MEGAN GREENE: I do think what we're seeing is a synchronized global slowdown.
Businesses have slowed down, certainly. And we're in a manufacturing recession.
There, the US really looks like the cleanest shirt or the cleaner shirt in the dirty laundry baskets.
The Eurozone has been really weak, you could end up seeing Italy crashing out of the Eurozone, and that that would be an existential threat for the entire project.
Hi, I'm Megan Greene. I'm a senior fellow at the Center for Business and Government at the Harvard Kennedy School. And they're doing a little bit of teaching, and I'm actually writing a book. And it's a book on all the rules and economics and the markets that don't seem to work very well anymore, and how they inform our understanding of inequality. Before that, I was the global chief economist at John Hancock Asset Management, and so I've spent a lot of time in the markets. And before moving back to the States for that role , I was in London for a decade and mainly focused on the euro crisis.
Are we in a synchronized global slowdown?
I do think what we're seeing is a synchronized global slowdown. And I also think that's what we could have expected. So, I was predicting that towards the end of last year already. In the developed world, that was a really easy call. Developed countries were all growing well above potential growth. For the US, that's around 1.8%. And for Europe, that's somewhere between 1% and 1.5%. For Japan, that's somewhere between 0.5% and 1%. If everybody was growing well above potential, the only way to keep that going would be to keep juicing the system with stimulus measures. And we might start to see some more monetary easing towards the end of this year, but probably not a game changer.
So, we all should have expected the developed world to slow down. The one risk to this view that we're experiencing global synchronized slowdown is China. And China's slow down really significantly at the end of last year. The data last December in 2018 was unambiguously awful. Authorities had already started providing fiscal and monetary stimulus measures about six months prior to that, it just kicks in with a lag. And it was starting to work before the US started imposing tariffs on China. And so, what we found is there have been successive rounds of Chinese authorities trying to ease, trying to reflate the economy, and in the US imposing more tariffs on China.
And so, that has really undermined Chinese authorities efforts to reflate the economy. So, we've seen a stabilization, I think, with the Chinese economy, but we haven't really seen it accelerate the way we might have hoped earlier this year. That being said, it could still happen. Chinese authorities have done a lot on the fiscal stimulus side, but they have much more room on the monetary stimulus side that they can still use. And so, we could see that happening. That's the big risk to the global synchronized growth story that we're seeing for 2019.
What could the Chinese do to retaliate in the trade war?
The latest round of tariffs, if they're implemented, and I think that they will be so a 10% tariff on 300 billion of imported goods from China certainly aren't good for the Chinese economy. That being said, I think that actually the last round of tariffs was what the Chinese were really worried about. And that hit the economy the hardest, this next round should hit them a little bit less hard. And they do have some more tools at their disposal to try to offset the tariffs. In the past with tariffs on imported Chinese goods, Chinese authorities, the PBOC has allowed the currency to adjust to try to offset some of that and now, there's this psychologically important level of seven for the renminbi.
And so, there are questions about whether Chinese authorities will allow the renminbi to trade through that seven level. And I do think that they could but I also think that most of the adjustment in the currency has probably already happened. The Chinese don't want to be labeled currency manipulators. And they're also a little bit worried about capital outflows. So, they have much better capital controls than they have in the past, they really tighten them up. But if they allow the currency to devalue significantly, or depreciate, then they could spark outflows. And they really don't want that.
So, I think most of the move in the currency we've already seen, but I do think it will be a drag on the economy. I also think China will impose further tariffs on the US in retaliation. And I also think we'll see things get more difficult for US companies operating in China, and also US companies who are relying on Chinese demand. So, immediately after Trump announced these 10% tariffs on the final 300 billion in imported goods from China, Chinese Southern Airlines announced that actually, they're just going to cancel their outstanding order for over 60 Boeing airplanes, and they had put them on hold because it was the 737 Max, but Boeing plays a huge role in US economic data, it's a really add sized role, actually, and it feeds through into investment and manufacturing data pretty significantly.
So, China is really hitting the US where it hurts, we're already facing a manufacturing recession in the US, Boeing is a big piece of that. So, canceling those flights, for example, or those orders, for example, could really hurt US data. So, China is going to retaliate, I think, in a whole bunch of ways.
What impact is the China trade war having on the US economy?
So, trade is hurting the US economy, certainly. And we see it most clearly in the investment data. So, businesses have really deferred and delayed their investment plans. You see it in the hard data. When I talked to a number of Fed regional presidents, their role is to go out and talk to businesses across their districts. And they're reporting that far and away, business CEOs are saying, look, we were thinking about investing. But now that there's so much uncertainty around trade, we just really don't know the new rules of the game. And so, we're not pulling back yet. But we're not investing further. And so, I do think that it's the business sector that's really flagged in the US this year.
The consumers, on the other hand, have remained really strong. We saw consumption growth of 4.3% in the second quarter of this year, that's way higher than where we were a year ago. So, the consumer isn't showing that they're really hurting yet. That being said, the final 10% tariffs that may be imposed on 300 billion of imported goods from China, mainly hit consumers, actually. Previous rounds were constructed so that they didn't hit consumers so directly, because that would have blowback politically for the White House, and now, they're finally getting at goods that will hurt consumers.
There's a question about whether tariffs are inflationary or deflationary, though, and I think what you believe really influences how you view these tariffs. And traditionally, according to economics, tariffs should be inflationary, so businesses had to pay these terrorists, they go ahead and pass the costs on to the end user and you get higher costs. And so, prices go up, you get inflation. I actually think these tariffs had been deflationary because you get a little bit of inflation from the tariffs. But for the most part, I think a lot of firms are afraid to lose market share. So, they're not passing the final cost on to the end user in the form of higher prices.
And so, I think the other factor is that businesses are no longer really investing. There's so much uncertainty, that's the worst possible scenario for businesses if the White House were just going to say, here's this new protection is view of the world and these are the rules of the game, businesses could adjust to that. But because it's so unclear, I think businesses have just stopped investing. And that's really deflationary. And so, I do think that that means that we aren't going to see the inflationary wave that you would see off the back of tariffs of this kind.
What can the Fed do to alleviate any economic weakness?
The July FOMC meeting was really interesting, because it seems like the Fed's inputs have really changed. Traditionally, the Fed was looking at its dual mandate, employment and inflation. But it seems like now actually, the Fed is looking at possible in certainties in the US economy. So, it's more growth, and specifically trade. So, Jay Powell, the first thing that he cited as a reason for the rate cut really was trade, essentially. It's weakness abroad and concerns coming from abroad. And I think that was really a code for trade.
Now, the problem with that is that there's absolutely nothing that the Fed can do about trade policy. So, the Fed is trying to support the economy in the event of possible trade disturbances, but there's nothing the Fed can really do about trade. And so, I do think that it's legitimate that the Fed's worried about growth because they're a knock on effects for employment and inflation. But I also think there are big questions about how rate cuts could really go ahead and influence growth.
Traditionally, when you cut rates, it serves as a stimulus for the economy, more people borrow, more businesses borrow, there's more money in the system, you get a boost in growth. But I don't think that we're going to see that this time around. So, we had rates at around zero for seven years, and we didn't have any kind of acceleration in inflation or boosting growth from that. And when you talk to businesses, even the small businesses, according to the NFIB survey, they see that actually, the cost of capital isn't really a constraint for them, they're not having any trouble getting money. And like I said, that's even for the small guys, the big guys are certainly having no problem getting access to capital.
So, cutting rates, I don't think will really have a significant impact on the economy. It will help on the margins with respect to interest rate sensitive sectors, so mortgages and auto loans in particular, and that will boost the consumer who's the bright light in the US economy already. And that will help on the margins. But ultimately, I don't really think Fed cuts are going to help. And the big risk with that, I think, is that the Fed's going to go ahead and cut now. It's done so once already, it might do so again later this year. And it might just not have the intended effects. And if it doesn't, then when we do go into a downturn, the Fed has this one blunt tool moving rates that it can use. And so, it can say, all right, we're going to cut rates and no one's really going to believe that it's going to help and any central bank that has lost its credibility like that is completely ineffective.
So, I think that that should be a really big worry for the Fed. But they've gone ahead and cut already. So, we're in a rate cutting cycle to some degree, we'll see how long it last. And I also think the Fed had no choice. I think that the markets really cornered the Fed into it. If the Fed hadn't cut rates, then the markets would have thrown a fit, financial conditions would have tightened significantly and that would have necessitated a Fed cut. So, the Fed didn't have a better choice, but I just don't think what it's done is really going to work.
What are the chances of a US recession?
I don't actually think that we're going to face a recession this year or next. I do you think the chances for 2021 go up, but anyone who tells me we're going into recession has a really hard time explaining to me what the choreography of that is. Businesses have slowed down, certainly. And we're in a manufacturing recession. Now, 20 years ago, that would have been really worrisome, manufacturing was about 25% of the economy. Now, it's about 11%. So, it's a much smaller share of the economy, services are doing really well still. So, we are a services-based economy.
And so, even if we're in a manufacturing recession, I don't think that necessarily means that we're going into an economic one, we had a manufacturing recession back in 2015-2016. We didn't go into economic recession then though growth definitely slowed down. The Fed really saved the day. So, the Fed was going to hike rates then and financial conditions were really tight. And so, they backed off. And that pretty much bailed the US economy out of a potential recession.
This time is a little bit trickier, because financial conditions are already really easy and the Fed's already just cut. And so, I think it would be difficult for the Fed to bail us out again. But I don't think that a manufacturing recession is necessarily leading us directly to an economic recession, the consumer is really strong still. And there's very little indication that that should change.
So, I don't see a recession in the next two years. I do think we could get one. But what usually causes recessions is some kind of bubble that's burst. If you try to look for bubbles, most of them aren't systemic. So, student loans, car loans, those are bubbles, I think, but probably not systemic, probably won't cause a recession. I think corporate debt is a little bit worrisome. So, leverage loans in particular and BBB credit. But again, I don't think that will cause the next recession, I just think it will make it a bit deeper, as happens in every credit cycle.
What is the US yield curve telling you?
So normally, an inverted yield curve does say that we're going to have a recession. Seven of the past seven recessions were predicted by an inverted yield curve. That's a better record than any economists I've ever met, including myself, though I wasn't alive for all of those to be fair. That being said, an inverted yield curve lets us know that a recession's coming. I don't think any of us needed an inverted yield curve to know that, it's been a really long expansion, we know a recession will come at some point. It gives us no indication of when exactly that recession will come, or what it will look like what will kick it off.
Also, I think there are a bunch of financial quirks this time around that actually have flattened or inverted yield curve that aren't any commentary whatsoever on what investors think about potential growth. And so at the short end of the yield curve, we're issuing tons of short term debt to finance the spending bill and the tax bill that we had. And so, that's really propping the short end of the yield curve up. And at the line to the yield curve, I think there are two factors. One, we have an insatiable demand for US dollar denominated assets. And I think that's partly because of what's going on elsewhere.
The entire German yield curves and negative territory at the moment, so you can didn't really make much there. JGBs are pretty much controlled by the Bank of Japan. So, it's hard to play along that yield curve. Sterling and gilt is really undermined by Brexit, so there just aren't that many safe haven assets out there. And so, I think a lot of investors are piling into US Treasuries at the long end for that reason. But I also think that we live in a world now where deflation is the tail risk rather than inflation, which is normal. And as a result, long term bonds are a great hedge for equity investors. And so, I think there's a lot of demand coming from them for long term bonds as well.
So, that keeps the long into the yield curve down. And none of that is to say, that anybody thinks that the US is careening for recession. So, I do think that there's this academic reasoning for why the yield curve might invert, and it might not actually have anything to do with what we expect in terms of growth for the US. That being said, most investors see yield curve inversion and think, okay, we're going to have a recession. And so, it's everybody believes that, then it becomes a self-fulfilling prophecy. And so, we may get a recession off the back of an inverted yield curve, anyhow.
Why is the US dollar not declining more?
So, it could be that it's a demand for safe haven assets that's really propping up the dollar. And that is making it really expensive for foreign investors to go ahead and pile into US Treasuries. So, having to hedge that currency risk is making it much more expensive. But I don't think that's the only factor that's really propping the dollar up. Usually, when you're looking at currencies, monetary policy divergence plays a role. But that doesn't seem to be really at play this time around.
So, we watched the Fed go from expecting a couple of rate hikes towards the end of last year, to now expecting at least one rate cut for this year. That's a huge turnaround in a relatively short period of time. And yet the dollar has really hardly moved off the back of that. And I think it's partly because if you look at what's going on with other central banks, a lot of other central banks are easing as well or talking about easing, at least. And so, that reduces some of the monetary policy divergence. But I think really, the fundamental reason is that we have to look at growth potential, and there, the US really looks like the cleanest shirt or the cleanest shirt in the dirty laundry basket.
So, if you look at PMI data, for example, which is where