Latest / Look Forward / A Conversation with Paul Gruenwald: Global Economic Trends and China's Role

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A Conversation with Paul Gruenwald: Global Economic Trends and China's Role · Look Forward

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Transcript Provided by Kensho Nathan Hunt This is the Essential Podcast from S&P Global. My name is
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Nathan Hunt. Periodically, here on the podcast, we like to back up and take the macro view. Usually,
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that involves bringing back friends of the podcast, Paul Gruenwald, for an interview. Paul is
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the Global Chief Economist for S&P Global Ratings, which means that his team's economic projections
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are important ingredients in our credit conditions reports, among other things. That means that I'm
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not the only one who wants to hear Paul's thoughts on the direction of the global economy. Paul has
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recently returned from the World Economic Forum annual meetings in China, and he's a regular guest
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on CNBC, Yahoo Finance, and Bloomberg News. Paul, I'm thrilled you could fit the lowly
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Essential Podcast into your busy media calendar. Paul Gruenwald Well, it's great to be back,
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Nathan. It's my pleasure. Nathan Hunt Paul, I want to dive in first to these meetings you were
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attending in China for the World Economic Forum. What were your general impressions coming out of
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those meetings? How were people talking about the global macroeconomic picture and also specifically
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about the macroeconomic picture in China? Paul Gruenwald Yes. Well, first of all, Nathan, this
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was the China Davos. This is not the Davos, Davos. So it was a bit China heavy. And it's really kind
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of a mix of macro finance and then talking about the big transitions, the energy transition,
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the digital transition. I guess, the demographic transition as well. I think there was a fair
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amount of optimism about the global economy. Inflation is under control. It looks like we're
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achieving the so-called soft landing. Economies have slowed enough to take out inflation,
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but not slowed enough to cause recessions and big dense in labor demand. So that looks kind of good
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so far. In terms of China, I went to a session by Li Qiang, the Premier, and he was talking about
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the challenges of China, the property market and trying to make sure that the property sector stays
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healthy, impact on local government finances, et cetera. But China is committed to get its
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5% GDP target this year. We've got a bit lower in our forecast, but also about China's rising
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role in the transition with the solar and the electric vehicle. So a lot of optimism around
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that as well. Nathan Hunt Excellent. I'm wondering, you spoke about demographics,
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the demographic transition, right? Obviously, particularly in the developed world, we have
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an aging population. I know you spoke on a panel related to demographics while you were at these
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meetings. What do you see as the macro impacts of these changing demographics? Paul Gruenwald Well,
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first of all, if an economy is aging, it's going to slow. I think Japan is case #1 for that. I
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said a couple of things in that panel that I was leading first, we have to maybe measure things
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a bit differently. So if you look at Japan, let's stick with Japan. GDP is the weakest in the OECD.
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But if we look at it per capita, it's in the upper half. And if we look at the people who
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are kind of actually in the workforce, it looks pretty good. So we have to adjust things for
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the fact that folks are going to be retired, they're going to be maybe working part-time
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whatever. There's a lot of worry about health and retirement expenditures, which were kind of
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built on the assumption that the population would continue to grow. But I think this biggest issue,
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and this is one the World Economic Forum has been working on, is this kind of changing the view of
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the workforce and longevity, lifetime learning, multiple careers, maybe you gear down and take
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half of a job, mentorship, using the old folks and the labor force. As we all become older,
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it started out as Japan then it was Europe, and now it's even spread to China and some of the
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Asian economies. We're going to have to figure out how to rejig our statistics and rejig the way we
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think about growth in order to stay healthy. Nathan Hunt One of the things that I wonder
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about whenever people talk about this demographic transition is that we hear a lot of talk about AI.
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And we hear a lot of talk about AI taking people's jobs. But isn't it also possible that AI could
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create a sort of a bridge of growth where, yes, people are dropping out of the economy,
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but maybe productivity increases as a result of AI. Can we consider AI engines almost like
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additional workforce participants? Paul Gruenwald Well, you nailed the debate, right? One side of
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the debate is like, "Oh my god, AI is going to take our jobs the disaster's coming." And the
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other one said, "Well, this is actually a pretty useful tool." Let's stick with demographics.
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People's smartphones can take the place of medical professionals in some ways, right? It can measure
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heart rates. It can measure other things. It can empower nurse practitioners. So I mean that's just
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a straightforward application of the technology that's going to make health care easier. We
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know about all the sensors for methane and the energy transition and emissions, and we can use
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the technology for that. We can heat our homes and power our cities more efficiently. So I think the
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trick is to put the technology in our service to improve productivity. And if we go down that road,
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then that's a positive road, particularly if the labor force is shrinking, and we're going to
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need some health from the technology to power our economies. Nathan Hunt Paul, I want to get further
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into this year that we have this year of many big elections. But the discussion about demographics
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makes me think specifically about the recent election in France. The party that came out of it
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with the most seats in parliament is a party that is committed as one of their sort of core planks
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to rolling back the change that Macron's party did that pushed back the retirement age. So they're
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essentially saying, no, 64 is too old, let's go back to 62. How does that fit with what you are
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hearing in terms of the forum looking at perhaps having people work for longer? Paul Gruenwald Yes.
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Well, I think that particular policy proposal is going in the wrong direction, right? We have to
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figure out how to keep people economically active. If we want our pension systems and our health
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systems to be financially viable, we're going to have to stretch out the length that people are
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working and contributing. So that's just kind of arithmetic, right? We have to be able to face that
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challenge. But I think it's also an opportunity, as we just discussed, to kind of rethink or
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reimagine the use of technology. What does it mean to be aging? There's a lot of kind of unpaid work,
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elder care, child care, mentoring. Maybe there's a way to bring that into the economy, some of the
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Scandinavian countries are experimenting with that. So I think the big issue is we need to
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kind of reimagine a lot of the things we do because the demographic transition is a real
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thing. Fortunately, it's happening slowly. So it's not kind of a 3- to 6-month thing. We've got time,
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but we know it's coming, right? It's not something that should surprise us, but it's difficult
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sometimes with a short-term election cycle to plan these longer-term transitions. But that
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has to happen, right, to get viability that has to happen. Nathan Hunt I know you also participated
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in a discussion well at the forum meetings around supply chains. I think here in the United States
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and Western Europe, we hear a very specific story about supply chains and economic decoupling
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between the West and the East. I'm wondering what you were hearing in China about supply chains and
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decoupling. Paul Gruenwald Yes. Well, first, again, going back to Li Qiang's presentation to
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the forum, he was basically saying China wants to share its technology. China is committed to
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free trade. China wants to keep the supply chains flowing. So maybe in a way he has to say that,
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but that was the part of the speech that I think was very sort of precisely calibrated. We did
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have some discussion, and there were some modules around decoupling. I think everyone's come to the
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view that at the margin that's happening. So some things produced in China now go through Vietnam
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and they have a made in Vietnam sticker on them or there's a lot of Chinese foreign direct investment
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into Mexico and some of the Chinese firms might set up shop in Mexico. So it will say made in
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Mexico, but it's really Chinese-owned. So at the margin, some of these things are happening around
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the geopolitical pressures. But the reality, the fundamental reality that the U.S. and Chinese
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economies are very closely interlinked and there's a lot of Chinese value-added regardless of what
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the label says made in country X, there's a lot of Chinese value-added embedded in the trade between
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the 2 countries and decoupling that just doesn't look feasible. There was another session with the
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premier where some of the big companies from the U.S. Coca-Cola was there. Exxon was there,
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making clear their long-term commitments to China. So yes, there's a lot of geopolitical
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tension. And yes, we've seen some reorganization of trade, but I don't think it's changed things
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fundamentally. Nathan Hunt When you think about things like the recent tariffs that the EU has
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proposed putting on electric vehicles coming from China. Do you believe that this is, in a sense,
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political theater? Or is there decoupling happening in some of these fast developing
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more growing industries? Paul Gruenwald Yes. Well, I think there's a concern -- well, first of all,
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China has leapfrogged and is at the frontier of electric vehicles as well as battery storage and
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other things I heard at the conference, but they're rolling out electric vehicles that
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are hypercompetitive. When you think about the energy transition, that's a good thing,
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right? We can go to electric vehicles faster. The challenge is there's a lot of subsidies in those
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manufacturers. And when they export that to the rest of the world, there are huge competitiveness
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concerns. So these companies get free land or tax breaks or low interest loans. It's hard to roll
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that in. The European commission's come up with, I think, a 38% tariff or up to 38% tariff on Chinese
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electric vehicles, trying to kind of neutralize the effect of that. We'll have to see if that can
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be a kind of work around. I think, personally, that approach at least is more in the spirit of
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open trade in the WTO. They're going to continue to trade, but they'll try to neutralize some of
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the subsidies, just banning things from going from country A to country B. It doesn't seem to be a
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particularly productive approach. But I think this is going to be a key sector because not too long
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ago, remember, China was exporting really low-end stuff, textile, clothing, footwear, backpacks,
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and all of a sudden, they're making cutting-edge electric vehicles. So a real test for the global
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trading system, whether we can find a way to maybe neutralize some of these subsidies that we all
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know are there and then continue to trade between countries. And let's be honest, get some of the
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benefits of these electric vehicles, we need them for the energy transition. Nathan Hunt Let's
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move away for a second from the meetings in China. I know your team releases regular sort
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of macroeconomic projections for different regions around the world. You're the Global
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Chief Economist, so I'm going to ask you for the global view. How do things look at this
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point? And where do you see things going for the global economy? Paul Gruenwald Well, we've been
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a little bit boring because we've had the same message for roughly the same year, 1.5 years,
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which is we continue to be surprised by the spending on services. We continue to be
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surprised by the strength of labor markets, and we continue to be surprised by the resulting demand
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pressures and inflation pressures. So if you're going to tighten monetary policy settings to try
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to bring inflation back to 2, which is what all the major central banks are trying to do,
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that's not a bad combination because it's going to allow you to engineer a soft landing. The fear is
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that the bottom falls out of the labor market, the bottom falls out of consumer spending and
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you get a recession. But we continue to be surprised by spending, particularly in the
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U.S. The U.S. is outperforming the rest of the world by a wide margin. But in Europe,
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they've already had their marginal slowdown. They had a manufacturing recession. They're coming out
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of it. So all the major central banks, Fed, Bank of England, European Central Bank, Bank of Canada,
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Reserve Bank of Australia, they're all fighting the same battle. We've started to see the cuts
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now. We got cuts from the Bank of Canada and the European Central Bank last month.
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Now we're going to start what we think is going to be a very slow kind of measured easing cycle,
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maybe 25 basis points every quarter. None of this rise by 50, 75, even 100 in the case of Canada,
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but it's going to be very gradual, very spaced out, maybe a little bit unsynchronized,
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Fed's going later. But that's what a soft landing is, very steady reductions in the rate while
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you're keeping your demand side of the economy pretty solid. Unemployment is low everywhere. So
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that's the recipe for a soft landing. Nathan Hunt Let's talk about the central banks. If you had to
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give grades to the various central banks in their performance coming out of the pandemic, right? So
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let's say, 2022, to the present, what kind of grades would you give the various banks in terms
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of how they have responded to the challenges? Paul Gruenwald Well, I think everybody missed
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the initial inflation boost or burst, right? So remember the big debate a couple of years ago,
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team transitory versus team persisting. I think we know that one. The other way to look at it
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is central banks kind of score themselves. They have these things called loss functions. So how
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far are you deviating from your inflation target? If your inflation target's 2 and inflation jumped
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to 8 or 9, you're not going to get a very good score, right? So I don't think any of the central
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banks passed that. And I think there's a case to revisit how they were sort of measuring and
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looking at inflation back then. With the wisdom of 2020 hindsight, of course, we can all say, well,
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they blew it, right? But I think since then, first of all, central banks responded very quickly. They
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weren't timid about raising rates. They raised rates faster and higher than anyone thought.
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We didn't know about the strength of the labor market, but I think the so-called damage to the
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economy because of high rates has been pretty modest. So I think the second half of the story
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has been better than the first half of the story. If we can engineer the soft landing,
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and this hasn't happened since the mid-'90s, that's the last time we had a so-called soft
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landing. That's not a bad ending this episode that, quite frankly, didn't begin very well.
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But I think we're all on guard now. We know that inflation hasn't been permanently slate.
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And if you put too much juice into the economy and demand picks up, you're going to get inflation. I
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think we all relearned that. Maybe we forgot because it hadn't happened, says whatever,
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2005, '06 before the crisis. Nathan Hunt So there is a lot of talk, particularly in financial
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markets about when are interest rates coming down? The interest rates are certainly higher than they
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were before the pandemic, but they aren't in some sort of absolute historical sense, all
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that high. Do you think the Fed is actually motivated to reduce rates that much? I mean,
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are we going to go back to what is essentially a 0% interest rate? Paul Gruenwald I don't think
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so. I think we're going to look back economic and financial historians are going to look back
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at that period between the global financial crisis and COVID as basically an anomaly, right? Interest
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rates, policy rates were close to 0. Real rates were close to 0. And it was a combination of the
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big hits of demand from the global financial crisis and China coming on to global supply
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chains, which was a big disinflationary force. That force has been spent. We're coming out of
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COVID now with a lot more government spending. We're looking a little bit like the 1990s,
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which was not a bad decade, right? The 10-year treasury was kind of 4.5% to 5%. Inflation was
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2% to 3%. Growth was high. Productivity was high. We had the tech boom. So that wasn't necessarily
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a bad thing. As you said, we've got this kind of mini generation that's been used to a very low
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interest rates. And I think we're going to go back to normal. That's good for savers, by the way,
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right, because you're getting a higher return on your savings, it's just bad for borrowers,
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and we're going to have to I think adjust to a new reality. When the Fed is done with this cycle,
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we're not going back to 2019 where things -- they're going to finish just under 3,
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which means if the inflation target is to the so-called real rate, subtract the policy rate
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minus 2%. Real rates are going to be higher. We think that structural is going to be around for
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a while. Nathan Hunt I'm wondering if, from the outside, from an uninformed perspective,
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it looks like what central banks would be tempted to do is keep interest rates a little bit higher,
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but keep the economy chugging along because that gives them, you could say some dry powder,
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right? They have this ability to respond to an economic downturn, whereas when we were at 0,
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we had actually little ability to respond to an economic downturn. Is that consistent? Is that
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true? Is that the way central bankers look at these things? Paul Gruenwald Well, you do hear
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that discussion sometimes about policy space. And you're absolutely right, when we hit the 0
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lower bound, and we still needed to stimulate the economy and fiscal wasn't doing anything,
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that's when we started QE and Central Bank started buying medium-term notes. And then that's kind
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of a distortion, right? You've got the Central Bank and the treasury or the government market,
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and we're still kind of grappling with that. But yes, well, the ultimate goal is to have
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low and stable prices. So we're trying to put the economy on a path where you've got 2% inflation,
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inflation expectations are anchored at 2. So everyone believes the Central Bank,
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and you've got something that resembles full employment, and that's job #1. If that
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leaves you with policy space, and you've got a couple of hundred basis points to cut rates,
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if something bad happens, then all the better. But the real objective is not the space. It's
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putting an economy on that path of low and stable prices and full employment. Nathan Hunt I had
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spoken earlier about it being an election year. We see there have been recent elections in France,
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in the U.K., in India. We have a small election coming up in the United States this year. What is
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your sense from a macroeconomic perspective? Do these elections matter in terms of macroeconomic
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outcomes? Or is the economy in some way sort of inured to partisan conflict? Paul Gruenwald Well,
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the government doesn't control the economy. So the economy is partially inured. But let's stay with
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the U.S., if you look at the 2 main candidates and you're trying to tease out some policy differences
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that could move the macro needle. Both candidates seem to like industrial policy or a bigger role
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for the government. Both candidates seem to not like China. So tariffs are around to stay. Neither
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candidate seems too keen on fiscal discipline in the U.S. and bringing the government under
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control. So there may be other differences, but the things that would kind of move the macro
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needle aren't obviously different between the 2. If we're talking about something more structural,
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let's say, taking away the independence of the central bank and making them the de facto cash
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machine for the government, then you'd have some concerns about inflationary bias in the system,
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whatever. But we don't have the official policy platforms yet of the major parties in the U.S.
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But for the big stuff, the role of government, the role of trade, the deficit, it doesn't seem
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like those differences are big enough to really move the needle for us so far. So we don't have
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a big distinction right now between whether it's a Biden or a Trump win in November in terms of
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the macro view. Nathan Hunt What about in India? Because what we saw in India was Modi called an
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election. His party obviously came out ahead in that, but it was less of the overwhelming victory
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than we expected. Do you see any moderation in the projected growth of India as a result of a certain
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amount of political disunity? Paul Gruenwald Yes. Well, I think there's a little bit of a surprise,
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right? Because people were thinking the BJP would keep its pure majority and now it has to make
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nice with some of the smaller parties to keep its majority. But we think India continues to be the
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best growth story amongst the major economies. So the economy has opened up a lot. They've got the
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labor market reform. They've got the reform of government services. They're trying to do
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top to bottom technology from the low end -- or sorry, services from the low end to the high end.
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They're not going to supplant China as the global manufacturing hub. But the combination of a good
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public investment program, some surprisingly good and welcome private investment and there's boom
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around tech, et cetera. And given the fact that they've got a lot of runway to catch up, we think
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they're probably 6.5% to 7% growth story kind of over the medium term. And if you do that for a
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couple of decades, that's a recipe for catching up. Nathan Hunt Paul, every time I talk to you,
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I try for a kind of a gotcha question, where I attempt to nail you down on what the Fed is
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going to do next. Your team has been projecting an expected rate reduction. Do you think that the
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Fed will preemptively lower rates in anticipation of a slowdown? Or is this Fed likely to wait for
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actual evidence of some kind of economic slowdown before reducing rates? Paul Gruenwald Right. Well,
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if you wait for the slowdown, then you're too late, right? Just so when you wait for the
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evidence of inflation to rise a couple of years ago, you're too late. So what you want to do is
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as you see the economy slowing, you start to take out the tightness you put in through your rate
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rises. So you don't wait for inflation to get down to 2 and say, oh, now I can start cutting
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rates from 5.25, right? That's too late. So you've got to sort of guide the economy down to where you
23:41
want to the extent that's possible for a central bank. So Palo's been pretty clear, right? And the
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Fed's been pretty clear, when they get a good series of numbers, good means that the economy
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slowed a bit below potential of 2 inflation pressures, looks like they're under control,
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then they're going to start to lower rates. Earlier this year, we got nervous because the
24:04
inflation numbers actually started to tick up. So all those rate cuts that the market baked in,
24:08
I think there were 6 or 7 rate cuts at one point were taken off the table immediately. Now we've
24:14
had 1 or 2 good data points and maybe the Fed can go a little bit earlier, the Fed forward curve
24:21
sort of leaning now towards September rather than December. But if we continue this data
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stream where we have a slowdown in inflation and a moderation of growth, the Fed could go
24:33
earlier. We're still sticking with our baseline of December. But if we think it's time to move that,
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we will move it. Nathan Hunt Paul, one final question. As you are aware, I am from Canada.
24:44
And so I think it is important that we stop talking about a fairly relevant economy like that
24:50
of the United States and focus on the Canadian economy. I know your team has been looking at
24:58
the direction of the Canadian economy, and for our many Canadian listeners, I am hoping you can
25:03
give me some information about where things are going in the next year. Paul Gruenwald Yes. Well,
25:10
remember, we had these sharp rate rises and then everyone was very resilient, and we were kind
25:15
of waiting for the economies to start to crack a little bit. And I think the Canadian economy has
25:21
slowed down much more than the U.S. in recent months. So the U.S. has slowed a little bit,
25:25
but Canada started to slow more sharply. So we've already had the rate cut. They actually cut rates
25:32
the day before the ECB. So they were the first major central bank to cut. Sequentially, it looks
25:37
like growth is closer to 0 than in the U.S. So that's a recipe for Canada maybe to go a bit
25:43
faster. So we still stick to this view that the U.S. is going to outperform and the Fed is going
25:48
to be higher for longer. So that's a strong dollar world. So I think where this comes out for Canada
25:53
is growth is going to slow a bit faster than the U.S., rates are going to come down a bit
25:57
faster and the currency is going to be a bit weaker. That's kind of the recipe for Canada
26:01
over the next couple of years. But once we get inflation under control and back to neutral-ish,
26:06
3-ish for the policy rate, then that's the landing scenario for Canada. Nathan Hunt Paul,
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thank you so much for joining me on the podcast again, and I look forward to having you back
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shortly. Paul Gruenwald Always a pleasure, Nathan. Take care. Nathan Hunt The Essential
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