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- [00:00]
Joe Weisenthal
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- [00:32]
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- [01:42]
Geeta Gopinath
Bloomberg Audio Studios Podcasts Radio News.
- [01:58]
Tracy Alloway
Hello and welcome to another episode of the All Thoughts podcast. I'm Tracy Alloway.
- [02:02]
Joe Weisenthal
And I'm Joe Weisenthal.
- [02:04]
Tracy Alloway
Jo the big story of markets right now has to be one of the big stories. The bond market sell off, by the way, as I say that I I just got this massive feeling of deja vu because I'm pretty sure we've done a few episodes where I've started out saying the exact same line.
- [02:19]
Joe Weisenthal
Well, I mean one obviously this is sort of one of the trends of our time, which is that after a decade pre Covid where we just sort of assumed the rates were going to head lower, there's been a regime change, as economists sometimes like to say. And so now we have rates pushing higher again. They've come back a little bit in, in the last like couple days, but that's not really the point. The point is it is this global phenomenon around the world, rates going up. I would still say probably the big story in markets is AI and memory and chips, but if it weren't for that, everyone would be talking about interest rates higher in almost every country in the world.
- [02:55]
Tracy Alloway
So here's the thing. I actually think AI and the rate sell off is kind of connected. So, you know, we're talking about yields going up generally in developed markets. And we've seen that recently. I know we saw for instance, the, the long end of the UK guilt market hit like the highest since 1998. The 10 year US treasury yield was kind of inching up towards 5%, but it's come down mostly. A lot of those yields have been moving in line with the oil price. Right. So a lot of people will say that this is just because oil's going up, that's inflationary, maybe we'll get higher rates. And so this is why yields have been backing up. However, there is an argument I'm seeing more and more people make this one, that what's going on is actually a repricing of something, you know, less transitory. Yeah, am I allowed to say that word anymore? Less transitory and something more secular in what's happening with the rates market. Something that's more about the massive amounts of capital that AI is actually consuming and having a crowding out effect on sovereign bonds. Or maybe something that's more about, you know, the ability of the developed world to actually finance itself in the longer term. And so you're starting to see some of those bigger themes creep into the discussion about the bond market. Sell off. This idea that it's something else is happening here, something more than the oil price.
- [04:15]
Joe Weisenthal
Totally. Actually, just speaking of the nexus between interest rates and AI, Torsten Slok has a good chart out. Came out this morning pointing out essentially that one thing with AI is the sort of FOMO aspect, not among investors per se, but about companies and not wanting to let their models be six months behind and so they'll pay whatever the cost is to catch up. And therefore he argues that perhaps higher rates do not have the slowing effect that they might have had in another cycle. Because it's like, well, yeah, it's no fun to finance this data center at higher rates, but if the alternative is being consigned to the permanent underclass, when the other company builds the most advanced model, you're going to do it nonetheless. And so yes, between oil, between the AI boom, between demographics and the challenges of sort of racism, resourcing for care of the elderly, of the infirm, between all of these things that we are in this real secular shift and we have to understand it better.
- [05:17]
Tracy Alloway
Yes. So I am very happy to say we do in fact have the perfect guest to talk about all of this we're going to be speaking with Geeta Gopinath. She is of course a professor of economics at Harvard University, but also famously the first deputy managing director of the imf. So truly a perfect guest to speak to someone who's been talking about, you know, a secular change in the bond market for quite some time. Gita, thank you so much for coming on.
- [05:40]
Geeta Gopinath
All thoughts, a pleasure. Tracy and Joe, great to be on your show.
- [05:43]
Tracy Alloway
So what's your take when you're staring presumably, you know, on a minute by minute basis at a chart of the US 10 year yield, what are you thinking?
- [05:52]
Geeta Gopinath
I mean, firstly, I think it's absolutely right to start with the conversation about what's happening in bond markets because frankly, despite all the many different shocks going around in the world, I actually do think the one that's most worrisome is what we see with public debt levels everywhere in the world. In the US we've seen yields go up. It's a combination of things. You just talked about all of them, which is one is the fact that inflation is now expected to be higher and there is a sense that the real rate at which the economy will stay at a somewhat stable level of inflation is higher. So the kind of the real interest rate has drifted up. The R has drifted up from pre pandemic when it was like half a percentage point. Now it's 1 percentage point. But on top of that you have the premia that's coming from the risk of inflation, from very importantly the large fiscal deficits that the US is running and is projected to continue to run into the foreseeable future. And of course the third element which is the AI boom and the expenditure, the capital expenditure that's being undertaken for that is also shifting the RSR up to maybe even higher than 1 percentage point. So because of all these reasons, we've suddenly moved away from the pre pandemic period of low for long interest rates. And what we were talking about, you know, the end of, I think we are have the end of secular stagnation at this point. Secular stagnation was about the fact that there was not enough investment happening, especially in the private sector. That is no longer an issue anymore. So because of the combination of inflation, AI boom, fiscal deficits all over the world, high public debt everywhere, we are seeing yields go up. And that's true in the US too.
- [07:52]
Joe Weisenthal
I want to drill into all of these specific things, but let's start with like the high level of public debt. That was a thing that people were talking about quite a bit prior to the pandemic as well. And rates just kept going lower and lower, including famously in Japan where debt to GDP levels are even much higher than they are in the Western world. And that was sort of famously known as the widowmaker trade because rates kept going lower. What changed between pre2020 and post2020 such that this suddenly in your view and perhaps the market's view, this became an important thing that was not perceived by the market as being important.
- [08:35]
Geeta Gopinath
Pre Covid a few things changed. One, the AI boom was unexpected. That was not something that was being priced in markets pre pandemic. For sure, that big increase in in demand for capital coming from the private sector is one big change. The other big change is the fact that fiscal deficits are now projected to stay at levels that nobody was expecting the US to run close to 7% fiscal deficits for the foreseeable future. That is the another important factor. And the third is the composition of who's the marginal buyer of this debt. So we had a period when central banks everywhere were buying government debt and that also helped keep interest rates low. In fact that was part of the strategy of how to strengthen the economy. Quantitative easing was part of the toolkit and so that helped keep interest rates low. But that's changed and now we have the central banks everywhere who have either stopped buying or they're running it down like it's happening in Japan. And the marginal buyer are the more volatile investors. Hedge funds in the US are the other market makers over here. And so whenever there are any shifts in global market conditions, you see a lot more rate sensitivity than you would have seen if it was mainly official credit flows. And by the way, that's also true about capital flows coming into the U.S. previously the buyers of U.S. treasuries used to be foreign central banks. They are not doing as much anymore. It's mainly coming from non bank financial institutions from the rest of the world. And so they're also much more volatile. And fleeties you're going to see just generally higher volatility in the yield curve.
- [10:27]
Tracy Alloway
Can you talk a little bit more about the AI boom? Because we hear people talk about a crowding out effect and I think this is actually like something that is just starting to get a lot of attention. But the proportion of issuance in the corporate bond market that's coming from AI companies or AI related, you know, investment right now is just insane. And you mentioned Torsten Slok chart. Torsten is going to be at our upcoming.
- [10:52]
Joe Weisenthal
That's right.
- [10:53]
Tracy Alloway
We're recording this on May 27, our upcoming live show in New York. And so I've previewed some of the charts he's going to be sharing there. There's a chart there that shows basically the proportion of AI in the corporate bond market. It's now 50% of all investment grade issuance year to date. And in even junk rated debt, it's creeping up to like almost 40%. So this is a significant amount of debt that's being issued into the market. Is it reasonable to think that investors are maybe going to think like, well, I'll buy some big tech mega cap IG debt versus a US Treasury?
- [11:30]
Geeta Gopinath
At least when we look at the pricing in markets that seems to be the case, especially when it comes to equities. Everybody wants to have a piece of the AI boom. And yes, I think there is that sense that, well, this is a sector where we could really see real gains, especially in terms of productivity increases and profitability. And that's going to help. That's going to be something that they want to be a part of. So there is that demand for corporate bonds and for US Equity, which is coming again both from domestic investors, but also from international investors, where AI is the trade. I mean, that's where all the dynamism is and that's where people want to park their money. Now, we pointed at all the reasons why rates are likely to stay high, but I just want to point out that since we still have the ongoing Iran conflict and we still have the Strait of Hormuz closed, if that is not resolved in anytime soon, like you know, the next month or so, and you see a even steeper increase in oil prices and crude prices going up to say $160 a barrel, which is what some of the projections would be. In that case, then we could see much more demand destruction than we are seeing today. And we could be back in that space where at least at the short end, interest rates are being cut pretty rapidly.
- [12:57]
Joe Weisenthal
On this question, going back to the effect that the AI buildout is having across rates and bonds and so forth, I want to sort of get some clarification here of what either you or the economists mean when they talk about say, like crowding out, because there's one version of it that is like there's a lot of debt being issued right now by very highly rated companies, probably yields a little bit more than US Government bonds. That is attractive for investors perhaps, and maybe that has some sort of crowding out in the financial markets the other way that one could that I tend to think of crowding out is that the AI build out. It's like they're taking up all of the wind turbines, they're taking up all of the trucking capacity to get the goods to the data centers. They're taking up all the skilled contractors and laborers within the regions that these data centers are being built. And that creates inflationary pressure, that adds to the strain and therefore, all things being equal, that says higher inflation and therefore higher rates for longer to maintain that. Which of those two models, whether it's the sort of financial markets version or the sort of real economy version, is a more useful way of thinking about that linkage between private and public sector spending slash debt.
- [14:17]
Geeta Gopinath
So both of those are in play right now. So that's the difference between what's happening to real rates versus what's happening to nominal rates and what's happening to the pricing of the Fed rate path. Right. So the first channel that you mentioned, which is just the fact that there is so much of demand from the private markets from AI investors for AI companies, for capital, is going to raise real rates. You know, even if there is no effect on inflation or inflation, expectations are not moving. We should expect to see real rates rise. And that's certainly we're seeing some of that. And then the other is the effect that's working through the demand for the different inputs that go into AI and that's creating an inflationary pressure which would then need higher nominal rates. And that is also, you know, playing out. I think right now. I suspect that the real rate piece is more important. The inflationary part is being driven a lot by what's happening with energy prices and the pass through from energy prices into also core inflation. So I think that's the more of the higher inflation, higher rate path story is coming from other forces on inflation as opposed to what's coming from AI itself. And then you have the real rate path which is going up also because of the general risk environment that we're in, but also because of what's coming from this increase in capital demand coming from the AI sector.
- [16:05]
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- [16:48]
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- [17:21]
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- [17:57]
Tracy Alloway
one of the reasons we wanted to speak with you is because you do have that very significant policy experience. And so when faced with, you know, potentially rising real rates because of an AI boom, what should policymakers be doing here? Because, you know, certainly in the US we've already seen some Fed officials or outgoing Fed officials start to argue that they can look through the AI boom and its impact on inflation. But if real rates are, you know, structurally rising, if our STAR is structurally higher than it was before, is that the right move?
- [18:30]
Geeta Gopinath
So, I mean, what matters crucially is what we believe are the main drivers of our STAR at this moment. Is it coming because of higher productivity growth, which is then leading to higher investment and therefore demand for capital? All of that is good as a kind of the good kind of increase in R star because that's an economy that is projected to grow at a faster rate. And that helps. That helps on many fronts, including in terms of bringing debt to GDP down. The other reason R STAR is going up is because of the increase in fiscal deficits and just general high levels of government borrowing. In the US that is less appealing because that tends to be not necessarily growth enhancing that, you know, the money that's being raised is not for productive, necessarily productive infrastructure investment that's going to generate enough growth. So that's more problematic because it's just generating higher R star without generating the higher growth that comes that should come with it. And that can be a problem from a policymaker's perspective, of course. You have to firstly be able to tell what is driving the R star. Is it a good kind or is it the bad kind? But regardless, if R is drifting up and you have an inflation target of 2%, you are looking at higher nominal interest rates. Right now, the Fed has an R forecast of about 1%. If you put 2% inflation on top of that as their target, we're looking at 3% nominal rates, which is a clear shift away from what it used to be pre pandemic. Then you have to check to see whether the R star increase is actually slowing the economy down or the increase in your nominal rates are slowing the economy down. And how much higher than that R star do you have to be to be able to bring inflation down? Because there is obviously above target inflation in the US at this moment. That is now the big question, whether the productivity boom is going to mean that you don't need that much of a above our star interest rate, or do we have too many other forces coming from energy prices passing through into core inflation, the lesser, lower levels of immigration in the country, just general trade disruptions, supply chain disruptions, and those are the main drivers in case. In which case maybe you need to keep interest rates even higher. So being able to tease that apart is, you know, I think that's where the tough decisions are. But what is clearly the case is that we are looking at higher nominal interest rates. I mean, regardless of whether our story is coming from the good kind or the bad kind, you know, there is
- [21:10]
Joe Weisenthal
this fantasy, and hopefully it comes true. But there is certainly this fantasy of a lot of people who are into AI, which they would call like the disinflationary boom. Right? So let's just imagine we have extremely powerful artificial intelligence that is capable of delivering incredible material gains for people. It makes healthcare really easy and quick. It can power robots that care for us. It can build things, et cetera. Meanwhile, the cost of commodities collapses. Maybe the cost of labor collapses. Is that a scenario in which it's worth contemplating and thinking about? So everything gets really cheap because it all gets super automated. But also our standards of living rise dramatically because the AI takes care of it for us. Is that conceivable? Like, from an economist's perspective, is there such thing as the disinflationary boomer, the deflationary boom?
- [22:09]
Geeta Gopinath
Even so, this is about, you know, making a distinction between now and what comes next. Yeah, now clearly it is about the high levels of investment.
- [22:19]
Joe Weisenthal
Right, right, clearly right now it's pushing everything up. But let's imagine 10 years from now and we've done it. We have this incredible and somehow we've solved all the sci fi scenarios so that the AI doesn't want to kill us all, etc. Let's just imagine the Rosie scenario in which we have this like, feel like
- [22:36]
Tracy Alloway
there are some under discussed risk factors.
- [22:38]
Joe Weisenthal
No, but right, like let's just say
- [22:40]
Tracy Alloway
assuming the robots don't kill us, assuming
- [22:42]
Joe Weisenthal
we solve that and the AI works on our behalf and it does what we want it to do and it can create incredible material gains while also delivering it cheaply because it's just one AI, et cetera. Is that a contemplatable scenario from an economist's perspective?
- [22:57]
Geeta Gopinath
There is absolutely a scenario where we could be in that wonderful place with high productivity growth. At the same time we don't have civil unrest or rogue forces using AI for ill. That is a scenario. But I do not know a single person who will put a probability on that scenario and say that that's going to happen with a significant amount of certainty. There is a very high degree of uncertainty and there are several who also believe that it's yet to be seen whether there is going to be any major productivity gain of the kind that there are analysts who believe that productivity could go up by 2 percentage points a year over and above what's where it is right now, which is around 2 percentage point a y. I mean that is huge. There is no evidence right now of that kind of productivity wave coming through. So it's early. But you know, I use the technology and I find it terrific. I mean it is, it's been really great for my own productivity. It's not affecting my wages or anything so far. But it's, it's there, it is, it is very valuable technology. But there is a lot of uncertainty and which is what is very curious about the markets. Right. Because on the one hand it is impressive where the stock markets are again at close to a record high. And maybe one can explain that by this by saying that while there is a scenario where everything goes perfectly well, but there are so many other scenarios that could play out between now and next year or even two years from now and you barely see that price being priced in markets. And I think that's frankly more surprising than just looking at what's happening with just the level of you know of the stock market.
- [24:47]
Tracy Alloway
So okay, we keep talking about the stock market and you know, debt issuance in the corporate bond market and how everyone wants a piece of AI. Does that basically mean that we're seeing, I guess maybe scarcity of capital versus the global. We used to call it a global savings clut in the early 2000s. Right. Which ended up, per Bernanke, pushing yields lower. Does anyone still talk about a savings glut or should we all be talking about, you know, like capital scarcity?
- [25:17]
Geeta Gopinath
No, we don't have a global savings glut anymore. And proof of that is real rates going up, interest rates going up. So that's, so that's that. What we certainly seem to have in the US is I don't know if what to call it, but gluttonous demand for U.S. equity.
- [25:33]
Tracy Alloway
Yeah.
- [25:33]
Geeta Gopinath
Coming both from domestic investors but also from foreign investors. It's, I mean we're at 40 trillion in terms of foreign holdings of US equities. That is at a historic high. Even if you look at it as a share of the rest of the world's gdp, it's about twice as high as what it was just before the 2000.com bust. I guess at the peak of the dot com. The world has never been that invested in U.S. equity markets. It's like it's the only game in town. So if there is a gluttony, rather I would say it is for US equities. We're all in this together and as we know in terms of what's coming into the markets right now, I mean we have some very big IPOs and that will make us even more all tied at the hip when it comes to AI and stock markets.
- [26:28]
Joe Weisenthal
Speaking of big IPOs, Tracy, this reminds me and saying this to a message to our producers. We should really do an episode soon about.
- [26:38]
Tracy Alloway
Are you including voice memos to producers?
- [26:40]
Joe Weisenthal
I'm not including voice memos to producers, no. I really want to do an episode soon about the fact that all the big index funds are going to have to include companies at basically their peak where you think like historically, okay, like a company like Apple, like it enters the S&P 500 at I don't know, maybe a $20 billion market cap and then it's a multi trillion dollar market cap. This will be the first time that the index fund owners are going to eventually have to buy these really big companies without having ever experienced any of the gains from the run up. And I think that's like going to be a historic moment for both Markets and indexing and etf.
- [27:23]
Tracy Alloway
This has been one of my long running criticisms of the big benchmark index providers, which is like they always say that they're not making investment judgments, they're just holding up a mirror to the market. But like, actually a lot of these decisions are like incredibly embedded with judgment calls and they do end up having an impact on the entire market.
- [27:42]
Joe Weisenthal
Yeah, this is, this is I think going to be a historic time for sort of index investing. Anyway, I know that this is a divergent. I just needed to get that voice memo into our producers.
- [27:52]
Geeta Gopinath
Yes, I mean, when was, you know, hey, there are now more ETFs than there are actually companies being created on the market. So if one needs, if you wanted to spend a lot of time picking and choosing, you could be, you could be selective too.
- [28:05]
Joe Weisenthal
Yeah, I want to switch ETFs, but then I have to take a capital gains hit, so I can't. You know, this is the. Anyway, we're, we're getting pretty sidetracked here. I want to talk more. I mean there are many phenomenons or many things going on at once, but when we think about these pressures, one of, and it relates to AI, but it also relates to commodities itself is this idea of essentially national resource hoarding and the decline of sort of free trade. And so the fact is, it's like maybe at one point we could say, you know what a country could say, you know what, it's great that America is building a bunch of fighter jets so we don't have to have our own indigenous fighter jet industry, et cetera. How much, when you look at what's going on with the rates picture and pushing up inflation and so forth, is this phenomenon in which no country fully trusts other countries to deliver goods for them. And therefore there's a lot of replication or duplication of capital investment happening in every country all at once, simultaneously.
- [29:08]
Geeta Gopinath
We're seeing a lot of that. I mean, we moved squarely, firmly, decisively away from a pure efficiency based model of I'm going to buy from the cheapest place and I'm going to sell if I'm the cheapest source to one where everybody is building up their own capacity as much as they can. And of course, depending on the country and depending on how much of physical space you have, that can be a small group of things or a big group of things for sure. Energy security is, everybody's paying attention to it. How do we make sure that we don't have to import fuel from the rest of the world and how can we have our own fuel at home either through renewables, whatever we need to do, or maybe just returning to coal for now, that is, we're going to see, we're seeing that defense expenditure. We need to be able to not just spend more on defense, but make sure that we can actually produce more of the weapons that we need. Semiconductor chips, rare earths. Yes, there are. You know, I think there's so little trust in the world right now in terms of relying on your trading partners that countries are just going to be spending a lot more on this. It's just that it depends on whether you're a country that can afford to raise the finances for it or not. But everybody is heading in that direction. So if you look at the list of, you know, all the sources of demand for capital, that is a very, very long list.
- [30:37]
Joe Weisenthal
Yeah.
- [30:38]
Geeta Gopinath
And if you look at the sources of supply of capital, there's just one category, which is aging demographics. I mean, that's. We often tend to blame old people for the fact that we need to spend so much on retirement and on health for the future. But the truth is the reason interest rates are not much more high than they would have been is because of the supply, supply of savings coming from aging demographics around the world.
- [31:01]
Tracy Alloway
Well, you mentioned fiscal space, and I know you've talked previously about the need to, you know, reduce some entitlement spending if governments are going to be serious about reducing deficits. And yet we've seen numerous attempts in the developed world to actually cut back on government spending. And it seems very, very hard to do in elected democracies. Right. Like it is not a popular platform to be elected and say what we really need is austerity for the longer and all of you are going to have to suffer in the near term. How are policymakers, like, realistically supposed to navigate that tension assuming that they're up for election every two to four years?
- [31:42]
Geeta Gopinath
I mean, we have the additional problem that I think policymakers actually are not really keen or particularly worried about where their debt to GDP is. If you look around the world, again, except for places where the bond markets are simply just not letting you do more spending. Even in the US I don't believe there's anybody in Congress who's truly worried. There are, sorry, not. There are a couple in Congress who are worried about the US Debt level, but not enough given where debt levels are and given the foreseeable path of spending that's happening. But again, to step back and see, it's helpful to look at what has happened historically and when have countries been able, and how have they been able to bring their debt to GDP levels down? It's a couple of things. One is just a spurt of growth that has come about either because you are some sort of a commodity exporter and you've just had positive terms of trade shock and because of that your debt to GDP comes down, you hit the jackpot, basically. Yes, exactly. You got lucky. Or productivity growth boom, higher, above average growth. And I believe that's what we're betting on this time with AI. The hope is that with AI we will get growth from 2% up to 4% and then that will certainly solve all of our problems if we have that on a persistent basis. Countries, especially developed countries, have tended to rely on that. And then you have inflation if you go back even further. And also obviously during right after the pandemic, inflation helped bring debt to GDP levels down. And then of course the third is what we see with developing countries is you end up with default and restructuring and crises and then again you bring debt to GDP down that way. So those have been this typical path. We've never had to worry about debt crises in developed economies, but now more and more, and I think this is also a new feature of the world we live in is the developed world is moving into that space where their debt costs and their borrowing costs are far more volatile, far more sensitive to markets conditions. I mean the stock case is the UK where you see that on a day to day basis. But you know, you see that in other countries too in Europe and some of it in France and more generally even Japan, where for the longest time we didn't have to worry about borrowing costs. Those have squarely moved up, the tenure rates have moved up. You know, Germany's tenure rates have moved up. So everywhere we are seeing developed economies also now having to face higher borrowing costs. The US I think is still the exception in the sense that even though 10 year yields are at say 4.5% right now, just given the level of supply of debt and what's expected to come out in the future, markets are still treating it as have giving it some privilege, even if it was not as big as it used to be in the past,
- [34:54]
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- [35:30]
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- [36:58]
Joe Weisenthal
What does, in your view, a debt crisis look like in a country that borrows in its own currency? Because obviously politically, maybe the debt ceiling doesn't get raised. There were certainly political ways to default, but economically the US Never theoretically has to run out of dollars per se. In fact, I would say you would say it's the same thing with the uk. You say it's the same thing with Japan. They can't run out of yen the same way in the same way that say, an emerging market that borrows in a foreign currency could theoretically run out of dollar reserves, which is why we watch reserve levels when we talk about sort of on the edge emerging markets. To you, what does a debt crisis look like in an advanced economy in which all of its debt is denominated in its own currency?
- [37:54]
Geeta Gopinath
A crisis in a developed economy would look more like a credit crunch that then leads into a financial crisis. So we would see A sharp increase in borrowing costs that will affect many other asset classes. You would see a slump in investment, the economy. So is this debt overhang, the high levels of debt and that you have to roll over on a daily basis, that overhang which slows growth, slow, slows dynamism. That is what a typical crisis looks like. And yes, you can have financial crises. One of the wonderful things about the last several years, despite all the shocks, we haven't had a financial crisis in developed world or in any emerging market, any big emerging market. And that has been very helpful to bring back a fast recovery of the world economy every time after every shock. And we talk about resilience. So in a case where we end up with just debt levels that are really high, it's just costs going up everywhere and that will eventually slow down economies, if not just trigger a financial crisis right away. Given how sanguine financial conditions have been.
- [39:07]
Joe Weisenthal
You mentioned that one of the things that's changed pre to post pandemic has been the change in marginal position of central bankers with respect to the bond market and the fact that they've gone from being, although Even in the U.S. i mean, quantitative easing ended in the 2010s, et cetera. But what happens if say we talk about central bank and one of these developed markets and they say, you know what, we're just going to, we're going to cap the long end. We're going to, we're going to buy bonds until the rates are, you know, they don't go above 2% or 3% or et cetera. Seems very plausible that something like that could happen in a developed market before too long. What would be the sort of fallout if a central bank explicitly came out and said we are going to buy government debt and just hold down the rates in a very explicit manner like that.
- [39:59]
Geeta Gopinath
If a central bank comes out and says that we are different from our mandate of price stability and full employment, regardless of what's happening there, if we are going to go out and buy long term debt, then that's what's going to happen is you're going to see inflation expectations drift up and then the nominal rates are going to go up and real rates will also go up because of the risk associated with inflation, premium will go up and that will be the end of the wonderful era that we've had of central bank independence and that's helping to keep interest rates low. So that strategy just doesn't exist. You can play for it for a little while, but eventually it gets priced into markets. So I mean, unless of course, it is a tool for monetary policy because you've hit the zero lower bound and you still need to simulate the economy, then you do that. But right now we have 5000 lower down.
- [40:58]
Joe Weisenthal
Right. We currently have the opposite.
- [41:00]
Geeta Gopinath
We have the opposite. So it is. Countries have tried it in the past and these are usually the countries that the IMF works with because they eventually find themselves in crises. But what typically happens is you get a tiny period when it looks like this is helping and then you just get much higher interest rates and you just don't get any of the benefits of the central bank buying your debt.
- [41:24]
Tracy Alloway
You mentioned earlier that we haven't really had a major financial crisis in recent years. And if we could just broaden that idea out a little bit, I think that the resilience of the global economy and certainly the US Economy has been surprising to a lot of people. We've had multiple shocks, but overall, certainly in America, people just keep spending. Everything kind of keeps ticking along. Is there something that economists are maybe like underestimating when it comes to why? It seems like again, the global economy to a lesser extent, extent, but certainly the U.S. economy seems so resilient in the face of all these once in a lifetime shocks that we keep seeing.
- [42:09]
Geeta Gopinath
There have been a combination of things that have helped and some of it have been surprises. Again, since we're talking about debt, that increase in debt has come about because of the very large amount of support that governments around the world give during each of these crises. So during the pandemic, I mean, advanced economies spent about 25% of GDP. If you look at the combination of not just outright support, but all kinds of loan guarantees and equity infusions and so on, that was huge. Those were much higher levels than anything we'd seen in recent times. And because of that, households and businesses came out of the pandemic with stronger balance sheets than they did going in. And that has helped hold up demand also and also has helped therefore helps hold up profitability in a lot of businesses. Because of that strength that came from all that large amount of support that was one second is the AI boom is a big player right now. If we didn't have AI and if we didn't have the increase in demand coming from AI, we would be looking at just much lower growth rates in many parts of the world at this time. And we would also see trade being much weaker. I mean, trade is being held up a lot by AI inputs flowing around. That's also been a big contributor. So we've had these positive offsetting events. The question is what happens the next crisis? In the next crisis, countries do not have the fiscal space to provide that kind of support. And we may see much less resilience than we've seen the last few years. I mean, I think that's something we should keep in mind. I don't think we should take this resilience as some sort of an absolute structural shift that keeps economies growing at their long term trends, regardless of how big the shock is that's affecting them.
- [44:08]
Inner Balance / Bethenny Frankel Advertiser
Yeah.
- [44:09]
Joe Weisenthal
You wrote a piece I think recently for the Financial Times, which you talked about the Bliss Trade, I think, as you called it. And can you clarify because it sounds like expand on this idea that there is this assumption of state support, there's an assumption of a backstop, things go bad, the government will be able to do something. And this seems to be the core of your idea that this is mistaken.
- [44:35]
Geeta Gopinath
We have this mindset right now in the policy world and therefore people who are investing in markets that the state is there to fix a lot of the problems and we see it right away. Even now, what's happening with energy prices going up is that there are many countries that are capping fuel prices, that are cutting energy taxes. The instinctive reaction is to protect households and protect their spending power. And when you do that, that helps corporate profitability and that is going to be favorable for markets. So we've been in this environment now, either explicitly or implicitly, I mean, there has to be this notion that the economy has been resilient and it is a reflection of what I call bliss, which is big lasting state support which has helped economies all over the world, not just in the U.S. but in many other countries. So the expectation is that that will continue. And going back to where we started with this conversation, just given how high debt levels are, that's just increasingly questionable. Which means that I think governments are going to move towards far more unorthodox approaches, including price controls, financial repression, the kinds of things that we haven't encouraged in a long time.
- [46:00]
Joe Weisenthal
You know, we've talked about some of the big structural phenomenons in the global economy. The AI boom, demographics, certain things with trade. There's one thing we haven't really talked about, which is something I think about, which is that if a country makes something physical, there is a very good chance that either right now or in the future, China will be able to make it cheaper and better. And this is no matter what it is, there are still some things that aren't the case. The Most advanced semiconductors aren't manufactured in China. Boeing and Airbus, jets and stuff, there's a few examples. But by and large, when you think about the stresses that are being placed on economies all around the world, how much is this particular dimension, a factor? The fact that like any, almost any tradable good might at some point be most efficiently originate from China?
- [46:54]
Geeta Gopinath
Yeah, I read a lot of pieces on this, that somehow China will continue to run trade surpluses because everything it wants, it wants, it produces for itself and produces for the rest of the world. And so that's that. I mean, that makes little sense to me. Okay, firstly, if you just look at China's spending behavior, they run a surpluses surplus on their goods trade front, but they run a deficit on their services trade front. And so one of the reasons why China's overall deficit, current account deficit, or trade deficit, is around 3% of GDP as compared to 10% of GDP before the great financial crisis, is because they are big consumers of services around the world. Chinese tourism has been a big contributor to incomes around the world and the service deficit that they run. So just that. Right. So there's nothing, there's no sense in which China ultimately gets to do everything. Secondly, usually if you get to a point where if you're so good at manufacturing making everything, you ultimately are going to have very high levels of investment. Investment, given the level of savings in your country, that usually means that you start running trade deficits. Right. So it cannot be a story of China being very successful in its investment and being very productive, because any kind of high productivity investment boom story means the country running deficits. What has happened in China is basically a lot of consumption suppression. Because of that, you're seeing surpluses that the country is running. And we are also now seeing all the problems of very high levels of investment. That's come from the fact that the crash in the property market, which despite the last four years of interventions and government policies, is actually looking quite bad. So the weakness in the property markets, the weakness in consumption, if China is running surpluses at this point, it is because investment has dropped in China. That's come both from the property market crash, but also because of all the excess supply and the overcapacity that they've created. You've seen a decline in investment. So 2025 was the first year when investment in China actually declined. That explains why it's running a big trade surplus now. Yes, there are a lot of exports coming out of China. Forget about the surplus deficit part, but just the fact that they are sending a lot of goods out of their country is a source of competition for manufacturers around the world. I believe that this is not sustainable. I don't think Europe or other Asian economies in East Asia are going to just say, well, that's okay. We are okay with China dumping all these goods on us. They're going to put tariffs on China. China is aware of that, which is also partly why they're trying to see how they can manage their own exports. To some extent, they will move in that direction. But I'm not a buyer of the whole. China produces everything and does everything on its own and somehow we still continue buying from China. That makes little sense to me.
- [50:16]
Tracy Alloway
Just going back to the beginning of this conversation, I mentioned a bit of a deja vu feeling because we do have these bond sell offs from time to time and we often record podcast episodes on them. And the idea of a debt crisis has also been a popular theme on many podcasts, not just ours. Do you have any sense of what a catalyst for, you know, this actually exploding into a real life debt crisis could be? Or are there certain levels or numbers or behaviors that you kind of watch out for from, from here?
- [50:49]
Geeta Gopinath
I think it's very important what's going to happen with AI and the productivity boom that we are hoping for. That is going to be very important if it turns out that there is very little showing up in productivity from AI or we have a setback that comes from just discovering that, oh, there's so much of hallucination that it's just you can't really use it for anything very important. If that's the case, then I could see a situation where the pricing of debt, it drops even more. It's a lot more concern about what's going to happen in terms of government's ability to repay all the debt that they have and not just now, but that's expected to come into the future. So for me, that's one thing. It is important that there is growth in the economy and that that growth is coming from good places. At this point, it seems like the growth is coming from investment and the hope that it's going to generate all that productivity growth. If that story goes away, we have a problem in terms of the concerns around fiscal positions around the world.
- [51:57]
Tracy Alloway
All right, Geeta, thank you so much for coming on odd lots. Truly the perfect guest for this moment in time. We really appreciate it.
- [52:05]
Geeta Gopinath
Thank you. It was a lot of fun.
- [52:19]
Tracy Alloway
Joe, here is my overwhelming takeaway from that discussion.
- [52:22]
Joe Weisenthal
Go on.
- [52:22]
Tracy Alloway
There is so much riding on AI.
- [52:25]
Joe Weisenthal
Yeah, right.
- [52:26]
Tracy Alloway
Like, like, honestly.
- [52:27]
Joe Weisenthal
No, I know. It's all.
- [52:28]
Tracy Alloway
The last answer is like, whoa. It kind of all depends on economic growth and whether we get that productivity boost via AI.
- [52:35]
Joe Weisenthal
Yeah.
- [52:35]
Tracy Alloway
Like the idea that the entire sort of western western economic model and I guess social compact with governments is now dependent on whether AI actually does what it says on, on the label on the tin is. It's nuts.
- [52:49]
Joe Weisenthal
Yeah. I mean the numbers are obviously just extraordinarily big and they're affecting everything and they're obviously it shows up in financial markets, but it also shows up in the real economy. It is a major force of sustained upward pressure. Yeah, I think there's no disputed that. It's like we're all watching along sort of like eating popcorn and knowing that our fates will somehow. And I'm serious, you know, Gita said
- [53:14]
Tracy Alloway
it really well, which is like, we're all basically in the AI trade together, whether you want to be or not.
- [53:19]
Joe Weisenthal
No, I know. And it's like, you know, I look at my like very passively diversified retirement money and I'm like, I'm such a genius these days, you know, because it's like, because you don't even have to
- [53:32]
Tracy Alloway
be an AI starly though, do you feel pressure to keep spending on tokens in order to support equity market valuations?
- [53:39]
Joe Weisenthal
Yes, that's right. I keep like thinking of more tests that I could do with AI because like, oh, I need to make sure the tokens are boosted. No, it's really wild. It really is everything. And then you, the whole conversation is like, man, the last six years have been crazy.
- [53:55]
Tracy Alloway
Crazy.
- [53:55]
Joe Weisenthal
Like, seriously. No, seriously.
- [53:57]
Tracy Alloway
I have a voice memo for producers which is we need to clip that quote of Joe going crazy.
- [54:02]
Joe Weisenthal
No, seriously, you just think of all the things that have happened in the last six years. Whew. And so I guess I'm not surprised. Well, that also did a regime shift during that time.
- [54:10]
Tracy Alloway
I mean, that also gets to Geeta's response about this idea that like there is this assumption in markets that, well, we got through the last like 18 once in a lifetime crises just fine and so we'll manage to get through the next one. But then the question is fiscal capacity and I guess political will.
- [54:27]
Joe Weisenthal
It's both of those. And it's like the way I think about it and Japan I think is an instructive example here, which is that when I think of fiscal capacity, I don't think of a sort of if you have 80% debt to GDP level, you have fiscal capacity. If you have 120%. You don't. Because we don't know if there is that number. But what you do know, and what we can say is, is that in a period of high inflation and in a period where resources are already constrained and governments have made a commitment, say to seniors that their standard of living will be X and governments have made a commitment to so and so the defense that it's not going to drop below X, that once a lot of these certain sort of commitments have been made. If you get another shock in which you say, okay, let's just God forbid, let's just say there were another pandemic in which a bunch of people temporary, we tried to do the same playbook again, and it's like, okay, we're going to replace your lost income for a few months. Well, at a time in which we're already very like resource constrained, you see how that just becomes, you know, there was a lag period where like instantly inflationary because we're already sort of. That's the difference of in early 2020 and late 2019. We were not pushing against our real resource limits in the way that we appear to be right now.
- [55:53]
Tracy Alloway
Yeah, I think that's right. Okay, well, on that happy note, shall we leave it there?
- [55:57]
Joe Weisenthal
Yeah, let's leave it there.
- [55:58]
Tracy Alloway
This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
- [56:03]
Joe Weisenthal
And I'm Jill Weisenthal. You can follow me at the Stalwart. Follow our guest, Geeta Gopinath. She's Geeta Gopinath. Follow our producers, Carmen Rodriguez, armenurmandashel Bennett at dashbot, Kale Brooks at kalebrooks and Kevin Lozano at Kevin Lloyd Lozano. And for more Odd Lots content, go to bloomberg.com oddlots we have a daily newsletter and all of our episodes and you can chat about all of these topics 24. 7 in our Discord Discord GG oddlots.
- [56:30]
Tracy Alloway
And if you enjoy Odd lots, if you like it when we talk about bouncing bond yields, then please leave us a positive review on your favorite podcast platform. And remember, remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. Thanks for listening.
- [57:20]
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- [58:38]
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