Is China creating a bubble both in commodity prices as well as its own economy?
Lindsey: I think it will lead to a bubble. I don't think we have one now, but the conditions that could ultimately create a bubble are all there. We have very accommodative monetary policy due to the currency peg, we have a irrational exuberance in the form of people expecting Chinese growth to go on forever; and we have a few special problems, such as there not being a lot of alternative financial instruments in China. So where you get excess demand it will tend to be focused and specialized. Right now you are seeing it in real estate and also in commodities.
So you would still be long commodities for a few years?
Yes. As long as China is growing, commodity prices will have upward pressure.
On the issue of the weak US dollar, how low can the dollar go before it becomes politically unsustainable for the EU and Japan?
There are three things that can happen which will cause markets to recalibrate. The US can grow more slowly in which case it would import less from overseas. Europe and others can grow more quickly, and demand more American goods. Or the dollar can go down. That's it.
The best option would be for others, particularly Europe, to start growing. Unfortunately it is probably the least likely.
The worst thing to happen is for the US to grow more slowly. That would help the current account, but would also cause economic problems around the world. So that is possible, but not desirable.
Option three is for the dollar to go down.
And the dollar will continue to decline until one of the others changes.
Could you see the dollar yen going back to its all time high of 85 in the next year and a half?
I don't think that is likely, but I am not going to pick a number.
A lot of people spoke about deflation in the past 18 months, and now there is talk about inflation again. What's your view of where we are in the cycle?
If we had to choose, then I would hope for inflation. But right now we have essentially stable prices in the US and around the world. But we have relative price changes. Because of China and others the global labour supply has roughly doubled. That has put pressure on wages. On the other hand because China is developing it is demanding commodities and energy and that is putting upward pressure on those. So when people point to the CRB index as a rise in inflation, well, no, it is just a change in relative pricings. For now, commodity prices are going to rise relative to final good prices. Increases will be held in check, because globally labour has got cheaper.
This sounds like it's good for consumers, but negative for stocks, as margins will compress.
It depends what you're in and depends whether other improvements can't improve your productivity enough to keep your margins up.
In the US we have had a recovery of margins. Between 1997 and 2001 margins fell by a third. They are now roughly back to where they were in 1997, at the peak level. In fact, US companies have coped well and repaired the efficiency of their operations in the past couple of years. That is a good sign going forward.
Do you see high oil prices leading to cost-push inflation like in the 1970s?
Oil is much less of a share of total production costs now than it was 25 years ago. In fact, on a real basis one would say oil is cheap relative to then. Certainly there is an upward pressure on demand that will put upward pressure on prices but I don't see that being sufficient to put pressure on the broad index of prices.
China doesn't have a strategic oil reserve. Presumably rising prices will be a problem for China?
Sure, the economic development process is not an easy one. It hasn't been anywhere. Certainly when a country with a fifth of the world's population is going through a rapid economic development process it causes stresses and strains on markets.
For any consumer, a higher price is not a good thing. The question is whether it is enough to derail global growth. By itself I don't think it is.
You don't see Saudi Arabia increasing production to bring down prices?
One of the effects of the bubble in the 1990s was to reallocate capital towards technology and out of traditional investment. So right now there is not enough invested in field maintenance, or infrastructure development so that is negative for increasing production in Saudia Arabia and elsewhere.
In that respect, the US bubble has been dangerous for the global economy by misallocating capital?
Not dangerous, but certainly costly.
Given your view on the global economy, what's your outlook on US interest rates? Will they go up dramatically in the next year and a half?
No, I think that would be a very unlikely scenario. The first issue is whether self-sustaining growth will get started in the US. The main downside risk here is insufficient demand once the tax cuts stop. There is a 70% chance that growth will be self-sustaining. If the 30% comes true, rates aren't going up at all.
On the other hand if we do make it the Fed has lots of time and will take its time in moving rates up - in part because of the bubble and its aftermath, leverage rates are very high. It would be dangerous if rates went up too fast.
Is US protectionism a serious issue, or is it just electioneering?
It is serious and it is more than just protectionism. The right word for it is 'isolationism'. The US is at a crossroads in deciding whether it wants to participate actively both in a geopolitical and economic sense. The public is constantly confronted with the costs of both. The bipartisan consensus towards internationalism has broken down. The Democratic Party has chosen the isolationist approach in both geopolitics and economics. If they were to win in November you would see at a minimum the stopping of any forward movement on trade liberalization and some backward steps. So it's real and it resonates with a good portion of the public. Elections are there to decide these types of issues. It is a crossroads and crossroad elections like this one can have very important ramifications for the whole world.
