The members of PIMCO’s Global Advisory Board, a team of world-renowned macroeconomic thinkers and former policymakers, recently joined the discussion at PIMCO’s annual Secular Forum, where they addressed critical factors likely to shape the global economy over the three- to five-year horizon. The board’s insights constitute a valuable input into PIMCO’s investment process, and the views they presented in September helped inform the latest Secular Outlook, “Escalating Disruption.” The discussion below is distilled from their far-ranging conversation.
Q: China’s rise as an economic and geopolitical power – and a secular disruptor – may be strengthened by its rebound from the pandemic and its evolving economic strategy. What is the longer-term outlook for China?
A: China has largely recovered from the pandemic-driven slowdown, and it has recently introduced a new economic development model: the “dual circulation” model. It’s an attempt at self-reliance, though not self-sufficiency. China’s leaders want to reduce the economy’s reliance on exports and foreign technology, strengthen their own supply chains, and look to their domestic market as the main driver of growth – all working together as “internal” circulation. China’s leadership will seek to balance these initiatives with international openness – “external” circulation via international markets. An important question is whether the domestic consumer market is big enough to absorb much of the demand.
In view of the pandemic and the continuing tension with the U.S. and its allies, China is likely prepared for its annual trend growth rate to drop to perhaps 3%.
“China’s ‘dual circulation’ economic model is really a response to what the government perceives as a long-term struggle.”
– Ng Kok Song
President Xi Jinping is in a position of unparalleled dominance, and everything China’s leaders do – politically, economically, financial system, exchange rate – is to prepare for a long geopolitical struggle. That said, China is not seeking to export its system around the world; it is effectively saying to the advanced economies, let us live with our system, and we’ll let you live with your system. It’s a basis for collaboration and mutual respect.
“In life as well as in piloting one’s economy, we have to face reality. The reality is that China is going to rise.”
– Ng Kok Song
Q: On the topic of geopolitics, what are the longer-term trends, and specifically how will the U.S. and other major economies approach China?
A: A political economy of protectionism, populism, and nationalism affects trade and growth. We are seeing not just a breakdown in international cooperation, but a whole series of individual initiatives that may lead to China being isolated from the mainstream of the international system.
In the U.S. – particularly if we see a Democratic victory in November (which as of this discussion is far from assured) – we can summarize the foreign policy approach with “three D’s”: domestic renewal, deterrence, and democracy.
Starting with domestic renewal, many believe that foreign policy starts at home: that the U.S. needs greater investments in infrastructure, industry, the green economy, technology, innovation, and education, along with a push toward social equity. The U.S., like China, is looking to become more self-sufficient.
The second “D” is deterrence – a focus on changing the calculus of the leaders of China, Russia, Iran, and North Korea by raising the costs of aggressive or disruptive actions against the U.S. Of note, either a President Trump or a President Biden would be tough on China, using different tactics (Biden would likely focus more on values and dialogue) but with a similar goal to isolate China.
The U.S. would also look to its allies to reinforce a deterrence strategy. Europe will be under pressure from both sides: While it may declare China a strategic competitor, it also has a bigger trading relationship with China than with the U.S.
The final “D” is democracy. Under Biden’s leadership, the U.S. would likely seek a values coalition of major democracies allied against China and Russia. However, many countries around the world will not want to choose sides; moreover, many young people, including young Americans, are questioning the efficacy of democracy.
“U.S. democracy is pretty battered at the moment, so we have a lot of work to do at home before we’re going to be able to lead credibly under that banner abroad.”
– Anne-Marie Slaughter
Q: Policymakers have taken extraordinary actions in response to the global health crisis. What are the longer-term implications of fiscal policy in the major economies?
A: Europe’s governments responded to the pandemic with a landmark recovery fund that provides bold fiscal measures, including massive public guarantees for loans to enterprises, while overall fiscal rules have been relaxed. Perhaps the most important takeaway is that there was a decision to embark on pan-European fiscal investments to stimulate the economy, demonstrating that when it is a question of survival, Europeans will not hesitate to step up and work together.
Turning to the U.S., which enacted a major relief package in March and (as of this discussion) is debating further response, the longer-term outlook is for a high level of fiscal activity under any outcome of the November elections, but especially in the case of a Democratic sweep. There is bipartisan support for infrastructure investment.
“Do not look for fiscal restraint from Washington over the course of the next several years.”
– Josh Bolten
If there is a Democratic sweep in November, we would expect legislation on stimulus, infrastructure, climate, and jobs as a priority, leading what could be a remarkably robust legislative period that may include an increase in tax rates, a return of the regulations recently unwound (especially on the environment), and movement on health care, immigration, and the minimum wage.
Under a Republican White House, on the other hand, we would not expect a major legislative agenda. Fiscal stimulus would focus on initiatives where we see bipartisan agreement, meaning we could expect little support for state and local governments.
“While monetary policy increases demand broadly, fiscal policy can be much more targeted, helping specific sectors or particular income groups.”
– Ben Bernanke
Of note, there is almost no international coordination on fiscal policy. And where we’ve seen significant government spending on rescue, this raises the question of how much is left to spend on recovery, i.e., investments in productivity and longer-term growth.
“Countries will increasingly be judged on their fiscal responses, not least on how much has been spent running up what people will call ‘bad debt’ and how little on productivity-enhancing ‘good debt.’”
– Gordon Brown
Q: Central banks around the world have also undertaken dramatic action to stabilize economies and markets. What is the longer-term outlook for monetary policy?
A: The U.S. Federal Reserve recently announced the conclusions of its policy framework review, which has two key elements pertaining to the Fed’s dual mandate on price stability and employment. The first element is a flexible average inflation targeting approach, which seeks a lower-for-longer dynamic in interest rates via a promise to overshoot the 2% inflation target to compensate for prior undershoots. We assume the Fed will not overshoot too much (i.e., not beyond 2.5%).
The second element is that the Fed now plans to respond only to shortfalls from full employment, not overshoots. In other words, the Fed will not tighten rates simply because unemployment is too low; inflation or other risks would need to be present as well.
There are some risks to the new approach in that, with a flat Phillips curve, inflation may not be evident until the economy is overheating; the tradeoff is that the Fed will avoid tightening short of full employment, giving more people good labor market opportunities.
“We can see the influence of populism on both monetary and fiscal policy.”
– Ben Bernanke
There appears to be a divergence between the U.S. economic recovery, which thus far has been faster than anticipated (though much depends on the path of the virus and the vaccine), and the Fed’s forecast of low rates for the next several years. Many Fed policymakers are concerned the pandemic-driven recession will change into a longer-term recession due to scarring mechanisms – higher precautionary savings, lower investment, skills obsolescence – as well as damage to supply chains following the loss of thousands of small businesses.
Financial stability remains a focus for the Fed, and March 2020 revealed some lingering risks. While the Fed does not seem inclined to use monetary policy to address financial stability, it did undertake policy that suggests a more activist role going forward, such as becoming a market-marker of last resort, lending through banks to medium-sized businesses, and buying corporate and municipal bonds.
“All central banks in the advanced economies have had to react to a situation that is absolutely unusual, with very low levels of potential growth, very low levels of inflation, and very low levels of real neutral interest rates.”
– Jean-Claude Trichet
Turning to the European Central Bank (ECB), these policymakers have not forgotten that financial stability remains a fundamental goal in the medium and long run, as it is in other advanced economies. Low interest rates and asset purchases are essential to bolster the economy at present, but central bankers should also be sensitive to the risks piling up in markets because of accommodative policy.
Also, given the Fed’s announcements about its framework review, the ECB may accelerate the timing for its own strategy review, which could potentially include clarifications on the ECB’s definition of its inflation objective, the horizon over which price stability is monitored, and whether to focus on core or headline inflation.
In contrast to many major central banks, the People’s Bank of China remains focused on conventional monetary policy. It is also trying to channel credit toward specific sectors, such as manufacturing and small- and medium-sized businesses.
Q: What is the sentiment of investors and corporations about the longer-term prospects for recovery?
A: Risk markets suggest many investors are sanguine about global growth, reflecting in part the view that the economies of both the U.S. and China have demonstrated resilience.
Among many CEOs of major U.S. corporations, there is a relatively sober view of how long the recovery will take, but no sense of pessimism about getting there eventually, and no real change in long-term risk appetite. In the U.S. and globally, we see adjustments being made, and an acceleration of trends that were already underway – especially in digital transformation.
“The pandemic is driving a formidable acceleration of previous trends toward digitalization, the green transition, and the divide between a growing China and the advanced economies.”
– Jean-Claude Trichet/span>
One anxiety for large U.S. corporations is that many small suppliers won’t be around after the pandemic, harming the robust supply chains that large companies need to restore their business. Another anxiety is the unraveling of social cohesion.
“Many U.S. CEOs worry about the tearing of the social fabric, and see an evolution in the role they believe they should be playing in society.”
– Josh Bolten
For PIMCO’s detailed insights into the longer-term trends shaping the global economy and market environment, please read the latest Secular Outlook, “Escalating Disruption.”