Next Big Risk: Debt, War, Recession - Wall Street leaders try to look ahead
I'm Sonali Basak, and this is the next big risk. It's an investor's job to calculate the possibility of the unknown and in a market that's navigating risks tied to the nearly thirty two trillion dollar U.S. debt load. A second year of a war in Ukraine and concerns about a global economic slowdown. The biggest market participants are trying to look further ahead. Karen CARNEY All Tamba Bridgewater is newly named co chief investment officer, worries about governments becoming hamstrung in expanding fiscal policy during a downturn and the potential for longer and more painful future recessions.
KKR Henry McVey sees the labor shortage becoming more profound, creating real complexities for central banks and governments with a real risk of economic reckonings. And new VIX CIO Sara Malik has concerns that climate change will lead to entrenched inflation in the years to come. Now let's begin with Karen Kearney al timbre in her first interview since being named CO CIO for Bridgewater, the world's largest hedge fund firm. We discussed how future recessions may play out more painfully than in the past. I think the next big risk is recessions that are deeper and longer than what we've been accustomed to. Everyone investing today has had their
whole investing career over a period of significant disinflation and a time where every single time there was any kind of downturn in the economy, central banks could just hop right in and reverse it. They didn't face any kind of tradeoff. And we saw it the most in Covid when the economy's going down, reversing it is a win win for everybody because growth is a disaster and there is no inflation. Just ease everything you can. So what that means is recessions could never be deep and long. They were always quick and shallow because there was always a savior to save the day. And we're going into a world where
that's just not what it's going to look like anymore, where every time the economy slows, it'll be painful because several banks will want to ease and at the same time will be struggling with how sticky inflation has been. And that will be exacerbated by the political situation. Paint a picture for me about what the world really looks like under this scenario. I mean, what are the ultimate implications of, you know, potentially more frequent recessions or deeper ones? They you step back. One of the really meaningful changes
that's happened that's hard for all of us to kind of just day to day is that for many, many years around the world, growth was kind of more or less a pretty good proxy for people's lives getting better. If you had good growth, people's lives got better. And about ten years ago, this started changing where you could get totally reasonable growth numbers. And yet anything that had to do is, you know, the quality of the 60, 80 percent of people's lives that wanted the very top weren't really moving in line with DAX.
It just wasn't happening in the same way. But that's kind of changed the game and made it so getting to the point where what do we really do? We try to avoid recessions. We try to get people's quality of life to keep going up. If you're going to have recessions now, they're going to feel really different because now suddenly political actors are part of the solution. They see a role. They've experienced what happened in
Covid and they realize that they can impact the outcome. So they're much more likely to step in. How big fiscal expansions and try to impact the social and environmental implications of downturns or problems that we see? You see this now is what's happening with war in Ukraine. You saw it in color with all the social issues and then monetary policy. On one hand, we'll be less important
because fiscal be doing what it's doing. On the other hand, there are going to be an even tougher spot because they'll have this much more entrenched inflation because you have secular inflationary pressures where you didn't for 40 years and they'll have fiscal policymakers stimulating at the same time. So they'll be forced to tighten a lot more than they would have otherwise wanted to ease a lot less than they otherwise want to. And then those become recessions that are much more difficult, much more painful. And how difficult and painful they are for whether individual people in households or environmental outcomes or market outcomes will depend a lot more about what fiscal policymakers end up doing and how they navigate that situation.
We're talking about that at a time where there's a lot of concerns around not just the U.S. government debt load, but the debt loads around the world. Is there really firepower behind government balance sheets to intervene? I believe that there is firepower until the market punishes them and tells them that there isn't. Right. So we started seeing this in the U.K. where the market basically said you've gone too far. And how do we see this? You start having rising bond yields, falling currency. They see the market saying this is too
much. This is unacceptable. And they stepped back and they didn't do what they're going to do, which to market based to is irresponsible. And so we don't really know how the market is going to treat it. But so far, most countries in the rich part of the world, in the developed world, have been able to do massive, massive fiscal intervention, run very high debt levels without the market really saying this is not something that's going to work more frequent, potentially deeper recessions. Can you give a sense of this, the scope of that? What does deeper mean? What does more frequent mean? When you have a recession that the central bank can just solve quickly because they'll go and they'll ease aggressively in this first sight of a downturn.
Right. You get a world where every time you have something go wrong in the economy, we can't use the fact that it just gets solved within a few months, even when it's really, really bad. And so these are very non painful recessions and a very core way because the most important firepower in the World Central Bank and then, you know, fiscal policymakers could step in and try to make them not painful and go away very quickly. And we're moving into a spot where there are actual tradeoffs. The central banks can do that if they
want, but they will live with much higher inflation than they think is prudent to tolerate. So they're less likely to. And that means if you're in a recession for the first time in decades, you'll be in a recession that might be hard to get out of. You might be kind of stuck in. And the stagflation years where that occurred are so far behind most of our memories. I think that these risks are exacerbated by weather, by how fast the pace of globalization is going to be and how problematic geopolitical tensions end up being. So if you look at what globalization had
done. You had decades where the fact that the world came closer and closer together was a very powerful deflationary force. You were constantly taking goods and services that were being produced and moved them to the cheapest possible place. And it made the whole world cheaper constantly and brought more and more labor online. And that was one of those big deflationary winds in the back. That allowed central banks to keep coming in and easing when things were tough.
Now we know that the world can't read globalize against that deflationary forces behind us, but you can decide how fast you're going to deal globalize. Are you going to literally go and tried to like tear apart all of those forces that put the world together in these years? And we don't know yet to what extent that will happen and now determine just how inflationary it is. And the biggest wildcard here force is how difficult the relationship gets with China, because China is so deeply embedded in supply chains that there's a big difference between having to kind of modestly cut them out or just have some double dos versus actually undoing actually decoupling from China. That could be a very inflationary event that exacerbates this whole environment very significantly. Who will suffer most in this scenario? It's the people that suffer the most are usually new entrants into the workforce. You see this in sort of a lost decade. You have in countries that go through deeper recessions where there is no kind of fiscal help that offsets this. But when you have people who need to be
joining the workforce and there ends up being a prolonged recession in those critical years, and by the time there is significant hiring, you know, years have passed and haven't really started their careers. It's very hard to guys careers back on track and to get productivity. And you can kind of have a lost generation. There's a lot of things that the system can do to offset that, but that's the risk. Coming up, Henry McVey, CIO of KKR as balance sheet on the global labor shortage. Why we're having this issue demographics.
Covid. And ultimately geopolitics. And that is leading to a workforce right now that's subscale relative to what we need. It's happening at a time of rapid technological change around the world. This is Bloomberg. Welcome back to the next big risk Sonali Basak of me McVay supervisors take Care's balance sheet and is no stranger to managing breast.
We spoke about the labor crisis and how it's likely to get worse. I think the biggest risk which changes around labor and that's a global statement. What's happened since Covid is we've really seen a lack of people come back into the workforce. It's been probably most pronounced in the US. But even countries like China, which have a massive population, their population actually shrink and 2022. So that has huge implications for not
only society but also for companies and ultimately how those companies are valued or what is kind of the long term outcome here. If this trajectory continues, I think I think ultimately what it will mean if you have fewer, more people on the sidelines, less people in the labor force, as you probably will have more government subsidies for those people that are there out of work. But there there are actually a lot of success stories around labor. If you look a lot of countries,
particularly Europe, I'd say Denmark, they're doing a lot more on worker retraining that hasn't really taken place in the United States. And so there's a huge mismatch. The U.S. right now spends about one sixth of what Germany does in about one twentieth of what a country like Denmark does on on labor.
So to me, ultimately, the when you look over history, the best economies, the best societies or where and when laborers engage working and they're bringing in pay and they feel good about their their job. What would happen after Covid? Let's let's use the U.S. as an example. 20, 21.
You should have had one hundred and sixty six million Americans in the workforce. We had one hundred and sixty two million. So let's take a step back and say what happened there. Point 1 is a lot of people that were 55 and older just stepped to the sidelines and said, OK, that's enough. My house went up in value. My stocks went up in value.
I'm going to take my ball and leave. And so that they've started to go into retirement early. The second is there's been a real slowdown in immigration. Not surprisingly, giving some of the issues around Covid and rising geopolitical tensions. And then the third that I mentioned was really around the fast moving nature of the economy where technology has created greater job obsolescence.
How much of this is a structural problem even beyond Covid? When you look at labor force, what is GDP? GDP is labor force growth times productivity. So get out those two things. In the 2000s, U.S. labor force gross was one point two percent. Today, it's less than half of that. That's a huge drop off.
And so if you have only two variables that you can control the labor force growth and productivity, it really puts a massive emphasis on productivity. And what happens is when you have a workforce right now, we're having job changing actually faster than we've seen ever. That actually leads to lower productivity or people decide they're going to be in the workforce, they're not going to be in the workforce that dents your productivity. And if that's underperforming, then your labor force growth is slower than expected. You end up with slower GDP. So why is this the next big risk dry out
in 10 years if this trajectory continues? This problem is not fixed. What does the world look like? Well, ultimately, it's a slower growth world. It is a world where you have less corporate profits. It's a world where you have more attention, where workers feel disenfranchised. And ultimately that puts more burden on the government. And you probably have more political,
I'd say angst. Those are all huge implications. Is the idea here that, you know, you're facing a growth cliff in the world because of these labor shortages or distortions? Or is the idea here that the larger risk is, you know, a populist uprising on the world? I think the more immediate risk is, is when you're not a populist uprising. I think generally you are seeing GDP per capita go up around the world. The question is, is we've been living in a world where corporate for investors. Watch your show. We've been living in a war where corporate profits have exceeded GDP. We could enter a phase where corporate profits lag GDP.
If companies don't figure out how to address this labor issue, what is the outcome here? A labor shortage leading to more unemployment. Is that part of the Fed has raised rates as fast as they ever have and into pretty high levels. And we're now at a three and a half percent unemployment rate.
That's a unbelievable statistic. The Fed has two mandates, right? One is around growth and the other one is around inflation. If labor is a huge inflationary force, that means you have to have more restrictive monetary policy. So we've been talking about some of the, you know, the offensive things to do for companies. From a macro standpoint, this is a huge issue.
This puts central bankers back on their heels. They're raising rates as fast as he can. And they see unemployment rates going down. Right.
Think about the Fed. Financial conditions actually eased despite the fact that they've raised they've raised rates as much as they have. So how do you kind of consolidate the big conundrum for four central bankers? I think they're in a tough spot. I think ultimately what they're going they're trying to use. Housing, which is a cyclical industry and a blunt interest, blunt instrument in the form of raising short rates in that calms a cyclical part of the economy. The goods part of the economy.
But back to what we said earlier, it doesn't fix the services part. And so where here's what's happening right now is the feds actually hitting its mandate on goods inflation, but it's missing badly on services. And, you know, I think we're seeing this to some extent, too, both in terms of the wages and both in terms of kind of that dynamic. You've pointed out here, which is you can have a job, but you can't pay for your house. Yeah. Is that. And so there's a dichotomy.
What the Fed what we what are we rooting for as investors right now? We're rooting for that, that inflation comes down and real wages actually go back positive so that employees can buy more groceries, they can pay more for education. They can do things for their households that they want to. That actually hasn't happened despite the fact that wages have been growing 5 to 6 percent. That's at the household level. The second is that will enable companies
to have greater visibility on what they're paying their employees and hopefully extend the duration of the employees. Right now on the switching costs are huge for employers because people are changing jobs at a record clip. And then finally, the third point is the central banks. The central banks, I believe, honestly
believe they think they're at a normalized level, but they're not seeing that show up in the labor date. We need to end up in a spot where we have rates up a little bit higher. Real wages are positive. And then you have some visibility around that that the Federal Reserve and the government feel good about. But I think this is going to I mean,
it's one of the reasons I think this is the big tension, which is this is not going away. We talked about a few different places in the world. Now, if you kind of think about kind of the labor distortion issue, where are the areas that are most pronounced and where are some areas that are probably winning and therefore could potentially. It sounds like, drive more investment. What do we have? The last 20 years we had we were going towards globalization and it was easy to move from your your centers to India to China.
Now, what's happening is that's coming under pressure for geopolitical reasons and also to the point here for labor. So I think if you ended up in a world where Asia could actually create more domestic consumption, which is I think where we're going. That would put them in an advantage. I mean, when we think about our footprint globally, we've taken our balance sheet for 10 percent, Asia to 20 percent. We want to have that by 25. So, you know, we believe in that. If you had to say what's the 30 second elevator pitch on why we're having this issue, demographics, Covid and ultimately geopolitics. And that is leading to a workforce right now that's subscale relative to what we need. And it's happening at a time of rapid
technology and technological change around the world. Coming up, Sara Malik, Naveen, CIO on the risks from climate change, the breaks from traditional energy to renewable energy is going to be long. We're still going to need oil. We think prices remain in a higher range than in the past. In the 60 to 80 dollar per barrel range and even with upside to 100, that's inflationary. This is Bloomberg.
Welcome back to the next big risk. Has over a trillion dollars in assets under management, but getting the best return for clients is not the only thing on CIO Sara Malik's mind. We spoke about how the rush for renewable energy will have its challenges and how the broader climate picture could risk more inflation. I'm worried about climate change and the path that we're taking to lower emissions. It's going to have impacts in three key areas real assets, the economy and inflation. We're worried about real assets because
they're part of the problem and the solution. Farmland and farmland, agriculture and real estate are some of the biggest producers of emissions and then infrastructure as part of the solution. As we electrify the grid, when you take a look at inflation, we're already dealing with multi decade highs and inflation because of wages and more consumer spending. But there's going to be tight supplies of inputs into clean energy and traditional energy that should be heavy.
Add even more to inflation going forward and then the economy will be impacted by climate change volatility as well as geopolitical conflicts as some countries may not agree on the path to lower emissions and climate change and also shareholders voting with their feet and how companies think about capital spent. This idea that, you know, inflation can be brought down by financial measures seems to conflict with what you're saying here. How does that work out? Are there things that people are not seeing in terms of how climate in particular will drive prices higher? So think about the inputs that go into traditional energy, starting with oil. Our peak investment in oil was in 2014. Supply has remained tight since then. Demand is increasing and producers are focusing on returning cash to shareholders over pulling more barrels out of the out of the ground.
So the bridge from traditional energy to renewable energy is going to be long. We're still going to need oil. We think prices remain in a higher range than in the past. In the 60 to 80 dollars per barrel range. And even with upside to 100, that's
inflationary. And when we take a look at renewable energy, metals go into solar, wind. The grid infrastructure and hybrid vehicles and batteries. This is cobalt, copper, lithium and nickel. Just taking a look at copper. In the last twenty five years, U.S. production of copper has dropped by
about 50 percent. But we expect a man for copper to double by the year two thousand thirty five because of the demand for copper and renewable energy. And from discovery to production of a copper mine takes 16 years. So inflation in metals and inflation and oil prices should continue to exacerbate the already high inflation problem that we have right now. Inflation has been impacted post the
pandemic because of higher wages, consumer spending on goods, which has now switched to consumer spending on services, higher shelter prices. Some of that may start to abate, especially because of the Fed continuing to raise interest rates and tighten the economy so they can tackle inflation from a demand point of view by dampening consumer spending and and cracking the employment market at some point. But these supply issues should continue to exacerbate the inflation problem on the other side. And this is the supply of metals. The supply of energy. And that's been a challenge for the Fed because they I don't think they can tackle that by just raising interest rates other than increasing funding costs. But the demand for renewable energy should continue to do to keep that supply tight.
Well, you know, the one thing that's interesting is we're having this conversation coming off of a year where that any year energy sector rose more than any other sector. When you looked at the S&P 500 and it rose very, very meaningfully. Is that a signal to you that maybe there isn't as much investor demand for cleaner renewable energy as there is for the ways that things have always been done? I just think that we're just not technologically very. When it comes to renewable energy. So there's a lot of positives as we race
to creating more renewable energy. But we're just the bridge to that is going to be long, which is why traditional sources of energy remain important, specifically oil, even coal and natural gas. And we've been under investing in many of these areas for many years. And I think the path is just going to be longer than we think. So what happens if change does not happen as quickly as you'd like it to over your planned investment horizons? What happens to the assets that you. Oh, it's most important for the real assets of real estate.
Farmland are the most significant producers of emissions worldwide. They need to think about, for example, 80 percent of buildings in existence today are going to be the ones in existence in 2050. So this is about transitioning your buildings to lower emissions rather than just building newer green buildings. Now, for real estate companies to do that, it can cost up to 20 percent of the net asset value of a building to move it to low carbon. Also, they have to think about the
physical risk, whereas the building located is it near sea level rising? They need to think about funding. Green bonds can have lower funding rates for buildings that are more carbon efficient. And when it comes to farmland, yields can be impacted by up to 50 percent by climate. And a lot of crops are concentrated.
Rice is mostly made in China and India. Soybeans in the US and South America and as well as corn, which is in the US, China and Brazil. So that can also be impacted by weather patterns. So both of these areas need to think significantly about how they transform their businesses so they can end up on the right side of the equation. Interestingly, you out of nine people we've interviewed for this project over a number of years are the first person, despite all of the conversation in the industry about climate to bring up climate as the biggest risk.
And so I'm wondering if you think that there is a disagreement in the investment community on how big of a risk it actually is relative to everything else out there. I think there's disagreement in the investment community politically, also with business leaders and with scientists. As with any other issue, that is something that is out in the future. You do look at the sort of big picture of climate change. So there's going to be challenges, opportunities and as an investor. Winners and losers on the Challenger
side, exactly this political disagreements on the path that we should be taking shareholders and how they're voting and how that might impact companies and their capital spending. What I'm very optimistic about is we're starting to see these opportunities from gathering that at the cop meetings every year. The Paris agreement, which just come into place, as well as the Inflation Reduction Act.
And from an investment point of view, which is key as we go through the next number of years and even decades, thinking about which companies can win over time if climate broadly is a risk. What is underpinning that risk for you? What keeps you up at night? You I think about climate change, not only the human element of it with, you know, what were the implications of the world heating up if we go past that tipping point and cause things such as sea level, rising, glaciers melting, ice shelves collapsing, what does it mean for companies, the winners and the losers? What is the regime for decades going forward? Mean, if interest rates are higher and inflation is higher than we've seen before in our careers, all of that is important. But I think, you know, the good news is as when we're working on solutions to it and as investors, there's companies that will very much transform towards it. There's large companies already working on the solutions to it.
And there will be a lot of winners and losers over time. But more winners and losers in areas, as I mentioned, like infrastructure. I think farmland and real estate will evolve over time to lower emissions and all of these great companies popping up to help these areas become more climate friendly. That's it for this episode of The Next Big Risk. You can watch previous interviews on Bloomberg dot com and on the terminal Sonali Basak.
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