Gita Gopinath on Why Interest Rates Have Surged All Around the World

0:02 Bloomberg Audio Studios, Podcasts, Radio News.

0:18 Hello and welcome to another episode of the AU Thoughts podcast. I'm Tracy Alloway and I'm Joe Wisenthal. Joe, 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 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.

0:39 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 the last couple of days, but that'sn't 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.

1:15 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 long end of the UK guilt market hit like the highest since nineteen ninety eight. The ten year US treasury yield was kind of inching up towards five percent, 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

1:56 and more people make this one that what's going on is actually a repricing of something, you know, less transitory. 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 totally.

2:36 Actually, just speaking of the nexus between interest rates and AI, Torsen Slock 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.

3:11 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 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.

3:37 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 Gita 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 the 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.

3:59 All thoughts A pleasure. Tracy Anjo, great to be on your show.

4:03 So what's your take when you're staring presumably you know, on a minute by minute basis, at a chart of the US ten yure yield, what are you thinking?

4:12 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 death levels everywhere in the world.

4:31 In the US, we've seen eels go up.

4:33 It's a combination of things you just talked about all of them, which is one is the fact that the inflation is now expected to be higher, and there is a sense that the real rate at which the economy will stay, you know, at a somewhat stable level of inflation, is higher. So the kind of the real interest rate has drifted up, the r star has drifted up from pre pandemic when it was like percentage point now it's a one percentage point.

5:03 But on top of that, you have the premiere that's coming.

5:07 From the risk of inflation from very importantly the last frisky deficits that the US is running and is projected to continue to run into the first yeable 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 our startrup to maybe even higher than one 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.

5:56 That is no longer an issue anymore because.

6:00 Of the combination of inflation, AI boom, fiscal deficits all over the world, high public debt everywhere you know, we are seeing meals go up, and that's true in the US too.

6:12 I want to drill into all of these specific things, but let's start with like the high level of public debt. That was the thing that people were talking about quite a bit prior to the pandemic as well. And race just kept going lower and lower, including famously in Japan where that to GDP levels are even much higher than they are in the Western world, and that was sort of famously known as the widow maker trade because rates kept going lower. What changed between pre twenty twenty and post twenty twenty such that this suddenly, in your view and perhaps the markets view, this became an important thing that was not perceived by the market as being important pre COVID.

6:56 Well, 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 demand for capital coming from the private sector is one a big change.

7:13 The other big.

7:14 Change is the fact that fiscal deficits are now projected to stay at levels that nobody was expecting the US to run close to seven percent fiscal deficits for the foreseeable future. That is 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.

7:42 In fact, that was part of the strategy of how to you know, strengthen the economy. Quantitative easing was part of the toolkit, and so that helped keep the interest rates slow. But that's changed, and now we have the central banks everywhere who have either stopped buying or they are running it down like it's happening in Japan.

8:03 And the marginal buyer.

8:05 Are the more volatile investors. Page funds in the US are 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 US. Previously, the buyers of US treasuries used to be foreign central banks, they're not doing as much anymore. It's mainly coming from non bank financial institutions from the rest of the world, and so there are also much more volatile infleeties. So you're going to see just generally higher volatility in the ill cuve.

8:47 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 torston slock chart.

9:09 Torston is going to be at our upcoming that's right. We're recording this on May twenty seventh, 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 fifty percent of all the investment grade issuance year to date, and in even junk rated debt, it's creeping up to like almost forty percent.

9:35 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 megacap ig debt versus a US treasury At is.

9:50 When we look at the pricing in markets, that seems to be the case, especially when it comes to equities.

9:56 Everybody wants to have a piece of the AI boom.

10:00 And yes, I think there is that sense that, well, this is a sector where we could really see real gains, especially you know in terms of productivity increases and profitability, and.

10:12 That's going to help. That's going to be something that they want to be a part of.

10:15 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.

10:35 Now, we pointed.

10:37 At all the reasons why rates are likely to stay high, but I just don't want to point out that we since we still have the ongoing Iran conflict and we still have the strait of horror moves closed.

10:50 If that's not resolved in.

10:52 Any time soon, like you know, the next month or so, and you see an even sleeper increase in oil price, is in crude prices going up to say one hundred and sixty dollars a barrel, which is what some of the rejections would be. In that case, then we could see much more demand destruction than we have seen today, and we could be back in that space where at least at the short end, interest rates are being cut pretty rapidly.

11:17 On this question, going back to the effect that the AI build out is having across rates and bonds and so forth, I want to sort of get some clarification here of what either you or what 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 may 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.

11:51 The other way that one can 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, 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 sectors spending slash debt.

12:36 So both of those are in play right now.

12:39 So that's the difference between what's happening to real rates versus what's happening to nominal rates okay, and what's happening to the pricing of the FED rate path.

12:48 Right.

12:49 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.

13:13 And then the other is the.

13:14 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.

13:57 And then you have the real rate path, which is going.

14:00 Up also because there's the general risky environment that we were in, but also because of what's coming from this increase in capital demand coming from the AI sector.

14:25 So 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 policy makers 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?

14:58 So, I mean, what mass is true virtually 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. You know, all of that is good as a kind of the good kind of increase in our star because that's an economy that is going to is projected to grow at a faster rate, and that helps.

15:23 That helps on many fronts, including in terms of bringing the to GDP down.

15:29 The other reason our star is going up is because of the increase in fiscal deficits and just general higher levels of government borrowing in the US. That is less appealing because that tends to be not necessarily growth enhancing.

15:43 That you know, the money that's being raised is not for.

15:47 Productive, necessarily productive infrastructure investment that's going to generate enough growth.

15:52 So that's more problematic because it's just.

15:54 Generating our star without generating the higher growth that comes that should come with it can be a problem from a policymaker's perspective. Of course, you have to firstly be able to tell where what is driving the our star.

16:08 Is it a good kind or is it the bad kind?

16:10 But regardless, if our star is drifting up and you have an inflation target of two percent, you are looking at higher nominal interest rates right So, right now the Fed has an our star fodcast of about one percent. If you put two percent inflation on top of that as their target, we're looking at three percent 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 our star increase is actually slowing the economy down or the increase in your nominal rates and slowing the economy down.

16:43 And how much higher than that our.

16:45 Start 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.

16:54 That is now the big question whether the air.

16:56 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.

17:28 But what is clearly the case is that we are looking at higher nominal and interest rates, I mean, regardless of whether our star is coming from the good kind or the bad kind.

17:37 You know, there is 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 it 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.

18:04 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 boom or the deflationary boom?

18:37 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 investments.

18:48 Right right, clearly, right now, it's pushing everything out. But let's imagine ten 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 care us all, et cetera. Let's just imagine the rosy scenario in which we have this, like, there.

19:04 Are some underdiscussed risk factors, no, right, like the robots do kill us.

19:10 Assuming we solve that and the AI works on our behalf and it does what we wanted to do, and it can create incredible material gains while also delivery it cheaply because it's just one AI, et cetera. Is that a contemplatable scenario from an economist perspective?

19:26 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 you know, 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, you know, with a significant amount of certainty. There is a very high degree ofment certainty. And there are several who also believe that it's yet to be seen whether there is going to be any major productivity.

20:03 Gain of the kind that you know, there are analysts.

20:07 Who believe that productivity could go up by two percentage points a year over and above what's where it is right now, which is around two percentage point a year.

20:16 I mean that is you there.

20:18 Is no evidence right now of that kind of productivity wave coming through.

20:24 So it's early. But you know, I use the technology.

20:27 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 there. It is. It is very valuable technology, but there is a lot of uncertainty, and which is what it's 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.

20:50 And maybe you know, one can explain.

20:52 That by this by saying that, well, there is a scenario where everything goes perfectly well, but there are so many others inni or is that could play out between now, in next year or even two years from now, and you barely see that price being priced in market. That's crankly more surprising than just looking at what's happening with just the level of you know, of the stock market.

21:15 So, okay, we keep talking about the stock market and you know, debt issuance in the corporate bomb 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 two thousands, right, which ended up perper Nike pushing yields lower. Does anyone still talk about a savings clut or should we all be talking about, you know, like capital scarcity.

21:46 No, we don't have a global savings glut anymore.

21:48 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 what to call it, but glut in the demand for US equity coming both from domestic investors but also from foreign investors. It's I mean, we're at forty trillion in terms of foreign holdings of US equities.

22:14 That is at a historic high.

22:16 Even if you look at as a share of the rest of the world's GDP, it's about twice as high as what it was just before the two thousand dot com bust. I guess at the peak of the dot com the world has never been that invested in US equity markets.

22:33 It's like it's the only game in town.

22:35 So you know, if there's a glut, if there's a glutt knee rather, I would say it is for US equities.

22:41 We're all in this together.

22:43 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.

22:56 Speaking of big IPOs tracing this reminds me saying this to message short producers, we should really do an episode soon about.

23:06 Are you including voice memos to producers.

23:09 I'm not saying 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 there's the S and P five hundred at I don't know, maybe a twenty billion dollar market cap, but 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 going to be a historic moment for both markets indexing and ETF.

23:51 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 investments judgments, they're just holding up a mirror to 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.

24:11 Yeah, this is this is I think it would be a historic time for sort of index investing anyway, I know that this is a divergence. I just needed to get that voice memo into our producers.

24:20 Yes, I mean, you know, hey, there are now more ETFs than there are actually companies being created on the market. So if one need, if you wanted to spend a lot of time picking and choosing, you could be you could be selective too.

24:34 Yeah, I want to switch etms, but then I have to take a capital gains had so I can't. You know, this is the anyway, We're getting pretty sidetracked here.

24:42 I want to talk more.

24:43 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, 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

25:26 goods for them, and therefore there's a lot of replication or duplication of capital investment happening in every country all at once simultaneously.

25:36 We're seeing a lot of that.

25:37 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 tell 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 a 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 three renewables, whatever we need to do, or maybe just returning to coal for now. That is we're going to see. We're seeing

26:23 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 around this.

26:50 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. And if you look at the sources of supply of capital, there's just one category, which is aging demographics, and that's you know, 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.

27:21 But the truth is, the reason interest.

27:23 Rates are not much more higher than they would have been is because of the supply of scene. Its coming from aging demographics.

27:29 Around the world.

27:30 Well, you mentioned fiscal space, and I know you've talked previously about the need to 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 term and all of you are going to have to suffer in the near term. How are policy makers like realistically supposed to navigate that tension, assuming that they're up for election every two to four years.

28:10 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.

28:21 World again, except for places where the bond markets are simply.

28:25 Just not letting you do more spending.

28:28 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 death level, but not enough given where death 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 dead to GDP levels down.

28:54 It's a couple of things. It is.

28:56 One is just a spurt of growth that has come about out 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.

29:09 You hit the jackpot.

29:10 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 two percent up to four percent, and then that will certainly solve a lot of our problems if we have that on a persistent basis. Countries, especially developed countries have tended to rely on that.

29:36 And then you have inflation.

29:38 If you go back even further, and also obviously during right after the pandemic, inflation helped bring 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 crisis and then again you bring a det to GDP down that way. So those have been this typical path we've never had to worry about debt crisis 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 they're borrowing costs are volatile pharmo sensus of the market conditions. I mean the stockcas is the UK where you see that on a day to day basis, But you know, you see

30:22 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, the thing is still the exception in the sense that even though ten year eels are i'd say four and a half percent right now, just given the level of supply of debt and what's expected to come out in the future, it's still treating it as giving it some privilege, even if it was not as big as it used to do.

31:05 In the past, What does a in your view, a debt crisis look like in a country that borrows in its own currency, because obviously, like politically, you know, maybe the dead sale 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 it's the 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.

31:55 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 market. 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.

32:18 A crisis in developed economy would look more like a credit crunch that then leads into a financial crisis. So we would see a shop increase in borrowing costs that will affect many other asset classes. You would see a slump in investment the economy. So it is this debt overhang high levels of debt and that you have to roll over on a taily basis that overhang, which slows growth, slows dynamism. That is what a typical crisis looks like.

32:51 And yes, you can have financial crisis. One of the wonderful things about the last several years is despite all the shocks, we haven't had any financial crisis in develop what we're in an 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.

33:11 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 if financial prices right away.

33:28 Given how sanguine financial conditions have been.

33:31 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 US, I mean quantitative easing ended in the twenty tens, 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 we're going to cap the long end.

33:57 We're gonna we're going to buy bonds until the rates or you know, they don't go above two percent or three percent or et cetera. Seems very plausible that something like that could happen in the developed market before too long. What would be the sort of fallout if a central bank explicitly came out and said we were going to buy government debt and just hold down the rates in a very explicit manner like that.

34:23 If a central bank comes out and says that we are, you know, 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 losso go up because of the risk associated with inflation, premium will go up and that would be you know, the end of the wonderful letter that we've had of central bank independence, and that's helping to keep interest rates low.

35:03 So that strategy just doesn't exist.

35:07 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 over bound, sure, and you still need to simulate the economy, then you do that. But right now we're far from the zero.

35:22 Over that, right, we're currently of the opposite.

35:24 We have the opposite.

35:25 So it is countries try have tried it in the past, and these are usually the countries that the IEM of works with because they eventually find themselves in crises. But what typically happens is you get piny peeded 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.

35:47 You're dead.

35:48 You know, you mentioned earlier that we haven't really had a major financial crisis in recent years, and if we can just broadened that idea out a little bit, I think that the resilience of the globe 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, but certainly the US economy seems so resilient in the face of all these once in a lifetime shocks that we keep seeing.

36:33 There have been a combination of things that have helped, and some of it have been surprises. Again, since we're talking about that increase in death has come about because of the very large amounts of support that governments around the world give during each of these crises. So during the pandemic, I mean, advanced economy spent about twenty five percent of GDP. If you look at the combination of not just outright support but is a loone guarantees and equity infusions and so on, that was huge. That was much higher levels than anything we'd seen in you know, 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

37:23 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.

37:56 That's also been a big contributor.

37:59 So we've had these positive ofpsetting events.

38:04 Now the question is what happens in the next crisis.

38:06 In the next crisis, countries do not have the fiscal space provide that kind of support, and we mean 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.

38:32 Yeah, you wrote a piece I think recently for the Financial Times which you talked about the bliss trade. I think if you'd call it and can you clarify because it sounds like expand on this idea that there is this assumption of states 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.

38:59 We have this mind said 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.

39:10 And we see it right away even now.

39:12 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 it bliss, which is big lasting state support, which has helped economies all over the world, not just in the US, but in many other countries. So the expectation is that that will continue, and going back to where we started this conversation, just

40:05 given how high death levels are, that's just increasingly questionable, which means that I think governments are going to move to us far more on orthodox approaches, including price controls, financial repression, the.

40:20 Kinds of things that we haven't encourage in a long time.

40:23 You know, we've talked about some of the big structural phenomenons in the global economy, the AI boom, demographic, 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.

40:56 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.

41:18 Yeah, I've 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.

41:31 And so that's that. I mean, that makes little sense to me. Firstly, if you just look at China's spending.

41:38 Behavior, they you know, they run a surpluses, a 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 three percent of GDP as compared to like ten percent of GDP before the Great Crisis, is because they are big consumers of services around the world.

42:05 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.

42:19 To do everything.

42:20 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 given the level of savings in your country.

42:34 That usually means that you start running free deficits.

42:38 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.

42:51 What has happened in China is.

42:53 Basically very a lot of consumption suppression. Because of that, you're seeing surpluces 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.

43:17 So the weakness and the property marketness, the weakness and consumption if China is going 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 over capacity that they've created.

43:38 You've seen a decline in investment. So twenty twenty five was the first year when investment in China actually declined.

43:45 That explains why it's running a big trade surplace. Now.

43:49 Yes, there are a lot of experts 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 company for manufacturers.

44:02 Around the world. I believe that this is not sustainable.

44:06 I don't think Europe or other Asian economies in Eastia are going to just say, well, that's okay, we are okay with China dumping all these goods on us.

44:16 They are going to put tariffs on China.

44:18 China is aware of that, which is also partly why they are trying to, you know, see how they can manage their own exports. To some extent, they will move in that direction. But I'm not a buyer.

44:31 Of the whole.

44:32 China produces everything and does everything on its own, and somehow we still continue buying from China.

44:38 That makes little sense to me, you know.

44:40 Just going back to the beginning of this conversation, I mentioned a bit of a deja voo 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 crisis has also been a popular theme on many podcasts, not just ours. Do you have any sense of what 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.

45:13 I think it's very important what's going to happen with AI and the productivity boom that we are hoping for.

45:22 That is going to be very important if it turns out.

45:25 That there is very little showing up in productivity from AI, or we have a setback that comes from just discovering that though 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 that they have and not just now, but that's expected to come into the future.

45:59 So for me, that's thing.

46:00 I mean, what's 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 AI investment and the hope that it is 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.

46:21 All right, Giza, thank you so much for coming on all thoughts. Truly the perfect guest for this moment in time. We really appreciate it.

46:29 Thank you. No, it was a lot of fun.

46:43 Joe.

46:43 Here's my overwhelming takeaway from that discussion. There is so much writing on AI. Yeah, right, Like the last answer is like whoa. It kind of all depends on economic growth and whether we get that productivity boost via AI. Like the idea that the entire sort of Western economic model and I guess social compact with governments is now dependent on whether AI actually does what it says on the label on the tin. Is its nuts?

47:13 Yeah, I mean the numbers are obviously just extraordinarily big, and they're affecting everything, and they're obviously shows up in financial markets but also shows up with the real economy. It is a major force of sustained upward pressure.

47:27 Yeah.

47:27 I think there's no dispute of it. It's like we're all watching along short of like eating popcorn and knowing that our fates will somehow And I'm serious, you know.

47:37 So get us said it really well, which is like we're all basically in the AI trade together, whether you want to be or not.

47:43 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 be an AIS.

47:56 Firstly, though, do you feel pressure to keep spending on tokens in order to support equity market valuations?

48:03 Yes, that's right.

48:04 I keep like thinking of more tests than I could do with AI because 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.

48:18 Crazy, like seriously, seriously, I have a voice memo for producers, which is we need to clip that quote of Joe going crazy.

48:26 No, seriously, you just think of all the things that have happened in the last six years, and so I guess I'm not surprised. Well, that also is a resume shiftduring that time.

48:34 I mean that also gets to Gita's response about this idea that like there is this assumption in markets that what we got through the last like eighteen Once in a lifetime cash 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.

48:51 It's both of those, and it's like, you know, the way I think about it in Japan, I think is an instructive example here, which is that like when I think of fiscal capacity, I don't think of like a sort of like, oh, if you have eighty percent debt to GDP level, you have fiscal capacity. If you have one hundred and twenty percent, you don't, because we don't know where if there is that number. But what you do know, what we can say is that in a period of high inflation and in a period where visit where resources are already constrained, and governments have made a commitment say to seniors that they're you know, that their standard of living will be xs, and governments have made a commitment to so and so the defense that it's

49:34 not going to drop low 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 the word another pandemic in which a bunch of people temperate and we tried to do the same playbook again, and it's like, okay, we're gonna 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's a lag cared where like instantly inflationary because we're already sort of that's the difference of twenty In early twenty twenty and late twenty nineteen, we were not pushing against our real resource limits in the way that we

50:15 appear to be right now.

50:17 Yeah, I think that's right. Okay, well, on that happy note, shall we leave it there?

50:21 Let's leave it there.

50:22 This has been another episode of the Odd Thoughts Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

50:27 And I'm joll Wisenthal. You can follow me at the Stalwart. Follow our guest Gita Gopinath. She's at Gita Gopinath. Follow our producers Carmen Rodriguez at Carmen Arman, Dashel Bennett at Dashbot, Caylebrooks at Kele Brooks, and Kevin Lozano at Kevin Lloyd Lisano. For more odd Lots content, go to Bloomberg dot com slash odd Lots. We have a daily newsletter and all of our episodes, and you can chat about all of these topics twenty four to seven in our discord discord dot gig slash oddlines.

50:54 And if you enjoy odd Lots, if you like it when we talk about bouncing bond yields, then please leave us a positive view on your favorite podcast platform. And 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.