Wall Street Week - Full Show 10/21/2022
Call it the rescue week, with the president trying to rescue buyers at the gas pump earnings, trying to rescue troubled markets and a British government just plain needing a rescue period. This is Bloomberg Wall Street week. I'm David Westin. This week, special contributor Larry Summers on having to make hard choices to get inflation down. If your deficit projection starts to get out of control and your real interest rates start to rise, you can get into a kind of doom. And Deborah Layer of the Paulson
Institute on whether President G's ideology can get China's economy growing again. She's facing a lot of headwinds when it comes to the economy. It was a tough time on global Wall Street, but nowhere was a tougher than at Number 10 Downing Street, where Liz Truss is on her way to becoming the shortest serving prime minister in British history, forced to resign after concluding she just couldn't get done what she'd set out to do. I cannot deliver the mandate on which I was elected by the Conservative Party.
I have therefore spoken to His Majesty the King to notify him that I am resigning as leader of the Conservative Party. It wasn't easy for President Biden either, as he continues to fight high gas prices, for which he largely blamed the oil companies and countered with yet another release from the Strategic Petroleum Reserve. The Department of Energy released another 15 million barrels from the Strategic Petroleum Reserve, extending our previously announced release through the month of December. The market spent the week looking for
some form of rescue from earnings, and they did get a bit of it from companies like Netflix with Reed Hastings giving thanks. Well, thank God we're done with shrinking quarters. That's a big feeling of we're back to the positivity.
But Tesla didn't help much by disappointing on sales, though Elan Musk predicted it would make it up in the fourth quarter as factories for it to a record breaking Q4. So it's really not the way it looks. Looks like you'll have an epic here. And although Goldman Sachs earnings were a pleasant surprise. Chief DOJ officer David Solomon said
they have a fair amount of work to do. Importantly, talent is moving around tremendously at Goldman Sachs to align behind David Solomon's new new vision to remake the remake I like Oh, boy. And at the end of what was a wild week, the markets did find some really. Finally, with the S&P 500 up four point seventy four percent for the week, while the Nasdaq was up 5 point to 2 percent.
And it was all pretty much driven by anticipation of where the Fed is heading. As the yield on the 10 year climb for much of the week, but after peaking over four point three, three percent midday on Friday, it fell to four point two percent to end the week, while the two year with the two year fell 13 basis points. On Friday alone, after speculation grew that the central bank might just slow its rate hikes after November. Take us through the week in the markets. We welcome now you're in Timmer. He's director of Global Macro for Fidelity Management and Sanada Sy CIO for the Franklin Templeton Fixed Income Group. Welcome both of you, back to Wall Street. Good to have you here.
So let me start with you, because so much of this week, I think was driven off of fixed income, particularly those Treasury rates. So what did we see this week and why were there so many apparently violent moves up and down? You know, David, I think that we're going to continue. It was a crazy week, but it's been several crazy weeks. I think until the market gets a sense of
where the Fed is going to go and stop, we're going to keep getting these wild bouts of volatility. We've been expecting it for a while. In a sense, you know, there was not that much of news in it in the Fed saying that they're close to being done. Of course they are. We already know that we're going to get up to five, maybe five point two, five, maybe a bit more. But quite early in the new year, it's pretty clear that they will be getting close to an end.
We get a seventy five, maybe we get another 50. After which do we get another 50? Another 25. I think the more interesting thing is what happens after that. Once the market feels that they know that the Fed is not going to pivot on a dime. I think we might get to a point where we stop seeing these wild back and forth because these are these are truly massive moves in the Treasury market. And I would just note that every single data point is going to carry with it this level of gravity in terms of the moves that we see until we get to the stage that the market buys what the Fed is selling and DAX is that going to raise and then they're going to keep it high for a while. And you're in where are we headed?
Where is the Fed head? Because I look at Bloomberg right now, the Fed futures rate looks like it's about five point 0 5 at one point this week was up close to five point two in terms of a terminal rate. Yeah. So what relook look at the sofa curve. It peaks at around 5 percent and you look at that, you know, the implied terminal rate. You know, it's around the turn of the same year. The markets have been in a relentless mode of price discovery this year. Right. And the glass has been half empty for the last nine months where, you know, every time we think maybe the markets are bottoming and the Fed's going to be close to being done. That moving target starts to starts to
move again in the wrong direction. But I do think we're we're getting to a more glass half full mode. And I think that's what the stock market is starting to signal here, that, you know, at this point, the expectations for the Fed are are so bad. Meaning they're going to go so far that the possibility of a surprise may start to, you know, go more in our favor.
So maybe the Fed doesn't have to go all the way to 5. Maybe it only needs to go to four and a half. Financial conditions have tightened significantly. So maybe the Fed is closer to being done than we think. But, you know, as as as Sunil mentioned, that's only half the equation. Right. Even if we know with clarity where the
Fed's going to go and when, whether it's four and a half or five or five and a half, we don't know what the path will look like after that. In terms of reverting back to a neutral policy and we don't even really know what neutral is, is a 3 percent, is it three and a half? But, you know, I think the Fed is pretty committed to getting inflation back towards its target of, let's say, to two and a half percent and know we're a long ways from that. And so I think the risk is not so much that the Fed overshoots or undershoot in the near term, but that it's going to take longer to get back to a neutral policy after it gets to that terminal point. So, you know, we've been talking about
this earlier today. And I when I listen to what you're saying, I can't help but feel that for most in the market, there is this desperate desire to believe that we have the Fed that we've had for the last 17 years and we can't because the environment is so different than it has been. Well, maybe not last 17, but as the last year, year and a half, I set me up in this news new world we're living in.
But don't you think that a lot of the volatility is markets which have become used to Matt Miller these shaped recoveries and asset prices? So you miss the train so people keep jumping and suddenly realize it's not going to happen yet. Come out and see you see those bouts of extreme volatility, largely because the market's been trained to expect that the Fed is going to step in when it gets too shaky. Yeah. No, I agree. And you know, since the financial crisis, the Fed has been able to not so much put the inflation mandate on the backburner because I don't think it ever is. But it was able to spend most of its time dealing with the full employment mandate. And then when financial conditions were tightening, they could deal exercise.
The Fed put, as we call it, of course, and an ease conditions and get the economy going. And inflation was never a clear and present danger. And of course, now it is. And ironically, now the Fed is in the position where it needs to not only maybe tolerate a higher unemployment rate, but even even, you know, even half that at its goal in order to, you know, to compensate for the overstimulation that clearly was happening a year or two ago in the economy with that combination of fiscal and monetary policy. So that Fed put is is either gone or out the money. And that does create a different response function in the markets. And so and again, to the point I made earlier, knowing with clarity, which we don't know anyway, where the Fed's going to go and whether it's going to overshoot because it waited too long to start tightening policy in the first place.
Now, instead of doing too little, too late, it's doing perhaps too much, too late. But even then, we don't know how quickly the Fed will be able to go to a neutral policy. And I do think that that factors into valuation, Neal, because as you know, short rates, the Fed's terminal rate, real rates are important drivers not only, of course, of the bond market, but of equity valuations as well for the discounted cash flow. And calculating that present value of
future cash flows does depend on where rates go and how far they go up and how quickly they go back down. It's going to be an important factor. So now let me jump in here with a question to you. Is the Fed. Put ever truly gone because we thought maybe a we put was gone over the UK, but when things got really rocky, the gilt market had to come back in. What about will happen in UK? What does it tell us potentially here as well about the fragility of markets and maybe the need for a sentiment to step back in to give support? So, you know, I think that the UK I'm not going to say the UK historically, we always use that phrase right canary in the coal mine.
However, I think in this particular case, the UK, what happened there is emblematic of what can go wrong. The immediate cause certainly was the mini budget, which was quite disastrous. The combination of spending and tax cuts, it clearly was. It was the wrong time for a budget like
that. But we tend to forget it was 17 years again in the making. We've had a very extended period of extremely loose monetary policy and that forced the UK where you have a higher proportion of defined benefit pension plans. The UK is in a different position. Let's put it that way. Which is not to say that the US and other countries should not look at the UK and worry about the unknowns. We don't know where markets will break. And the reality is we are in a position where there is some possibility that something breaks. Will the Fed put hasn't gone away?
I think the Fed might be left with this completely internally and in position that the Bank of England is in with simultaneously buying gilts, but will continue to raise rates. You're where it's only 10 cents. So you go ahead and exactly. You, the Fed put may be gone for the stock market, but I think it will be coming back for the bond market. And, you know, its actions have consequences. Right. And policy actions have consequences.
And we only have to look to the Bank of Japan to see an example where the day have, you know, the Bank of Japan owns half of the GDP market and has completely tamed to the bond market. You know, the annualized volatility of long J.G. BS is three in the US, the long treasuries have an annualized vol of about, I think 12 or 13. And so if you're going to make fiscal decisions that have wide ranging impact yield and your central bank that has really dominated, you know, the bond market as of course the Fed has as the Bank of England has, as the Bank of Japan, as you know, you can't really leave that market. So I think that's how the Fed put is going to reappear.
But just in a different market. Listen, I'll one more here. Maybe the Bank of Japan has tamed the bond market. It sure hasn't tamed the F X market. And then on Friday, we got that news that a NIKKEI at least that they are now intervening to support that yen, which would weaken so much. We've got the BMJ next week.
Tell us about that. What does that mean? Is the yen broken? So, you know, what we're seeing is something we haven't seen in a very long period of time. We have the EU, Japan and the US all in dramatically different monetary policies. And as I think about this.
And when times were good to misquote Tolstoy, all good markets, functioning markets look the same. And all of these markets, as they're breaking, they're breaking in different ways. And I think that is that could just it could. It's never been more apparent than what you see in Japan. The reality is the yen is moving in line with interest rate differentials with the US. You look at us 10 year yields and you look at Japan's yen as it continues to kind of the Bank of Japan actually actually can control the yen. I I have my doubts.
You know, they might take some of the air out of it. But ultimately, this is a global system which is very interlinked and the interest rate differential is simply too extreme right now to simply intervene to fix it. The other issue, of course, is Japan does not have the US's inflation issue. And speaking to the size of the bond market that is held up in the US, depending on what bonds you're looking at, the Fed owns between 25 and 33 percent of the bond market. Right. So it's huge, huge impact. So now I'll decide. And your and Tim are gonna be staying
with us as we turn to what investors should be doing in these uncertain times. That's coming up next on Wall Street week on Bloomberg. Does Governor Reagan now concede that it would be inflationary if we just cut federal taxes and didn't cut federal spending? I don't know whether he does or doesn't, but that's not his program. His program is, in fact, to cut taxes significantly 10 percent a year over the next three years each year, but also to restrain the growth in federal spending. That, of course, is Luis Brookhiser talking with a pre chairman, Alan Greenspan, on Wall Street week back on October 24, 1980.
Back when Alan was simply part of Townsend, Greenspan and company, it was just before Governor Reagan was elected president. And the concern back then was about tax cuts without spending cuts, something that, frankly, we're still talking about today. The top movie back then was a Goldie Horn's Private Benjamin and Woman in Love. You remember it by Barbra Streisand
topped the Billboard Hot 100 chart for the week. Still with us, Arsenal Deci of Franklin Templeton. And you're in TEMA of Fidelity Management. You Shery Ahn to start with you. What's an investor to do in this environment where we do have inflation that seems to be broad, maybe entrenched. We have a Fed that's on the move.
What does an investor do? What's overpriced? What's underpriced? You know, the good news is in in a in a period where there isn't very much of it, is that both the 40 and the 60 side of the 60 40 paradigm I think are now, you know, really attractively valued. I mean, you can get a 10 year yield at the 10 year note at four point to a two year note at four and a half. You can buy the S&P 500 at around 15, 16 times forward earnings. Now, that P is only as good as the forward earnings. So we will find out whether the earnings hold. So far they have. So valuations have had a tremendous reset from the overvaluation days following the Covid lock down when the Fed basically repressed interest rates down to much lower levels than they really deserve to be.
And that raised asset price inflation in the stock market because, again, interest rates are an important factor in valuation. And so it's been a very painful nine months during which neither of the 40 nor the 60 has worked. That's a very unusual environment to be in. But I think, you know, the good news is that if the Fed does overshoot, I think the 40 will really present a lot of value at 4 percent plus yields, and maybe the 40 will start becoming negatively correlated again to the 60. And if other recession is averted, then
the 60, I think we'll do well because earnings then will likely hold up and valuations are now much more reasonable. So for me, the glass half full view here is that at least one of those two engines is going to start working. I can't tell you which one it is, unfortunately, but I do think it's not going to be any longer this monolithic market where basically nothing works. So now when will the bond market be the engine that starts working our bonds getting cheap enough now that it's time to go back in? They're beginning to look interesting. Let's put it this way, because if I look
at investment grade bonds, I look at short shorts, paper. You know, we already we just discussed her and just discussed that. We were talking about four point four, four point five and getting and getting to interesting levels. We're seeing something finally that we haven't seen for, again, close to 17 years, fixed income, delivering income. What a concept.
I think income becomes more and more important as we look forward. I do think that 10 year yields are likely to still go up. But having said that, it does stopped becoming attractive. So over the coming weeks and sorry, coming weeks and months, I think the first step would be areas like investment grade because you're getting paid healthily to hold good credit. And our baseline is not to have a steep recession. We'll have a recession.
But I think we might be able to avoid a steep one, which means that fundamentals can still look good. And furthermore, if I look in areas like high yield in emerging markets, you we are now getting paid between 8 and 10 percent in these areas, which means that finally liquid fixed income starts becoming a very decent alternative to alternatives, which up till now have really been the only area in the last multiple years that could deliver those style of style of return. So I actually am also glass half full at this point for the first time in quite a while. You're in just coming back to you and just kind of cash flow way of looking at stock valuations, as I understand it. In fact, you've taught me, in fact, the Fed has been buying bonds for they're also buying tips.
Is that skewing? That is a measurement. It's interesting you you mentioned that because I'm trying to I'm trying to figure that out actually in my latest my latest research, because the Fed owns 33 percent of the Bloomberg Tips Index. So that may not be all of all tips. So the overall number will be less than that. And so it makes you wonder whether there's any price signal left. But, you know, when I compare, for instance, the tips break even to the inflation swap market, which is, you know, a direct swap, I don't really see a tremendous amount of price distortion from the Fed owning so many tips.
And of course, the Fed owns a bunch of nominal ISE as well. So maybe one cancels out the other. So I think the jury is still out. But clearly the tips market is saying a different message than the headline inflation numbers are because the tips break evens are around two and a half across the curve. And that's that's totally different from an 8 percent CPI. It's a great discussion. I really owe it to both of you. Thank you so much. That's Sonali Basak. Franklin Templeton.
And you're in Timmer of Fidelity Management. Coming up, we're take a look at next week on Wall Street, week on Bloomberg. This is Wall Street. I'm David Westin. It's time to look ahead at next week on global Wall Street, starting with Juliette Saly in Singapore. Thanks, David.
China's closely watched party Congress wraps this weekend and investors will be awaiting the likely release of GDP and activity data that were delayed during the meetings when the reports finally land. Bloomberg Economics expects them to show an anemic third quarter recovery elsewhere. The Bank of Japan will likely stand pat on its ultra low interest rate and asset purchases, despite a plunge in again that's driving up import costs. And in Australia, the central bank's preferred measure of core inflation is likely to hit a 31 year high. It is a big week for European earnings. It's an even bigger week for European Bank earnings. We've got a whole range of numbers,
including HSBC, UBS, UniCredit, Standard Chartered, Barclays and Deutsche Bank. But the big one really comes on Thursday with the numbers that we're gonna get from Credit Suisse out of Zurich. But the numbers are not going to be the focus. The focus will be the upgraded strategic plan. The management is also expected to
announce on Thursday in Zurich, in Frankfurt that day. We have the ECB on deck as well. We are expecting the ECB to hike by circa 75 basis points. We're also potentially expecting the ECB to deliver some changes to other policies, including the cheap loans it offers to banks in the form of Telstra's. We could see some shifts there as well. Friday, we get the industrials, we get Airbus and we get Volkswagen. More than 160 members in the S&P 500 are
scheduled to report earnings next week. That includes big tech companies, Apple, Microsoft, Alphabet Matter and Amazon. There will also be earnings from UBS report late General Motors, Kraft, Hines and McDonald's.
Economic data include the US government's first estimate of third quarter GDP. GROSS domestic product did contract in both the first and second quarters of the year, but is projected by economists to reverse that trend rising by more than 2 percent. The weak rounds out with Friday's release of the personal consumption expenditures data, which the Fed uses for its inflation target. That data expected to show a continued re acceleration in consumer prices. David? Thanks to Juliette Saly, Guy Johnson and Romaine Bostick. Coming up, what ails the Chinese
economy? And does President G have what's needed to fix it? We're going to talk with Deborah Lair of Edelman Global Advisory. That's next on Wall Street week on Bloomberg. Ten years of remarkable growth. That's what President Xi Jinping of China focused on in his speech to the party Congress last Saturday. Watching what he thought about the historical significance in China's economic strengthening. Since this past decade, China's GDP has
grown from 5 trillion run to one hundred and four times for new Zambia income to account for eighteen point five percent of the world economy. Not a bad track record during Xi's time in office. But if President Xi had been willing to go back to before he was president. The story is even more dramatic since Dung Shopping initiated the open door policy in 1978. China's economy has gone from under one hundred and fifty billion dollars to nearly 18 trillion dollars last year. Now that growth is slowing down with possible repercussions for the rest of the world, according to the head of the WTO. If China's economy continues to slow,
the way we have seen DAX will have a big impact on what happens. That was the economy. And U.S. officials like Deputy Treasury Secretary Wally ISE, IMO, say that the open door isn't as open as it used to be. In addition to our resilient supply chains, we want to make sure that American companies are competing on a level playing field with companies in China and around the world.
And that's why we've taken actions like restraining the ability to shift some key components. But Bridgewater is Ray Dalio, who's been back and forth to China over the last 30 years, insists that despite all the problems, he wouldn't bet against Beijing over the long term. I think the longer term picture in China is still bright because I know the people and I know the culture and I think that's good. But they have major issues now. And when it comes to China, the person we turn to here at Wall Street week is Deborah Lear. She is the CEO of Edelman Global Advisory and executive director of the Paulson Institute. Deborah, welcome back.
Good to have you. We are all focused on President Xi and what's going on over in Beijing this week. Give us your sense about what we're learning.
It strikes me that one of the biggest challenges he has is the economy and growing the economy. And yet, I'm not sure we're hearing much about his economic policy. I hear a lot about politics, a lot about security. And that's right.
I mean, Xi Jinping gave his all important work report at the beginning of the plan, and it gave off a few previews of how he's going to start to look at the economy. One of the things that he's emphasizing is common prosperity. His slogan about how he brings greater equality. One of the things that he's looking at is also how the party can continue to play an important role in the economy. And also, he did give reassurance to foreign companies that they will continue to push for a market opening in key areas. So will we get a sense from the person now that surround him of where it might be headed? Because as I understand it, eventually we will see him come out from behind the curtain.
We assume everybody assumes that he will get his third term. But there's going to be a critical question of who is with him and he comes out. Absolutely. The important thing and we're all watching for this weekend when the new party lineup is going to be announced. There's a lot of rumors starting to fly around, although not as many as there usually are. But it's a big guessing game because that will give us really our first clue into what the third term is going to look like. And I think there are three important things to watch.
One is going to be what happens to Li Keqiang, the current premier. Does he continue to stay on the standing committee? He's he's termed out of staying on as the premier. But could they make him the number two and head of the National People's Congress? Who will be in the lineup to then take the premier position? And the two leading candidates appear to be one yang, who is viewed as being more open on the economic issues, and Wang, who knowing who really is an ideologue. And the third to watch is what happens to Leo, her, who is currently the vice premier, who's in charge of the economy and finance. Does he stay?
He has good relations with many foreign firms or who really comes in to take his portfolio. Deborah, one of the things that we watch in the West and we may be right or wrong in watching it, is the extent to which the markets in some way play a substantial role in economic policy over there. It strikes me that it's possible to interpret President Xi thus far as moving somewhat away from the markets. A lot of what do you emphasis right now is ideology.
And I think it's what he came out of more than perhaps we've seen in the past. Absolutely. We're seeing much more emphasis on ideology under Xi Jinping. And if we look back under Jiang Zemin, Jiang Zemin was saying the party is big enough to include business. She takes it in a different way.
He says the party is all encompassing and it should be forced. Into business, and so ideology is playing a much bigger role. Also, we need to keep an eye on how she's favorite slogan, Common Prosperity is going to be implemented. China, surprisingly, is actually much more unequal than the United States. And one of the things that he's trying
to do through this common prosperity slogan is say there should be a cap on executive salaries. We should be looking at big companies, particularly the private sector, giving back to the community and how that's going to be implemented. At the same time, when he's trying to grow the economy, when he's trying to encourage entrepreneurship and create jobs. It's going to be a very tough thing for him to balance. Well, I was going to ask exactly about that, because through history, a lot of people have said we should have more equality, less inequality, whether it's income or wealth.
But a lot of attempts to get that done actually do get in the way of growth overall. Absolutely. I mean, in China and we've talked about this before, the overwhelming majority of Chinese companies are small or medium sized enterprises. It's up into the 90s. They are responsible for about 60
percent of China's growth and about 60 percent of job creation. And so if you can't create the right atmosphere for them to grow, you're going to have a significant impact on China's ability. And right now, she's facing a lot of headwinds when it comes to the economy. He's got issues still to deal with with the real estate market. It's one of the only places the Chinese people can invest. And obviously, housing prices are going down at the moment.
The world is facing a global recession. And she is still very dependent on exports to grow the economy. He needs to find a way to unlock consumer spending. And that's very hard to do when you don't have confidence in the path of the economy, and particularly when you don't have the kind of social safety nets in place, particularly around health, that make people feel comfortable enough and have confidence to spend their money. If you put a longer course of Chinese history because you've been really very active in China for a good long time now we're seeing something of a turn back toward Mao and away from dung shipping. Well, certainly we're seeing a difference in the way that she is governing the economy.
The Chinese Communist Party has about 93 million members. And to put that in context. That's 10 million more people than the whole population of Germany. And he views this as the way to govern the economy. And so, therefore, the party is involved in every aspect. As we look at this new leadership coming in, watching the ideology versus the technocrats, it's going to be really important. And give us a sense of what the
government appointees which will take place next March will look like and how they're going to approach the economy. Is there going to be this emphasis on a more socialist economy? Or are they going to be more emphasis in what they call the socialist market economy? The fact that they didn't put out the GDP numbers this week on time, I think is very disconcerting for the world's second largest economy to place politics over just the standard transparency and publication of data is not an encouraging sign. Deborah, looking into your crystal ball there, what do you think this might mean for U.S. China relations? I mean, it strikes me at least that going back five or 10 years, a lot of it was about economics. It was about trade. Things like that increasingly from
Beijing, but also from Washington. When they talk about one another, it's about geopolitics, it's about Taiwan, it's about Russia. It's about security in the Asia area. Well, national security definitely dominates the headlines and there are some very serious issues that we're dealing with. I was just in the UK and they were telling me Taiwan didn't even used to really be on their agenda and now they're spending about 75 percent of their time.
These are the China experts focused on this. So those are absolutely definite, important issues to watch. But I think the real story here is going to be what happens with the economic and trade relationship. Traditionally, it's been the foundation of the relationship and it's created the people to people ties and built some levels of trust without these exchanges with Western companies reconsidering both because of the politics, but also because of the state of the Chinese economy and the complications that have come with dealing with Covid 0.
They're reconsidering their strategies and not being that level of trust. I think really is going to have an impact and ensure that they're going to continue to be fraught relations between the United States and China. Do you have, Deborah hopes, if not expectations, that after we're through the party Congress and maybe actually after they meet in the spring and confirm that as president of the country, that that will free President Xi to reach out to the United States? Or will it embolden him to become even more assertive? Well, I think once we know what the lineup looks like, I think it's gonna be easier to answer that question. I think whatever happens on the political front, Xi Jinping needs to find a way to grow its economy because his power both internally and internationally, stems from their economic might. China right now is the largest trading partner to 70 percent of the world. The US used to have that role 20 years ago.
And in order to maintain that, he has to show that he can grow the economy. It can't grow the economy through ideology. He has to go grow it through basic economics. Okay. There is always such a pleasure to have you here. You are really are our China expert.
That's Deborah Lear and she is CEO of Edelman Global Advisory. Thank you for having me. Coming up, we'll wrap up the week with our special contributor, Larry Summers of Harvard. This is Wall Street week on Bloomberg.
This is Wall Street week. I'm David Westin. Welcome once again, our very special treat on Wall Street week. He is Professor Larry Summers, of course, former treasury secretary. So thank you so much for being with us, Larry, once again. Much of the week was consumed with the drama over the United Kingdom, which is good and serious, serious business for people who are living in Great Britain. But what lessons might it have for the rest of us? Look at one level, Brit. Britain is unique.
They went through Brexit. They've had some unique political challenges that have taken place within their Tory party. We've rarely seen the kind of extreme incompetence that was represented by the original trust's proposals. But I think there are two lessons that policymakers around the world need to heed. The first is that things can change extraordinarily fast if you lose credibility, just as it takes a long time to grow a forest. But you can burn it down very quickly. Something similar is true with respect
to credibility and confidence. And I think at a time of rising government debts and rising interest rates, that's a lesson to be careful that policymakers in many different countries need to take account of. I would say the second more specific lesson just goes to the potential instability in government debt markets, and that's got both a macroeconomic aspect that if your deficit projections starts to get out of control and your real interest rates start to rise rapidly, you can get into a kind of doom loop. And it also has to do with liquidity in the markets and the possibility that you'll get a situation where they'll be selling, but there won't be buying, which will beget a kind of liquidation cycle. And I think given the magnitude of the increases in interest rates that you're seeing in other parts of the world, that's something that policymakers are going to have to be very careful of. I thought Secretary Yellen was right to warn about issues around illiquidity in the US Treasury markets. I think we're going to need to be
watching our own fiscal projections in the United States very carefully, because I think they're going to look different with current market interest rates. If you factor in the recession that's likely to come, that's going to have some significant effects. If you factor in all the different steps that are being taken, whether it's the student loan debt relief for the emergency funding that's going to take place because of the hurricane in Florida or the increases in national security expenditures that I think are almost inevitable given what's happening in other parts of the world. I suspect that the fiscal issue is going to need sooner or later to be back on the table in the United States.
So I think that we can be amused. Those of us who don't live there by some of the things that are happening in Britain. But if we think of it as an experience that's entirely outside of any kinds of concerns that other countries could have. That would be a real mistake. And, Larry, as you say, we have to perhaps pay much more attention, the fiscal side be a bit more responsible. That's at the same time that many people and you included are warning that we may won't be heading to a recession here. In the past several years, it's thought
that if there's a recession, we can just write some fiscal checks for it. If we don't have that ability that way, it turns out lives trust did not have over in the United Kingdom. What does that mean about our ability to pull out of it? And what is the prospect that we've had so many years of feast? We may be headed for some famine and higher interest rates, lower growth and lower productivity increase. Look, David, there's always a tendency at the beginning or in the early stages of very problematic periods to assume that everything is going to be resolved much more quickly than actually proves to be the case. Think about Covid. I was early on your program and was very worried about Covid, but I certainly didn't envision that it would be something that would still be on people's minds going into the winter of 2023. And I think it's a mistake to think that
all of our economic challenges are going to be met quickly, particularly if we heed what I think would be the dangerous advice that are coming from the erstwhile members of team transitory that the Fed can back off already and not carry through on the increases. The market is now expecting I think for that to happen would be to almost guarantee a protracted period of stagflation as we had both we lacked both price stability and confidence. I think we need to remember that apart from anything we do with discretionary policy. We have a whole set of natural stabilizers that kick in in our economy as the economy goes down. Tax collections go down as unemployment crosses certain thresholds. There are increases in unemployment insurance payments. But unfortunately, I think we fired the
fiscal cannon so strongly that there's going to be limited room for discretionary fiscal policy. If we have another recession. Finally, Larry, one of the other events of the week was the release of further release from the Strategic Petroleum Reserve by President Biden, who swears this is not a political issue. But could you give us the economic potential effects of those sorts of releases? David, I think the spurt the initial Spiro release was a powerful thing that over the last months has done a lot to contain oil prices.
And I think the Biden administration was exactly right to do it strongly, do it for a long time, do it in coordination with others. I think it's much less clear how much scope there is for that policy to work further going forward. In part, that's because of the many of the constraints are on the refining side. In part, that's because what it's a little bit like QE for the Fed. Whatever you put out there, you're going to have to get back in at some point and that's going to have the opposite impact on oil prices.
So I think you got to be careful about that instrument from here. And I think that we've all got to be very apprehensive about the degree of confrontation that now exists between the United States and what might be called the Russia and Saudi axis. This is going to be a very complex time, and I hope that we get through it while avoiding oil price spikes. My guess is that that's going to happen.
But I think that's a major downside wild card from here, both with respect to inflation and with respect to recession. Okay, Larry, thank you so much once again for joining us on Wall Street week. That's Larry Summers of Harvard. Coming up, what's up and down with Great
Britain? Bloomberg Stephanie Flanders gives us one more thought on a wild and wacky week for the British government and the economy. That's next on Wall Street week on Bloomberg. Finally, one more thought, and this weekly comes from Bloomberg senior executive editor for economics and government, and it's about her native land. Here is Stephanie Flanders. I think Liz Truss started off with the right idea, which is the UK has been held back by a slow growth since the global financial crisis.
Actually, in that in the two decades before 2008, we'd averaged around two and a half percent growth, which was higher than many of our trading partners. We sort of caught up a bit with Germany. We caught up a bit with the US during that period. But since then, growth has been less than half that and certainly much slower than other countries. So it did make sense to focus on growth and it made sense to also to be spending some money in her initial mini budget on supporting households through a massive energy squeeze as we approach the winter. I think the problem for financial markets is that the government showed no willingness to engage with the difficult tradeoffs that all governments are facing in this environment where they want to stimulate growth. They want to help households face rising
energy bills, but they don't want to make it harder for the central bank to bring down inflation. And they don't want to be building up a lot of debt just at a time when we know the cost of money, the cost of borrowing all around the world is going up. So it was not what she did, but the way she did it and the kind of gay abandon with which the government was proposing tax cuts that were not funded by any form of spending constraint and not targeted to the people who in this particular environment needed help the most. I think what we also saw in the UK,
there had been this nervousness in financial markets that maybe dates back to the Brexit referendum, that some of the constraints, the institutional constraints on policymakers in the UK that had prevented, you know, silly politicians from doing silly things, that those have been worn away in the years and the tumult since since Brexit. And I think what happened when you saw the new chancellor installed the seventh since 2016. You saw potentially those institutional constraints come back that the Treasury, the Bank of England is still in charge. That's the message to markets, even if politicians are still messing around the edges.
There's a lot of schadenfreude potentially and certainly there. But for the grace of God, go I. Central bankers and treasury officials around the world, they are looking at the UK and wondering what's happened to this previously great nation. But they should also be looking at potential pitfalls that they, too, will face as we go into this environment in which interest rates are going to be higher.
The cost of government borrowing is going to be higher and potentially strains are going to be put on financial markets. We saw a particular investment strategy, the liability driven investments in the UK, which were which are particular to the UK, mess up the pension market, forced the Bank of England to intervene. But we know we saw similar fragility in the US Treasury market back in March of of 2020. And there may be other things out there that we should be nervous about as we see this very significant shift to a higher interest rate environment that does it for this episode of Wall Street Week.
I'm David Westin. This is Bloomberg. See you next week.
2022-10-23 14:48
