PIMCO’s Global Advisory Board, a team of world-renowned macroeconomic thinkers and former policymakers, recently met to discuss factors influencing the global economy and markets. Their insights constitute a valuable input into PIMCO’s investment process. The discussion below is distilled from their in-depth conversation.
Q: What are the geopolitical risks you worry most about?
A: Both state and nonstate actors are contributing to an international environment in which greater turbulence and fragility are becoming the norm.
Among states there is growing multipolarity: The U.S. is pulling back from global leadership in diplomacy, security and trade, with rising powers like China and Russia stepping into the void. New powers are emerging, particularly in the Middle East, where the U.S. pullback has enabled Iran and Russia to play a more active role, and with Turkey also considering its position.
North Korea remains a significant area of worry. Both China and the U.S. recognize they must find a diplomatic solution, but China has incentives to delay resolution, and Russia’s presence is complicating the situation. Brinksmanship increases the risk of miscalculation.
Nonstate actors add a layer of complexity: Notably, terror networks will continue to pose a threat and cyberattacks are becoming commonplace. In addition, weather (witness the violent 2017 hurricane season) and epidemics can have far-reaching effects that challenge the capacity of the international system to respond.
Q: How have these risks changed over the last decade?
A: One of the biggest changes is the ongoing rise in anti-globalization, populist movements. Politically, these movements promote nationalism and weaken international cooperation. Economically, they inhibit trade, immigration and economic integration, while increasing the use of fiscal policy for political purposes, even when cyclical conditions don’t require fiscal action.
Despite ebbs and flows, populism appears likely to remain an important political force in the advanced economies and in some emerging markets as well.
Q: What is the outlook for China’s economy following the 19th Party Congress?
A: President Xi Jinping has cemented his position as the paramount ruler of China. While he has respected the forms of Chinese political leadership already in place, in practice he has concentrated power, with significant consequences for the economy and financial markets.
His administration has two overarching goals: By 2035, China will become a world leader in innovation and in the exertion of soft power with rule of law, and by 2049 (the 100th anniversary of the founding of the People’s Republic), China will be a fully developed, rich, and powerful country. Growth targets remain important, but these broader, qualitative goals are now the higher priority.
Achieving these goals relies on avoiding the “Thucydides trap,” the idea that a rising power must inevitably challenge the incumbent power (the U.S., in this case). China’s peaceful rise is now in the interests of both China and the global community, which is supportive of economic and political stability. Trade imbalances will remain a political sticking point, but a full-blown trade war appears unlikely. Indeed, as the U.S. has become more inward-looking, China is stepping up as a key supporter of the global trading system as well as in such areas as countering climate change.
China’s significant debt levels could pose risks, as could its extensive shadow banking system. However, there are some encouraging recent signs of progress in slowing and rationalizing credit growth and in reforming state-owned enterprises. China’s leaders also seem focused on maintaining a stable exchange rate. Overall, these developments point to economic stability in the next 10 years but also a lower growth rate as the economy deleverages and steps are taken to rebalance between heavy industry and services.
Q: How much more room does the U.S. economic expansion have?
A: There is no evident reason why the expansion, now in its ninth year, should end soon. The U.S. economy is in good shape, despite the recent hurricanes. Job creation is strong, the housing market remains healthy and wealth is well above its pre-crisis peak in real terms, all factors that will support household spending. And as they say, expansions don’t die of old age alone.
Historically, two kinds of triggers have caused the demise of U.S. expansions: inflation, which when tackled by interest rate rises led to a recession, and financial instability. Today, core inflation remains below the Fed’s target, and the central bank’s cautious and gradual approach to monetary policy normalization (via interest rate hikes and balance sheet runoff) is likely to continue under new Fed leadership.
Financial instability is more difficult to predict, but overall the U.S. is not an overly leveraged economy. So a decline in stock markets, for example, could slow growth somewhat but would be unlikely by itself to lead to a severe downturn.
Q: What impact could U.S. tax cuts or tax reform have at this point in the expansion?
A: Globally, as mentioned earlier, fiscal policy is now being driven more by the political cycle than the economic cycle, and this is happening in the U.S. too. However, political constraints will make either sweeping reform of the tax system or large tax cuts difficult to achieve. Consequently, the implications for near-term growth and the Fed’s policy strategy are likely to be modest.
Q: Has populism peaked in Europe?
A: Although populist parties were defeated in key elections in the Netherlands, Germany and France, they increased their vote share compared with previous years. They may have underperformed expectations in the short term, but the fundamental sources of their support remain in place. Populists may not control many governments, but they will be influential for the foreseeable future.
Populism in mainland Europe is not necessarily directed at the European Union. For example, in Germany, what began as an anti-EU movement has now become primarily an anti-immigration movement. Likewise, popular support for the euro and the eurozone remains generally solid, as was evident in the second round of the French presidential election.
Q: Can the monetary union survive the next recession?
A: Concerns about the future of the eurozone seem overdone. The monetary union survived the financial crisis and the ensuing recession, and increased its membership during that time. Now the prospect is for continuing economic growth and job creation, supported by structural reforms and monetary policy. Inflation is still low but deflation risk is gone.
This is not to say that all is well: If a new recession were to come, the European Central Bank would have little scope to ease monetary policy further. Moreover, the banking union is far from complete, and there is a lot of work to do around deposit guarantees and non-performing loans. European leaders will have to continue with structural reforms and with careful steps toward greater fiscal union.
Q: What is Brexit’s likely impact on the UK economy? And is there any chance that it won’t happen?
A: It’s interesting how few people seem to have changed their minds since the referendum despite some unfavorable economic developments and political uncertainty. For Brexit to be reconsidered, we would need to see a “game changer,” meaning a compromise or new approach to one of the four main issues surrounding EU membership: immigration policy, the EU budget, the role of EU courts and rules, or trade arrangements. Such a game changer seems very unlikely. In the meantime, the transition plan should become clearer in the next few months, but the UK will likely be more a “rule taker” than a “rule maker.”
Brexit is exerting a notable influence on Bank of England (BOE) policy. After the 2016 referendum, the BOE assumed the economy would contract, and it cut rates. Today, the BOE can point to growth, above-target inflation, and diminishing slack in the labor market as a rationale for raising rates. That said, we expect any increase in rates is more a recalibration than the onset of a rate hike cycle. The longer-term impact of Brexit on the BOE and the UK economy remains highly uncertain.
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