The Munk Debates Podcast - Friday Focus: Truss Tumble – Xi Ascendant

Episode Date: October 14, 2022

Friday Focus provides listeners with a focused, half-hour masterclass on the big issues, events and trends driving the news and current events. The show features Janice Gross Stein, the founding director of the Munk School of Global Affairs and bestselling author, in conversation with Rudyard Griffiths, Chair and moderator of the Munk Debates. The following is a sample of the Munk Debates’ weekly current affairs podcast, Friday Focus. The free portion of the program sees Janice and Rudyard discuss this week’s financial news, from hot inflation in the US to the Truss government’s humiliating walk back of its economic agenda in the face of crisis in the UK bond market. Now that Britain has demonstrated that borrowing a lot of money at a time of inflation and rising rates is not an option, what does this mean for Canada and our free-spending governments? The donors-only second half of the show features a discussion of China-US competition and Beijing’s big leadership confab next week that will see Xi appointed to an unprecedented third term as the country’s leader.   To access the full-length editions of the Friday Focus podcast, consider becoming a donor to the Munk Debates for as little as $25 annually, or $.50 per episode. Canadian donors receive a charitable tax receipt. This podcast is a project of the Munk Debates, a Canadian charitable organization dedicated to fostering civil and substantive public dialogue. More information at www.munkdebates.com.Become a Munk Donor ($50 annually) to get 72-hour advanced access to the full length editions of Friday Focus and Munk Dialogues. Go to www.munkdebates.com to sign up. Hosted on Acast. See acast.com/privacy for more information.

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Hello and welcome to the regular Friday Focus podcast. I'm Rudyard Griffiths, Chair of the Monk Debates, and I am joined as a very much. We are each and every Friday with Janice Gross Stein, the founding director of the Monk School of Global Affairs, internationally renowned author and scholar Janice. Great to be in conversation with you this the 14th of October 2022. Great to be here, Roger, and no shortage of high wire stories to talk about. Absolutely. We're going to spend the first half of the show, which we will continue to make available.

to everyone and anyone talking about a big week in financial news, both here in North America, but also across the pond of the UK. And then the second half of the show, which is exclusively for donors to the monk debates, we're going to go deep on China with Xi's big party Congress next week, his ascension to this, well, not unprecedented, but Mao-esque third term. we're going to unpack all that for our donors. So if you are not a monk donor for as little as $25 a year, 50 cents a Friday Focus episode, what a deal,

you can get the full-length editions of each and every Friday Focus podcast. Janice, let's kick off, though, on the week that was in financial news, two stories to weave together. Hot CPI, that's inflation print out of the United States. Again, over 8%, more inflation, seemingly building in the core part of the index, which are the stickier parts of rents and incomes and other things that are harder for central banks to bring down. And then across the pond on today Friday, you know, in some ways the consequences of these

higher rates reverberating through politics and political economy, the UK government of new Prime Minister Liz Trust firing her chancellor of the exchequer. That's a kind of fancy British. The British always have these fancy names for things. This is basically like the finance minister, fired unceremoniously, and seemingly a reversal on these tax cuts and a big fiscal expenditure that had unsettled the UK bond market, seemingly imperiled pension funds, many of which were maybe soon in need of a bailout. What are the lessons, Janice, that you take from this week of kind of seismic shifts in the financial tectonic landscape? Roger, let's start off by just acknowledging this has been one horrible week for the British Prime Minister. She, you know, her authority is in Tatters, fired her oldest and best friend two weeks or three weeks into the job.

Boy, this in, if this were in the private sector, she would be gone. No question about it. But the story is much bigger for two reasons. One, it shows how central banks are the institutions that have to put their fingers in the dike, even when they might not otherwise want to do so. Bank of England was caught, had to reverse its policy. Why? Because, as you said, pension.

funds were at risk. Defined benefit pension plans. There is nothing that will make people both angrier and more insecure than worrying that their defined benefit pension plan will not be there for them when they retire. They're becoming extinct these defined benefit pension plans just because they promise people. Here's what you're going to get every month. But, if those were at risk. And the deeper story, and I think the more worrying one, there is, again, it appears, and we won't know, unfortunately,

until an unless financial catastrophe happens. But we're seeing, eerie echoes of shadow banking, of derivative markets, where pension funds, pension funds, the most sober and secure funds in the world, were exposed. And that's what is underneath this crisis. Now, that is very worrying.

We saw in 2007, 2009, how connected these markets are. It's not likely that the British pension funds are not counterparty to others. and I looked at that as week and thought, oh, my God. Let me jump in on that and go to the political economy piece of this, which I think is fascinating. I mean, to me, what this whole object lesson in the UK around the trust government's kind of humiliating reversal on, again, these were key policy planks coming under her successful leadership bid, the firing, as you say, of her longtime friend,

the Chancellor of the Exchequer, and tying that back. back to the hot inflation numbers out of the U.S., I think all of this shows that Britain has, in some ways, demonstrated maybe they're the first in the queue. The Brits love queues, they love lighting up, that borrowing a lot of money in a time of inflation and rising rates is simply not an option. It's not that the big, bad old bond vigilantes of the 1980s and Drextel Lambert and all those, Mike Milken, those aren't the villains this time. In some ways, the villains are, for better or worse, the central banks who suddenly have this incredible inflation fight on their hands.

I saw a chart today, the day of our recording that if you take the inflation rates facing all the advanced economies across the world and you blend them together, so you're really pulling back to that macro 30,000 foot view. Year over your inflation is at 10% and the line on the chart is just going up and up and up. So, Janice, I think the question is we like to bring this podcast back to Canada. You know, what does this say about what may be governments in Canada, both of the provincial and federal level, need to think about when they look at what happened to the UK. We are, let's remind ourselves, the second most indebted country in the world on a per capita basis. So if you add up corporate debt, personal debt, government debt, and you're divided by the population, we're ahead of Greece and behind Japan.

So I look at this, Janice, and I think there's a lot of lessons here to take away from the UK experience because this is not a road that the Canadian dollar, the Canadian bond market, the full faith and trust in our credit wants to go down. Well, this is a very sobering moment. I agree with you, Roger, for Canada. just a few days ago, the IMF warned that our inflation rate was too high and that we were over-indebted, warned against any additional fiscal spending. I know that, you know, and had Canada in its sights in that warning. So this could be just an enormous problem for Canada. our governor of the Bank of Canada, Tiff McElaghan, has said in the most determined voice that Tiff can muster,

he is going to continue to raise raise raise, because it is core inflation that is still going up, as you just said. You know, as as inflation rates go up, we have a very exposed housing market, one of the worst in the world, frankly. You know, the Chinese in Canada. Actually, just jazz, on that nice little data point, UBS was at this week saying this is the Swiss bank, they do this regular quarterly report on the most bubbleicious housing markets in the world. Toronto, number one, number one, like ahead of Hong Kong, ahead of London. If you look at the disparity between prices and income, prices and rents, all the kind of conventional metrics were finally number one. I just don't know if it's the sweepstakes that we wanted to win. No, this is not a list that we want to be number one on for sure.

And housing markets are just extraordinarily sensitive to rising rates, especially if there are large numbers of investors in these markets. And from everything we know, and again, it's hard to get good data, but from everything we know, Toronto has a significant proportion of investors in markets. And as these rates go up, their investments are not, frankly, sustainable, Redyard. So there is a story that one could tell here about Canada over the next 12 months. Pretty tough.

To jump beginning, back to the political economy piece, understandably, there are going to be things that are happening that will be outside of the government's control. There will be problems that are too large to solve. I mean, housing is the number one asset class in Canada, trillions of dollars. There's no government program that can bail it out. No, but on the other side of that, right here, we have a housing shortage that is driving away skilled people from our big cities. Right. And as borrowing costs go up, you know, housing prices have to come down even further to make it affordable for first-time buyers to enter the market.

But there's so many demands right now on government. You know, we're facing what seems to be a crisis of health care capacity and supply. We're seeing, you know, the variance circulates. circulating cases ticking up, public health officers now saying mask up again. I just wondered, how do we reconcile over a decade and a half of kind of public psychology that, and let's face it, political psychology, the deficit spending was not only okay, it was desirable because interest rates were so low. We were throwing money at problems.

And now we're faced with many of the same problems, the environment. health care. You can go through the list. Maybe housing supports of the future. Wow. Think about trying to bail that out. Yet on the other side, the Liz Trust government proving in a sense

that if you implement big fiscal expenditures, you risk a crisis in your currency. You risk a crisis in your ability to borrow on international markets through the issuance of your bonds. Are Canadians ready to square this circle, Janice? are politicians ready to acknowledge that we're in a new normal? Of course not.

And you just have to look at list trust over the last three weeks, you know, as she dangled by a thread on the edge of a cliff. And all you can see was her riding rather than dealing with the problem. So of course not. Just to take a step back for a minute, Roger, you said, what are the lessons? It wasn't only the rates were low. It was that these low rates fueled asset bubbles. And they always do.

Whenever borrowing is so cheap that it makes sense to borrow money, people borrow money, that's what they do. And they fuel asset bubbles. And we have to look back and say coming out of the last global financial crisis, and particularly COVID, was it sensible to allow interest rates to go? as low as they did to stimulate an economy that was really struggling. Looking back over these 20 years, would we have been better to have a little bit of pain, but keep interest rates a percentage higher to avoid what we've seen, which is perfectly rational behavior on the part of consumers to borrow, borrow, borrow,

because money was fundamentally free. Now we dug ourselves into a situation. where the central bank has no choice but to raise rates because no people are badly hurt when inflation gets when core inflation gets to double digits. We have a serious problem because in so many ways the wrong people get hurt. It constrains government spending and all we have on the table are bad choices. I think I look back at the 20 years and say there's modern monetary theory didn't prove to be very modern is all. Yeah, here, here.

I think it was one of the, it felt good. So we did it. It was a kind of Dr. Ruth version of, of economic engineering. But I digress. I think my final point in this is just to remind listeners, you know, to turn our own horn a little bit, Janice. Over two months ago, we had this podcast. We called the episode regime change.

And I think we warned listeners that it's not that we had any great crystal ball, but you could see a lot of this coming. And I would just say, again, a warning to people, look at currency, because currency is the tell. And a gambler at the table, it kind of shows who's sweating. The Canadian Looney has corrected significantly over the last few weeks. Keep an eye on that. That puts more pressure, arguably, on the Bank of Canada to maintain a pace of rate hikes

because it needs to defend the value of the currency. Because if bond investors feel that the currency is going to depreciate over the the time that they're holding their bonds, they need a higher yield to compensate for that risk. And the final point, Janice, going back to the Fed and, you know, this big CPI, this inflation number out of the U.S., it looks like another 75 basis points is inevitable in November. And I just think Canadians, you know, if you look at people's expectations and their hopes, they're all saying, oh, boy, rates are going to come crashing down in 2023 because the economy is going to be so bad. The economy may be so bad, but it's hard to see how Canada can't match the U.S.

you know, both speed and the terminal endpoint for those American rates. Because if there's too much daylight between our rates and their rates, well, our bond yields are going to soar, our currency is going to tank. And I just don't think, based on the examples of history and other cycles like this, that we can assume that we actually have that much latitude or flexibility in our rates versus our economy versus what Chairman Powell, Jerome Powell in the United States does. Absolutely agree. A bigger story here, as you said, the macro story. Roger, how interconnected our markets still are. You know, the governors of central banks always have their eye on one the neighboring governor is doing, these markets are interconnected.

I'm concerned coming out of this week in London how interconnected bond markets are. We know something about guilt in the United Kingdom, but boy, they don't operate autonomously either, and there could be other, there could be shadow banking going on in places that you and I haven't even thought to look yet. And so there isn't a national solution. There isn't a Canadian solution or UK solution or U.S. solution to this. These markets are all interconnected. And, you know, frankly, economic policy makers are caught in a squeeze now. They really are very, very tough choices for them.

The squeeze is that old U.S. adage. It's our dollar. It's your problem. We have, you know, a soaring U.S. dollar. that if Canada doesn't defend the value of its currency, it leads to us importing inflation because so much of our food and consumer goods comes from that United States, from that U.S. dollar-denominated market. So let me make a prediction.

I'll ask you for one, too, and then we'll wrap up this section. I think 2023 is going to be a really tough year for Canada because what I expect is our recession is going to be worse than the United States. We would, if we could have our cake and eat it too, like to cut our rates sooner and faster than the United States, but we won't be able to because, again, we'll have to match their hiking cycle in order to defend our bond markets, defend our currency, and ultimately conquer inflation in our own country, which is looking in some ways just as sticky, just as persistent as it is in the United States and other advanced economies around the world. What's your prediction,

Janice, for 2023? Does Canada get a skirt here? I don't know, some kind of off-ramp, or does the coming 12 months look like a tough period of time for us economically? I think we're in for a tough goal, Rudyard. I think the Bank of Canada has to raise rates yet again now, given what's happened in the UK and what likely will happen in the United States. every 75 basic points that goes up sends shutters through the bubble markets that we have in this country. I don't think we've seen the end of this. What does history tell us at some point when the pain gets too much? And there's where the political economy matters.

There is a point at which even when there is some core inflation, government, government's back off because the political cost of fighting inflation is so high. You know, we did this. We fought indebtedness in the 90s under a prime minister with a huge majority government who built a consensus that we were going to go over the edge because we were at the cliff in terms of debt. That was the Kratan Martin government. I don't see the stability in the Canadian political system.

system to have that kind of fight a game. So I'm, I'm, I'm, I'm less optimistic that we will stay the course here. And therefore, probably, um, for consumers, 2023 might not be as bad as economic logic dictates. Wow. So you're in a sense predicting that the central bank, which arguably should be completely independent from politics, in a sense, blinks and tolerates higher inflation. I think they might want to do that because as you agree, the pain could be very acute. The risks in housing and the GDP effects of that could be supersized in 2023. But I don't know, Janice, I just don't know if they have that flexibility anymore in a rising rate inflationary environment. It's hard to come up with a, for me, a scenario where they

cut before the U.S. because I just think the risks to a crashing loony importing tons of inflation back into Canada as a result of a depreciating currency, stress on our bond market like we've seen in the United Kingdom. We are a small economy, 35 million people, not particularly dynamic or productive vis-a-vis some of our peers like the United States. I don't know, Janice. I'm maybe a little, again, a little more the cup half empty here that the risks are on the downside. And central bank independence may ultimately be, in fact, what we rely on to get out of this after a very painful kind of debt workout across a lot of, as you're right, bubbleicious assets in Canadian society.

You know, it may not be the central bank that blinks, Roger. It may be the politicians who blink and start to spend. It can come from either side of the house here to reduce the political pain. And that's probably the more likely scenario. And then enjoy. Enjoy the just desserts that Liz trusts is now getting served. Okay, let's say goodbye to our complimentary listeners right now. We'll take a short break and we're back on the other side with monk donors for a check-in on China.

Big news next week. Xi joining Mao for a second ever three-term premiership of China. What does that all mean? Thanks for listening to this excerpt of the Friday Focus podcast. To get full-length editions of each and every episode of this program, simply go to our website, www.com. Click on the Friday Focus tab in our navigation on the top right of the site. Make a donation as little as $25 a year or 50 cents an episode,

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