Stephen Roach, Senior Fellow at the China Center of the Yale Law School, discusses China's near and longer-term economic prospects with Mark, Cris and Marisa. Steve explains why he has evolved from a bull to a bear on China's economy, why the critical relationship between China and the U.S. has gone sideways, and how to get the relationship moving in a positive direction.
Stephen Roach, Senior Fellow at the China Center of Yale Law School, discusses China’s near and longer-term economic prospects with Mark, Cris and Marisa. Steve explains why he has evolved from a bull to a bear on China’s economy, why the critical relationship between China and the U.S. has gone sideways, and how to get the relationship moving in a positive direction.
For more on Stephen Roach, click here
For more information on Stephen Roach's book, Accidental Conflict: America, China, and the Clash of False Narratives, click here
For the full transcript, click here
Follow Mark Zandi @MarkZandi, Cris deRitis @MiddleWayEcon, and Marisa DiNatale on LinkedIn for additional insight.
Mark Zandi: Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by my two trustee co-hosts, Cris deRitis and Marisa DiNatale. How are you guys doing this week?
Cris deRitis: Good.
Marisa DiNatale: [inaudible 00:00:26] Mark, good.
Mark Zandi: That's good. Busy week. Would you ever tell me that you weren't doing well? Like, "I'm not doing so well?"
Cris deRitis: I would.
Mark Zandi: Oh, you would? Okay.
Cris deRitis: When I had COVID, I told you I was...
Mark Zandi: Oh yeah, that's right. [inaudible 00:00:37] You did tell me that. Keep it real. I keep it honest. Yeah. Marissa, would you ever tell me that things are going?
Marisa DiNatale: I don't know. It depends. I guess it depends the source of the angst.
Mark Zandi: I got it. Yeah. Makes sense. Makes sense. But I'm glad you guys are doing well. And we have a guest, Steve Roach. Stephen Roach. Good to see you, Steve.
Steve Roach: Good to see you, Mark. I'm doing well, too. You didn't ask, but I'm doing well.
Mark Zandi: That was next, and absolutely the very next question. You look like you're doing well.
Steve Roach: I can't complain.
Mark Zandi: Yeah, that's very good.
Steve Roach: I mean I could, but what's the point?
Mark Zandi: Right, sure. What's the point? Exactly. And it's really an honor to have you on Inside Economics. We are going to talk a lot about China, because of course that's your focus. You're a senior fellow at the China Center, at the Yale Law School. And you've been associated with Yale now for about a decade, right? Has it been about that long?
Steve Roach: Yeah, since 2010.
Mark Zandi: 2010.
Steve Roach: I was still working at Morgan Stanley at the time, but nearing my 30-year anniversary, which I felt was an appropriate time to escape from Wall Street. So I overlapped for a couple of years to see if I wanted to go into full-time teaching, and I did. So I pulled the plug on Morgan Stanley in 2012 and have been a full-time faculty member at Yale since then.
Yeah. And it's in the Yale School of Management, right? Is that the business school for Yale? Forgive me, I should know that.
Marisa DiNatale: Well, yeah, it is. Yale has its own jargon, so business is not an accepted word in the pristine environment of Yale. They call it management.
Mark Zandi: I see. Got it.
Steve Roach: But I'm, actually about a year ago decided that after a dozen or so years teaching, I would stop doing that. And so now I'm more in a China research center in the law school, allowing me to write and speak and engage with a select group of students, which is perfect for me at this point.
Mark Zandi: That sounds cool. And you recently wrote a book. You've written a bunch of books over the years, but the most recent one, Accidental Conflict: America, China, and the Clash of False Narratives. That you published, I guess at the end of '22 coming into '23.
Steve Roach: I did. I published it in late November. And timing is everything. These two nations want to be at each other's throats. So the conflict has continued to escalate and the demand of my time to talk about a seemingly intractable conflict has grown, and it's good for conflict business.
Mark Zandi: Yeah, right. It's good to be wanted, certainly. And we're going to come back to the book a bit in the conversation. Before we move on, you mentioned this. You were at Morgan Stanley for 30 years and you were a chief economist for I don't know how long, at least was it the- [inaudible 00:03:53] most of that period, yeah.
Steve Roach: Certainly beginning and the late... In 1980s, early 1990s, I became a chief economist and first just focused on the US and then decided in the late '90s to turn it into more of a global job with an Asian focus.
Mark Zandi: And when I invited you to come on, and we were going back and forth a little bit, you sent me a piece about what you consider to be your worst forecast ever made. But before we talk about that, tell me what your best forecast you ever made. What are you most proud of that you know, you got and perhaps many, most other people did not?
Steve Roach: Well, I joined Morgan Stanley in 1982 in the depths of what was then the worst recession on record. And I came out of the blocks as the new economist, the new US economist, with a seemingly outrageous, optimistic view of the coming recovery. And that turned out to be right. And then I quickly realized, unlike you, that forecasting is just too hazardous to do on a full-time basis, and I would prefer more of a thematic approach. So I identified a lot of key themes that I focused on over the years, like corporate debt, productivity, corporate restructuring.
And then I think the pivotal moment for me, Mark, came in the late '90s, the depths of the Asian financial crisis. I was heading up a highly ranked global economics team that I built at Morgan Stanley that had no clue as to how this crisis was about to unfold and what would bring it to an end. And I started going out to China in the late 1990s every other month, and I'd been there before, but I didn't know the place at all. And quickly figured out that China was cut from a different cloth and would lead Asia and eventually play an important role in driving the global economy in the early 2000s. And that really became my calling card. Moved out there full-time in, around 2007 and really became hugely optimistic on China and stayed on that trajectory for a number of years. And it was only recently that I have seriously began to rethink my sort of permanent optimism on China.
Mark Zandi: So that was a great forecast, late '90s, early 2000s, to forecast China was going to be such a dominant player on the global economic scene. I don't think many people saw that coming.
Steve Roach: Yeah, I was criticized, sometimes ridiculed, for being a sort of Wall Street sell side shill. I did a lot of things on Wall Street that I'm proud of, and a few things I regret, but I always stayed true to my own convictions. I felt that analytical credibility was key. There are always conflicts of interest in Wall Street where big companies like Morgan Stanley represent clients who want you to say good things about their companies and their markets. But I never did that. I never really compromised my view for commercial purposes. And so my forecast was really, I think pretty reflective of some deeply held analytical views that I developed over the years with respect to China and its role in Asia.
Mark Zandi: Yeah, and you should know I'm a huge fan. I, of course, followed you from afar. I was this young economist and always learned a lot from, as you said, your thematic view of the world. It was really very important to provide that kind of context as to what was going on in the broader economy. So I've always been a big fan and I'm very appreciative that you, again, decided to come here and talk with us. Hey, before-
Steve Roach: Thank you for your kind words.
Mark Zandi: Oh, but before we dive into China, I got to ask you, turning to the US because I know you're... and I'm going to force you to forecast a little bit, but where do you stand on US recession? I mean, that has been top of mind now for the better part of the year, ever since the Fed started jacking up interest rates here. And historically, obviously when you have high inflation and the Fed on the war path, you end up in recession. So it's understandable, but what's your thinking, current thinking about the US economy and recession prospects?
Steve Roach: Well, you started out by making note of a piece I wrote, I don't know, a year and a half ago called My Worst Forecasting Error Ever. And that's when I was dumb enough to go put my forecasting hat back on for the US, which I had stuffed in a closet somewhere, and argue that coming out of COVID we were going to lapse back into a double dip. Obviously we did not do that. And that was just a reminder of the impossibility of sometimes forecasting these off the wall, low probability aberrations. I had actually written a fair amount about double dips back when I was a US forecaster and got a few of those calls right, and thought I was still smart enough to pull it off again. And I was not.
It is a long way of answering your question is, I don't know if we're going to go into recession or not. I am convinced that the lags of monetary policy long and variables, they are certainly going to take a toll on economic growth. Whether that culminates in outright recession or just a growth recession where the growth rate stays below potential for long enough to drive the unemployment rate up, it's hard to say at this point. I do feel strongly that the Fed has a long way to go in keeping the policy rate at this elevated level. Whether or not they do another tightening or two, as Jay Powell indicated yesterday, that remains to be seen. I don't think it really matters if the funds rate peaks at 5% or five and a half percent. But I think it's important to note that only in the month of May did the nominal federal funds rate go above the year on year headline CPI inflation rate.
I mean, we've had maybe two months now, if you want to throw in June, where monetary policy can be described as restrictive. And I just want to remind you, not you, but your viewers because you know all this stuff, that the real federal funds rate, fed funds less headline CPI, the average of it since 1960 has been a positive 1%. So we're just sort of getting back to average. And if you believe that the Fed needs to be restrictive for a while to make certain that inflation is not going to rear its ugly head again, then you probably ought to have a view that real federal funds rate has got to be higher than average for a fairly lengthy period of time. And we're just now entering that zone for the first time in... I mean, I think I looked at the numbers. First time in 44, 45 months. So long way to go, and we'll see how those lags kick in.
Mark Zandi: Yeah, you don't want to tell us one way or the other. Chris, it sounds bearish to me. I don't know.
Cris deRitis: That's what I heard.
Mark Zandi: That's what Chris has heard. You too, Marissa?
Marisa DiNatale: Yeah, I heard him describing a slow session.
Mark Zandi: Oh, oh really? Okay.
Marisa DiNatale: Yeah.
Steve Roach: Slow session. Growth Recession.
Marisa DiNatale: Growth recession.
Steve Roach: Growth recession, yeah.
Mark Zandi: Well, Marissa's a referring to a term that Chris coined, the slow session. Actually he bought the URL. It's a, no recession, but an economy that's not going anywhere fast for a while. It sounds like that.
Steve Roach: Yeah, it's sort of a gutless answer to your important question.
Mark Zandi: Not at all. Although just to say, Steve, when you sent me that piece, and you have this illustrious career, over four decades, so many predictions of what's going to happen and forecast and that was your worst, I'm going, "Boy, that wasn't really that bad," because how could you have figured out that we were going to get the massive policy response that we did, right? Both on the monetary side but also on the fiscal side because we got that huge American rescue plan, 2 trillion deficit financed, and that kind of... I think you were right. If we didn't get something like that, we might have ended up in recession at that point.
Steve Roach: Who knows? I mean, it was a good title, so it got a fair amount of attention. And I argue in that piece that as wrong as I was on the outcome, I made the mistake what I think were for the right reasons, and many of those you just alluded to.
Mark Zandi: So let's turn to China and real time. The Chinese economy, a lot of hope that it would kind of take off here this year as it ended it's no COVID policy at the end of last year coming into this. And it feels like there's been recovery, but it's been disappointing. And today's June 15th for the listener, because we're going to play this in a couple weeks. I think if I read the headlines correctly, I haven't had a chance to look, the Chinese cut interest rates overnight in an effort to try to stimulate the economy. So obviously the Chinese authorities are not happy with the way things are going. Steve, how would you characterize the Chinese economic recovery at this point? What's going on there?
Steve Roach: Yeah, it's disappointing and I think this is a surprise. I mean, if what we and most large economies learn is when you lock down your economy for understandable reasons, even if your policies are sort of screwed up as they were in China with this zero COVID policy, once you end the lockdowns and you do any semblance of reopening, it's a sure thing that you're going to have a snack back to some degree. And that was evident for a few months, January, February, and March. And then things were really petered out in April and May, and the second quarter on a sequential basis, if I look at my old Morgan Stanley team. The sequential growth for the second quarter is a number close to zero. And they're moving, I think pretty aggressively to provide some stimulus to housing and infrastructure, which is an old playbook they've used repeatedly over the years in China.
And they I think are frustrated that the turnaround and improvement in sentiment that they expected would occur once they ended zero COVID, just didn't catch, and in particular the consumer where sentiment is adversely affected by a number of things, not the least of which is a youth unemployment rate. And those in the 16- to 24-year-old population cohort is like 21%. And they had a lot of people graduating college this summer. And the risk is that number's going to go higher. And that's a real red flag for a nation that has always been so focused on social stability and providing opportunities for the younger generation.
So they're going to move aggressively on policy. It may provide some impetus for the second half of this year, but my concerns about China are really more fundamental than that. And I worry that it's not just the conflict with the US, it's not just the problems with some of the regulatory changes they've made, but they've got some big longer term growth issues underscored by the twin pressures of demography and weakness in underlying productivity. And that's sort of a Japanese like problem that has up until recently really hobbled Japan for decades, and could prove far more problematic for China than they ever thought.
Mark Zandi: Yeah, I want to explore that in a lot more detail. But one more thing before we move on, because I generally think of what's going on in China through the prism of what it means for the rest of the world an the US. And I'm a little confused there. Obviously a weak Chinese economy means less global trade and perhaps foreign direct investment, but it also has kept commodity prices down, particularly oil prices down. And oil has been so central to pushing US economies into recession.
I mean, I don't think I'm exaggerating. I think we've had a dozen recessions since World War II. Every single one of them has been preceded by a spike in oil prices. We're less dependent than we were in the past, but we're still dependent. And the fact that China's been struggling here a bit and not consuming a lot of oil has kept oil prices down. And that's been helpful. So when you add this all up, what do you think, is this a good thing, a bad thing that the Chinese economy is struggling here at this point in time, for the US and European economies?
Steve Roach: Well, looking aside from some of the geopolitical issues, which we can come back to if you want, I think it's generally a bad thing for the world. China, since the global financial crisis, accounted for about a third of cumulative growth in the world GDP. So that one third is not going to zero, but it's going to a number now significantly below that.
Another way to look at this is, the five-year moving average of the Chinese GDP growth rate peaked at 11.7% I believe, in 2007. And this year it's below five. So a big engine of the world economy is, I won't say it's sputtering, but it's certainly slowing down enough to worry about a stalling out. And I look at the IMF's five-year forecast for global GDP starting in 2024, the number is, for five years going out is 3%.
Now that may not sound like a big deal, but it turns out that's the weakest five-year ahead forecast for global growth the IMF has had in about 25 years. The trend growth in the global economy is about three and a half percent because world economy is a big place, 200 countries, some grow rapidly, some grow less rapidly. But relative to a three and a half percent trend for the broad constellation of economies in the world, the prognosis is lousy. And I think that China, the slowdown in China accounts for a huge portion of that weak prognosis.
And the final thing I'd say is, when you have global growth and Chinese growth as slow as it appears to be likely over the next several years, you don't have the resilience, that you don't have the cushion that you might normally have to withstand the blow of a shock. We always have shocks, and that's why I worry about us stalling out here. If you have a shock at a slow growth rate, you could tip into outright recession for the global economy or even for China.
Mark Zandi: Yeah, totally. I guess in the current environment where everybody's trying to get inflation back in, except in China where inflation isn't the issue, but everywhere else maybe it's not such a bad thing that... If the China was rip roaring right now and the global economy was feasting on that, that might be a real problem for monetary policy and interest rates, again in the current context. But.
Steve Roach: Yeah, I think that's, a major source of global growth is significantly impaired. And that is not a concern for inflation fighting central banks in our country or elsewhere around the world. They got plenty of other problems on their hands, like a record low in the unemployment rate, but certainly not getting of overheating from a segment of the global economy that had been really white hot for a long, long time.
Mark Zandi: Yeah. Let's turn to the longer term forces or trends that you were just talking about, and I thought I'd do it in from this prism. One point of contact that we have is we're both on the National Committee of US-China relations. And that's the, for folks out there, that's the same group that I think helped sponsor the ping pong tournament back in the day. And a lot of illustrious folks been on that committee over the years. Certainly not including me, but folks like Stephen. And it's a cool group because it got a lot of different folks, both Chinese and US.
And when I first joined, and this was before things went south for China in a big way, and some of the concerns. You were a pretty strong what I would call China Bull. You were very optimistic about China's growth prospects and future. And we have another fellow that we've had on the podcast before, Dan Rosen of Rhodium Group who's a screaming China bear, I mean about, a very bearish guy. And you guys would go at it, and I'd love that. I wish I could had that as a podcast. You two, you'd always go at it. It was great. And everyone just stood back and listened to this. But more recently you've turned, and I hope I've got this right, you are something of a bear now. Do I have that roughly right?
Steve Roach: Yeah. About a year ago I did write a piece. I write regular pieces for this Project Syndicate group, and I wrote something I think in December of '20... When was it? I was going to say 2022, but it was longer ago than that. But anyway, I was bemoaning the once optimistic view that I had held of China. And I spoke about it from this prism of the Japanese experience of the twin forces of demographic headwinds and productivity problems. But then I added in the US China conflict and then this mega shift back to an ideologically centric central planning model that revolves around Xi Jinping and his autocratic leadership. And I said that China's now in a vise, and it's hard to envision a scenario that unleashes the powerful growth that we had gotten accustomed to in China for 35 to 40 years.
Mark Zandi: So there's a long list of, it feels like a long list of worries about China, China and its longer term growth prospects. You've mentioned a few already, demographics, the aging of the population. You mentioned the autocratic shift in the way China has governed, mentioned the property markets. If you had a rank order, what would be at the top of your list of concerns? Or is that even fair to do? Is it just a melange of things that we should be worried about here?
Steve Roach: Well, the anchor to it I think is the decline of the working age population. The working age population in China peaked in, I think it was 2016. And we knew this was coming because of the unsustainable one child family planning policy. And so we know from just simple growth accounting, then when you lose your working age population, the only way you can sustain high growth is to increase the growth rate of productivity. So we look to productivity as the offset. And for developing an economy like China, there are lots of reasons to think that they could pull it off 'cause they were going from an agrarian, poor society to more of a, initially manufacturing, eventually services based urban society, investing in human capital, smart people, hardworking people, dynamic new industries.
There was good reason to be optimistic that China had the wherewithal and the commitment to do what most aging societies have a very difficult time doing. And that is to put in place a model of accelerating productivity growth. And then one by one the reasons to believe that have sort of, I think been undermined by actions that they have taken, sort of own goals of their policymakers.
The first one came early on when Xi Jinping took over and decided to provide huge support for state owned enterprises. State owned enterprises are big behemoths that straddle major sectors of the Chinese economy. And all the research that has been done on state owned enterprises tell you that they're largely ossified bureaucracies that generate low productivity, low returns, and that would really be a significant force in hobbling the productivity story.
That was bad enough. The second thing they did that I think has more of a prospective problem for productivity, was they went after the private sector, especially the internet companies that had been so dynamic in leading China down the road of a innovative, vibrant society that would not only boost overall productivity but would provide employment opportunities for their young people.
And of course couple that with the point I just made on soaring youth unemployment, you can see that the regulatory pressures they have put on the sector now for now nearly three years have raised a real red flag with respect to youth employment and the dynamism that a large economy like China needs to sustain innovation and again, provide another important source of productivity growth that an aging society needs. So those are two really tough developments that have come about largely I think through policy mistakes that they have made, that they seem unwilling to really reverse.
Mark Zandi: What also, and you've alluded to this and mentioned it a couple times, is the shift in the political economy of China? Do you think, is it fair to say that it has moved in an autocratic direction and that is a problem in terms of longer term economic growth? Is that fair to say?
Steve Roach: Well, that's certainly the conclusion that I've come to. It's highly debatable and they would take the other side of that of course. But you got to look at the long history of how China's pulled it off. The economy was on the brink of failure after the cultural revolution ended with the death of Mao in 1976. And so after a post Mao power struggle under the guidance of, leadership of Deng Xiaoping, they moved to a more market based opening up of the economy and drawing heavily on investment and exports. The state still had a lot of control, but it was a trajectory that was driven by reforms and opening up.
And so it was largely for that reason that many, and this is where I got my optimism from, became super bullish on the upside of Chinese economic growth. The pivotal point for me, Mark, came in 2007 right before the global financial crisis. A former premier of China by the name of Wen Jiabaoo, a guy who I actually got to know pretty well. He said in March of 2007 that, and I'm sort of paraphrasing this, he's saying something like, "Don't be fooled. Our economy looks strong on the surface, but beneath the surface it's unstable, unbalanced, uncoordinated, and ultimately unsustainable."
And a big debate then ensued about how to respond to this criticism that the premier was making. And out of that debate emerged a decision to rebalance the economy away from investment and exports and manufacturing, toward internal private consumption and services. And I became even more optimistic then because this was a model that was, turned out to be flexible, and the leaders were willing to stay the course, make a big bet and change the model to stay the course of rapid growth and development until Xi Jinping came along.
And in late 2012 when he first took office as the general secretary of the Communist Party of China, a few months later became the president, which he has remained in both capacities since then. And it looks like he's going to stay there for a long time to come. The shift toward reforms and opening up has really backtracked, and Xi Jinping has asserted power in all major aspects of economic decision making and has made a lot of policy moves that run against the grain of the Deng Xiaoping model. And for those of us who were optimistic on China because of the power and the potential of the Deng Xiaoping model, this has been a major wake up call and a source of consternation and ultimately for me, a rethinking of the trajectory of China going forward.
Mark Zandi: Yeah, that makes a lot of sense. And I think it's one of the key reasons why companies are now, they're certainly not moving in to the same degree they were and many are now moving out quickly, not only China but Hong Kong and moving into Singapore, it's, I think...
Steve Roach: Well, I would take a little issue with that. I think multinationals are not wedded to ideology. They're wedded to the bottom line. And they can hold their nose if ideology runs against the grain of their own sentiment. I think the big rethink for multinationals has arisen from this major conflict between the US and China that raises long-term questions about the desire on the part of the US and its allies now to put in place very tough policies that end up containing China.
And in the last five years, initially under the Trump administration, but surprisingly continued under the Biden administration, we've gone from a trade war to a tech war to now a new Cold War. And this is what I wrote about in my latest book. And the premise of this conflict, I've argued is largely based on a lot of false impressions or false narratives that we hold about China and that China holds about us, but they're politically expedient for us to embrace. And they've taken us into a pretty dangerous place in terms of this conflict that I think have got a lot of multinationals who were once committed steadfastly to China as an offshoring solution or as a market to be tapped, are really rethinking their strategies toward China.
Mark Zandi: Yeah, I agree with you. Multinationals can hold their nose. It's when the property rights are questioned and when people were there and then are not there, or they knock on the door and you don't know what that means for your business. I think that's what has got people, multinationals a little bit of angst, or a fair amount of angst I'd say at this point. But before I move on to the US China relationship, I'm going to stop for one second and I'm going to turn to Chris and Marissa. Anything, and we are going to talk about US China next, anything that I should have brought up that I didn't, that you guys would like to ask? Anything at all? You don't need to. I'm just asking if I missed something.
Cris deRitis: Yeah, I think this is where you're probably going anyway, but given this backdrop, which sounds quite pessimistic, how does this resolve? What do you think is the path forward here for China's economy and for the relationship, but- [inaudible 00:40:06]
Steve Roach: I've got a good answer for the relationship, but maybe I'll hold off till we get into that in more detail. But since you guys don't have a question you want to add, I've been dying to ask Mark a question based on the piece that I wrote about my worst forecasting mistake. How about- [inaudible 00:40:34]
Mark Zandi: Oh, no. You're not going to do that to me.
Steve Roach: Yeah, I mean it's only fair, right?
Mark Zandi: Yeah, no, no, it's fair. I've got this kind of mental bias. I only remember the things I got right. I kind of forgot the things that I got wrong. Let me think about that as we can move on and I'll come back with an answer, but I don't have a really good one right at the top of my mind, which is bad, but I should. But let me, let's turn back to you US China for a second. And by the way, I will answer your question, Steve. I just have to give that three seconds- [inaudible 00:41:09].
Steve Roach: Don't worry.
Mark Zandi: I have plenty. The problem is-
Marisa DiNatale: ... change the subject.
Mark Zandi: The problem, I've got so many areas-
Steve Roach: No, my answers are long enough, you'll have the answer- [inaudible 00:41:17].
Mark Zandi: I'm not sure which one to pick. But here I want to, going back to your book and the title of the book that the false narratives, the accidental conflict around false narratives. I want to just take two minutes and tell you my narrative and you tell me if I've got, if I'm falling into the trap.
So my sense is that the relationship with China entered into the modern times with its entry into the World Trade Organization in 2001. And the idea was, let China come in and hopefully flourish, and they did as global trade expanded and investment in China increased. And yeah, China may not be playing exactly by the rules and flouting them here or there, but no big deal. They're still small country. And over time, the thinking is that once they saw the benefits of a free and fair global trade and investment in property rights and everything else, that they would evolve into a market economy that mimicked the US and others. And this would be good for everybody, a win-win, at least in a macroeconomic sense.
We came up to Obama. In Obama, and now we're 10, 15 years in. Clearly there's been some losers in all of this, the US manufacturing base. And it doesn't look like China's coming on board to the degree that was hoped for in terms of playing by the rules. So Obama's idea was, "Okay, let's have the Trans-Pacific partnership, free trade deal, Pacific Rim nations can't, China can't enter until they play by the rules." So you know, get a carrot approach.
Of course Trump, that TPP kind of sort almost got up to the finish line, didn't quite get across. Obama left and Trump came in. Trump said, "That doesn't make any sense to me." Blew it up pretty immediate, pretty quickly through some... It might've been in his first executive order, I don't know, maybe a second. And said, "We're not doing that." And then proceeded to go down the trade war path. And since then we've been at each other's throat, and it becomes self-reinforcing at this point.
So we're now pulling away at a very rapid pace. We are decoupling. And the global economy, which was clearly globalizing, more integrated from 2000 to Trump, is now moving in the other direction. And it doesn't look good because this isn't going to change anytime soon. Because if there's one thing that Republicans and Democrats can agree on, it's they don't like China. It doesn't matter who you are, we don't like China. And so we're not, there's no way to put this thing back in the bottle, we're moving apart. And we're going to have to learn to live with that and all the ramifications of that. Okay, I'm going to stop right there. Did I get that? Is that one of the false narratives?
Steve Roach: Yeah, you nailed it. Mark, you did a really good job.
Mark Zandi: I knew it. I knew it.
Steve Roach: I think you've done a very accurate job of describing the Washington narrative with respect to China. I think that is the view. The one thing you left out is the intellectual framework that the Obama administration embraced to formulate the Trans-Pacific partnership. This is the so-called Asian pivot where Obama had this view, and it was actually developed by Kurt Campbell, who's now his primary Asian point person for the Biden administration. But back in the Obama administration, Kurt Campbell was fairly high up in the State Department under Hillary Clinton.
The idea was that we were moving to a point where we were going to be done with our adventures in the Middle East, and we need to get back to focusing on Asia. And this really did, I think, set the framework for a China containment strategy that the Obama, President Obama and Kirk Campbell to this day deny. But the actions speak louder than words.
The reason this is a false narrative is for some of the points that you alluded to, that the Washington view has long thought that the trade deficit that the US has is the enemy of the manufacturing sector, blue collar workers, American communities, and China's the culprit behind the carnage that has occurred in the manufacturing sector. Never mind, by the way, this was the same argument that was utilized not nearly as vehemently, but very strenuously at the time against Japan in the late 1980s. And what I argue in the book is that this is a false narrative because it really doesn't give due appreciation to the fact that the trade deficit in the United States is not a bilateral problem between two nations like US Japan in the '80s and US China right now. But it's a multilateral problem reflecting our shortfall of domestic savings.
When countries don't save and they want to invest and grow, they have to run a balance of payments to deficit to import the surplus saving to close the circle. And when we do that, we run deficits with many, many countries, hence the name multilateral trade deficit. Last year we had trade deficits, Mark, on 106 different countries. China was the biggest, but the share had come down a lot because of Trump's tariffs. But the Chinese share, although it shrank,, that shrinkage just was diverted to other higher cost countries that ended up putting taxes on American companies and consumers. We blamed China just like we blamed Japan because we are unable or unwilling to boost our overall rate of domestic savings, which today is... I think it, and I haven't checked in a while. The last number I saw was net domestic savings, and taking out depreciation, which is a correct way to look at, was less than 1.5% of overall national income.
And for a leading nation in the world, that is really unacceptable. And it is largely driven by our budget deficits, but it's also driven by shortfalls of personal saving, which if you strip out the windfalls due to COVID assistance, remains sharply below historic norms for American households. And until we can get our savings rate back up, we're going to have trade deficits in perpetuity. And our politicians are not going to want to look in the mirror and say, "God, look at what we have done with these budget deficits. Let's blame them on Japan in the 1980s and China today." And that I think is a classic false narrative that I devote a full chapter to in my book called Bilateral Bluster. It works for Washington, but it really doesn't square the circle from a macroeconomic point of view, in my opinion.
And finally, just one other aspect of your narrative that I find, again, very accurate in terms of describing the Washington sentiment but not accurate in terms of what is embedded in China's WTO accession protocols. China, after a lengthy negotiation, was admitted to the WTO in late 2001. I've read those protocols so many times. They're technical. There were a lot of things that China agreed to that they have complied with. There are a number of things where the compliance has certainly been disputed, and there are probably some areas where they have just not compliant at all.
But in nowhere in those protocols did China say, "Okay, we're going to join and we are going to become more like you." The idea that signed up for WTO on the provision that they would become more like us is something, is wishful thinking at best. China's always been, I think very focused on maintaining its own system with its own values, its own characteristics as they like to call it, and felt they were always well within their right to maintain their strong sense of an independent approach to governance and economic organization. And I think they take enormous exception, understandably so I might add, to a US-centric view that says that you've broken a promise to become more like us. That was never a promise that the Chinese made, nor would they have been expected to have made in signing up to join the WTO.
Mark Zandi: Yeah, no, I think you're right. That's probably wishful thinking. I'm sure that's what people thought, but there was, yeah, I agree. There was no reason to actually believe that. It certainly wasn't codified in the WTO. But what about intellectual property, or cyber, or the ability to own assets and businesses within China, to reciprocate with regard to that FDI. You know, those other points of contention.
Steve Roach: All those are fair points and many of them are contentious. The idea of reciprocity is very important and that's one of the key premises on WTO accession that has been under dispute for a number of years, especially the subsidies that China directs to its state-owned enterprises are at odds with the reciprocal agreement that we felt is appropriate in injecting subsidies into our own system. Although of course we have now moved aggressively to subsidize a number of industries during crises as well as in dealing with global competition. The Biden administration has moved full force into the industrial policy the Trump administration was so critical of China for embracing for years. So we have to be, I think, a little bit more circumspect in substantiating that criticism.
On the cyber area. I think there's clearly major issues between us and China. We are, I think, both in a quagmire with respect to the cyber hacking that occurs, the listening that occurs. There's a big dispute now over surveillance, offshore surveillance from a Cuban listening post. And yet as you read, as the story unfolds, you recognize and you read about all the listening posts that we have that are pretty close to China as well. Satellite surveillance is something that both nations practice.
The intellectual property rights is a very thorny and very important issue. And again, I have a chapter on that in my latest book. And I won't bore you with all the details, but the evidence that we have assembled to provide quote hard estimates of intellectual property theft coming out of China, are not worth the paper they are printed on. And they're based on a series of very dubious studies that were wrapped up in a slick cover by something called the IP Commission, headed up by two illustrious Americans. It gets cited all the time in congressional debates as hard evidence of the greatest theft of intellectual property in the history of humanity. And again, the reports are not worth the paper they are printed on.
Mark Zandi: I do want to talk about what we should do about this, but before I get there, one further, one final question before we get onto the policy prescriptions is, China, Taiwan, US. How worried should we be? I mean, we have a lot of clients in APAC that are very, very... Everyone's nervous about around the world, but particularly in APAC for good reason. They're very nervous about this and asking us to run different scenarios with regard to how that conflict may play out. How do you think about that and how big a deal is that?
Steve Roach: I think it's a big deal. I think I would certainly advise being worried about it and that your scenario, contingency exercises that you go through are important to inform your multinational clients about the risk of this. I think if left to its own devices, China recognizes that while it certainly has long term aspirations of reunification with Taiwan, that to accelerate the reunification through forceful means would really be an unmitigated disaster, that the world would respond if not militarily, with really serious draconian type sanctions that would isolate China from the world at a time when it can't afford anything close to that right now. And that would be really a catastrophic development for China, for Asia, and for the world.
Why? So you would think that if that view is correct, and there are those who say it's not correct, Xi Jinping has already listed a date, which is not correct, of 2027 when he is going to make a move. I would challenge that view as being credible. Why worry about it if it's not going to happen? Well, the US Congress is putting enormous pressure on this trouble spot, pouring salt in the wound, if you want to call it that. Nancy Pelosi's visit to Taipei last August, Kevin McCarthy's meeting in April in California with the President of Taiwan. These are hugely contentious issues.
Joe Biden has said, I think three or four times that in the event of a Chinese military action in Taiwan that we would rush to their defense. And those comments have been quickly rolled back by the diplomatic staffers in the administration saying, "Oh, he didn't mean that. He really didn't, don't worry about it. We're still in favor of the one China policy. Nothing has changed."
Well, nothing has changed, but the political spin has changed a lot. And if we continue to put our foot on the throat of the Chinese with respect to Taiwan, the risk of an accident, hence the title accidental conflict, is something to take very seriously. So I worry about it a lot. And the Congress is, if anything, continuing to beat really hard on this issue and many other issues with respect to their political dissatisfaction with everything that China stands for.
Mark Zandi: So how far out on the tail is it, Steve? I know military conflict is one thing, but any kind of thing that boils over here that really results in sanctions and significant economic disruption, is it 1%, 5%, 10%, I mean just order... Where on the tail, do you think it is?
Steve Roach: If it's 1%, I wouldn't worry about it. I don't think it's as high as 25%, but somewhere in mid range of that zone, and it's therefore a higher number than I would like it to be if I were, you know running scenarios like you and would tell my clients, "Oh, don't worry about it, it's not a big deal." This is a big deal, it's worth worrying about. And I think we need a better approach to dealing with China on this and many other issues.
And as we speak right now, and you say this'll be broadcast in a few weeks, we'll know the outcome of the Secretary of State Blinken's visit to Beijing this coming weekend. I run the risk of being embarrassed again by saying something ahead of that that will be broadcast after the fact. But I'm not looking for a major breakthrough here. I think there's just a lot of bad blood right now that is not going to be resolved. It's a good thing he's going, but I don't think he's going with any secret agenda for conflict resolution.
Mark Zandi: So here we are. Obviously things are gone, if not off the rails... Yeah, I think that's fair to say. They're off the rails. How do we get the train back on the track? And I'm sure there's no smoking gun solution here. It's one step at a time, but how do you think about the path forward to get us back on the track?
Steve Roach: Well, I've written this book called Accidental Conflict, which is a pretty depressing book. And when I finished the draft of the book, I said, "I'm more depressed having written it than I was going into it." So I learned from all my years on Wall Street that identifying a problem is... You've got to do more than that. And so I went back and worked for another six months on a way out.
Mark Zandi: Oh, cool.
Steve Roach: And there are three legs to the stool for me to resolving this seemingly intractable conflict. The first one is really obvious, just rebuilding trust. There's no trust right now between the countries. And so I came up with a trust agenda with some little things, easy things, low hanging fruit. First, reopening closed consulates in both countries, restarting popular student foreign exchange programs like the Fulbright, making it easier to get visas. And then tougher things like relaxing constraints on non-governmental organizations, NGOs, to bring civil society, civic society back into the trust building framework. And then big existential issues like climate, global health and cybersecurity.
Presuming we can make some progress in some aspects of the trust agenda, two other things quickly, Mark. One focus on market opening initiatives to allow and encourage more cross border investment between the two countries. These are inherently pro-growth and they would need to be framed around successful conclusion of negotiations on a bilateral investment treaty. We were about 95% of the way done on that in 2016, and then Trump immediately took it off the table. And we need to go back, and to borrow Biden's sort of mantra, finish the job.
The third leg of the stool is the one that I'm most excited about and actually have the most invested in, having written about it extensively. And that is to create a new architecture of engagement between the two countries, framed around the establishment of a US China secretariat, a permanent organization located in a neutral venue, call it Switzerland, call it Singapore, that is staffed up by large compliments of US and Chinese professionals who are working full-time on all aspects of the relationship, economics and trade to technology and innovation, to the existential issues like cyber health and even human rights, I would add to that.
And this would be an organization that would, unlike the current sort of episodic dialogue driven efforts where Blinken goes to Beijing or Xi Jinping meets with Biden in Bali, the secretary would be doing this on a full-time basis 24-7, and really develop policy white papers, would have a convening function to bring experts in to solve difficult problems like COVID for example, which could have been resolved far better than it was back in 2020, and have a dispute resolution screening function so when issues come up between the two countries, they can be resolved without hyper escalation as we're seeing right now.
So that's my plan. Rebuild trust, lower investment barriers and come up with a new architecture for permanent engagement. And the odds of it being implemented right now are a number slightly larger than zero, but I'm more than willing to listen to any other plans. I think we're on the wrong path right now, and the risk of accidental conflict is high and rising.
Mark Zandi: I hear you. I hear you. And it's a wonderful future you laid out, and I think you'd make a fantastic leader of that institution. That would be, we need someone like you running the show.
Steve Roach: I'm too old for that. I'm looking for- [inaudible 01:07:37]
Mark Zandi: No, never, never. Hey, we're getting long in the tooth here. I don't want to keep you much longer. I do want to answer your question. My major forecast error, and I'm going to answer it this way. It's more about an error in forecast I think bias. You've heard the whole hedgehog versus the fox in terms of forecasting. I am definitely a hedgehog. I've got a worldview, I've got a model in my mind, I've honed it down to the detail, every detail. And I am reluctant to give that up even when I should.
And sometimes that serves me well. Oftentimes it gets me into some trouble. But I will say this, Steve, I'm getting older as well, and I have been out there very outspokenly saying that this time is different. And those are the very dreaded words in our economics profession, that we will be able to navigate through this period without an outright recession. And we'll see. I could go down inflamed here, and that could be my biggest forecast error, but I think it's just being a head hedgehog.
Can I ask Steve, finally, are you, because the national committee's going to be meeting in Beijing in October, are you going to be there? Are you going to go to that? Are you going to be able to go?
Steve Roach: I'm not sure. I may have a conflict, because I'm actually committed to going to speak in China, possibly in the same week. If it works, I would combine them and I would really like to go. I've really valued that dialogue over the years. I think the guys on the other side are really terrific. I've gotten to know them pretty well, and I think this is a great time to exchange views and hear what they have to say at a pivotal point, and for them to get a sense of what's going on in our side. So I hope that will work, but I just right now, don't know.
Mark Zandi: Well, I hope to see there. I think I'm going to be able, I got... The stars aligned. I was going to Asia anyway. I was supposed to be in Singapore and mid Asia and Japan and so forth and so on. So this, I think it's going to work.
Steve Roach: Yeah, that would be great. It's
Mark Zandi: I'm looking forward to it.
Steve Roach: Yeah, no, it's really worth doing. So I hope it can work for me too.
Mark Zandi: Good. I hope to see you there. And hey, Steve, thanks so much for coming on, and really appreciate the time and energy. And I do think your path forward is a very hopeful one, and hopefully we go down that path or something close to it in the future.
Steve Roach: Well, let's put it this way, Mark. We need a new path.
Mark Zandi: We need a new path.
Steve Roach: The path we're on is a bad path, and the framework that shapes the path is the one that I find most troubling. I don't think we have a really coherent, grand strategy of what we would like China to look like and what we would like our relationship with China to look like in sustaining our future. And I think we can do a much better job than we've done.
Mark Zandi: And to Chris and Marissa, I'm sorry guys, I locked you out. I mean, I had Steve all to myself-
Marisa DiNatale: That's okay.
Mark Zandi: I was very protective of that. But we have another podcast. I think we're going to tape it tomorrow for this weekend. And we got a lot to talk about, Fed, we'll play statistics game, a lot of things on in the economy to talk about. So we'll have an opportunity to do that. But with that, we're going to call this a podcast. Take care, everyone.