WEBVTT - How China and Evergrande Are Trying to Avoid Disaster 0:00:05.080 --> 0:00:08.399 Hello, and welcome to Stephanomics, the podcast that brings the 0:00:08.440 --> 0:00:11.680 global economy to you. My name is Tom Orlick. I'm 0:00:11.720 --> 0:00:15.360 the chief economist for Bloomberg and this Halloween Week with 0:00:15.440 --> 0:00:18.959 regular hosts Stephanie Flanders, busy putting the finishing touches to 0:00:19.040 --> 0:00:22.720 her modern monetary theory costume, I'm stepping in as master 0:00:22.800 --> 0:00:26.320 of Ceremonies. In keeping with the spirit of the season, 0:00:26.600 --> 0:00:29.360 we have a Frankenstein's Monster of a show for you, 0:00:29.800 --> 0:00:33.199 stitching together some of the scariest risks in the global economy. 0:00:33.880 --> 0:00:36.680 In a bit, we'll hear from Logan Rights of Rhodium 0:00:36.760 --> 0:00:39.720 Group and Bloomberg's own David Chu on why the ghost 0:00:39.720 --> 0:00:43.280 time problem that has long haunted China's economy is coming 0:00:43.320 --> 0:00:47.320 to a head. To start, though, Bloomberg's own Tom Hancock 0:00:47.560 --> 0:00:50.400 has gone trick or treating at the Hong Kong headquarters 0:00:50.400 --> 0:00:53.200 of ever Grandy, one of the developers that built all 0:00:53.200 --> 0:01:04.720 that empty property. Let's see what candy he collected. Yeah, 0:01:08.040 --> 0:01:11.399 I've come to the headquarters of China Evergrand Group in 0:01:11.480 --> 0:01:15.400 Hong Kong, the epicenter of a burgeoning debt crisis that 0:01:15.520 --> 0:01:19.320 the sharply slowed growth in the Chinese economy. The sides 0:01:19.360 --> 0:01:22.920 of the twenty six story building are plastered with advertisements 0:01:23.200 --> 0:01:28.679 for Evergrands luxury property developments, but it's the headquarters itself 0:01:28.760 --> 0:01:31.720 which has been up for sale this year. Evergrand tried 0:01:31.760 --> 0:01:34.480 to raise two billion dollars by selling it off to 0:01:34.520 --> 0:01:39.080 pay debt, but the deal hasn't progressed. Evergrand staff who 0:01:39.160 --> 0:01:42.120 walked the lobby's marble floor and take elevators to their 0:01:42.160 --> 0:01:46.600 offices face an uncertain future. In a cafe next to 0:01:46.640 --> 0:01:50.600 the building's lobby, Evergrand staff meet over covees or soft 0:01:50.640 --> 0:02:01.960 piano music plays. More than a month after entering its 0:02:01.960 --> 0:02:05.080 acute phase, the financial drama at the company that had 0:02:05.120 --> 0:02:09.520 been China's largest property developer until recently is far from over. 0:02:10.320 --> 0:02:13.560 After waiting about a month for an interest payment, some 0:02:13.720 --> 0:02:17.160 of Evergrand's dollar bond holders received their money over the weekend, 0:02:17.560 --> 0:02:21.320 allowing the company to avoid a default for now, but 0:02:21.400 --> 0:02:25.560 investors have little insight into how long Evergrand can continue 0:02:25.639 --> 0:02:28.960 to pay its bills. The bonds initially had a bit 0:02:29.000 --> 0:02:32.280 of a pop and then sort of very quickly came 0:02:32.320 --> 0:02:35.680 back down to almost unchanged. On the day. That's Monica 0:02:35.760 --> 0:02:40.240 saw of Triatic Capital an asset manager UM. I think 0:02:40.480 --> 0:02:44.160 that UM it made made sense for them to pay 0:02:44.240 --> 0:02:47.400 this just pretty much about a day before the end 0:02:47.400 --> 0:02:49.639 of the grace period in order to kick the can 0:02:49.720 --> 0:02:53.520 down the road while they figure out a comprehensive resolution 0:02:53.639 --> 0:02:58.400 to this. This whole Osaka, like many in the market south, 0:02:58.440 --> 0:03:02.360 sees the hand of China's government behind the scenes. Evergrand 0:03:02.440 --> 0:03:06.160 status as China's biggest dollar bond issue means whether it 0:03:06.200 --> 0:03:09.520 pays its bills will help determine how easy it is 0:03:09.680 --> 0:03:13.680 for other Chinese companies to access overseas lending in the future. 0:03:13.919 --> 0:03:17.919 So the payment of this coupon, I would assume does 0:03:18.040 --> 0:03:21.800 involve the government, including the p POC, in order to 0:03:22.760 --> 0:03:26.000 maintain stability of the whole financial system. I think that 0:03:26.080 --> 0:03:29.800 much is sort of clear to the market. The heart 0:03:29.840 --> 0:03:33.440 of evergrands troubles are its high debt burden. It counts 0:03:33.440 --> 0:03:37.120 more than three hundred billion dollars in liabilities and a 0:03:37.200 --> 0:03:43.200 slowdown in sales attributable to the Chinese state itself. According 0:03:43.240 --> 0:03:47.080 to Juning, a former advisor to China's Central Bank, the 0:03:47.200 --> 0:03:51.040 Chinese government is trying to reduce the economy's dependence on 0:03:51.160 --> 0:03:55.480 real estate. He argues that a constant expectation of rising 0:03:55.480 --> 0:04:00.000 prices among households has created a bubble that threatens financial stability. 0:04:00.040 --> 0:04:03.040 Team but in the process of trying to deflate the 0:04:03.040 --> 0:04:07.600 bubble by slowing housing sales, officials are undermining the finances 0:04:07.720 --> 0:04:11.600 of huge companies like ever Ground, that in turn creates 0:04:11.640 --> 0:04:15.120 a threat to financial stability. If you crack down the bubble, 0:04:15.880 --> 0:04:19.359 you would create a financial brisks on its own. But 0:04:19.440 --> 0:04:22.400 if you don't, you wouldn't be able to convince the 0:04:22.480 --> 0:04:25.440 market that you really minute. I think that's the here 0:04:25.480 --> 0:04:30.080 in challenge Chinese regulate or Chinese comment phase. Evergrund sales 0:04:30.120 --> 0:04:34.800 fell by a whopping nine percent during China's October holidays, 0:04:35.160 --> 0:04:38.240 usually a peak period for home buying, as the government 0:04:38.279 --> 0:04:42.520 told banks to limit mortgage lending and buyers also worried 0:04:42.600 --> 0:04:48.159 about ever grounds ability to complete its construction projects. Juning 0:04:48.200 --> 0:04:51.279 believes that Beijing will continue to try to slow housing 0:04:51.320 --> 0:04:55.680 sales until households lads their expectations that the government will 0:04:55.720 --> 0:04:59.000 always step in to support house prices. I think the 0:04:59.120 --> 0:05:02.520 end of it is to have the market, have the 0:05:02.600 --> 0:05:08.120 household to have been fairly study explanation of the housing part, 0:05:08.720 --> 0:05:11.440 but I don't think we're reaching that point yet, Evergrand 0:05:11.520 --> 0:05:14.880 needs to focus more on selling off its considerable assets 0:05:15.040 --> 0:05:17.960 to keep servicing its huge debt pile, since it has 0:05:18.040 --> 0:05:21.359 less money coming in the door from home bias. The 0:05:21.440 --> 0:05:25.200 trouble is it's having difficulties finding any bias for those 0:05:25.240 --> 0:05:29.039 as well. Evergrand has also tried to sell its property 0:05:29.080 --> 0:05:33.320 management arm, which charges homeowners fees for organizing services like 0:05:33.400 --> 0:05:36.520 security and cleaning. It hoped that that would bring in 0:05:36.720 --> 0:05:40.479 two point six billion dollars, but talks about that also 0:05:40.680 --> 0:05:46.800 ended without a deal. Evergrand's founder and chairman, Wakayan, has 0:05:46.880 --> 0:05:50.000 always been a risk taker. He was born into grinding 0:05:50.040 --> 0:05:52.440 poverty in the central province of her Nan in the 0:05:52.520 --> 0:05:56.480 nineties fifties and founded his property company just as China 0:05:56.640 --> 0:05:59.760 began to create a commercial housing market in the late 0:05:59.839 --> 0:06:04.799 night nineties. Two decades later, in seventeen, he was China's 0:06:04.800 --> 0:06:08.760 second richest man. So far, Way has been low key 0:06:08.800 --> 0:06:13.920 about the details of Everground's finances, avoiding media engagements. However, 0:06:14.400 --> 0:06:17.159 local press accounts suggest he is sticking with the kind 0:06:17.160 --> 0:06:21.320 of big, bold bets that have defined his career. The 0:06:21.400 --> 0:06:24.760 Securities Times reported that Way plans to scale down real 0:06:24.839 --> 0:06:28.560 estate operations and won't buy much land for another ten years. 0:06:29.120 --> 0:06:34.520 The new focus designing and manufacturing electric vehicles. The company 0:06:34.560 --> 0:06:37.120 got into the new energy vehicle's business a couple of 0:06:37.200 --> 0:06:40.400 years ago, but as yet to manufacture a single car. 0:06:41.960 --> 0:06:44.919 Everground faces more tests in the coming weeks as the 0:06:44.960 --> 0:06:48.560 grace periods on more bonds expire. The fate of one 0:06:48.600 --> 0:06:51.760 of the world's largest real estate firms and the world's 0:06:51.760 --> 0:06:55.919 biggest real estate market still hangs in the balance. For 0:06:55.960 --> 0:07:09.559 Bloomberg News, I'm Tom Hancock in Hong Kong. Scary stuff 0:07:09.560 --> 0:07:14.360 forever grandy bond holders and with ever grandy emblematic broader 0:07:14.400 --> 0:07:18.880 problems in an overbuilt, an over leverage property sector. Scary 0:07:18.880 --> 0:07:22.520 stuff also for China's economy and financial system as a whole. 0:07:23.120 --> 0:07:25.880 To get into those broader issues, I'm joined now by 0:07:25.960 --> 0:07:29.360 Lugan Right, a director at Radium Group and veteran analyst 0:07:29.440 --> 0:07:33.080 of China's financial system, and Bloomberg's David Chew, both of 0:07:33.120 --> 0:07:36.200 them dialing in from Hong Kong. Logan, let me start 0:07:36.240 --> 0:07:39.800 with you. Why is a downturn in real estate potentially 0:07:39.880 --> 0:07:42.640 such a big problem for China. I think it's a 0:07:43.520 --> 0:07:47.160 it's a big problem largely because just of the size 0:07:47.520 --> 0:07:52.160 of the property sector within China's economy, which most analysts 0:07:52.280 --> 0:07:58.360 estimate between twenty of GDP. Overall property sales in China 0:07:58.720 --> 0:08:02.680 in terms of just the pre construction sales are as 0:08:02.760 --> 0:08:06.120 high as fifteen point seven trillion u N over the 0:08:06.200 --> 0:08:10.800 last um year, of the last twelve months. And so 0:08:11.200 --> 0:08:15.800 if you hypothetically look in the future and if property 0:08:15.840 --> 0:08:19.640 sales decline by let's say over the next year and 0:08:19.760 --> 0:08:23.360 prices are down by say ten percent um, that's a 0:08:23.440 --> 0:08:27.760 huge gap that it's very difficult for developers to make up. 0:08:27.800 --> 0:08:30.239 It's a gap as high as three point five percent 0:08:30.280 --> 0:08:33.880 of g d P. It is not a an imbalance 0:08:33.960 --> 0:08:36.800 that is easily remedied by policy. So this is one 0:08:36.840 --> 0:08:39.920 reason that the you know, the potential costs of such 0:08:39.960 --> 0:08:45.120 a property downturn that exemplified by ever grands difficulties are 0:08:45.160 --> 0:08:47.679 so significant. And it's not just a growth risk we're 0:08:47.720 --> 0:08:50.480 talking about here, is it a slump in the property 0:08:50.520 --> 0:08:53.560 sector could mean defaults on loans and end up in 0:08:53.559 --> 0:08:56.960 a financial crisis, a Lehman movement for China, if you 0:08:57.000 --> 0:09:02.119 will lugan, how could that plan? The more likely scenario 0:09:02.440 --> 0:09:05.760 that we would be concerned about in terms of financial 0:09:05.800 --> 0:09:10.760 distress in China stems through local governments and the difficulties 0:09:10.760 --> 0:09:16.800 of property developers continuing to um slow down their purchases 0:09:16.800 --> 0:09:20.559 of land, which would add to financial stress among China's 0:09:20.559 --> 0:09:24.040 local governments which depend heavily upon land sales for revenue 0:09:24.400 --> 0:09:28.400 and repaying their own significant debt burdens. So what you 0:09:28.440 --> 0:09:30.680 could see is if you have a continued slow down 0:09:30.679 --> 0:09:34.720 in land purchases, you could have a rise in financial 0:09:34.760 --> 0:09:38.920 distress at smaller banks that lend to these local government 0:09:38.920 --> 0:09:43.079 financing vehicles, which have really lad the expansion in China's 0:09:43.080 --> 0:09:46.280 debt over the past decade, which were also essential to 0:09:46.360 --> 0:09:51.320 the funding um the investment that has taken place. David Chew, 0:09:52.440 --> 0:09:55.560 You've worked inside the People's Bank of China, and not 0:09:55.720 --> 0:09:58.440 just inside the People's Bank of China, but inside the 0:09:58.440 --> 0:10:02.680 financial stability vision of China's Central Bank, the group which 0:10:02.720 --> 0:10:06.359 cares most and focuses most on this kind of problems. 0:10:07.200 --> 0:10:10.720 How do you think China's policymakers are thinking about what's 0:10:10.760 --> 0:10:13.200 going on with ever Grandy and some of the broader 0:10:13.320 --> 0:10:18.640 risks that Logan has described for China's financial sector. The 0:10:18.760 --> 0:10:22.960 banking sector is the key, particularly the big banks are 0:10:22.960 --> 0:10:27.439 the key. They are the natural firewall for the financial 0:10:27.480 --> 0:10:32.840 crisis or financial risks because they have the guarantee from 0:10:32.880 --> 0:10:36.040 the government. So for example, if you're deposit the money 0:10:36.080 --> 0:10:40.040 into i CBC, that means you are you are depositing 0:10:40.160 --> 0:10:43.480 it with with the with the government, so that is 0:10:43.880 --> 0:10:46.760 the SEBC. Under the big banks, they are steign credit 0:10:47.280 --> 0:10:52.120 so that this makes them a natural firewall during a 0:10:52.800 --> 0:10:58.040 credit crisis or credit risk. Remember what happened thirty years 0:10:58.040 --> 0:11:02.160 ago in ninety nineties, hialized banks used that to have 0:11:02.280 --> 0:11:06.680 at pent on the Rachel but the banks was still surviving. 0:11:07.040 --> 0:11:10.520 And that tells us how confident that people are to 0:11:10.800 --> 0:11:14.480 the banking sector. So the principle for us is even 0:11:14.480 --> 0:11:17.199 the banking sector remains good and this do have the 0:11:17.280 --> 0:11:21.520 credibility things will be good. So data is the the 0:11:21.559 --> 0:11:36.600 most ultimate backdop or backstorm for for the all the argument, logan, 0:11:36.640 --> 0:11:39.680 help me out with one crucial question before we get 0:11:39.720 --> 0:11:45.760 back to the substance of this ever grand or ever grandy. 0:11:46.240 --> 0:11:49.360 I've heard both the translations I've been What I hear 0:11:49.400 --> 0:11:52.680 most often is ever grant, But you know, technically it's 0:11:52.679 --> 0:11:55.400 a you know, it's und do so it's a question 0:11:55.480 --> 0:11:58.400 of whatever English and translation prefer, the Chinese will still 0:11:58.400 --> 0:12:02.280 operate historic. I went with ever Grand, but ever Grandy 0:12:02.440 --> 0:12:05.120 seems to have much more of a dramatic flourish to it, 0:12:05.200 --> 0:12:06.920 So I think I'm going to put the accent on 0:12:07.000 --> 0:12:11.520 the going forwards fair fair enough, So so Logan and 0:12:11.720 --> 0:12:14.839 David makes an important point, doesn't he There is a 0:12:14.880 --> 0:12:19.080 powerful firewall in the financial system in China, which is 0:12:19.080 --> 0:12:22.560 the credibility of the big banks. And as long as 0:12:22.559 --> 0:12:25.319 the I C, B c s and the China construction 0:12:25.360 --> 0:12:30.040 banks of the world a solid it's difficult to imagine 0:12:30.320 --> 0:12:34.520 a systemic crisis in China. Do you agree with that point? 0:12:34.760 --> 0:12:38.439 And what could happen in your view to start eroding 0:12:38.920 --> 0:12:43.120 confidence not just in a property developer or a local bank, 0:12:43.440 --> 0:12:47.960 but in the giant state banks which dominate the system. 0:12:48.000 --> 0:12:51.559 I mean, I think it's very improbable that giant state 0:12:51.600 --> 0:12:56.040 banks would suddenly lose confidence among the local population. But 0:12:56.160 --> 0:13:00.480 the concern I would have is in state guarantees being 0:13:00.640 --> 0:13:05.480 eroded over time. The issue in China's financial system has 0:13:05.559 --> 0:13:09.440 been that the system expanded when there was a high 0:13:09.440 --> 0:13:13.720 degree of moral hazard um that was pervasive throughout a 0:13:13.800 --> 0:13:17.200 number of different asset markets. So the idea was that 0:13:17.440 --> 0:13:21.439 even when there was financial stress that occurred, investors didn't 0:13:21.480 --> 0:13:25.160 need to protect themselves because they could always count on 0:13:25.360 --> 0:13:29.160 Beijing to step in in the case of any financial stress. 0:13:29.240 --> 0:13:32.200 We saw this during even the stock market meltdown in 0:13:33.480 --> 0:13:38.439 we saw this during the inner bank market turmoil. And 0:13:38.520 --> 0:13:43.200 so that assumption, that track record of interventions over time 0:13:43.640 --> 0:13:47.120 created the impression that there would always be um some 0:13:47.160 --> 0:13:50.440 sort of government support. But that is changing and it 0:13:50.520 --> 0:13:53.760 had to change. In fact, it was natural that that 0:13:54.040 --> 0:13:57.880 guarantee would change because Beijing really had no interest in 0:13:58.040 --> 0:14:01.000 defending these very risky and peri ferral parts of the 0:14:01.000 --> 0:14:04.760 financial system when the shadow banking system, when peer to 0:14:04.800 --> 0:14:09.440 peer lending network started expanding, and as those guarantees have 0:14:09.520 --> 0:14:14.000 been eroded, it causes investors to start questioning where those 0:14:14.520 --> 0:14:18.760 Beijing's guarantees will truly extend, where they will stop looking 0:14:18.800 --> 0:14:23.680 longer term logan, China has to transition away from property 0:14:23.840 --> 0:14:28.000 as a driver of growth. You mentioned that contribution of 0:14:28.040 --> 0:14:32.360 property to GDP that has to come down. That's going 0:14:32.400 --> 0:14:35.560 to be a painful process, isn't it. I would think. 0:14:35.600 --> 0:14:38.520 So the issue is just that when an industry is 0:14:38.600 --> 0:14:42.640 that large, there's no obvious replacement. When something that goes 0:14:42.720 --> 0:14:46.240 from powering the economy becomes a meaningful drag on the economy. 0:14:46.640 --> 0:14:49.920 You can talk about transitioning growth models, but that becomes 0:14:49.960 --> 0:14:53.400 a longer term process, and it requires the costs of 0:14:53.440 --> 0:14:56.720 the previous investment to be to be paid and new 0:14:56.760 --> 0:14:59.480 investment decisions to be made, which which take time to 0:14:59.560 --> 0:15:03.320 be productive. So it does mean that, you know, whatever 0:15:03.400 --> 0:15:07.800 you're thinking about China's long term growth trajectory becoming um 0:15:07.840 --> 0:15:10.960 it probably involves that being a couple of percentage points 0:15:10.960 --> 0:15:15.280 lower in the immediate future. David, the last word to you, 0:15:16.000 --> 0:15:20.160 We've already seen China's economy really screeched to a halt 0:15:20.400 --> 0:15:22.840 in the third quarter. If you look at the quarter 0:15:22.960 --> 0:15:27.200 on court at growth rate just no point two, way 0:15:27.240 --> 0:15:29.520 down from numbers we used to see in the pre 0:15:29.680 --> 0:15:34.560 COVID era. Do you share Logan's view that working through 0:15:35.080 --> 0:15:38.480 these deep problems is going to require a period of 0:15:38.560 --> 0:15:42.600 lower growth. Before answering this question, we should think of 0:15:42.680 --> 0:15:46.480 one thing. It is why the authorities are so tough. 0:15:46.960 --> 0:15:50.960 Could real actate a sector for the past of a 0:15:50.960 --> 0:15:54.720 couple of years. So I think we can we need 0:15:54.760 --> 0:15:57.920 to think of it in the bigger picture, and in 0:15:58.040 --> 0:16:02.360 my mind, I think that the UH, the top leaders, 0:16:02.400 --> 0:16:06.760 they realized that China needs the transition and they are 0:16:06.840 --> 0:16:11.520 willing to UH to endure a period of slower growth 0:16:12.080 --> 0:16:14.720 UH in the next couple of years. That is the 0:16:14.800 --> 0:16:18.320 price for transition. I think that is what in their minds. 0:16:18.680 --> 0:16:21.880 So this can explain what happened in the past several 0:16:21.960 --> 0:16:25.880 quarters after China recovered from the COVID nineteen that they 0:16:25.920 --> 0:16:29.480 accelerated the reform and the transition and many of the 0:16:29.520 --> 0:16:33.800 Titan issue Titan policies issued. I think the view it 0:16:34.000 --> 0:16:38.240 a time window for the transition and they are willing 0:16:38.280 --> 0:16:41.560 to pay some price for that. But on the other hand, 0:16:41.640 --> 0:16:46.320 I think they won't allow the growth to to to 0:16:46.520 --> 0:16:49.400 break the bottom line. I think one of the bottom 0:16:49.440 --> 0:16:53.720 line is the employment. So if we see the rise 0:16:53.800 --> 0:16:58.520 of the unemployment, we will see some policies to be 0:16:58.880 --> 0:17:03.600 made to relate to the the economy. Well, if we 0:17:03.640 --> 0:17:06.440 have to sum up such a complex discussion, I guess 0:17:06.440 --> 0:17:08.720 we can say that, Ever, Grandy is probably not going 0:17:08.760 --> 0:17:12.080 to be China's Lehman moment. A financial crisis is not 0:17:12.160 --> 0:17:15.760 an immediate prospect, but a period of lower growth as 0:17:15.800 --> 0:17:18.520 the economy works through the problems of overbuilding and over 0:17:18.520 --> 0:17:23.120 capacity is a very real prospect. David, you logan, right, 0:17:23.440 --> 0:17:44.000 thanks very much, thank you. Well, It's Halloween this Sunday, 0:17:44.320 --> 0:17:47.359 and so in the spirit of the season, we've invited 0:17:47.400 --> 0:17:52.280 Bloomberg Economics best vampire hunters and monster slayers to tell 0:17:52.359 --> 0:17:56.119 us about the biggest risks, the scariest risks facing the 0:17:56.119 --> 0:18:00.720 global economy and markets. Very pleased to be joy by 0:18:01.000 --> 0:18:04.040 chief US economist and a Wall dialing in from Washington, 0:18:04.160 --> 0:18:08.719 d C. Senior UK economist Dan Hansen joining us from London, 0:18:08.880 --> 0:18:14.959 and Chief Emerging Markets economist z Dowd dialing in from Dubai. Zad. 0:18:15.160 --> 0:18:18.400 Let's start with you tell us about the beastly problem 0:18:18.560 --> 0:18:22.600 facing the emerging markets. So we know do things from history. 0:18:22.880 --> 0:18:25.560 We know the first thing is that rising US rates 0:18:25.640 --> 0:18:28.960 have a negative spill over to emerging markets, and the 0:18:29.000 --> 0:18:32.320 second thing is that weaker economies in the developing world 0:18:32.560 --> 0:18:36.040 gets hit harder. We saw that repeatedly in recent years, 0:18:36.119 --> 0:18:39.600 including the two thousand and thirteen Taper tantrum. We saw 0:18:39.600 --> 0:18:43.360 it also in the twenty eighteen emergent market crisis. Now 0:18:43.520 --> 0:18:46.720 US rates are rising, and some emerging markets are vulnerable 0:18:46.800 --> 0:18:49.960 this time around. So who is the most exposed was 0:18:50.000 --> 0:18:53.439 the group of countries that we group under the acronym BEAST. 0:18:53.800 --> 0:18:59.280 These are Brazil, Egypt, Argentina, South Africa and Turkey. These 0:18:59.280 --> 0:19:03.280 economies have law foreign exchange reserves, have high external debt 0:19:03.560 --> 0:19:07.720 and sizeable current account deficits, and the particularly exposed if 0:19:07.920 --> 0:19:11.119 you get any surprises in terms of interest rates in 0:19:11.160 --> 0:19:14.760 the US now, fans of the horror genre will know 0:19:15.000 --> 0:19:18.639 that often the sequel is gorrier than the original. In 0:19:18.680 --> 0:19:26.600 the UK, we had strikes, shortages, garbage, even corpses piling 0:19:26.680 --> 0:19:29.399 up in the street. The crisis was so bad it 0:19:29.440 --> 0:19:32.840 became known as the Winter of Discontent, Dan Hansen, does 0:19:32.880 --> 0:19:36.600 the UK now face winter of discontent? The return? We've 0:19:36.720 --> 0:19:38.960 had a year of two halves in the UK. We've 0:19:39.000 --> 0:19:41.960 had a blistering recovery following the end of the lockdown 0:19:41.960 --> 0:19:44.639 earlier in the year, but since then the economy has 0:19:44.720 --> 0:19:47.480 slowed and much of that has been due to, as 0:19:47.520 --> 0:19:52.040 you mentioned, supply constraints both global and domestic as well, 0:19:52.119 --> 0:19:54.480 and they've really hindered the ability of the economy to 0:19:54.520 --> 0:19:58.080 make meaningful further progress. And we've had a look at 0:19:58.119 --> 0:20:01.000 what recent supply disruptions might cost the economy, and we 0:20:01.040 --> 0:20:02.960 think it could knock as much as one point three 0:20:03.000 --> 0:20:04.920 percent off the level of g d P by the 0:20:05.000 --> 0:20:07.119 end of the year, and it could add as much 0:20:07.160 --> 0:20:10.239 as point four percentage point to headline inflation, which as 0:20:10.240 --> 0:20:12.159 we know, is already pretty high in the UK. It's 0:20:12.200 --> 0:20:14.399 running at about three point one percent at the moment, 0:20:15.359 --> 0:20:17.960 and I think if we look ahead, it's important to 0:20:18.000 --> 0:20:20.719 recognize that that loss of growth momentum has occurred at 0:20:20.720 --> 0:20:23.640 a time when more headwinds are appearing on the horizon. 0:20:24.200 --> 0:20:27.760 Inflation is likely to go higher still on energy prices 0:20:27.760 --> 0:20:30.760 this winter, moving above four percent, more than doubling the 0:20:30.760 --> 0:20:34.719 Bank of England's target, and that will crimp real income growth. 0:20:35.640 --> 0:20:38.920 And meanwhile you've got fiscal support being tapered, and there's 0:20:39.080 --> 0:20:41.919 also a risk of a rising unemployment following the end 0:20:41.960 --> 0:20:44.960 of the furlough scheme, which the government's wage support scheme. 0:20:45.840 --> 0:20:48.320 So if we bring all of that together, it's it's 0:20:48.320 --> 0:20:50.760 not hard to see why references to stagflation are on 0:20:50.800 --> 0:20:54.160 the rise um, though we don't think we're quite there yet. 0:20:54.720 --> 0:20:57.640 Our baseline view is that the economy will continue to grow, 0:20:58.440 --> 0:21:01.480 albeit at a significantly lower pace than in earlier in 0:21:01.520 --> 0:21:05.000 the year, And our baseline also sees GDP passing its 0:21:05.000 --> 0:21:07.640 pre virus peak in the first quarter of next year, 0:21:07.680 --> 0:21:09.960 which is a little bit later than we previously envisaged. 0:21:15.440 --> 0:21:19.240 Sometimes in horror films, the problem gets so bad that 0:21:19.359 --> 0:21:23.000 the heroes have to adopt a scorched Earth policy to 0:21:23.119 --> 0:21:28.159 wiping out the villains. Remember Ripley in Aliens promising to 0:21:28.240 --> 0:21:31.280 take off and nuke the entire site from orbit. It's 0:21:31.320 --> 0:21:35.119 the only way to be sure, Anna Wong, was inflation 0:21:35.320 --> 0:21:38.480 in the United States reached that proportion, should we be 0:21:38.560 --> 0:21:41.160 worried that the Federal Reserve will have to lift off 0:21:41.320 --> 0:21:44.199 and nuke the economy from orbit to bring price pressure 0:21:44.240 --> 0:21:50.320 under control. So dud, everybody is worried about inflation here, 0:21:50.640 --> 0:21:54.359 even my my, my nanny is worried about inflation. And 0:21:54.400 --> 0:21:58.800 the risks of inflation moving higher than the FED prediction 0:21:59.359 --> 0:22:03.080 right now seems higher than a couple of weeks ago, indeed. 0:22:03.480 --> 0:22:07.840 But to me, the scarier scenario is not so much 0:22:07.920 --> 0:22:10.919 inflation running away to the level we have seen in 0:22:11.000 --> 0:22:14.480 nineteen seventies, because for that to happen, the FED has 0:22:14.520 --> 0:22:18.040 to make policy errors for many, many years, and I 0:22:18.119 --> 0:22:20.720 just don't think that's likely. The Fed will move, will 0:22:20.840 --> 0:22:24.480 raise rates next year if inflation runs hotter than much 0:22:24.520 --> 0:22:28.560 hotter than they expected. But the real scary thing is 0:22:29.040 --> 0:22:32.320 what happens to the economy when the Fed does move 0:22:32.800 --> 0:22:35.679 under the new policy framework. The FET is only going 0:22:35.720 --> 0:22:38.800 to move until the labor market is really hot, right, 0:22:39.240 --> 0:22:41.320 So when they do finally start to move, they have 0:22:41.400 --> 0:22:45.080 to move faster and quicker, and the path of FED 0:22:45.200 --> 0:22:48.399 rates will be steeper. And we have had two years 0:22:48.440 --> 0:22:53.320 of very easy conditions monetary conditions. We have many bubbles now, 0:22:53.440 --> 0:22:57.720 we have asset record highs in many asset markets. So 0:22:57.960 --> 0:23:01.439 when the FED brings this party to a halt, it 0:23:01.480 --> 0:23:04.080 will be very hard. And historically the FED does not 0:23:04.680 --> 0:23:09.479 have a very good track or record in engineering soft lending. Okay, 0:23:09.680 --> 0:23:13.280 let's round this section out by talking about perhaps the 0:23:13.359 --> 0:23:16.840 biggest fear out there for some investors, the fear that 0:23:17.000 --> 0:23:20.080 record highs for the stock market are the sign of 0:23:20.119 --> 0:23:23.920 a bubble and that that bubble could burst Z. How 0:23:23.920 --> 0:23:26.400 should we think about that risk? Right? So, the main 0:23:26.480 --> 0:23:29.720 question is whether the stock market is in a bubble 0:23:30.040 --> 0:23:34.400 or not right now, with the SMP hitting record highs. 0:23:34.680 --> 0:23:37.879 So to answer this question, we use an econometric model 0:23:38.160 --> 0:23:41.439 that estimates the large notable bubble based on the speed 0:23:41.480 --> 0:23:45.719 of decoupling of equity prices from their fundamentals, in this 0:23:45.800 --> 0:23:49.560 case is dividends. The method finds that we are on 0:23:49.640 --> 0:23:51.679 the cusp of a bubble. We're not in a bubble 0:23:51.760 --> 0:23:55.600 territory yet, but we are very close now. Economically speaking, 0:23:55.680 --> 0:23:58.080 the direct effect of a sharp correction in the stock 0:23:58.160 --> 0:24:01.080 market on the US economy my not be very large, 0:24:01.440 --> 0:24:03.520 but at a time where we have other risks such 0:24:03.560 --> 0:24:07.600 as the spreading of the coronavirus variant, the rise of 0:24:07.680 --> 0:24:11.240 global interest rates, the slow down the Chinese economy, and 0:24:11.280 --> 0:24:16.000 the disruption and the supply chains. Adding a another risk 0:24:16.200 --> 0:24:19.720 in the form of an assetprise bubble would compand these 0:24:19.840 --> 0:24:23.159 risks and add an additional layer of uncertainty to the 0:24:23.160 --> 0:24:27.880 global economy. Well, Anna, Dan and Zad didn't enter into 0:24:27.880 --> 0:24:30.199 the Halloween spirit quite as fully as I did, But 0:24:30.240 --> 0:24:32.320 then I guess on a show like this, it's really 0:24:32.359 --> 0:24:48.320 economic expertise that counts, and that's about all we have 0:24:48.400 --> 0:24:50.880 time for on this week's Stephonomics. So it's the door 0:24:50.880 --> 0:24:54.360 of the crypt Creaks closed, it only remains for me 0:24:54.440 --> 0:24:58.639 to thank our contributors, Tom Warlock, Logan White and Demon 0:24:58.720 --> 0:25:02.639 Chew as Yeah Dead, The Ghost of Anime, Wong and 0:25:02.720 --> 0:25:07.440 Dan Hank, Song producer Magnus the Thing Henrickson, and executive 0:25:07.440 --> 0:25:12.080 producer Mike the Exorcist Sasso join us next week, when 0:25:12.119 --> 0:25:15.560 regular host Stephanie Flanders will be back, The guest host 0:25:15.640 --> 0:25:19.360 Nightmare will be over, and normal standards of economic analysis 0:25:19.800 --> 0:25:22.560 and editorial judgment will be restored