00:00So we're looking at U.S. futures. We're back at 7,000 in the S&P.
00:05VIX futures suggest this war is mission accomplished.
00:08Are markets getting this one correctly and as far as what the economic fallout is likely going to be on
00:14the back end of this?
00:16I mean, I find it puzzling that it's sort of no problem.
00:22We have lived in this very volatile situation.
00:24I think what markets look at is that we had the tariffs, we had this, and the resilience was phenomenal.
00:31Maybe the AI, the background of AI and growth, maybe all the deregulation that's been going on in the Trump
00:38administration.
00:39Some of it, I think, very good, some of it very ill-advised, both of them making things go forward.
00:46So, you know, it's coming from a high level, but I think it's naive to think it's mission accomplished.
00:52I think it's a temporary respite.
00:55The Iranian regime is still in place.
00:58Frankly, the U.S. regime is still in place.
01:01And I think more things will happen.
01:03But again, the markets have just decided it doesn't matter, you know, everything's going to be fine.
01:08I think it's a little naive.
01:10And you've said this could potentially be bigger than Liberation Day and what we saw with the tariff impact last
01:16year.
01:17How are you factoring in all the consequences from this war now economically?
01:21Is it going to be stagflation light?
01:23Some are even saying, you know, if you're going to shut down 20% of the oil supplies in the
01:27Strait of Hormuz, that could lead to a recession.
01:29How are you assessing the second order and third order effects, too, of this war?
01:33Well, I mean, it's definitely a big stagflationary shock, even as it stands.
01:38And following on the tariffs, which are also a stagflationary shock and still working their way through the system.
01:45I mean, it depends on how far it goes, how things react.
01:48I think over the medium term, this pushes interest rates up, not down.
01:54There's inflation is not coming down.
01:58It's been up for many years.
02:00The Federal Reserve says, oh, don't worry about the tariffs.
02:02Don't worry about this.
02:03Don't worry about the next thing.
02:05And after a while, expectations will adjust.
02:07And I think real interest rates are being pushed up, inflation, adjusted interest rates, because more military spending, populism, high
02:17debt levels everywhere.
02:19So I think this is the kind of shock that the system is not that resilient longer term.
02:26You bring up a very good point, because we were already having trouble getting inflation back into range before the
02:34war started.
02:35And here we are.
02:37And I wonder, do Central Backstreet, do we think that 2% number?
02:40Does 2.5% make more sense given the realities that we have?
02:44Well, first of all, most people have no idea what inflation is, not just if it's 2% or 2
02:50.5%.
02:51But my colleagues at Harvard who do surveys on this find that the average person, most of them, have no
02:58idea even what the definition of inflation is.
03:00So if it stays moderate, it's not so bad, and probably no one notices.
03:06No, I don't think the Federal Reserve should change what it says it's trying to do.
03:09But the trouble is, I mean, people notice it drifting up and prices not coming down.
03:14And so it's certainly a problem.
03:17I don't think you can wish it away.
03:19It makes it harder, what seemed to be coming along, inflation coming down, and now postpone further.
03:29What does this mean for the dollar?
03:31I mean, I think when the Iranians suggested that any sort of safe passageway through the Strait of Humbus was
03:36going to be paid in either crypto or renminbi,
03:38it did raise a lot of eyebrows of what the outlook for the dollar is.
03:42We have seen this whole theme of de-dollarization, but how much do you think that narrative has been eroded
03:47now?
03:49Well, it depends on how the war works out, right?
03:51I mean, if it's a big win for the United States, it's probably good for the brand, probably strengthens the
03:58U.S. hand.
03:58Military power is a part of the strength of the dollar.
04:03On the other hand, if it doesn't go well, if it looks more like Iraq or Vietnam, which is very
04:10much a possibility still here,
04:12all possibilities are there, then I think it's negative.
04:16I mean, regardless, Asia, which is half the dollar block, is dominated by China.
04:21China has been working for some time to build out its back office, its pipelines.
04:28It's switching at least its imports pretty rapidly into RMB.
04:33It's working on the exports.
04:35And I think what Iran was saying was really just in place with what a lot of countries were saying.
04:41It didn't surprise me at all.
04:42What are they going to do?
04:43Ask to be paid in dollars and then find out there's a sanction on them and they can't use them?
04:48Well, the Fed could give them a swap line.
04:51I think that's a difference.
04:53Maybe if we're going into business with them on controlling the Straits of Horloos, as Trump suggested, who knows?
04:59That was an option.
05:01That's right.
05:01I mean, we were coming off.
05:03So we have this war.
05:04Prior to that, we have terrorists.
05:06Prior to that, we had the pandemic.
05:07All three forced companies to rethink their supply chains and trade links.
05:12Does this accelerate that phase, you think?
05:14Oh, I mean, for sure.
05:16I don't know how things are going to reorient themselves.
05:19It'll change what kinds of energy countries use.
05:22But if we step back, it also underscores how Europe and, say, India, many parts of Asia are really weak
05:32in building out their electricity.
05:34They're not competitive in AI already because they don't have enough electric power to support it.
05:42And now this underscores it where they're having problems maintaining what they have.
05:47So, you know, I don't know what action we'll take.
05:51But I certainly sense on the European side maybe some real movement on both trying to be more independent from
05:59the dollar,
06:00building out their own back office, doing what China is doing, having swap lines in Europe,
06:05and also trying, you know, to build up electricity, India.
06:09But this really hurt the rest of the world much more than the United States.
06:14That's part of why it happened.
06:15If the U.S. were taking the hit that its allies were taking in the Middle East,
06:20that Asia has been taking, that the Europeans have been taking,
06:24I don't think it would have happened that the U.S. did this, our dollar, your problem.
06:29You know, we're doing it. We don't really care.
06:32And I think in the long run this sort of undermines the leadership of the U.S.
06:36Again, if it turns out, whoa, you know, brilliant.
06:41You know, they took out this regime.
06:44They're now becoming part of a normal Middle East.
06:46The world is developing.
06:48It's different.
06:49We don't know how it's coming out.
06:51But, you know, it definitely could go the other way.
06:55China, I mean, obviously has in some ways been that voice of stability in this whole world order in some
07:01ways.
07:02I'm just wondering in terms of the economy,
07:05there's this also idea that they're a bit more resilient because they have the cheap energy.
07:09They've been transitioning into renewables for the past 10 years.
07:12How resilient do you think China and the economy is to these global shocks that we're seeing now?
07:18Well, on the one hand, China's economy has been in a very weakened position for a long time due to
07:25its overbuilding of real estate and infrastructure,
07:29way out into the, you know, netherlands in China, way out in the hinterlands, I should say.
07:35And it's still working that out.
07:39I think it's got years to go.
07:41That's a big part of the economy.
07:43And these things like electric vehicles, having solar panels, they're small potatoes compared to the size of the real estate
07:51industry.
07:52But that said, I mean, there's a tremendous determination in China to keep moving forward.
07:58You know, if there's a step back, we're going to keep moving forward.
08:01A lot of resilience to the system.
08:05I've listened to discussions in the United States of, well, how do we get around China?
08:09How do we home shore?
08:10How do we not have this?
08:12And it's almost like a joke.
08:15It's clear that it's not easy to do.
08:18I mean, at the moment, the U.S. is basically importing the parts it needs to fight a war with
08:23China with.
08:24I mean, it's sort of at that level.
08:26And the idea, you know, striking independence.
08:29China has a lot of determination, a lot of state capacity.
08:33They make mistakes.
08:34They go too far in one direction like they did in real estate.
08:38And I think we're seeing it in other things.
08:40The idea they'll just grow to the moon is wrong.
08:43And the IMF's forecast for them, I think, are still optimistic, where they have it coming down to 4%.
08:49I think if China averages 3% growth over the next 10 years, they'll be doing well.
08:55But it will be doing better than the United States.
08:57And so, you know, certainly China is coming, but slower.
09:03Does 3%, 4% growth in China, you think, distill inflationary forces to sort of show up on the surface?
09:14Is that enough, given the capacity of the economy?
09:16They're in deflation right now in China.
09:19They've had a massive fall in consumer wealth.
09:22Housing is 70% of total private wealth.
09:26And it's, you know, fallen 20% nationally by the official numbers.
09:32Probably it's fallen more.
09:34It doesn't necessarily lead to the kind of banking problem that Bernanke wrote about
09:39and that we emphasize in Western economies because there are actually not so many houses underwater
09:44because down payments are way larger and prices went up.
09:50But people's wealth went down.
09:51And if you just calculate, you know, how much that wealth shock, I have a paper from Brookings
09:56a week ago about this with Juan Chen Yang.
10:00If you just calculate that, it can drop consumption for a long time.
10:04And so the Chinese government, in order to get to a higher growth rate, would really have to do something
10:10to build out consumption, which it struggled to do.
10:13But that said, even if they're at 3% and rolling along, building out their AI, their military,
10:20I mean, it's still formidable.
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