Listen: The Essential Podcast, Episode 105: A Conversation with Paul Gruenwald: Global Economic Trends and China's Role

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Nathan Hunt: This is the Essential Podcast from S&P Global. My name is Nathan Hunt. Periodically, here on the podcast, we like to back up and take the macro view. Usually, that involves bringing back friends of the podcast, Paul Gruenwald, for an interview. Paul is the Global Chief Economist for S&P Global Ratings, which means that his team's economic projections are important ingredients in our credit conditions reports, among other things.

That means that I'm not the only one who wants to hear Paul's thoughts on the direction of the global economy. Paul has recently returned from the World Economic Forum annual meetings in China, and he's a regular guest on CNBC, Yahoo Finance, and Bloomberg News. Paul, I'm thrilled you could fit the lowly Essential Podcast into your busy media calendar.

Paul Gruenwald: Well, it's great to be back, Nathan. It's my pleasure.

Nathan Hunt: Paul, I want to dive in first to these meetings you were attending in China for the World Economic Forum. What were your general impressions coming out of those meetings? How were people talking about the global macroeconomic picture and also specifically about the macroeconomic picture in China?

Paul Gruenwald: Yes. Well, first of all, Nathan, this was the China Davos. This is not the Davos, Davos. So it was a bit China heavy. And it's really kind of a mix of macro finance and then talking about the big transitions, the energy transition, the digital transition. I guess, the demographic transition as well. I think there was a fair amount of optimism about the global economy.

Inflation is under control. It looks like we're achieving the so-called soft landing. Economies have slowed enough to take out inflation, but not slowed enough to cause recessions and big dense in labor demand. So that looks kind of good so far. In terms of China, I went to a session by Li Qiang, the Premier, and he was talking about the challenges of China, the property market and trying to make sure that the property sector stays healthy, impact on local government finances, et cetera.

But China is committed to get its 5% GDP target this year. We've got a bit lower in our forecast, but also about China's rising role in the transition with the solar and the electric vehicle. So a lot of optimism around that as well.

Nathan Hunt: Excellent. I'm wondering, you spoke about demographics, the demographic transition, right? Obviously, particularly in the developed world, we have an aging population. I know you spoke on a panel related to demographics while you were at these meetings. What do you see as the macro impacts of these changing demographics?

Paul Gruenwald: Well, first of all, if an economy is aging, it's going to slow. I think Japan is case #1 for that. I said a couple of things in that panel that I was leading first, we have to maybe measure things a bit differently. So if you look at Japan, let's stick with Japan. GDP is the weakest in the OECD. But if we look at it per capita, it's in the upper half. And if we look at the people who are kind of actually in the workforce, it looks pretty good.

So we have to adjust things for the fact that folks are going to be retired, they're going to be maybe working part-time whatever. There's a lot of worry about health and retirement expenditures, which were kind of built on the assumption that the population would continue to grow. But I think this biggest issue, and this is one the World Economic Forum has been working on, is this kind of changing the view of the workforce and longevity, lifetime learning, multiple careers, maybe you gear down and take half of a job, mentorship, using the old folks and the labor force.

As we all become older, it started out as Japan then it was Europe, and now it's even spread to China and some of the Asian economies. We're going to have to figure out how to rejig our statistics and rejig the way we think about growth in order to stay healthy.

Nathan Hunt: One of the things that I wonder about whenever people talk about this demographic transition is that we hear a lot of talk about AI. And we hear a lot of talk about AI taking people's jobs. But isn't it also possible that AI could create a sort of a bridge of growth where, yes, people are dropping out of the economy, but maybe productivity increases as a result of AI. Can we consider AI engines almost like additional workforce participants?

Paul Gruenwald: Well, you nailed the debate, right? One side of the debate is like, "Oh my god, AI is going to take our jobs the disaster's coming." And the other one said, "Well, this is actually a pretty useful tool." Let's stick with demographics. People's smartphones can take the place of medical professionals in some ways, right?

It can measure heart rates. It can measure other things. It can empower nurse practitioners. So I mean that's just a straightforward application of the technology that's going to make health care easier. We know about all the sensors for methane and the energy transition and emissions, and we can use the technology for that. We can heat our homes and power our cities more efficiently.

So I think the trick is to put the technology in our service to improve productivity. And if we go down that road, then that's a positive road, particularly if the labor force is shrinking, and we're going to need some health from the technology to power our economies.

Nathan Hunt: Paul, I want to get further into this year that we have this year of many big elections. But the discussion about demographics makes me think specifically about the recent election in France. The party that came out of it with the most seats in parliament is a party that is committed as one of their sort of core planks to rolling back the change that Macron's party did that pushed back the retirement age.

So they're essentially saying, no, 64 is too old, let's go back to 62. How does that fit with what you are hearing in terms of the forum looking at perhaps having people work for longer?

Paul Gruenwald: Yes. Well, I think that particular policy proposal is going in the wrong direction, right? We have to figure out how to keep people economically active. If we want our pension systems and our health systems to be financially viable, we're going to have to stretch out the length that people are working and contributing. So that's just kind of arithmetic, right? We have to be able to face that challenge.

But I think it's also an opportunity, as we just discussed, to kind of rethink or reimagine the use of technology. What does it mean to be aging? There's a lot of kind of unpaid work, elder care, child care, mentoring. Maybe there's a way to bring that into the economy, some of the Scandinavian countries are experimenting with that.

So I think the big issue is we need to kind of reimagine a lot of the things we do because the demographic transition is a real thing. Fortunately, it's happening slowly. So it's not kind of a 3- to 6-month thing. We've got time, but we know it's coming, right? It's not something that should surprise us, but it's difficult sometimes with a short-term election cycle to plan these longer-term transitions. But that has to happen, right, to get viability that has to happen.

Nathan Hunt: I know you also participated in a discussion well at the forum meetings around supply chains. I think here in the United States and Western Europe, we hear a very specific story about supply chains and economic decoupling between the West and the East. I'm wondering what you were hearing in China about supply chains and decoupling.

Paul Gruenwald: Yes. Well, first, again, going back to Li Qiang's presentation to the forum, he was basically saying China wants to share its technology. China is committed to free trade. China wants to keep the supply chains flowing. So maybe in a way he has to say that, but that was the part of the speech that I think was very sort of precisely calibrated.

We did have some discussion, and there were some modules around decoupling. I think everyone's come to the view that at the margin that's happening. So some things produced in China now go through Vietnam and they have a made in Vietnam sticker on them or there's a lot of Chinese foreign direct investment into Mexico and some of the Chinese firms might set up shop in Mexico. So it will say made in Mexico, but it's really Chinese-owned.

So at the margin, some of these things are happening around the geopolitical pressures. But the reality, the fundamental reality that the U.S. and Chinese economies are very closely interlinked and there's a lot of Chinese value-added regardless of what the label says made in country X, there's a lot of Chinese value-added embedded in the trade between the 2 countries and decoupling that just doesn't look feasible.

There was another session with the premier where some of the big companies from the U.S. Coca-Cola was there. Exxon was there, making clear their long-term commitments to China. So yes, there's a lot of geopolitical tension. And yes, we've seen some reorganization of trade, but I don't think it's changed things fundamentally.

Nathan Hunt: When you think about things like the recent tariffs that the EU has proposed putting on electric vehicles coming from China. Do you believe that this is, in a sense, political theater? Or is there decoupling happening in some of these fast developing more growing industries?

Paul Gruenwald: Yes. Well, I think there's a concern -- well, first of all, China has leapfrogged and is at the frontier of electric vehicles as well as battery storage and other things I heard at the conference, but they're rolling out electric vehicles that are hypercompetitive. When you think about the energy transition, that's a good thing, right? We can go to electric vehicles faster.

The challenge is there's a lot of subsidies in those manufacturers. And when they export that to the rest of the world, there are huge competitiveness concerns. So these companies get free land or tax breaks or low interest loans. It's hard to roll that in. The European commission's come up with, I think, a 38% tariff or up to 38% tariff on Chinese electric vehicles, trying to kind of neutralize the effect of that.

We'll have to see if that can be a kind of work around. I think, personally, that approach at least is more in the spirit of open trade in the WTO. They're going to continue to trade, but they'll try to neutralize some of the subsidies, just banning things from going from country A to country B.

It doesn't seem to be a particularly productive approach. But I think this is going to be a key sector because not too long ago, remember, China was exporting really low-end stuff, textile, clothing, footwear, backpacks, and all of a sudden, they're making cutting-edge electric vehicles.

So a real test for the global trading system, whether we can find a way to maybe neutralize some of these subsidies that we all know are there and then continue to trade between countries. And let's be honest, get some of the benefits of these electric vehicles, we need them for the energy transition.

Nathan Hunt: Let's move away for a second from the meetings in China. I know your team releases regular sort of macroeconomic projections for different regions around the world. You're the Global Chief Economist, so I'm going to ask you for the global view. How do things look at this point? And where do you see things going for the global economy?

Paul Gruenwald: Well, we've been a little bit boring because we've had the same message for roughly the same year, 1.5 years, which is we continue to be surprised by the spending on services. We continue to be surprised by the strength of labor markets, and we continue to be surprised by the resulting demand pressures and inflation pressures.

So if you're going to tighten monetary policy settings to try to bring inflation back to 2, which is what all the major central banks are trying to do, that's not a bad combination because it's going to allow you to engineer a soft landing. The fear is that the bottom falls out of the labor market, the bottom falls out of consumer spending and you get a recession.

But we continue to be surprised by spending, particularly in the U.S. The U.S. is outperforming the rest of the world by a wide margin. But in Europe, they've already had their marginal slowdown. They had a manufacturing recession. They're coming out of it. So all the major central banks, Fed, Bank of England, European Central Bank, Bank of Canada, Reserve Bank of Australia, they're all fighting the same battle.

We've started to see the cuts now. We got cuts from the Bank of Canada and the European Central Bank last month. Now we're going to start what we think is going to be a very slow kind of measured easing cycle, maybe 25 basis points every quarter. None of this rise by 50, 75, even 100 in the case of Canada, but it's going to be very gradual, very spaced out, maybe a little bit unsynchronized, Fed's going later.

But that's what a soft landing is, very steady reductions in the rate while you're keeping your demand side of the economy pretty solid. Unemployment is low everywhere. So that's the recipe for a soft landing.

Nathan Hunt: Let's talk about the central banks. If you had to give grades to the various central banks in their performance coming out of the pandemic, right? So let's say, 2022, to the present, what kind of grades would you give the various banks in terms of how they have responded to the challenges?

Paul Gruenwald: Well, I think everybody missed the initial inflation boost or burst, right? So remember the big debate a couple of years ago, team transitory versus team persisting. I think we know that one. The other way to look at it is central banks kind of score themselves. They have these things called loss functions.

So how far are you deviating from your inflation target? If your inflation target's 2 and inflation jumped to 8 or 9, you're not going to get a very good score, right? So I don't think any of the central banks passed that. And I think there's a case to revisit how they were sort of measuring and looking at inflation back then. With the wisdom of 2020 hindsight, of course, we can all say, well, they blew it, right?

But I think since then, first of all, central banks responded very quickly. They weren't timid about raising rates. They raised rates faster and higher than anyone thought. We didn't know about the strength of the labor market, but I think the so-called damage to the economy because of high rates has been pretty modest. So I think the second half of the story has been better than the first half of the story.

If we can engineer the soft landing, and this hasn't happened since the mid-'90s, that's the last time we had a so-called soft landing. That's not a bad ending this episode that, quite frankly, didn't begin very well. But I think we're all on guard now.

We know that inflation hasn't been permanently slate. And if you put too much juice into the economy and demand picks up, you're going to get inflation. I think we all relearned that. Maybe we forgot because it hadn't happened, says whatever, 2005, '06 before the crisis.

Nathan Hunt: So there is a lot of talk, particularly in financial markets about when are interest rates coming down? The interest rates are certainly higher than they were before the pandemic, but they aren't in some sort of absolute historical sense, all that high. Do you think the Fed is actually motivated to reduce rates that much? I mean, are we going to go back to what is essentially a 0% interest rate?

Paul Gruenwald: I don't think so. I think we're going to look back economic and financial historians are going to look back at that period between the global financial crisis and COVID as basically an anomaly, right? Interest rates, policy rates were close to 0. Real rates were close to 0. And it was a combination of the big hits of demand from the global financial crisis and China coming on to global supply chains, which was a big disinflationary force.

That force has been spent. We're coming out of COVID now with a lot more government spending. We're looking a little bit like the 1990s, which was not a bad decade, right? The 10-year treasury was kind of 4.5% to 5%. Inflation was 2% to 3%. Growth was high. Productivity was high. We had the tech boom. So that wasn't necessarily a bad thing.

As you said, we've got this kind of mini generation that's been used to a very low interest rates. And I think we're going to go back to normal. That's good for savers, by the way, right, because you're getting a higher return on your savings, it's just bad for borrowers, and we're going to have to I think adjust to a new reality.

When the Fed is done with this cycle, we're not going back to 2019 where things -- they're going to finish just under 3, which means if the inflation target is to the so-called real rate, subtract the policy rate minus 2%. Real rates are going to be higher. We think that structural is going to be around for a while.

Nathan Hunt: I'm wondering if, from the outside, from an uninformed perspective, it looks like what central banks would be tempted to do is keep interest rates a little bit higher, but keep the economy chugging along because that gives them, you could say some dry powder, right?

They have this ability to respond to an economic downturn, whereas when we were at 0, we had actually little ability to respond to an economic downturn. Is that consistent? Is that true? Is that the way central bankers look at these things?

Paul Gruenwald: Well, you do hear that discussion sometimes about policy space. And you're absolutely right, when we hit the 0 lower bound, and we still needed to stimulate the economy and fiscal wasn't doing anything, that's when we started QE and Central Bank started buying medium-term notes. And then that's kind of a distortion, right?

You've got the Central Bank and the treasury or the government market, and we're still kind of grappling with that. But yes, well, the ultimate goal is to have low and stable prices. So we're trying to put the economy on a path where you've got 2% inflation, inflation expectations are anchored at 2. So everyone believes the Central Bank, and you've got something that resembles full employment, and that's job #1.

If that leaves you with policy space, and you've got a couple of hundred basis points to cut rates, if something bad happens, then all the better. But the real objective is not the space. It's putting an economy on that path of low and stable prices and full employment.

Nathan Hunt: I had spoken earlier about it being an election year. We see there have been recent elections in France, in the U.K., in India. We have a small election coming up in the United States this year. What is your sense from a macroeconomic perspective? Do these elections matter in terms of macroeconomic outcomes? Or is the economy in some way sort of inured to partisan conflict?

Paul Gruenwald: Well, the government doesn't control the economy. So the economy is partially inured. But let's stay with the U.S., if you look at the 2 main candidates and you're trying to tease out some policy differences that could move the macro needle. Both candidates seem to like industrial policy or a bigger role for the government. Both candidates seem to not like China. So tariffs are around to stay.

Neither candidate seems too keen on fiscal discipline in the U.S. and bringing the government under control. So there may be other differences, but the things that would kind of move the macro needle aren't obviously different between the 2. If we're talking about something more structural, let's say, taking away the independence of the central bank and making them the de facto cash machine for the government, then you'd have some concerns about inflationary bias in the system, whatever.

But we don't have the official policy platforms yet of the major parties in the U.S. But for the big stuff, the role of government, the role of trade, the deficit, it doesn't seem like those differences are big enough to really move the needle for us so far. So we don't have a big distinction right now between whether it's a Biden or a Trump win in November in terms of the macro view.

Nathan Hunt: What about in India? Because what we saw in India was Modi called an election. His party obviously came out ahead in that, but it was less of the overwhelming victory than we expected. Do you see any moderation in the projected growth of India as a result of a certain amount of political disunity?

Paul Gruenwald: Yes. Well, I think there's a little bit of a surprise, right? Because people were thinking the BJP would keep its pure majority and now it has to make nice with some of the smaller parties to keep its majority. But we think India continues to be the best growth story amongst the major economies. So the economy has opened up a lot. They've got the labor market reform. They've got the reform of government services.

They're trying to do top to bottom technology from the low end -- or sorry, services from the low end to the high end. They're not going to supplant China as the global manufacturing hub. But the combination of a good public investment program, some surprisingly good and welcome private investment and there's boom around tech, et cetera.

And given the fact that they've got a lot of runway to catch up, we think they're probably 6.5% to 7% growth story kind of over the medium term. And if you do that for a couple of decades, that's a recipe for catching up.

Nathan Hunt: Paul, every time I talk to you, I try for a kind of a gotcha question, where I attempt to nail you down on what the Fed is going to do next. Your team has been projecting an expected rate reduction. Do you think that the Fed will preemptively lower rates in anticipation of a slowdown? Or is this Fed likely to wait for actual evidence of some kind of economic slowdown before reducing rates?

Paul Gruenwald: Right. Well, if you wait for the slowdown, then you're too late, right? Just so when you wait for the evidence of inflation to rise a couple of years ago, you're too late. So what you want to do is as you see the economy slowing, you start to take out the tightness you put in through your rate rises.

So you don't wait for inflation to get down to 2 and say, oh, now I can start cutting rates from 5.25, right? That's too late. So you've got to sort of guide the economy down to where you want to the extent that's possible for a central bank. So Palo's been pretty clear, right? And the Fed's been pretty clear, when they get a good series of numbers, good means that the economy slowed a bit below potential of 2 inflation pressures, looks like they're under control, then they're going to start to lower rates.

Earlier this year, we got nervous because the inflation numbers actually started to tick up. So all those rate cuts that the market baked in, I think there were 6 or 7 rate cuts at one point were taken off the table immediately. Now we've had 1 or 2 good data points and maybe the Fed can go a little bit earlier, the Fed forward curve sort of leaning now towards September rather than December.

But if we continue this data stream where we have a slowdown in inflation and a moderation of growth, the Fed could go earlier. We're still sticking with our baseline of December. But if we think it's time to move that, we will move it.

Nathan Hunt: Paul, one final question. As you are aware, I am from Canada. And so I think it is important that we stop talking about a fairly relevant economy like that of the United States and focus on the Canadian economy. I know your team has been looking at the direction of the Canadian economy, and for our many Canadian listeners, I am hoping you can give me some information about where things are going in the next year.

Paul Gruenwald: Yes. Well, remember, we had these sharp rate rises and then everyone was very resilient, and we were kind of waiting for the economies to start to crack a little bit. And I think the Canadian economy has slowed down much more than the U.S. in recent months. So the U.S. has slowed a little bit, but Canada started to slow more sharply. So we've already had the rate cut.

They actually cut rates the day before the ECB. So they were the first major central bank to cut. Sequentially, it looks like growth is closer to 0 than in the U.S. So that's a recipe for Canada maybe to go a bit faster. So we still stick to this view that the U.S. is going to outperform and the Fed is going to be higher for longer.

So that's a strong dollar world. So I think where this comes out for Canada is growth is going to slow a bit faster than the U.S., rates are going to come down a bit faster and the currency is going to be a bit weaker. That's kind of the recipe for Canada over the next couple of years. But once we get inflation under control and back to neutral-ish, 3-ish for the policy rate, then that's the landing scenario for Canada.

Nathan Hunt: Paul, thank you so much for joining me on the podcast again, and I look forward to having you back shortly.

Paul Gruenwald: Always a pleasure, Nathan. Take care.

Nathan Hunt: The Essential Podcast is produced by Patrick Moroney. At S&P Global, we accelerate progress in the world by providing intelligence that is essential for companies, governments and individuals to make decisions with conviction. From the majestic heights of 55 Water Street in Manhattan, I am Nathan Hunt. Thank you for listening.

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