De-Dollarization, the IMF, and the Erosion of Monetary Norms | Global Macro | Ep.89
Summary
De-Dollarization Concerns: The podcast discusses the potential fragmentation of the international monetary system, which could undermine the US dollar's dominance due to unpredictable US policies.
IMF's Evolving Role: The International Monetary Fund's role is shifting, with less focus on industrial economies and more on emerging markets and low-income countries, despite fewer financial crises in these regions.
Tariffs as Fiscal Policy: The discussion highlights tariffs being used as a tool for reducing the US trade deficit and generating revenue, with skepticism about their effectiveness and potential regressive impacts on the economy.
US Economic Policy Risks: The podcast raises concerns about the US using tariffs and other economic policies as coercive tools, which could lead to a loss of confidence in the dollar and increased global financial fragmentation.
Potential Impact on the Dollar: There is a risk of a weaker dollar and reduced demand for US treasuries if foreign entities lose trust in US economic policies, potentially leading to higher yields.
Federal Reserve's Role: The Fed faces pressure to support fiscal policy by keeping interest rates low, which could conflict with its mandate for price stability and lead to inflationary pressures.
Global Economic Shifts: The podcast discusses a potential shift towards economic nationalism and public investment, moving away from neoliberal policies, with implications for global markets and economic growth.
Investment and Innovation Concerns: The current US administration's interventionist policies may negatively impact investment and innovation, drawing parallels to less free-market-oriented economies.
Transcript
[Music] You know, again, this is an area where I think there are a lot of risks that haven't been carefully considered and where, you know, governments outside the US are are quite um alarmed about the, you know, the possible incursions into their domestic payment systems and um haven't quite figured out how to react. But um you know certainly thinking thinking hard about the risks that might be posed and again that I think this could be another source of fragmentation going forward. Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged. The place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Neils Krop Len. Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan D. [Music] Thanks for that introduction, Neils. Today I'm delighted to be joined by Morris Obsfeld. Murray is the senior fellow at the Peterson Institute for International Economics and also professor of of economics emiritus at Berkeley. He has served as a member of the Council of Economic Adviserss under President Obama and was previously chief economist at the IMF. He's also been an honorary adviser to the Bank of Japan. He's won countless awards in academia for his work in international economics, the international monetary system, exchange rate and financial crisis. And he's also been the author co-author of uh some leading textbooks on economics with Paul Krugman and Kenneth Rogoff. Murray, great to have you with us today. How are you? >> I'm great, Alan. How are you? >> I'm very well, thanks. So, um, I I I went through your your very long and distinguished career, but we always like to start off getting a sense on how people started off in economics and the markets. What got you interested in economics in the first place? >> Oh, great question. Uh, that's a story I actually love to tell. I was a uh mathematics major as an undergraduate and uh in the early 1970s I had the privilege of uh spending a couple of years at Cambridge University uh do you know doing maths again but uh it was obviously a very turbulent time in the UK economy and the world economy generally and um uh I was in King's College Cambridge which was Kansas College and I had a number of friends who were doing economics and I just got gradually uh drawn to it. You know, my problem was that I had a I had a fellowship to go back uh return to the US and do a doctorate in mathematics at MIT and I wasn't quite sure how to how to switch that around if I wanted to do economics. But uh fortunately, when I got there, they were willing to just let me uh come over and enroll in the economics program. So, uh that worked out quite well for me. and you you've been an academic and a and a policy adviser. Um I mean you've you've served at the IMF, you've done a bunch of different things. Any standouts or do you prefer the research to teaching? Which aspect is I guess you're most most drawn to? Well, at the moment, uh, uh, you know, I'm showing my, uh, my age and the, uh, you know, the, uh, typical life cycle of, uh, many macroeconomists and I've been drawn more to the policy sphere and the, uh, sphere of commenting on current events. Um, I still try to keep my, uh, hand in research. Uh but um it seems to me that as as one one gets older, the the the accumulation of what you may have learned is uh usefully deployed and trying to make the world a better place. And uh that's what I've been trying to do in recent years. I I retired from teaching at Berkeley um a couple of years ago. So I still advise some graduate students, but I'm not giving lectures uh anymore. >> Very good. Well, I mentioned you were um chief economist at the IMF a number of years ago. Um and um curious to get your perspective on on that experience and and maybe the the IMF and in as we see it today. I I know Scott Besson spoke there not so long ago and calling for a form and maybe the need for for for a new approach not just at the IMF obviously at other institutions as well. Um I mean we're seeing less financial crisis generally in emerging markets. Is is the role for the IMF diminished or changing do you think? >> Well the the IMF role has evolved over the years. uh you know it was primarily a uh organization based at you know the more industrial economies back in the 50s and 60s uh you know in the sort of post-war recovery recovery period. Um when the world moved to floating exchange rates in uh 1973, many wondered what the role of the fund would be because the you know the original idea of the bread and wood system was that the world would be on fixed exchange rates. The fund would be there to lend resources if countries had balance of payments difficulties as a result of um the need to intervene uh using foreign exchange reserves to hold those exchange rates fixed. Suddenly, if everyone's floating, what do you need a fund for? Uh but as it turned out the move to floating also coincided more or less with a move to more open capital markets and the possibility of uh uh fastmoving financial crisis and so the fund found a uh you know a new role u now primarily uh it has been involved with emerging markets though the the the euro crisis was a glaring exception to that to that general ization but um you know it still has numerous programs uh in emerging markets and also in in low-income countries. Uh so there there's definitely a role there. I think even even though emerging markets have done well in recent crises and we can we can talk about why that why that might be um there's always the the um risk out there that you know with the vast expansion of of global capital markets um there could be reversals and in those situations IMF funding uh can be can be critical. Yeah, I mean that's something uh maybe we'll get on to as we uh progress, but um you wrote a paper recently maybe you you you're mentioning how you're commenting on current policy. You wrote a paper around tariffs as fiscal policy. Uh and obviously tariffs has been the big topic um in the markets this year. For a lot of market participants, you know, there was a lot of uncertainty as to what was the purpose of the tariffs in the first place. Was it more from a budgetary perspective? because of trade industrial policy and in the paper you address this. I mean what what's your assessment on what's been the rationale for the tariffs and and the likely impact? >> Well, if you look at the uh you know 1.0 tariffs 2018 2019 the rationale was um twofold. it was to uh to try to uh reduce the US trade deficit and uh furthermore to bring back manufacturing to the US. I think both of those motivations were fueled by a grievance narrative that uh foreign countries had been unfair to the US through their trade policies and the tariffs would uh you know level the playing field uh and offset some of those alleged harms. Now what we've seen in this new uh round is the um uh use of very broad tariffs uh you know on all imports. you know, the targeted tariffs are still there on certain sectors, but the, you know, the sort of across the board tariff idea is novel and um it's motivated by the same the same goals, the trade deficit manufacturing uh renaissance hopes and um redressing grievances. But it also raises the possibility of largecale revenues. And um uh you know in this recent round starting in the election campaign, Donald Trump raised the possibility of using the tariff revenues to offset um tax cuts in other in other areas. You know, he even floated the idea of replacing the US income tax entirely with tariff revenues. So uh you know in some sense that is a you know additional motivation basically reforming the US tax system uh to make it much more heavily dependent on tariffs as opposed to say income tax or corporate tax or other taxes. And that raises a host of a host of issues that um you know Kim Clausing and I tried to uh assess in that um recent paper on tariffs as fiscal policy. >> I mean this was was as you say muted as part of the campaign but but generally the view was well you know it had been done before in the I think like in the 19th century but but obviously the the amount of spending was a lot less then and and the tax requirement was a lot less. So there was kind of general skepticism as about this being a a plausible kind of tax revenue um tool. But that that seems to have shifted a little bit. I mean if you look at the financial markets last month or so >> now the view is well if the tariffs got repealed that would be seen as negative or a problem for the deficit. So and obviously the CBO have come out saying you know the tariffs will will contribute around 4 trillion over the next decade. So has that has that viewpoint shifted in in economic and and financial market circles, do you think? >> Well, the the premise of the uh Trump tariff idea was basically the premise of a a sort of free lunch that somehow these tariffs were um going to be paid by foreigners. um you know it's money for the taking and therefore we can we can you know have our cake and eat it. We can lower income tax. We can um get revenue from foreigners for free and um you know win-win for the US and um you know we're not too worried about the effect of foreigners or the possibility that they may retaliate. Now um you know that that you know the idea that that foreigners pay for tariffs you know as a as a operational matter is is wrong um simply because it's importers in the US who actually pay the fees that go to the treasury. um as a substantive matter um it's not so clear because you know one of the one of the fundamental issues in analyzing any tax is its incidence. Uh in other words it it may not matter who actually pays the tax in the operational sense. you know, do we tax um buyers or sellers of our product because the market equilibrium uh that that results from the tariff uh you know will result in effects on both buyers and sellers uh which may disproportionately fall on buyers or sellers regardless of you know who is physically handing the money over to the the government. So in the tariff sphere the idea would be that um uh you know yes importers pay the money to the treasury but uh you know foreigners uh who are exporting to the US facing reduced demand will be induced to lower their prices and um in the Trump narrative uh they lower their prices by the full amount by the full amount of the tariff. Therefore um even though US importers, you know, are the ones who fork over the money to the Treasury. They're benefiting from proportionately lower global prices and therefore there's no loss to them. The incidence of the tariff is all on the foreigners. So that's basically what Trump, you know, that's the the most charitable way of interpreting Trump's um insistence that foreigners pay for tariffs. Um, now if we look at the evidence of the 2018 2019 tariffs, very little evidence that foreign sellers of goods into the US market lowered their prices. Now with these across the board tariffs, that's a different situation. But the early returns would still indicate that they haven't lowered their prices that importers are not paying lower prices for imports and there therefore you know American residents firms or consumers are paying for this tariff revenue that is flowing into the treasury which by the way is more likely to be closer to uh 200 billion a year than the 400 billion a number that you that you cited. So, you know, as far as the markets are concerned, you know, they're they're looking at what's happened on to consumer inflation, to the consumer prices of imported goods and goods that compete with them. And you you haven't seen increases that are in line with the tariff increases. So, you know, the conclusion seems to be, okay, fine. uh you know we've moved to this new regime. We haven't seen big inflation consequences. The other consequences of tariffs namely that they're you know if you levy tariffs and lower income taxes on rich people this is a very regressive policy. Markets don't care a wit about that. But um you know in reality if foreigners haven't lowered the prices they charge the US and if the treasury is getting all this revenue which is you know basically about 20 to 25 billion a month in new revenue then who's who's paying for that? Someone's got to be paying for that. And uh you know where it's coming from is a combination of some increase in consumer prices but also um uh you know importing businesses which are swallowing a reduction in their margins. Now they can't do that forever. So likely more price increases are on the way. uh or uh you know if if these firms feel unable to low raise their prices this this is and this is um probably more true of some of the some of the smaller businesses um they're going to they're going to go out of business and so there are consequences which I believe are inevitably coming down the pike and I think which might um disturb some of the complacency we've seen in the in the markets Now, that that being said, uh you know, the Supreme Court in early November is going to hear um an important case on the constitutionality of um Trump's broad-based tariffs, the emergency tariffs. And uh there there is as you said concern in the markets that if suddenly the Supreme Court rules that these are illegal the government would have to actually refund large amount of tariff revenue uh the revenue wouldn't be available on a uh ongoing basis to fund uh the huge hole in the budget left by the one big beautiful uh budget act. And uh then you have a situation where you're opening up the bond market to um stresses that uh could be pretty severe down the road. So um that's something certainly we'll all be watching carefully. >> Yeah. I mean, as you say, um the long-term ramifications, we're still to see them. Obviously, it's going to take time. Um we've seen a very different approach to policym under under Trump. Uh go goes goes without saying. Um you you you wrote a separate uh paper recently kind of looking at how that may impact the global international monetary system um called uh the dollar and double um called a fork in the road. um and and and that the the paper is about how the shift in US policym may may set up a scenario where the we get more fragmentation in the international monetary system which could undermine under the the US dollar. So um I mean could you give us a sense on what you think are the key components of this argument that that that this change in policy uh approach could ultimately um undermine the dollar? >> Well, the dollar's premacy in international markets rests on a number of pillars. uh not all of which are you know purely economic pillars but um you know I would say that that what what the share is the idea that the um you know the United States is a predictable and reliable player in global you know economics, finance and security that um to some degree internalizes the effects of its actions on the rest of the world. you know, in some sense, I I don't want to say that it it depends on the US being a hegemonic power, which, you know, it was for basically some years after 1990. But, um, you know, it's still it's still at this point the undisputed, you know, leading power, you know, most powerful nation. And um uh you know countries throughout the world have relied on it in in many respects for security asurances, for aid, for financial support, for um you know interventions in in uh stabilizing interventions in financial markets. So now instead we've moved to a situation where um you know the Trump administration is taking a hatchet to um international institutions and agreements to domestic institutions and agreements and where all of that is now now in question. You know, if you look across the spectrum of policies being followed both in the economic and the security realm, and they're linked, they're linked policies. Uh it's caused a great great deal of concern such that um foreign players may lose faith both in the value of the dollar and in the wisdom of um you know exposing themselves to US pressures that might be connected with their reliance on a system that is that is based so heavily so heavily on the dollar. So yeah, take an example, you know, tariffs. Um, you know, be it would be one thing for the US to simply say, well, we, you know, we feel we need a 15% across the board tariff because we'd like to um, you know, address our trade deficit as a revenue source, you know, for whatever reason. And we can discuss whether tariffs are an effective way of addressing the trade deficit. I don't believe they are. Uh but what the Trump administration has done is it's been using tariffs as a coercive instrument to um you know sometimes extract uh concessions from other countries that are that are not really trade concessions or to um make political demands on countries. So in the in the former category, you know, the US has been negotiating with um Korea, Japan, Europe for large investment funds that would be uh basically um under the discretion of the president. It's very unclear what the details are on these and to what extent the foreign partners have actually agreed, but this is this is sort of unprecedented. It's basically a a uh you know a form of extortion in which the US says you know give us give us these funds or else. Now again you know when when I say the tariff threats are being used here yes there are tariff threats but all the policy makers involved you know across Japan, Korea and the EU understand that um the implicit threat is a withdrawal of military support. you know, Japan and Korea, you know, very worried about um security in East Asia given um not only China's sometimes aggressive behavior, but um North Korea, which has nuclear weapons and is totally totally unconstrained and is actually moved much closer to Russia and to, you know, more normal relations with China. China and Russia are no longer trying to constrain North Korea's behavior. Um you know in Europe there there is you know still considerable US um assistance if not monetary than in other areas and Europeans are very worried about that. So, you know, this is this is a very different world from the, you know, the pre-Trump world in which US security guarantees were predictable and reliable. And of course there would consider there would there would occasionally be discussions about cost sharing uh which is certainly a legitimate topic. But you know the idea that that the US would would um even implicitly threaten to withdraw these um supports uh in return for monetary um or commercial payoffs was not really really on the table. Um you know within the domestic sphere uh key institutions are also being being attacked. you know, when when the US government insists on taking uh stakes in US enterprises or in um deploying export controls to um pressure country companies for stakes in uh their foreign revenues, when the government attacks the independence of the Federal Reserve, uh you know, when the Congress throws off any pretense of um fiscal prudence and um you know manipulates its budgetary rules to um pretend that it's not um creating possibly unsustainable budget deficits. You know, cheered on by the administration. You know, these are all these are all um things that make the uh you know, the rest of the world worry about the uh security of uh of dollar assets >> and the wisdom of being so plugged into the dollar system, >> you know, and there's subtle ways too in which this works. I mean the um you know one of one of the factors that has promoted the prevalence of of dollar borrowing throughout the world is that the Fed makes swap lines available to key countries which allow them to um you know support their financial systems which are very dollar dependent at this point. um if the Fed's independence is compromised then maybe those swap lines can become additional tools of coercion >> and this is a real concern for among foreign governments. >> Yeah. I mean it's interesting at on the one hand you know as you touch on there is this you know ambivalence towards the the value of the dollar at the same time the the administration is talking about stable coins as a mechanism to promote even greater demand for US treasuries um so I mean how do you reconcile those viewpoints um that's one question I mean and I take point about um you know foreign concern about US policym but I mean against that the view has always been well there's no alternative so what else can people use >> well there's no alternative to to the dollar as a sort sort of universal currency which is kind of the status it has now I mean almost you know 90% of transactions in the foreign exchange market pass through the dollar uh you know as a vehicle currency Uh and I would say that the you know the reach of the dollar globally at the moment or at least you know moving coming into this Trump administration is really unparalleled even compared to the days when the Brettonwood system required countries to peg basically to the dollar. So it's got it has a quite quite an amazing reach at this point. But you could move to a multipolar system where more countries elect to be more aligned with the euro or more countries particularly in Asia and possibly Africa, you know, are more aligned with the uh the Chinese yuan. And so instead of having this you know global dollar system you have a a system based on multiple multiple currencies and even some smaller currencies. You know the Japanese yen could play a regional role. Uh you know sterling could could improve its share even although UK you know has its own problems. Um so that would be the world we we move to and um you know that's that's less efficient but um it's not a disastrous scenario in in and of itself. What's more more worrisome are the forces that are would be driving the world to a multipolar configuration. But I think that's completely feasible. >> Yeah. I I mean it's been talked about for a while and maybe we've had Barry Arking Green on here before and spoke to him about it and he's made the point that there has been increased demand for international reserve managers for the smaller currencies likes of Australian dollar and sterling Canadian dollar etc. Um you talk your paper is all about fragmentation and a more fragmented international system. I mean what do you think that would mean? Um presumably mean a dollar block, a euro block, a yuan block. Is that it? Does and as you say not necessarily disastrous just a change of features or is there some kind of implication from moving to that kind of system for for global markets? >> Well, I think there are a number of lay layers to this. Um the the use of multiple currencies, you know, in itself as a form is a form of fragmentation. The possibility that regulatory cooperation erodess in the financial sphere could be another source of fragmentation. I mean you know the US participation in the um the Basel process in the financial stability board uh how that will evolve going forward you know is a is a question but the administration certainly seems to be you know rejecting multilateral cooperation in a number of a number of other areas not so far in the IMF and we can you know certainly talk about that more the discretionary use of um tax policies in capital markets I think is not really off the table. Um you know either for outflows or or inflows. Um one um possible harbinger was the uh you know the so-called revenge tax that was contained in the house version of the bill that became the o crippleba. you know, the idea that if foreign countries um try to um you know, impose taxes on US corporates um then, you know, the US can tax their revenues, prevent repatriation, you know, on a on a one for one basis. Um that threw a a fright into into markets momentarily or at least into uh you know, the business community. You know, you raised the the issue of stable coins. I think the the capacity of the stable coin um initiative to raise the demand for treasuries is probably exaggerated. The idea that this would be a net demand and you know would not subtract from demand elsewhere in the system is really untested and un not not thoroughly considered uh by those who promote stable coins. But the stable coin issue, you know, raises a number of problems. Um, uh, you know, countries may, you know, not be happy about, um, parts of their payment system moving to a more lightly regulated venue based on the dollar. It might affect the transmission of monetary policies. It might raise the um possibilities of uh financial um instability or um illicit transactions. And so this could lead to more you know more um barriers to international payments in that in that in that sphere. you know if countries become highly dependent say on US stable coin providers they become uh more vulnerable to actions that the US government might pressure these providers to take like cancelling wallets and the like. So um you know again this is an area where I think there are a lot of risks that haven't been carefully considered and where you know governments outside the US are are quite um alarmed about the you know the possible incursions into their domestic payment systems and um haven't quite figured out how to react but um you know are certainly thinking thinking hard about the risks that might be posed and again that I think this could be another source of fragmentation going forward [Music] the big risk obviously from a financial markets perspective what people worry about is, you know, a big sell-off, a big decline in the dollar as for all the reasons you're highlighting that foreigners decide to reduce their holdings of US assets. Um, you're talking about potential fragmentation. Do you see that associated with a potential much weaker dollar or a secular downtrend in the dollar? And and then linked to that, would it also mean less demand for US treasuries and and and obviously and higher yields as a result of that? Yeah, I think those would be possible consequences for sure. >> Yeah. And I mean, you talked about possible tax policy and the other one that has been mentioned with Steve Marin's paper before is um you know, dollar swaps. So, so swapping kind of treasuries into longerterm data issuance or some kind of I guess coercion um as a I suppose maybe as part of quidd pro proquo for access to the market or you know or for defense as you say. Do you think that's likely? I mean everybody's talking about possible financial repression. I guess that would be part of that kind of approach. Do you see that as a possible risk as well? Yeah, I don't think that the Moran idea is likely to attack to attract a lot of support uh you know even from within the administration. I mean it would be a direct hit on the Treasury market and um you know I think I think from the standpoint of um you know the Treasury's desire to you know smoothly finance these deficits um they're much happier to pursue the um you know the idea that the uh you know stable coin initiative will uh will help solve the problem. uh you know and now again you know this administration has proved pretty unpredictable but um you know I think I think what Dr. Moran proposed really doesn't have a lot of a lot of support uh on the Treasury side. I mean you also mentioned obviously the kind of the international impact of all of this is you know mistrust I guess or concern uh lack of confidence in the US and then you also talked about you know the more unusual approach to policym domestically you know taking stakes in in um the likes of uh Intel uh cutting deals with Nvidia etc which is all new and and obviously I guess counter to kind of free market economics um what where does what do you think from an economics perspective this leads to or you know if you were tracing this out simply economists don't advocate these kinds of policies for a reason so what what are the adverse effects of these policies over the longer term >> well I think ultimately they they they harm investment innovation um you know the cl the sort of classic arguments that um free market conservatives have made um you know have a more than a grain of truth and um if you're contemplating an investment and you think the government may um come along and uh you know force you to give up a stake of that I mean this is this is taxation but it's not taxation that is um you know debated in the congress and that has some um uh you know firm political or um uh public policy purpose. It's it's you know or basis, you know, it's it's um it's it's it's it's um capriccious actions um at the um whim of an executive that is not really constrained by the judiciary or the legislature. And you know we know that those environments which you know characterize authoritarian countries are not particularly good for investment and they're also terrible for you know for inequality. I mean just you know you you end up with a sort of um a system you know closer to the Russian system in which um you know oligarchs are willing to invest on the premise that um they're protected by the state but that they'll also do the state's bidding and that's you know clearly we're not close to that in the US at this point but these sorts of moves certainly push in that direction and um you know Had they occurred under a Democratic administration in the US, you know, the the other party would be screaming bloody murder. But, you know, they seem to be fine with with this approach, which, you know, to me is very surprising and very puzzling. M I mean the other big the big issue that's a cause of concern is around the Fed and obviously the pressure the overt pressure that the the Fed is under to for an easier policy. Um I mean not just we we the fact that we we we've got a we will have a new Fed chair presumably next year but there's lots of calls for reform a new approach at the Fed from Scott Bessant from from other people. Do you think we're possibly at a fork in the road for the Fed as well? Could you see us take could you see the Fed taking a a different approach uh looking ahead? >> Well, I think there there are legitimate um questions you could raise about um you know the Fred Fed's um performance. um you know as with any legislatively independent agency you need transparency and accountability and um it's not as if that has been that has been missing you know the chair does uh appear before Congress and um uh you know has tried to be more transparent with press conferences and the like. So you know there's always there's always room for doing better and there's always room for reassessment. I would um say that the Fed's performance has not been perfect, but it's done it's done pretty well in the face of uh you know a lot of disruptions. Uh you know COVID uh reopening, the Ukraine war uh has not been a you know sort of easy easy period. Now that being said, um you know, while one can legitimately make those criticisms, I think the you know, this is this is not really what um the president's agenda is. The the agenda is to um fund the Treasury at lower at lower interest rates. It's basically a fiscal dominance agenda. The president's statements are very clear. you know, the Treasury is paying too much for borrowing and the US should have low interest rates like other countries because um that would make it much cheaper for the Treasury to uh to finance its deficit. So that's I mean that's sort of the key issue here. it's not even really so much supporting the economy because Trump denies that there are any negative pressures on the economy. So, um there's a pretty clear danger that instead of the Fed, um being devoted to this, uh you know, the current dual mandate of price stability and maximum employment, it basically uh becomes a uh you know, an agency for financing the fiscal deficit. >> Yeah. I mean, I did see Scott Besson in in the Wall Street Journal, he had an article talking about the third mandate of stable interest rates. So, I'm not sure if that's a formula or if that's one he just added in himself. >> No, no, that's that's actually in the legislation. It is, is it? Okay. Yes. In fact, well, you know, okay, the these come out of the Humphrey Hawkins Act, which was passed in the in the uh late 1970s when inflation was out of control and uh uh long-term interest rates were skyhigh. And the previous Fed mandate, which came out of legislation passed in the late 1940s, was uh based entirely on um full employment. And this new legislation said, okay, you know, price stability is also important. And um uh I think I think there's been a general recognition that the main cause of very high long-term interest rates is inflation. That's been the case historically. And if you basically achieve the price stability mandate, you'll automatically achieve the the long-term interest rate mandate. Now, that being said, if the um if the federal budget is totally out of control, which it was not in 1977, and if the uh government is uh the administration is pushing the uh the uh Federal Reserve to become a uh you know, its fiscal agent uh by accommodating deficits at lower interest rates. then long-term interest rates are going to reflect that. And then to to sort of, you know, bring up that mandate at such a time is very is very rich because what you're basically saying is um okay, you know, we in the administration are undermining the Fed's credibility and um thereby possibly pushing up longerterm interest rates and now we want the Fed to suddenly, you know, remember this third part of the mandate and to push those interest rates down. But I think that that that does lead to a policy which would turbocharge inflation which is um uh yield curve control that basically the Fed you know uh and this was practiced in Japan in the face of uh deflationary pressures until recently. um you know, the idea that the Fed would would would um manage, say, the 10-year yield to keep it low by buying up, you know, that part of the um bond market effectively. You know, that's what the Japanese did. And that would that would turbocharge inflation. So, um, you know, I view this invocation of the, uh, the third and, you know, least known part of the mandate as as incredibly disingenuous, uh, on the part of the Treasury Secretary. >> I mean, how would that play out? I mean, I mean, because obviously the Fed still has an inflation target. So on the one hand it would be buying bonds to to keep interest rates down and presumably ignoring the fact that inflation is running above target. Do you think would that is that how it would play out in that scenario or would you uh presumably they wouldn't formally abandon the inflation target? >> You know the the inflation target is not you know in the Humphrey Hawkins bill. This is, you know, the idea that there's an inflation target is much more recent and came in under the Bernani chair. Um, you know, in line with international practice. Um, so there's no legislation. There's no mandate. Uh, the Fed could just not say anything. Uh, you know, they they're not they're not really constrained in that sphere. And I think we would just see inflation creep up. you know, the Fed would still say, you know, we're committed to price stability. And, you know, I think there would be the hope of somehow managing expectations through um you know, what in the past have been called openmouth operations. Um and and uh you know, it simply wouldn't work. You know, it might might work briefly uh but it but it wouldn't work in the long term. So I I wouldn't say it's terra incognita because we we were certainly there in the 1970s but um you know we would gradually in the US slip into a much higher inflation environment until such point as you know the the uh political backlash became so strong that um there was um you know a reaction from the administration uh to to you know induce the Fed to do something else. >> Yeah. Obviously you've done a lot of work on crises and in emerging markets and elsewhere in fiscal crisis. A lot of I suppose traditionally when we get debt crisis it's also in in often in the private sector and the banking sector but at the moment there's no issues in the banking sector and private sector balance sheets are in good shape by and large it seems. So it's very much a public uh debt issue. So I mean looking at the situation particularly in the US but not just in the US obviously the likes of the UK, France, Japan all with high debt levels. I mean what's the typical scenario that this goes from being a problem into a crisis would you say? >> Well we should never say that um you know the banking system is immune to crisis. I you know I I think there's you know I mean we recently in the US had the you know Silicon Valley bank episode which could have which could have been become more systemic without the um you know the immediate uh backstopping from the from the treasury. So um we should never ever ever be complacent uh you know in the face of um you know there's always financial innovation and um you know whenever whenever we think we've uh figured out a way to reduce risks uh financial activity moves to the riskier less regulated sectors and you know we've seen this with um you the move to non-bank financial intermediaries like hedge funds where a lot more a lot more activity takes place. The um uh the stable coin sphere might be another area where there is um you know trouble trouble a foot uh eventually. So you know but putting that aside um the the risks do seem to be much more at the moment in the public finance area. the risks would play out more in the form of um you know concerns about um long-term solveny um uh leading to you know problems auctioning off debt or rolling over debt. you know much higher interest rates in um you know countries which have a you know their own central bank which which can backs stop the debt the the higher long-term rates might might reflect fears of inflation more than fears of outright default you know in countries like France which which would be reliant on the um European central bank for support uh and then that becomes a political issue within within Europe. Um some of the jitters might reflect the possibility of restructuring which which of course would be you know unprecedented for France in recent in recent history but you know it's it's a tale event that we can't take off the uh the table. I mean generally speaking um you know there's a lot of public sector debt and there's a lot of private sector debt and um much of it was contracted in the COVID period at low interest rates um particularly in the private sector and um you know if we're moving out of that era then you know we'd be unwise to discount um you know financial treads in either sector and in public sector. Um, you know, the aging of populations brings in the entire question of entitlement programs, um, pensions, healthcare, how are you going to support those programs, you know, with with aging populations and which become more expensive with aging populations. So um that sort of demographic time bomb I think is a an important factor partic particularly for for industrial countries but not just industrial countries you know everywhere with the exception of Africa you know we see we see demographic slowdown >> the flip side of that I mean from an optimist's perspective is that AI will be a gamecher and can can boost the the growth side of the equation uh even in the face of the labor market challenges. How optimistic or not? Are you on AI as a an economic driver? >> It's it's clearly going to have some some positive effect in terms of productivity. Not clear how big that will be. Not clear if that will be an ongoing growth effect as opposed to, you know, more or less one time shift in productivity. How that affects output is unclear. I mean you we can't have both you know largecale unemployment which some people fear and you know a big increase in output you know if the AI is merely replacing workers so it's just it's just basing your your hopes for um fiscal salvation on the idea that AI will come to the rescue is um you know pretty pretty brash rash in my view and um you know in any case any any sort of um prudent scenario planning would allow for the possibility that AI does not does not come to the come to the rescue. Uh and that um you know we actually we actually end up um you know having to pay these bills or or you know more accurately future generations end up having to pay these bills. >> Yeah. Um just conscious of the time um we're coming up to the hour. Obviously you spent a lot of time at at the IMF and that's kind of synonymous with the term kind of the Washington consensus and we've also had Gary Gerl on here talking about the end of the neoliberal um era. I mean what do you think comes next? Obviously it looks like economic nationalism maybe in the US. Is that going to be the trend globally or is that a US phenomenon or how do you think the global markets uh from a kind of a policy ideology might look over the next number of years? Well, I think there there's going to be more of a realization that public investment is is important and that um you know key sectors vulnerable to security threats are important. Yeah, to some extent the neoliberal less afair Washington consensus view was based on the premise of a stable peaceful world in which the biggest threats you know the cold war you know had had receded. you know to some extent I would I would argue that social policy in that world uh was also distorted by the or if not distorted at least shaped by the the hope that um you know peace and security would be durable. So basically if your if your country is not in a position where it might have to go to war where you might have to uh you know draft young people to serve in the army social solidarity might appear less important right I mean in some sense social solidarity is a national security asset and you get social solidarity by uh you know worrying more about inequality worrying more about public education worrying more about, you know, things that things that that I think, you know, economists have all always been worried about. Um, you know, the idea that, you know, economists never thought about these things is a distortion of um economist actual thinking. I mean, Adam Smith in the Wealth of Nations made a a really strong case for public education of the um the laboring classes, you know, and that's still something that that I think is important. So, No, I think I think you know certainly economists got a bad rap. I think um you know the less a fair um aspects of neoliberalism probably are not suited to to the world we we live in and we just have to we just have to recognize recognize that fact. Now on the other hand uh the sort of interventions that the Trump administration is implementing um are are going to be negative for efficiency, negative for growth in my view. Um you know run against the the uh uh the investments you would want to make for example in your research establishment to actually enhance national security. You know, I I I expect to see Europe trying to move in a counter in a counter direction and you know, if they if they implement the type of recommendations that are in the Draggy report and the letter report, you know, that calls for more um purposeful investments in in key areas. And I don't think that's necessarily a bad thing. But um you know we we shouldn't lose sight of the fact that um some of the lessons of neoliberalism are important and you know remember where where neol liberalism came from the sort of um you know the sort of hyekian view of um how the economy should be managed. you know, Hayek was a refugee from uh from Nazism and he saw how the Soviet system and the Nazi system, you know, oppressed individual freedom. And so part of his espousal of neoliberalism was based on this idea that individual freedom is is important. And as we see the US move toward this sort of authoritarian opportunistic self-deing interventionism, you know, I think it might make us more um nostalgic for for Hayek and his general his general um you know view that um you know the free market can be a bull work against arbitrary authoritarian actions by by the government. There is more than a kernel of tr truth in that perspective. >> Very good. I'm conscious of that we've uh just run over. We we always like to ask um our guests for maybe for advice for people who are coming into uh the economics or the markets uh early in your career. Obviously you've worked as an economist uh a policy maker policy advisor for people looking to pursue a career in macro or international economics. anything you would think has been very beneficial or influential in your career or things that people should read or do you >> if you look across universities uh and look at what PhD students are working on there's less interest in macro in international uh uh and it's partially because you know if you go into applied micro areas you know the formula for writing a dissertation is pretty clear you you find a novel data set which allows you to identify the um uh economic effects you're looking for econometrically and then you uh then you're you've got it made and mac macro finance international they appear more mysterious to people in some sense but I think that that um I would I would use student I I would advise students not to you know not to give up uh you know when I went into to macroeconomics and international um it was after my experience in the UK seeing the effects of high inflation. Um uh uh uh seeing the uh you know the effects of a transition to a new international monetary system. Uh I think these issues are fascinating and important and susceptible of good research. And so I would, you know, say what um my my adviser Rudy Dornbush said to me when I was on my way to my, you know, first job interview uh with the IMF in in um you know, 19 uh 79, which is uh learn something about the real world, not just what we teach you in graduate school. And I think that's, you know, that's great advice. >> Absolutely. I think that's definitely makes a lot of sense. Um so well Murray thanks very much for coming on. It's been uh fascinating to get your perspective on policy and economics uh and and everything that goes with that at the current juncture. Um so for all of our listeners make sure to follow uh Murray's work at the Peterson Institute and we'll be back soon on Top Traders Unplugged with more content. So talk to you soon. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. [Music]
De-Dollarization, the IMF, and the Erosion of Monetary Norms | Global Macro | Ep.89
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[Music] You know, again, this is an area where I think there are a lot of risks that haven't been carefully considered and where, you know, governments outside the US are are quite um alarmed about the, you know, the possible incursions into their domestic payment systems and um haven't quite figured out how to react. But um you know certainly thinking thinking hard about the risks that might be posed and again that I think this could be another source of fragmentation going forward. Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged. The place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Neils Krop Len. Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan D. [Music] Thanks for that introduction, Neils. Today I'm delighted to be joined by Morris Obsfeld. Murray is the senior fellow at the Peterson Institute for International Economics and also professor of of economics emiritus at Berkeley. He has served as a member of the Council of Economic Adviserss under President Obama and was previously chief economist at the IMF. He's also been an honorary adviser to the Bank of Japan. He's won countless awards in academia for his work in international economics, the international monetary system, exchange rate and financial crisis. And he's also been the author co-author of uh some leading textbooks on economics with Paul Krugman and Kenneth Rogoff. Murray, great to have you with us today. How are you? >> I'm great, Alan. How are you? >> I'm very well, thanks. So, um, I I I went through your your very long and distinguished career, but we always like to start off getting a sense on how people started off in economics and the markets. What got you interested in economics in the first place? >> Oh, great question. Uh, that's a story I actually love to tell. I was a uh mathematics major as an undergraduate and uh in the early 1970s I had the privilege of uh spending a couple of years at Cambridge University uh do you know doing maths again but uh it was obviously a very turbulent time in the UK economy and the world economy generally and um uh I was in King's College Cambridge which was Kansas College and I had a number of friends who were doing economics and I just got gradually uh drawn to it. You know, my problem was that I had a I had a fellowship to go back uh return to the US and do a doctorate in mathematics at MIT and I wasn't quite sure how to how to switch that around if I wanted to do economics. But uh fortunately, when I got there, they were willing to just let me uh come over and enroll in the economics program. So, uh that worked out quite well for me. and you you've been an academic and a and a policy adviser. Um I mean you've you've served at the IMF, you've done a bunch of different things. Any standouts or do you prefer the research to teaching? Which aspect is I guess you're most most drawn to? Well, at the moment, uh, uh, you know, I'm showing my, uh, my age and the, uh, you know, the, uh, typical life cycle of, uh, many macroeconomists and I've been drawn more to the policy sphere and the, uh, sphere of commenting on current events. Um, I still try to keep my, uh, hand in research. Uh but um it seems to me that as as one one gets older, the the the accumulation of what you may have learned is uh usefully deployed and trying to make the world a better place. And uh that's what I've been trying to do in recent years. I I retired from teaching at Berkeley um a couple of years ago. So I still advise some graduate students, but I'm not giving lectures uh anymore. >> Very good. Well, I mentioned you were um chief economist at the IMF a number of years ago. Um and um curious to get your perspective on on that experience and and maybe the the IMF and in as we see it today. I I know Scott Besson spoke there not so long ago and calling for a form and maybe the need for for for a new approach not just at the IMF obviously at other institutions as well. Um I mean we're seeing less financial crisis generally in emerging markets. Is is the role for the IMF diminished or changing do you think? >> Well the the IMF role has evolved over the years. uh you know it was primarily a uh organization based at you know the more industrial economies back in the 50s and 60s uh you know in the sort of post-war recovery recovery period. Um when the world moved to floating exchange rates in uh 1973, many wondered what the role of the fund would be because the you know the original idea of the bread and wood system was that the world would be on fixed exchange rates. The fund would be there to lend resources if countries had balance of payments difficulties as a result of um the need to intervene uh using foreign exchange reserves to hold those exchange rates fixed. Suddenly, if everyone's floating, what do you need a fund for? Uh but as it turned out the move to floating also coincided more or less with a move to more open capital markets and the possibility of uh uh fastmoving financial crisis and so the fund found a uh you know a new role u now primarily uh it has been involved with emerging markets though the the the euro crisis was a glaring exception to that to that general ization but um you know it still has numerous programs uh in emerging markets and also in in low-income countries. Uh so there there's definitely a role there. I think even even though emerging markets have done well in recent crises and we can we can talk about why that why that might be um there's always the the um risk out there that you know with the vast expansion of of global capital markets um there could be reversals and in those situations IMF funding uh can be can be critical. Yeah, I mean that's something uh maybe we'll get on to as we uh progress, but um you wrote a paper recently maybe you you you're mentioning how you're commenting on current policy. You wrote a paper around tariffs as fiscal policy. Uh and obviously tariffs has been the big topic um in the markets this year. For a lot of market participants, you know, there was a lot of uncertainty as to what was the purpose of the tariffs in the first place. Was it more from a budgetary perspective? because of trade industrial policy and in the paper you address this. I mean what what's your assessment on what's been the rationale for the tariffs and and the likely impact? >> Well, if you look at the uh you know 1.0 tariffs 2018 2019 the rationale was um twofold. it was to uh to try to uh reduce the US trade deficit and uh furthermore to bring back manufacturing to the US. I think both of those motivations were fueled by a grievance narrative that uh foreign countries had been unfair to the US through their trade policies and the tariffs would uh you know level the playing field uh and offset some of those alleged harms. Now what we've seen in this new uh round is the um uh use of very broad tariffs uh you know on all imports. you know, the targeted tariffs are still there on certain sectors, but the, you know, the sort of across the board tariff idea is novel and um it's motivated by the same the same goals, the trade deficit manufacturing uh renaissance hopes and um redressing grievances. But it also raises the possibility of largecale revenues. And um uh you know in this recent round starting in the election campaign, Donald Trump raised the possibility of using the tariff revenues to offset um tax cuts in other in other areas. You know, he even floated the idea of replacing the US income tax entirely with tariff revenues. So uh you know in some sense that is a you know additional motivation basically reforming the US tax system uh to make it much more heavily dependent on tariffs as opposed to say income tax or corporate tax or other taxes. And that raises a host of a host of issues that um you know Kim Clausing and I tried to uh assess in that um recent paper on tariffs as fiscal policy. >> I mean this was was as you say muted as part of the campaign but but generally the view was well you know it had been done before in the I think like in the 19th century but but obviously the the amount of spending was a lot less then and and the tax requirement was a lot less. So there was kind of general skepticism as about this being a a plausible kind of tax revenue um tool. But that that seems to have shifted a little bit. I mean if you look at the financial markets last month or so >> now the view is well if the tariffs got repealed that would be seen as negative or a problem for the deficit. So and obviously the CBO have come out saying you know the tariffs will will contribute around 4 trillion over the next decade. So has that has that viewpoint shifted in in economic and and financial market circles, do you think? >> Well, the the premise of the uh Trump tariff idea was basically the premise of a a sort of free lunch that somehow these tariffs were um going to be paid by foreigners. um you know it's money for the taking and therefore we can we can you know have our cake and eat it. We can lower income tax. We can um get revenue from foreigners for free and um you know win-win for the US and um you know we're not too worried about the effect of foreigners or the possibility that they may retaliate. Now um you know that that you know the idea that that foreigners pay for tariffs you know as a as a operational matter is is wrong um simply because it's importers in the US who actually pay the fees that go to the treasury. um as a substantive matter um it's not so clear because you know one of the one of the fundamental issues in analyzing any tax is its incidence. Uh in other words it it may not matter who actually pays the tax in the operational sense. you know, do we tax um buyers or sellers of our product because the market equilibrium uh that that results from the tariff uh you know will result in effects on both buyers and sellers uh which may disproportionately fall on buyers or sellers regardless of you know who is physically handing the money over to the the government. So in the tariff sphere the idea would be that um uh you know yes importers pay the money to the treasury but uh you know foreigners uh who are exporting to the US facing reduced demand will be induced to lower their prices and um in the Trump narrative uh they lower their prices by the full amount by the full amount of the tariff. Therefore um even though US importers, you know, are the ones who fork over the money to the Treasury. They're benefiting from proportionately lower global prices and therefore there's no loss to them. The incidence of the tariff is all on the foreigners. So that's basically what Trump, you know, that's the the most charitable way of interpreting Trump's um insistence that foreigners pay for tariffs. Um, now if we look at the evidence of the 2018 2019 tariffs, very little evidence that foreign sellers of goods into the US market lowered their prices. Now with these across the board tariffs, that's a different situation. But the early returns would still indicate that they haven't lowered their prices that importers are not paying lower prices for imports and there therefore you know American residents firms or consumers are paying for this tariff revenue that is flowing into the treasury which by the way is more likely to be closer to uh 200 billion a year than the 400 billion a number that you that you cited. So, you know, as far as the markets are concerned, you know, they're they're looking at what's happened on to consumer inflation, to the consumer prices of imported goods and goods that compete with them. And you you haven't seen increases that are in line with the tariff increases. So, you know, the conclusion seems to be, okay, fine. uh you know we've moved to this new regime. We haven't seen big inflation consequences. The other consequences of tariffs namely that they're you know if you levy tariffs and lower income taxes on rich people this is a very regressive policy. Markets don't care a wit about that. But um you know in reality if foreigners haven't lowered the prices they charge the US and if the treasury is getting all this revenue which is you know basically about 20 to 25 billion a month in new revenue then who's who's paying for that? Someone's got to be paying for that. And uh you know where it's coming from is a combination of some increase in consumer prices but also um uh you know importing businesses which are swallowing a reduction in their margins. Now they can't do that forever. So likely more price increases are on the way. uh or uh you know if if these firms feel unable to low raise their prices this this is and this is um probably more true of some of the some of the smaller businesses um they're going to they're going to go out of business and so there are consequences which I believe are inevitably coming down the pike and I think which might um disturb some of the complacency we've seen in the in the markets Now, that that being said, uh you know, the Supreme Court in early November is going to hear um an important case on the constitutionality of um Trump's broad-based tariffs, the emergency tariffs. And uh there there is as you said concern in the markets that if suddenly the Supreme Court rules that these are illegal the government would have to actually refund large amount of tariff revenue uh the revenue wouldn't be available on a uh ongoing basis to fund uh the huge hole in the budget left by the one big beautiful uh budget act. And uh then you have a situation where you're opening up the bond market to um stresses that uh could be pretty severe down the road. So um that's something certainly we'll all be watching carefully. >> Yeah. I mean, as you say, um the long-term ramifications, we're still to see them. Obviously, it's going to take time. Um we've seen a very different approach to policym under under Trump. Uh go goes goes without saying. Um you you you wrote a separate uh paper recently kind of looking at how that may impact the global international monetary system um called uh the dollar and double um called a fork in the road. um and and and that the the paper is about how the shift in US policym may may set up a scenario where the we get more fragmentation in the international monetary system which could undermine under the the US dollar. So um I mean could you give us a sense on what you think are the key components of this argument that that that this change in policy uh approach could ultimately um undermine the dollar? >> Well, the dollar's premacy in international markets rests on a number of pillars. uh not all of which are you know purely economic pillars but um you know I would say that that what what the share is the idea that the um you know the United States is a predictable and reliable player in global you know economics, finance and security that um to some degree internalizes the effects of its actions on the rest of the world. you know, in some sense, I I don't want to say that it it depends on the US being a hegemonic power, which, you know, it was for basically some years after 1990. But, um, you know, it's still it's still at this point the undisputed, you know, leading power, you know, most powerful nation. And um uh you know countries throughout the world have relied on it in in many respects for security asurances, for aid, for financial support, for um you know interventions in in uh stabilizing interventions in financial markets. So now instead we've moved to a situation where um you know the Trump administration is taking a hatchet to um international institutions and agreements to domestic institutions and agreements and where all of that is now now in question. You know, if you look across the spectrum of policies being followed both in the economic and the security realm, and they're linked, they're linked policies. Uh it's caused a great great deal of concern such that um foreign players may lose faith both in the value of the dollar and in the wisdom of um you know exposing themselves to US pressures that might be connected with their reliance on a system that is that is based so heavily so heavily on the dollar. So yeah, take an example, you know, tariffs. Um, you know, be it would be one thing for the US to simply say, well, we, you know, we feel we need a 15% across the board tariff because we'd like to um, you know, address our trade deficit as a revenue source, you know, for whatever reason. And we can discuss whether tariffs are an effective way of addressing the trade deficit. I don't believe they are. Uh but what the Trump administration has done is it's been using tariffs as a coercive instrument to um you know sometimes extract uh concessions from other countries that are that are not really trade concessions or to um make political demands on countries. So in the in the former category, you know, the US has been negotiating with um Korea, Japan, Europe for large investment funds that would be uh basically um under the discretion of the president. It's very unclear what the details are on these and to what extent the foreign partners have actually agreed, but this is this is sort of unprecedented. It's basically a a uh you know a form of extortion in which the US says you know give us give us these funds or else. Now again you know when when I say the tariff threats are being used here yes there are tariff threats but all the policy makers involved you know across Japan, Korea and the EU understand that um the implicit threat is a withdrawal of military support. you know, Japan and Korea, you know, very worried about um security in East Asia given um not only China's sometimes aggressive behavior, but um North Korea, which has nuclear weapons and is totally totally unconstrained and is actually moved much closer to Russia and to, you know, more normal relations with China. China and Russia are no longer trying to constrain North Korea's behavior. Um you know in Europe there there is you know still considerable US um assistance if not monetary than in other areas and Europeans are very worried about that. So, you know, this is this is a very different world from the, you know, the pre-Trump world in which US security guarantees were predictable and reliable. And of course there would consider there would there would occasionally be discussions about cost sharing uh which is certainly a legitimate topic. But you know the idea that that the US would would um even implicitly threaten to withdraw these um supports uh in return for monetary um or commercial payoffs was not really really on the table. Um you know within the domestic sphere uh key institutions are also being being attacked. you know, when when the US government insists on taking uh stakes in US enterprises or in um deploying export controls to um pressure country companies for stakes in uh their foreign revenues, when the government attacks the independence of the Federal Reserve, uh you know, when the Congress throws off any pretense of um fiscal prudence and um you know manipulates its budgetary rules to um pretend that it's not um creating possibly unsustainable budget deficits. You know, cheered on by the administration. You know, these are all these are all um things that make the uh you know, the rest of the world worry about the uh security of uh of dollar assets >> and the wisdom of being so plugged into the dollar system, >> you know, and there's subtle ways too in which this works. I mean the um you know one of one of the factors that has promoted the prevalence of of dollar borrowing throughout the world is that the Fed makes swap lines available to key countries which allow them to um you know support their financial systems which are very dollar dependent at this point. um if the Fed's independence is compromised then maybe those swap lines can become additional tools of coercion >> and this is a real concern for among foreign governments. >> Yeah. I mean it's interesting at on the one hand you know as you touch on there is this you know ambivalence towards the the value of the dollar at the same time the the administration is talking about stable coins as a mechanism to promote even greater demand for US treasuries um so I mean how do you reconcile those viewpoints um that's one question I mean and I take point about um you know foreign concern about US policym but I mean against that the view has always been well there's no alternative so what else can people use >> well there's no alternative to to the dollar as a sort sort of universal currency which is kind of the status it has now I mean almost you know 90% of transactions in the foreign exchange market pass through the dollar uh you know as a vehicle currency Uh and I would say that the you know the reach of the dollar globally at the moment or at least you know moving coming into this Trump administration is really unparalleled even compared to the days when the Brettonwood system required countries to peg basically to the dollar. So it's got it has a quite quite an amazing reach at this point. But you could move to a multipolar system where more countries elect to be more aligned with the euro or more countries particularly in Asia and possibly Africa, you know, are more aligned with the uh the Chinese yuan. And so instead of having this you know global dollar system you have a a system based on multiple multiple currencies and even some smaller currencies. You know the Japanese yen could play a regional role. Uh you know sterling could could improve its share even although UK you know has its own problems. Um so that would be the world we we move to and um you know that's that's less efficient but um it's not a disastrous scenario in in and of itself. What's more more worrisome are the forces that are would be driving the world to a multipolar configuration. But I think that's completely feasible. >> Yeah. I I mean it's been talked about for a while and maybe we've had Barry Arking Green on here before and spoke to him about it and he's made the point that there has been increased demand for international reserve managers for the smaller currencies likes of Australian dollar and sterling Canadian dollar etc. Um you talk your paper is all about fragmentation and a more fragmented international system. I mean what do you think that would mean? Um presumably mean a dollar block, a euro block, a yuan block. Is that it? Does and as you say not necessarily disastrous just a change of features or is there some kind of implication from moving to that kind of system for for global markets? >> Well, I think there are a number of lay layers to this. Um the the use of multiple currencies, you know, in itself as a form is a form of fragmentation. The possibility that regulatory cooperation erodess in the financial sphere could be another source of fragmentation. I mean you know the US participation in the um the Basel process in the financial stability board uh how that will evolve going forward you know is a is a question but the administration certainly seems to be you know rejecting multilateral cooperation in a number of a number of other areas not so far in the IMF and we can you know certainly talk about that more the discretionary use of um tax policies in capital markets I think is not really off the table. Um you know either for outflows or or inflows. Um one um possible harbinger was the uh you know the so-called revenge tax that was contained in the house version of the bill that became the o crippleba. you know, the idea that if foreign countries um try to um you know, impose taxes on US corporates um then, you know, the US can tax their revenues, prevent repatriation, you know, on a on a one for one basis. Um that threw a a fright into into markets momentarily or at least into uh you know, the business community. You know, you raised the the issue of stable coins. I think the the capacity of the stable coin um initiative to raise the demand for treasuries is probably exaggerated. The idea that this would be a net demand and you know would not subtract from demand elsewhere in the system is really untested and un not not thoroughly considered uh by those who promote stable coins. But the stable coin issue, you know, raises a number of problems. Um, uh, you know, countries may, you know, not be happy about, um, parts of their payment system moving to a more lightly regulated venue based on the dollar. It might affect the transmission of monetary policies. It might raise the um possibilities of uh financial um instability or um illicit transactions. And so this could lead to more you know more um barriers to international payments in that in that in that sphere. you know if countries become highly dependent say on US stable coin providers they become uh more vulnerable to actions that the US government might pressure these providers to take like cancelling wallets and the like. So um you know again this is an area where I think there are a lot of risks that haven't been carefully considered and where you know governments outside the US are are quite um alarmed about the you know the possible incursions into their domestic payment systems and um haven't quite figured out how to react but um you know are certainly thinking thinking hard about the risks that might be posed and again that I think this could be another source of fragmentation going forward [Music] the big risk obviously from a financial markets perspective what people worry about is, you know, a big sell-off, a big decline in the dollar as for all the reasons you're highlighting that foreigners decide to reduce their holdings of US assets. Um, you're talking about potential fragmentation. Do you see that associated with a potential much weaker dollar or a secular downtrend in the dollar? And and then linked to that, would it also mean less demand for US treasuries and and and obviously and higher yields as a result of that? Yeah, I think those would be possible consequences for sure. >> Yeah. And I mean, you talked about possible tax policy and the other one that has been mentioned with Steve Marin's paper before is um you know, dollar swaps. So, so swapping kind of treasuries into longerterm data issuance or some kind of I guess coercion um as a I suppose maybe as part of quidd pro proquo for access to the market or you know or for defense as you say. Do you think that's likely? I mean everybody's talking about possible financial repression. I guess that would be part of that kind of approach. Do you see that as a possible risk as well? Yeah, I don't think that the Moran idea is likely to attack to attract a lot of support uh you know even from within the administration. I mean it would be a direct hit on the Treasury market and um you know I think I think from the standpoint of um you know the Treasury's desire to you know smoothly finance these deficits um they're much happier to pursue the um you know the idea that the uh you know stable coin initiative will uh will help solve the problem. uh you know and now again you know this administration has proved pretty unpredictable but um you know I think I think what Dr. Moran proposed really doesn't have a lot of a lot of support uh on the Treasury side. I mean you also mentioned obviously the kind of the international impact of all of this is you know mistrust I guess or concern uh lack of confidence in the US and then you also talked about you know the more unusual approach to policym domestically you know taking stakes in in um the likes of uh Intel uh cutting deals with Nvidia etc which is all new and and obviously I guess counter to kind of free market economics um what where does what do you think from an economics perspective this leads to or you know if you were tracing this out simply economists don't advocate these kinds of policies for a reason so what what are the adverse effects of these policies over the longer term >> well I think ultimately they they they harm investment innovation um you know the cl the sort of classic arguments that um free market conservatives have made um you know have a more than a grain of truth and um if you're contemplating an investment and you think the government may um come along and uh you know force you to give up a stake of that I mean this is this is taxation but it's not taxation that is um you know debated in the congress and that has some um uh you know firm political or um uh public policy purpose. It's it's you know or basis, you know, it's it's um it's it's it's it's um capriccious actions um at the um whim of an executive that is not really constrained by the judiciary or the legislature. And you know we know that those environments which you know characterize authoritarian countries are not particularly good for investment and they're also terrible for you know for inequality. I mean just you know you you end up with a sort of um a system you know closer to the Russian system in which um you know oligarchs are willing to invest on the premise that um they're protected by the state but that they'll also do the state's bidding and that's you know clearly we're not close to that in the US at this point but these sorts of moves certainly push in that direction and um you know Had they occurred under a Democratic administration in the US, you know, the the other party would be screaming bloody murder. But, you know, they seem to be fine with with this approach, which, you know, to me is very surprising and very puzzling. M I mean the other big the big issue that's a cause of concern is around the Fed and obviously the pressure the overt pressure that the the Fed is under to for an easier policy. Um I mean not just we we the fact that we we we've got a we will have a new Fed chair presumably next year but there's lots of calls for reform a new approach at the Fed from Scott Bessant from from other people. Do you think we're possibly at a fork in the road for the Fed as well? Could you see us take could you see the Fed taking a a different approach uh looking ahead? >> Well, I think there there are legitimate um questions you could raise about um you know the Fred Fed's um performance. um you know as with any legislatively independent agency you need transparency and accountability and um it's not as if that has been that has been missing you know the chair does uh appear before Congress and um uh you know has tried to be more transparent with press conferences and the like. So you know there's always there's always room for doing better and there's always room for reassessment. I would um say that the Fed's performance has not been perfect, but it's done it's done pretty well in the face of uh you know a lot of disruptions. Uh you know COVID uh reopening, the Ukraine war uh has not been a you know sort of easy easy period. Now that being said, um you know, while one can legitimately make those criticisms, I think the you know, this is this is not really what um the president's agenda is. The the agenda is to um fund the Treasury at lower at lower interest rates. It's basically a fiscal dominance agenda. The president's statements are very clear. you know, the Treasury is paying too much for borrowing and the US should have low interest rates like other countries because um that would make it much cheaper for the Treasury to uh to finance its deficit. So that's I mean that's sort of the key issue here. it's not even really so much supporting the economy because Trump denies that there are any negative pressures on the economy. So, um there's a pretty clear danger that instead of the Fed, um being devoted to this, uh you know, the current dual mandate of price stability and maximum employment, it basically uh becomes a uh you know, an agency for financing the fiscal deficit. >> Yeah. I mean, I did see Scott Besson in in the Wall Street Journal, he had an article talking about the third mandate of stable interest rates. So, I'm not sure if that's a formula or if that's one he just added in himself. >> No, no, that's that's actually in the legislation. It is, is it? Okay. Yes. In fact, well, you know, okay, the these come out of the Humphrey Hawkins Act, which was passed in the in the uh late 1970s when inflation was out of control and uh uh long-term interest rates were skyhigh. And the previous Fed mandate, which came out of legislation passed in the late 1940s, was uh based entirely on um full employment. And this new legislation said, okay, you know, price stability is also important. And um uh I think I think there's been a general recognition that the main cause of very high long-term interest rates is inflation. That's been the case historically. And if you basically achieve the price stability mandate, you'll automatically achieve the the long-term interest rate mandate. Now, that being said, if the um if the federal budget is totally out of control, which it was not in 1977, and if the uh government is uh the administration is pushing the uh the uh Federal Reserve to become a uh you know, its fiscal agent uh by accommodating deficits at lower interest rates. then long-term interest rates are going to reflect that. And then to to sort of, you know, bring up that mandate at such a time is very is very rich because what you're basically saying is um okay, you know, we in the administration are undermining the Fed's credibility and um thereby possibly pushing up longerterm interest rates and now we want the Fed to suddenly, you know, remember this third part of the mandate and to push those interest rates down. But I think that that that does lead to a policy which would turbocharge inflation which is um uh yield curve control that basically the Fed you know uh and this was practiced in Japan in the face of uh deflationary pressures until recently. um you know, the idea that the Fed would would would um manage, say, the 10-year yield to keep it low by buying up, you know, that part of the um bond market effectively. You know, that's what the Japanese did. And that would that would turbocharge inflation. So, um, you know, I view this invocation of the, uh, the third and, you know, least known part of the mandate as as incredibly disingenuous, uh, on the part of the Treasury Secretary. >> I mean, how would that play out? I mean, I mean, because obviously the Fed still has an inflation target. So on the one hand it would be buying bonds to to keep interest rates down and presumably ignoring the fact that inflation is running above target. Do you think would that is that how it would play out in that scenario or would you uh presumably they wouldn't formally abandon the inflation target? >> You know the the inflation target is not you know in the Humphrey Hawkins bill. This is, you know, the idea that there's an inflation target is much more recent and came in under the Bernani chair. Um, you know, in line with international practice. Um, so there's no legislation. There's no mandate. Uh, the Fed could just not say anything. Uh, you know, they they're not they're not really constrained in that sphere. And I think we would just see inflation creep up. you know, the Fed would still say, you know, we're committed to price stability. And, you know, I think there would be the hope of somehow managing expectations through um you know, what in the past have been called openmouth operations. Um and and uh you know, it simply wouldn't work. You know, it might might work briefly uh but it but it wouldn't work in the long term. So I I wouldn't say it's terra incognita because we we were certainly there in the 1970s but um you know we would gradually in the US slip into a much higher inflation environment until such point as you know the the uh political backlash became so strong that um there was um you know a reaction from the administration uh to to you know induce the Fed to do something else. >> Yeah. Obviously you've done a lot of work on crises and in emerging markets and elsewhere in fiscal crisis. A lot of I suppose traditionally when we get debt crisis it's also in in often in the private sector and the banking sector but at the moment there's no issues in the banking sector and private sector balance sheets are in good shape by and large it seems. So it's very much a public uh debt issue. So I mean looking at the situation particularly in the US but not just in the US obviously the likes of the UK, France, Japan all with high debt levels. I mean what's the typical scenario that this goes from being a problem into a crisis would you say? >> Well we should never say that um you know the banking system is immune to crisis. I you know I I think there's you know I mean we recently in the US had the you know Silicon Valley bank episode which could have which could have been become more systemic without the um you know the immediate uh backstopping from the from the treasury. So um we should never ever ever be complacent uh you know in the face of um you know there's always financial innovation and um you know whenever whenever we think we've uh figured out a way to reduce risks uh financial activity moves to the riskier less regulated sectors and you know we've seen this with um you the move to non-bank financial intermediaries like hedge funds where a lot more a lot more activity takes place. The um uh the stable coin sphere might be another area where there is um you know trouble trouble a foot uh eventually. So you know but putting that aside um the the risks do seem to be much more at the moment in the public finance area. the risks would play out more in the form of um you know concerns about um long-term solveny um uh leading to you know problems auctioning off debt or rolling over debt. you know much higher interest rates in um you know countries which have a you know their own central bank which which can backs stop the debt the the higher long-term rates might might reflect fears of inflation more than fears of outright default you know in countries like France which which would be reliant on the um European central bank for support uh and then that becomes a political issue within within Europe. Um some of the jitters might reflect the possibility of restructuring which which of course would be you know unprecedented for France in recent in recent history but you know it's it's a tale event that we can't take off the uh the table. I mean generally speaking um you know there's a lot of public sector debt and there's a lot of private sector debt and um much of it was contracted in the COVID period at low interest rates um particularly in the private sector and um you know if we're moving out of that era then you know we'd be unwise to discount um you know financial treads in either sector and in public sector. Um, you know, the aging of populations brings in the entire question of entitlement programs, um, pensions, healthcare, how are you going to support those programs, you know, with with aging populations and which become more expensive with aging populations. So um that sort of demographic time bomb I think is a an important factor partic particularly for for industrial countries but not just industrial countries you know everywhere with the exception of Africa you know we see we see demographic slowdown >> the flip side of that I mean from an optimist's perspective is that AI will be a gamecher and can can boost the the growth side of the equation uh even in the face of the labor market challenges. How optimistic or not? Are you on AI as a an economic driver? >> It's it's clearly going to have some some positive effect in terms of productivity. Not clear how big that will be. Not clear if that will be an ongoing growth effect as opposed to, you know, more or less one time shift in productivity. How that affects output is unclear. I mean you we can't have both you know largecale unemployment which some people fear and you know a big increase in output you know if the AI is merely replacing workers so it's just it's just basing your your hopes for um fiscal salvation on the idea that AI will come to the rescue is um you know pretty pretty brash rash in my view and um you know in any case any any sort of um prudent scenario planning would allow for the possibility that AI does not does not come to the come to the rescue. Uh and that um you know we actually we actually end up um you know having to pay these bills or or you know more accurately future generations end up having to pay these bills. >> Yeah. Um just conscious of the time um we're coming up to the hour. Obviously you spent a lot of time at at the IMF and that's kind of synonymous with the term kind of the Washington consensus and we've also had Gary Gerl on here talking about the end of the neoliberal um era. I mean what do you think comes next? Obviously it looks like economic nationalism maybe in the US. Is that going to be the trend globally or is that a US phenomenon or how do you think the global markets uh from a kind of a policy ideology might look over the next number of years? Well, I think there there's going to be more of a realization that public investment is is important and that um you know key sectors vulnerable to security threats are important. Yeah, to some extent the neoliberal less afair Washington consensus view was based on the premise of a stable peaceful world in which the biggest threats you know the cold war you know had had receded. you know to some extent I would I would argue that social policy in that world uh was also distorted by the or if not distorted at least shaped by the the hope that um you know peace and security would be durable. So basically if your if your country is not in a position where it might have to go to war where you might have to uh you know draft young people to serve in the army social solidarity might appear less important right I mean in some sense social solidarity is a national security asset and you get social solidarity by uh you know worrying more about inequality worrying more about public education worrying more about, you know, things that things that that I think, you know, economists have all always been worried about. Um, you know, the idea that, you know, economists never thought about these things is a distortion of um economist actual thinking. I mean, Adam Smith in the Wealth of Nations made a a really strong case for public education of the um the laboring classes, you know, and that's still something that that I think is important. So, No, I think I think you know certainly economists got a bad rap. I think um you know the less a fair um aspects of neoliberalism probably are not suited to to the world we we live in and we just have to we just have to recognize recognize that fact. Now on the other hand uh the sort of interventions that the Trump administration is implementing um are are going to be negative for efficiency, negative for growth in my view. Um you know run against the the uh uh the investments you would want to make for example in your research establishment to actually enhance national security. You know, I I I expect to see Europe trying to move in a counter in a counter direction and you know, if they if they implement the type of recommendations that are in the Draggy report and the letter report, you know, that calls for more um purposeful investments in in key areas. And I don't think that's necessarily a bad thing. But um you know we we shouldn't lose sight of the fact that um some of the lessons of neoliberalism are important and you know remember where where neol liberalism came from the sort of um you know the sort of hyekian view of um how the economy should be managed. you know, Hayek was a refugee from uh from Nazism and he saw how the Soviet system and the Nazi system, you know, oppressed individual freedom. And so part of his espousal of neoliberalism was based on this idea that individual freedom is is important. And as we see the US move toward this sort of authoritarian opportunistic self-deing interventionism, you know, I think it might make us more um nostalgic for for Hayek and his general his general um you know view that um you know the free market can be a bull work against arbitrary authoritarian actions by by the government. There is more than a kernel of tr truth in that perspective. >> Very good. I'm conscious of that we've uh just run over. We we always like to ask um our guests for maybe for advice for people who are coming into uh the economics or the markets uh early in your career. Obviously you've worked as an economist uh a policy maker policy advisor for people looking to pursue a career in macro or international economics. anything you would think has been very beneficial or influential in your career or things that people should read or do you >> if you look across universities uh and look at what PhD students are working on there's less interest in macro in international uh uh and it's partially because you know if you go into applied micro areas you know the formula for writing a dissertation is pretty clear you you find a novel data set which allows you to identify the um uh economic effects you're looking for econometrically and then you uh then you're you've got it made and mac macro finance international they appear more mysterious to people in some sense but I think that that um I would I would use student I I would advise students not to you know not to give up uh you know when I went into to macroeconomics and international um it was after my experience in the UK seeing the effects of high inflation. Um uh uh uh seeing the uh you know the effects of a transition to a new international monetary system. Uh I think these issues are fascinating and important and susceptible of good research. And so I would, you know, say what um my my adviser Rudy Dornbush said to me when I was on my way to my, you know, first job interview uh with the IMF in in um you know, 19 uh 79, which is uh learn something about the real world, not just what we teach you in graduate school. And I think that's, you know, that's great advice. >> Absolutely. I think that's definitely makes a lot of sense. Um so well Murray thanks very much for coming on. It's been uh fascinating to get your perspective on policy and economics uh and and everything that goes with that at the current juncture. Um so for all of our listeners make sure to follow uh Murray's work at the Peterson Institute and we'll be back soon on Top Traders Unplugged with more content. So talk to you soon. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. [Music]