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Eric Lascelles, Chief Economist, RBC Global Asset Management, sits down with David Richardson to discuss his outlook for the global economy and delve into the complicated workings of the ongoing trade relationship between the two biggest economies, the United States and China.


Welcome to Personally Invested. I'm your host Dave Richardson. Today, we check in for our regular update from Eric Lascelles, the chief economist at RBC Global Asset Management. Eric's recently written a piece on protectionism, and we will focus on that at the end of the broadcast after we take a scan around the world taking a look at the global economy and particularly, what is happening in the United-States right now with interest rates dropping and the impact that that has on Canada and the rest of the world. As always with Eric, it is a fast-paced, energetic and interesting discussion about the global economy and again, his great paper on protectionism. We will post the links for you. Enjoy Eric.

Eric, welcome to Personally Invested again. We had planned to have you on every quarter, but the glamorous life of the chief economist has made it very difficult and of course, the glamorous life of the podcast host has made it difficult for us to connect for our last quarter. So, we are six months out from your last visit. First of all, how are things going?

Just fine, yeah, still a skeleton crew, but pumping out the research. We think we are on top of what is happening in the markets and the economy. So yeah, we are still alive.

And we just got the summer global investment outlook. Of course, you are a key part of that at Global Asset Management, and we are going to get to your new thought piece, your paper on protectionism, which is just fantastic. And we will talk about that at the tail end. But from where your thoughts were, if you can recall from six months ago, what do you think are the key things that are happening in the global economy that investors need to think about right now?

Right, well gosh, well six months ago there were a lot of head winds in place weren't there? And so, markets were pretty nervous, and protectionism was actively mounting, and growth was slowing quite considerably and so it was a little bit of a scary place to operate. Don't let me pretend we are in perfect tranquility right now, but let's acknowledge at a minimum that central banks have come to the rescue, it would seem. And, so hopefully, we can talk a little bit about that, but the US Federal Reserve, the European central bank some others having pivoted away from tightening toward easing, greatly pleasing markets, perhaps helping to stabilize growth over time. So that is a big shift, I think. The protectionism story is hardly fully resolved, and that is something we will talk about in detail a little bit later, but we have reached perhaps a form of stasis there. We are not seeing active deteriorations, which seemed to be happening there for a while, particularly with regard to the US and China, and maybe that leaves then as an initial highlight the growth story. And so, let's acknowledge global growth has continued to slow over the last six months. That hasn't stopped. However, I do want to emphasize that perhaps we are all a little bit misguided and focusing almost exclusively on these manufacturing leading indicators. They are important. They do tell us things about more than just their own sector. I don't want to trivialize them in that sense, but it is interesting that when we look at some of the service sector metrics out there, they are holding together better anyhow, not perfectly, but better. And when we look at some of the consumer spending metrics and that sort of thing, actually, they are looking pretty good. And so, as much as we do need to acknowledge that manufacturing is in decline for the moment and that does spill over in all sorts of directions. There are some parts of the economy out there that are still chugging along as well.

And so let's get in that discussion on interest rates because we were sitting here years ago and we wanted to make sure we record this that we are having that discussion on July 27, 2019. So next week the Federal Reserve will make an announcement on interest rates, but we were sitting here years ago we would have been talking perhaps about how many times the Federal Reserve is going to raise interest rates in 2019 and now we are looking at something completely different.

Well that's it. It's quite remarkable when you put it that way because exactly rate hikes were happening quite aggressively just a year ago, less than that in fact, and the expectation was there would be some continuation of that into 2019, possibly even into 2020 that is simply not on right now. As you say recording this just before it could be a cut, probably is a cut so let's not get too precise about that specifically since the listeners already know all about that perhaps. But in the end, the fed is pivoting, and a number of rate cuts seem fairly likely at this juncture. Not inappropriate, I don't think, in the sense that growth has slowed and that has been a change of sorts and financial markets have revealed a bit of their underbelly to the extent that there was that sharp drawdown in stocks late last year since undone but nevertheless revealing some vulnerability there. It's a slightly curious thing, in fact, one of the interesting things right now is what I would describe as a divergence between the Bank of Canada and the US Federal Reserve because both apply very similar economic critiques. They both acknowledge their domestic economies are OK. They acknowledge global growth is slowing, protectionism is a bad thing. And yet the Bank of Canada's conclusion is rates are unchanged for the immediate future. And the US conclusion is rate cuts are appropriate. And without getting into the weeds too too much and boring absolutely everyone, it really comes down to almost a philosophical approach to monetary policy as opposed to the things that these central banks are seeing. And so, the Bank of Canada says, "well, gee, we acknowledge like everyone else that there is perhaps a bigger than usual recession risk, the most likely scenario by a considerable margin is still growth. And so, we are going to position monetary policy for that continuation of growth." And the US says something similar, except it says, "Gee, there is 30% or even 35 or 40% chance of recession over the next year, and if that's true then we need to be in a position of getting ahead of that and cutting rates, may be preventing that. And so, they are very much in the business of rate cutting. Again, it's not the forecast of the scenarios are different. It's more of an emphasis on which scenario deserves the greatest attention right now.

Now, now, does this in any way speak to perhaps an overreaction that people may have had to uncompetitiveness of Canada relative to the US? That a lot of people were talking about over the last year or 18 months.

Well, that's a great question. I would start by saying I am certainly guilty of that as much as anyone else and looking at divergent tax rates and regulatory changes and these sorts of things, and so being somewhat concerned about Canada. To Canada's enormous credit, it has done pretty darn good over that last few years and a lot of thanks goes back to the US as a close economic relationship, of course, but Canada has held its own better than I and many would have thought. That is one of the reasons the Bank of Canada isn't immediately thinking of cuts. I do think though, at least my bias right now is to think if we fast forward a year or even two years, I suspect the central banks of Canada and the US will be more similar than different. I'm not saying the same about cutting or hiking, but I'm saying that I suspect that the Fed doesn't get too too far out ahead of the Bank of Canada or vice versa. And so, we will see some adjustments from one or the other, I suspect, over time. And one of the considerations for the Bank of Canada for competitiveness is that the Canadian dollar is a little stronger than it was as of several months ago and that's a competitive challenge, and so sometimes, you do want to keep up with the Joneses when it comes to rate cuts and we will see if that does transpire over the rest of this year.

That will be really interesting to watch. We've been talking a little bit more about short-term rates that are set by the central banks. What do you see down the curve? So, we've also seen for a year ago longer-term interest rates have come down significantly. Is that something that is going to continue or do these rate cuts sort of steepen things up again and you start to see some movement at the long end?

Well, classically rate cuts do steepen things up a little bit, and so it's notable at least as we record this, that US three-year ten-years spread has at least for the moment uninverted, creating some trepidation, but the jury is still out on that. We'll see. It may yet reinvert. And who knows? It may yet keep bouncing back and forth perhaps. But for the moment we have seen some steepening again that would suggest that perhaps the growth outlook is a little bit better than it was. Mathematically, we can acknowledge that lower interest rates are less than an impediment to growth so there's a bit of support coming into the economy from what central banks have done and how the bond market has reacted to that. But let's also acknowledge that there is one other reasons that longer-term bond yields, there are so many reasons why longer-term bond yields are so low relating to slow speed limits on growth and lots of debt and just a habituation to low rates. But we can say perhaps even beyond that and looking at the low rates is because inflation expectations are quite tame right now and so is worth distinguishing there: inflation itself is looking quasinormal, I would say, both for Canada and the US, not far from 2%, a little below for the US, but in the realm a lot more normal-looking than it did five or 10 years ago and so nothing overly concerning, I don't think. But inflation expectations for the more distant future for 5 or 10 years from now have drifted a little bit lower, and that's one of the things that is pulling nominal bond yields a little bit lower as well and also probably one of the reasons why central banks are thinking about rate cuts because their job is to keep inflation around two. And as much as a lot of it comes down to what's the price of oil and what's the price of vegetables and all these sorts of things, expectations can also be destiny when it comes to inflation. And if everyone is expecting no inflation, it is pretty hard to create some. And despite popular conviction to the contrary, it is useful to have a little bit of inflation, if only to keep you away from the opposite thing, which is deflation.

Absolutely, so let's just take a quick scan of some other areas of the world and then let's get to your, this fantastic piece on protectionism that you have written. Europe, also in the news this week around the central banks saying they are seeing a deteriorating environment there. What do you see going on in Europe and the impact on Canada?

Right, well I mean to begin with in the European growth story is similar, in fact, really similar almost everywhere right now, which we just see economies grow less quickly, and it's disproportionately their manufacturing sectors that have gotten hit. And I did not mention it earlier but, of course, manufacturing is trade oriented. Protectionism is at least part of that story. So, that is also hitting Europe even though Europe is not the region actively imposing tariffs. There has just been a chill perhaps cast across trade more generally. Beyond that, of course, some populism bumping around in Italy may be most prominently though Brexit fits into that category as well, I suppose in the UK. Let's not pretend it's all negative politically though because you recall we were all so concerned about Greece on and off, and Greece has actually pivoted away from its populist government back to a much more traditional government. So, it's not a one-way street there, but there are still some issues. For the moment, I don't think there's too much of a drag hitting Canada necessarily immediately from Europe, but it's just another place in the world that is moving a little bit less quickly, and we are going to have to watch Brexit in particular quite closely that new British Prime Minister Boris Johnson is either putting on a very good bluff or is very serious about this, but October 31 is that Brexit deadline. He has said it's do or die either the EU gives him a new deal or he is out. And I must confess, and I'm speaking with David Riley-my colleague at BlueBay-just today and we were hashing this out, and it doesn't look that likely that the EU is going to blink here. And that doesn't mean that a bad, bad Brexit thing happens, but it does mean we could yet have confidence votes, and we could have new elections and referendums. It's going to be a pretty rocky few months in terms of sorting out how this plays forward, and there is a higher risk than there was of a damaging Brexit outcome that has to be acknowledged at this point in time.

And that Halloween date just seem to fit in right there.

Very spooky, I guess [...] for it, I suppose.

Absolutely, so just one very quick question before we move on. The emerging markets and the kind of one of the untold stories of what's going on there, which we're not as focused on is the strength of the US dollar and the impact it's having on emerging markets.

Yeah, I mean emerging markets don't particularly like a strong US dollar. You know, there are several reasons why but at least one of them is just that many of them are borrowing in US dollars and so when their currency is weakening, it means they essentially owe more money, effectively, in US dollars. And also, I should say when the US dollar is appreciating, that encourages investors to put money into the dollar, it takes away from other places and so emerging markets don't get as much in capital as they might otherwise get. So that is a challenge. I will say though going forward we are not expecting the US dollar to rally much, if at all versus emerging market currencies or even versus a broader basket of currencies and that's in part because we hear every single day American politicians prefer a weaker dollar, which is quite a new policy. Recall it used to always be the strong dollar policy whether they really meant it or not; at least they spoke to that. And that is not the case right now, with the US Federal Reserve in the business of cutting rates, it would appear. And I don't think there is too much else going against the US beyond that, but we can say from the emerging markets specific perspective, we think those emerging market currencies are a bit cheap at a minimum. So, that might cease to be as much of a burden. Let's celebrate that emerging market economies aren't confronting rising rates anymore and so they're happy about that as well, I think. Beyond that, it is a slower growth environment there too to some extent. And China now trundles along 6% instead of 6.5 or 7, which is still completely fine but less than it was. But, in general, again they're moving forward from what we can tell and, in some ways, maybe a little bit less vulnerable to what's going on in the developed world.

Well, I'm going to look forward to your research paper on the race to the bottom or the race to 0 on currencies because but that's an interesting topic. Now we'll transition into protectionism by going to China first, although let's just say the overall global economy: B-minus rate now?

I think something like that. We were running along with a solid A there, I think, in late 2017 early 2018. And yeah, we're down to something like a B-minus. It's not disaster by any means in China at 6 and the US, at least when we recorded this, recorded a 2. I mean, these are completely acceptable numbers that are not bad in any way, but they are not exciting. A so-so grade like that makes sense.

And then I guess this is again maybe the best place to transition into protectionism because the Chinese economy and where we are sitting in China.

Yeah, absolutely and so, of course, the Chinese discussion is much broader than that, but let's work our way toward protectionism. And so, to begin with, the Chinese economy was once upon a time growing at 10%+ a year, and now it's more like 6. So, that it is a significant deterioration that has come from a variety of sources, some of it is just that globalization was naturally reaching the end of its rope because China was fully integrated into the global economy. They already had their fingers into all the various pies that one could reasonably aspire to. And Chinese demographics are not great, in fact, they are fairly challenging, come to think of it. So, that's a constraint on growth. Chinese competitiveness has deteriorated over time. And by the way, this is a completely natural outcropping of getting richer. When you are richer, it means wages are higher, so you are not the low-cost manufacturing anymore. The silver lining is there is now a consumer base in China that can buy products. And so, it works out, but it adds up to less sustainable growth. So, China has been slowing but slowing in a pretty reasonable fashion and in a controlled manner and with policymakers making little adjustments as appropriate. And indeed, they have delivered some stimuluses this year. Of course, on top of that, we have had more of a cyclical issue which is-we'll see if it's cyclical, I suppose-which is protectionism. And so, protectionism has come on, and it always made sense that the US-China relationship would be the key one in part because it's just the two biggest economies-but in part because the underlying complaint in the US is a trade deficit and China is responsible for at last count 61% of the trade deficit-it always made sense would come down to this relationship. And whereas Canada and Mexico and maybe some others are distinctly smaller parties and so can't really argue as fiercely and are more vulnerable to US actions because of the extent of the trade reliance, that's less the case in China. Certainly, big trade flows, but these are big economies with huge domestic markets and pride to think about and this is a hegemonic era and so it is a tougher one to resolve on a number of counts, essentially. And it's tough not just because of the big deficit surplus. It's tough not just because they are two peers as opposed to maybe a weaker and stronger party, but it's also tough because the US complaints, they are not primarily about Chinese tariffs on US cars, although that is one little complaint, they have much more to do with big complaints about the structure of the Chinese economy and the support the government gives state-owned enterprises and intellectual property practises and big capital controls. And so essentially, the US ask is to completely revamp the Chinese economy. And you can imagine China not immediately [...] to that request.

Not too excited about that. Well, this paper is just fantastic. I was reading it, and there's an executive summary, a full report. We will put the links up, attached to the podcast and, of course, if you follow Eric on Twitter, and I highly encourage you to do that, he will, he tweets the reports out as he writes them and he is a prolific and excellent writer. I normally read economics decks to my kids before bed to get them to fall asleep, but I was getting so excited reading this one that it actually did not work. They were staying up. I encourage you to dig into the full report, not the executive summary, but the executive summary is good. And you really, you talk about this before where we were this era of globalization and lay that scenario out and then you really think we are moving into a different era now or at least it look that way.

Well, I think so for a couple of reasons. So, some of it is unsurprising. In fact, we could see it coming and in fact we wrote about some of this four or five years ago just in the sense that globalization involves more trade and more interaction across national borders. It used to be for many decades, we have seen trade grow twice as fast as the global economy is growing. So, that's the intensification of trade. It has been quite remarkable, and prosperity and these sorts of things have resulted-with some downsides as well-but more good than bad most would agree. However, when we are now in a world where, gosh, the European Union has been around for a number of decades. They've already been mostly integrated. And NAFTA got introduced 25+ years ago, and Canada, the US and Mexico are trading quite a lot with each other as it happens. And the World Trade Organization absorbed China in the early 2000s, and the Iron Curtain came down in the early 1990s. These were all giant positive trade impulses. New billions of people suddenly available to work cheaply or to buy things, and it's a variety of the two and that drove globalization. And we just don't have those things in the offing, even setting aside new tariffs, there is not another region of a billion people just waiting to be admitted into the global economy and to start buying and making things all of a sudden. And we enjoyed that for quite some time. And even though there are some trade deals, and Europe is a particular proponent that deals and has had deals with Japan and Mexico and Canada. And of course, there was that CPTPP deal with some Pacific partners. Let's recognize that the low-hanging fruits have already been plucked for globalization. We already took the tariffs from 50% down to 2%, and now we are talking of going from 2 to 1 and it doesn't have the same kind does not pack the same kind of punch. So, some of it is just unavoidably that the globalization tailwind is fading, but of course, equally there is this headwind which is the US and a few others.

Have we seen the best we are ever going to see and then how bad could it be?

Yeah, I don't know that we have seen the best we are ever going to see. I mean, if you can imagine, there are still quite poor parts of the world that just are not economically relevant, and they will get richer, and they will help and benefit as well. And so, you know, India is perhaps starting to reach that role, and we all wait for Africa to do something similar. And so, I think there are plenty of ways this can work but maybe not as explosively and beneficially as the last few decades. And again, the low-hanging fruit has been plucked for the moment. When it comes to the tariffs specifically, but many of the tariffs being imposed by the US are explicitly these temporary measures really meant to force other countries to change other rules. So, it's not meant to be a permanent condition. It's just meant to encourage behaviour to the US advantage. That's equally true of the US-China relationship, and the challenge there is you are now in his multipolar world, a world in which there are now two sheriffs in town, you might say. We haven't seen it in a while and historically, when you're in a multipolar era, there are frictions that stick around. I'm not sure I'm quite saying the existing tariffs are going to stick around forever, in fact, I'm not sure that they will, but frictions economically and militarily, maybe culturally and so on. Probably more likely than not and more often going forward in the next few decades than we've seen over the last few decades. And so, all else equal, there is probably is going to be something of a drag. Again, not to say all the current tariffs are going to stick around forever, though I must confess, equally we are not expecting those to go away in the next few months either.

And I think at some time on one of these broadcasts, we will have to go through how the world is really on so many measures a better place than it's ever been.

Oh, absolutely.

Even with this noise because there is always a lot of focus on some of the negatives and the challenges that we face, but overall, things just keep getting better and better.

Economies grow almost all the time, and more importantly GDP per capita grows almost all the time. That your and my financial well-being. And, of course, I think this is what you're really getting at, the nonfinancial well-being is growing even faster as you look at measures of longevity and infant mortality and other metrics of that sort of thing. And those are getting so much better even in places that that objectively aren't enjoying much economic growth.

We should try to be positive in the short period of the year when the weather's nice in Canada, and we can really enjoy it. It is always enjoyable spending time with you, and again, I just think this is a ...for people who are watching the news and concerned about protectionism and the real impact that it has in understanding the dynamics in play, this paper is just...you are just a fabulous writer. So, it sounds like I'm just completely sucking up to you, but I really do mean it. It's a great read, and I really hope that people dig into it as I know you spent so much time on putting it together.

Well, thank you so much.

We'll see you in about three months.

I would love it.

Thanks, Eric.


Recorded on July 27, 2019
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