the repressed capital markets, which is really detrimental to both consumption, labor supply and retirement, and safety net. So, unless you can work on that, get the financial repression reduced so that the people in China can have better assets to invest in for savings purposes, this will be a real ... it will make policy-wise in ameliorating the demographic challenge very severe.
So the financial markets need to really be put in order. And this has obviously to do with deleveraging so that people can get back into better savings, and then they would be ready to do consumption. China has great difficulty getting consumption up because everyone is trying to save, and particularly because returns are so low for folks there. So this is the issue I would like to explain. Yes, it is a challenge. It is really a financial capital market reform challenge at the end of the day, fundamentally.
The other things that are significantly important in all this demographic is that you also have a gender imbalance problem, which has problems for family formation which feeds back into labor supply, consumption, and savings behavior as a whole. Now the gender balance policy is not something you can fix because imbalance is imbalance, right? There’s not much you can address. A retirement age you can ... in theory, through policy, do, as difficult as it may be. Finally, in terms of whether this will spark technology to do that, I think it would but it will also depend fundamentally on human capital investment. One must also remember a big part of Chinese population is still rural, right? Despite all the ... China and the US are very different economies. The percent of population that are rural [inaudible] is literally irrelevant, right? But in China it is still very substantial.
So this is still a developing economy, and therefore finding policy that works for the urban sector doesn’t mean it works for the rural sector. And then China still has a household registration system, so welfare rights benefits, etcetera, are not even. The only thing that’s incredible about China is that even in the urban sector, they have a property homeownership rate that’s in excess of 85 percent, right? And in the rural sector it’s 100 percent in principle, right? So homes are the only form of savings, right? Primarily, there are no other diversification … so looking at the demographic, I think one should focus a lot more on capital market adjustments. And I think reforms in that sector, otherwise it will always be very lopsided. Thank you.
Thank you. I’m coming back to you now, Chang. I want you to talk about the impact of technology on jobs in Asia. As I said, three years ago, everyone was talking about the greatest challenge would be job creation, especially in countries like India, and would the lowest value-added jobs, construction, be replaced by robots? Autonomous vehicles would eliminate trucking jobs. Today we’re talking about labor scarcity. Is this a short-term or a long-term phenomenon? How worried are you about emerging Asia’s ability to generate quality jobs?
Let me say two things. First, the direct answer to your question: I am not worried at all. I’m not worried at all. And the second thing I want to say is that this issue of labor scarcity is really, I think, only a phenomena that we see in the US. It’s a phenomena we see in the US and I think partly it’s because the relative … so wages of less-skilled workers in the US, for a variety of reasons, I think, have been much lower than their market clearing, or their equilibrium price. And I think that what we’ve been seeing in the last year is really just a long overdue adjustment. In other labor markets I don’t think that there is the same phenomena, and I don’t think we see the same amount of labor scarcity.
I guess I have always not been very partisan to the idea that technology destroys jobs. Yes, it does destroy some jobs, but at the same time it creates lots of other jobs. So the argument that technology destroys jobs is something that we’ve been saying, or it’s been around, for at least 200 years. There was a period in the 1810s where people were out there destroying the looms that threatened to displace the work of lots of people ... and it did, but at the same time it created lots of other jobs.
So let me just come back, or another example I’d like to put is, what happened to all the people that used to make horseshoes in 1910? The demand for horseshoes went away but they were replaced by something else. And this has been a pattern that we have seen time and time again.
I’m going to cut you off there because we only have five minutes. I want to take this one question from the floor, and then I want to ask a final question about ESG. This is a very thoughtful question from the audience referring to significant shifts in political culture in both the US and China, each moving in its own way to greater central control, both economic and political. Who wants to take this question, agree or disagree? Who wants to take this question?
I can take it. So I would say my biggest fear on the Asian side are the economic consequences on the Chinese side of the feeling of political vulnerability. ... I think about sort of the main economic events in China in the last three, four, five years, I think stem from that sense of feeling politically vulnerable. The crackdown on the tech companies, the feeling that China was vulnerable to economic pressure from the US, the campaign to try to bring Huawei to heel.
My sense is that that feels really scary on ... and my sense is that a lot of the things that are being done is to try to make sure that the regime is not vulnerable. On the US side, on the same issue, one of the things that really distresses me is how much of sort of this ... I’m going to say this view that the world is an important partner, and also that China can be an important partner to what we are trying to accomplish, has gone out the window. So anyway, that’s all I’ll say, and I’ll let Randy and Richard chip in.
We have two more minutes, so I’m going to ask one yes-or-no question to Richard and one yes-or-no question to Randy, and then I fear our time will be up, and I’m sorry we didn’t get to all your questions. A lot of them had to do with inflation, and some of them have to do with the pandemic. And one of them of course has to do with my home of Hong Kong, and I think it says a lot that I’m sitting in New York rather than in Hong Kong today.
Richard, yes-or-no question for you. Is China serious about ESG, and to the extent that it is spending so much on producing solar panels for the world, wind turbines for the world, has a big control of the raw metals that go into batteries—is China serious and will it emerge stronger as a result of these trends?
I think it is [inaudible 00:57:44] emerge stronger because being serious doesn’t mean you get your policies correct.
Very interesting answer. I’m so sorry we don’t have time to parse that very tantalizing answer, but hopefully I’ll be invited back next year and we can continue that debate. Randy, for you, final word. What are the long-term risks that you worry about, and will our discussion, if there is one, a year from now be more optimistic or more pessimistic than today?
So key risks are … one of the things we talked about a lot are inflation expectations becoming unanchored. And so central bank policy has to be very, very tough, and that could lead to both asset prices as well as economic activity to tank. Second are the vulnerabilities related to health and the pandemic. I think global policies have not been most effective in dealing with something that is a truly global issue. We see dramatic differences in approach of, the kind of lockdown approach of much of Asia versus the approach in the West. I think we’re still learning what the right combination of approaches are, but I’m not sure the policymakers have learned the lessons, and so I worry about that in the long run. Will we draw the right lessons from the pandemic rather than just sticking in our heels ideologically? We did this right, we did that right, you did that wrong, you did that wrong, that’s not very helpful. We need to have a careful analysis of it, and we haven’t had that yet.
Optimistic or pessimistic year at this time?
Optimistic. I think we’ll be able to rein things in, although there’s very high risk we won’t, but I think there’s more likely that we will be able to rein in the inflation expectations without having a crash. And I’m hopeful that the incredible innovation that is related to the mRNA virus inoculations, the innovations in also the way medical devices and vaccines are approved—that’s been a big plus, and hopefully that’s going to stay with us.
I’d like to thank you all for making my job so easy and educational, and with that I’ll close. Stay safe, everybody, and thank you all once again.
Bye. Thank you.
The Fed Will Raise Rates Soon, and Continue to Tighten throughout the Year
Kroszner said the US Federal Reserve appears finally ready to act after acknowledging that high inflation following pandemic spending is no longer a “transitory” issue. He said to expect interest rate increases to begin in March, followed by further rate hikes and a reduction of the size of its balance sheet throughout the year.
“Today they’re going to lay the foundation for an interest increase, and we’ve seen some central banks around the world already start to raise rates in Asia as well as in the West,” he said.
As interest rates rise, the United States may draw investment away from some emerging markets, triggering further rate hikes in Asia and elsewhere, he added. Both Kroszner and Hsieh said increasing interest rates will require some caution. If the Fed acts too quickly, it could lead to a sharp rise in market interest rates and trigger troubles for debt repayment. If it acts too slowly, however, it could lose credibility to fight inflation and allow the expectation of high inflation to become “baked-in.”
China’s Economy Needs to Reform Deep Structural Problems
As the United States begins to raise interest rates, China’s central bank continues to move in a reverse pattern due to low inflation, said Wong. China’s “COVID-Zero” strategy has allowed its economy to keep functioning as it relies on internal circulation, but it is still burdened by its debt-laden property sector, Wong said. While investing in property has known risks in China, it is still extremely popular as one of the only vehicles for investment and savings available to ordinary people.
“The financial markets need to be reformed, and this has obviously to do with deleveraging in a still repressed financial market, so that people can get back into better quality and diversified forms of savings, and then they would be ready to increase consumption to achieve a better balance between consumption and investment,” said Wong, describing China’s main issue as “a repressed financial capital market reform challenge.”
Beyond the property market, China has also taken steps recently to rein in the power of its tech companies as it attempts to address areas of vulnerability to US economic pressure, said Hsieh.
“If you’re making supply chains more resilient, that’s totally sensible. If you’re doing it just to protect some particular groups in the long run, that’s not going to be helpful to anyone.”
Supply Chains Will Change Irrevocably Following the Pandemic
Wong said the full impact of COVID-19 on supply-chain disruptions is still being assessed around the world, as different regions were affected in different ways—whether it was increased shipping costs and container rates or the constrained ability to source materials.
Kroszner said he expects to see a shift in how supply chains are managed from operating on a “just in time” delivery model to a “just in case” model that is more thoughtful about long-term risks. The next challenge, he said, will be how to make supply chains more resilient without drifting into protectionism.
“If you’re making supply chains more resilient, that’s totally sensible,” he said. “If you’re doing it just to protect some particular groups in the long run, that’s not going to be helpful to anyone.”
Only a Shift in Consumption Will Bring US Inflation Fully to Heel
Hsieh also warned that adjusting interest rates alone will not solve the US inflation problem, because the issue was also triggered by a pandemic-era shift toward the consumption of goods over services.
“At what point are we going to go back and shift our demand back toward services in the same way that we were doing back in 2019? The question is by the time we get there, what is going to be the change in terms of our expectations of inflation?” Hsieh said, describing this as a key challenge for policymakers.
Kroszner, however, said that the US readjustment may not be as painful as some may fear. Part of the current inflation pressure was the result of unprecedented government spending through stimulus checks—but many consumers chose to save rather than spend. As the pandemic subsides, their savings will enable them to support consumption above pre-pandemic levels, including of services, even as new government fiscal spending fades.
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