Episode 9: What's next in 2023?

Transcript: Season 4, Episode 9: What's next in 2023?

Disclosure: The opinions expressed by Eurasia Group analysts in this podcast episode are their own, and may differ from those of Citigroup Inc and its affiliates.

Ian Bremmer: Let us recognize that the average voter has reasons to feel bad. The average voter does feel that inflation going up faster than their wages have gone up.

David Bailin: I do think that we are coming out of a period of uncertainty. And we've all been thinking it would go much faster than it has, but in the event we get to a more normal economy in 2024, given how vastly impactful COVID was, I think that that's a pretty fast outcome

Shari Friedman: Welcome to Living Beyond Borders, a podcast from Citi Global Wealth Investments and GZERO Media. On this program, we examine global risks and opportunities from the angles of both politics and economics. I'm Shari Friedman, managing director of climate and sustainability at Eurasia Group.

If you listen to this podcast regularly, you know we throw out a lot of numbers, and I have a few for today. Twenty four: that's the percentage of Americans who say the US economy is in good shape, according to an AP poll. Thirty three: just a third of Americans think President Biden is doing a good job handling the economy. But then, on the other hand, we have other numbers. 3.4%, that's the unemployment rate, which is at a 53-year low. And inflation rates have been declining steadily for the last 10 months, and yet there's still talk of a recession.

So what's really happening? We're going to talk about that and the potential risks that it could affect the global economy in the second half of this year. I'm joined by David Bailin, chief investment officer at Citi Global Wealth. Welcome back to the show, David.

David Bailin: Thanks, Shari.

Shari Friedman: And Ian Bremmer, president and founder of Eurasia Group and GZERO Media. Hey, Ian.

Ian Bremmer: Greetings to both of you.

Shari Friedman: So, David, we're going to start with a big question that's on everybody's mind. Is there a recession on the horizon? And if there is, why is the stock market up for the year in 2023?

David Bailin: Well, you said it at the beginning, a third of Americans think that President Biden is doing a good job, and we talk about unemployment and all of these things are somewhat contradictory. So let's take a closer look for a second. When we think about what has been in the news, there's been an enormous amount of talk about a recession and inflation. And inflation is something that people feel every day, whether they go to the food store, whether they go to the gas station, they're experiencing increases in prices, and that is very uncomfortable. But in truth, when we take a look at the economy, more people are employed and more people are getting real wage increases today than really anytime over the last year and a half or so.

So the rolling recession that we're having right now means that some parts of the economy, like for example, manufacturing are doing relatively poorly and some parts of the economy like restaurants and airlines are doing well. Right now, housing construction is down, apartment construction is up, and this type of recession is something we're not used to, where the economy itself is being roiled by all of the events that are taking place in the global economy and in fact, the extraordinary stimulus that was added to the economy during COVID.

So for us, this rolling recession means is that we're going to have slow growth in 2023 and in 2024, and that when we get to 2024, it'll become much clearer where the growth opportunities are. I would just say that when we get to next year, we're going to have much greater clarity, and the markets are anticipating that.

Shari Friedman: You've used this term rolling recession, could you take a step back and define what you mean by a rolling recession?

David Bailin: Well, normally what happens is you have negative GDP growth and negative employment as the hallmarks of what a recession is. Right now, you still have positive employment growth and extremely slow average economic growth. So that's not a traditional recession. And if the Fed were to keep raising rates and ultimately cause a credit crisis, then we can have a regular recession, but right now we're having this unusual one. And it's something that's really atypical. It's not something we've had really for the last 30 years in the United States. So that explains to me why people are having a bad experience, they're thinking things are worse than they are, but why the stock market is up.

Shari Friedman: Ian, adding to this confusion, I shared some of the poll numbers in the intro, and I'm sure being a political scientist, it won't surprise you to learn that the Republicans polled very differently than the Democrats. 61% of Democrats approved of President Biden's handling of the economy, among Republicans just 6%. And you recently wrote about this in an issue of GZERO weekly newsletter. How much is partisanship really coloring this perception? And is this really different than it's ever been? And if so, what's the impact of this increased partisanship?

Ian Bremmer: It is much greater than it used to be. There's very little space in between committed Democrats and committed Republicans. Even though total party membership is actually going down, the level of polarization is increasing dramatically across the spectrum in the United States. But separate from the fact that partisanship really matters in how you assess the Biden administration on the economy, let us recognize that the average voter has reasons to feel bad. The average voter does feel that inflation going up faster than their wages have gone up. And yes, inflation's coming down now, but it's coming down from already high levels. It's not like prices are going down, they're just going up less quickly than they were. They're still going up a lot faster than wages have been and that they have been for 40 years. So if you are the average voter, this feels a lot worse for you than the macro numbers would imply.

There's also concerns of an eroding safety net that a lot of Americans feel like if they were to lose their job or if they were to have a sudden health issue or health issue in their family, they won't be able to respond effectively in a way that 20, 30, 40 years ago, not as many people were concerned about that.

And when you look at America's wealth and compare it to life expectancy, compare it to suicide rates, compare it to drug addiction, the United States underperforms dramatically compared to any other advanced industrial economy, Japan, Germany, the UK, even Canada, which isn't all that different from the United States. Just of all those Canadians that are just across the border, right? But they're doing a lot better, why? The politics. So when you combine that with the extreme partisanship that exists in the United States, you get a lot of pronounced anger and you also get a fact-free zone in terms of the response that you get of how people think about what they're being told by experts, including even experts like me and David.

Shari Friedman: Well, I think that we're getting a lot more truth right now, but I think that it's interesting. I mean, what you're saying, there's two things, there's the issue around what you call this fact-free zone, and then there's also the issue that the numbers that are being reported are not the whole story and the numbers that everybody really cares about. Going back over to a big issue that just recently got resolved in the US in the first half of this year, the political focus has really been dominated around the negotiations on the debt ceiling. And sitting here in Washington DC I think I heard a collective sigh of relief in early June when the Senate signed the bill. Ian, given this polarization that you were just talking about, do you think that these nail-biting debt negotiations are going to be a common occurrence? And what do you think the long-term effect is going to be?

Ian Bremmer: Well, first of all, let's have an optimistic take. McCarthy, speaker of the House, Republican, and Biden, president Democrat have a better working relationship than any president and House speaker of opposite parties that we have seen since Pelosi and Trump. And I say that in an amusing way because, of course, they didn't like each other at all. But they were able immediately after the pandemic hit to come up with one of the most effective economic responses of any government in the world, and it was absolutely bipartisan and necessary. And this debt negotiation deal was necessary, you couldn't actually default.

So at the highest levels, no matter what progressive Democrats and MAGA Republicans were saying, you had to come to an agreement, or was going to really hurt the American economy. And wouldn't you know it? Biden and McCarthy got it done and a majority of members of the House and Senate, and both parties signed up, actually got it done. And the deal is, I'm sure David will agree, not such a bad deal. But the fact is that until we were close to crisis, literally the last few days, the sides were barely talking to each other, and that is set up to happen yet again in 2025 after the next presidential election. We've got some breathing room that is very, very welcome, but no one should mistake that for a new bipartisanship.

Shari Friedman: So Ian, how do you think that's going to manifest? If we go through this every single cycle, we have this going to the brink of default, what do you think the practical implications are going to be?

Ian Bremmer: Well, the practical implications were that market participants were unconvinced, and understandably so, that there was going to be a default. And so the markets didn't really move all of that much. You didn't see a sense of panic and volatility in the markets running up to the so-called X date reminds me of the way a majority of Republicans in the House of Representatives chose not to certify the U.S. election results on the evening of January 6th after the House had been violently occupied. Why not? Because those same people were convinced that there wasn't an actual crisis. So as long as the political actors and the markets say, there's really no danger here of a U.S. default, of a U.S. collapse, you're going to keep seeing this happen. It's deeply dysfunctional, but ultimately a deal gets done.

Shari Friedman: David, what might you be looking for to see which way this is going to go?

David Bailin: There may be nothing to avoid in the sense that if the Fed were to pause and allow the bond issuance and note issuance to take place, that would be I think a wise thing to do. And we might see bond spreads, especially in high-yield bond spreads blow out. All of those would be indications of stress in the marketplace and I think would be difficult dues. On the other hand, if we get by the next 12 weeks and we see markets normalize, then I think we're going to be getting ready for 2024. And markets typically anticipate the economy to come by about six months. When we begin looking at 2024, we would imagine that ultimately interest rates will go down in parallel with inflation and we could see some unemployment, but not a ridiculous amount of it. And in that case, I think that the markets will begin to look at what corporate profitability will be in 2024. So that would be the smooth sailing scenario, it's just unclear how we get there at this point.

Shari Friedman: Taking this concept of debt global, you know, debt is not just a factor in the U.S. Sovereign debt globally stands at 300 trillion, and 60% of low-income countries are in debt distress or they're approaching it. Ian, what impact do you see this debt burden having in both the short and the long term?

Ian Bremmer: For some countries, this is an unmitigated disaster. They can't service their debt with higher interest rates. They can't get more investment with more market participants acting in a risk-off way. I mean, I look at Sri Lanka and I mean 75% of government revenues right now are going to service their debt. This is no longer a functioning economy, right? That's a staggering number. Argentina is getting much closer to a very serious crisis.

We've got political elections in place. The existing regime will be shunted out of power, but you might get a very radical libertarian pro dollarization, but without access to any dollars candidates winning in Argentina, and Argentina will have yet another meltdown. So there are definitely low-income economies in this environment that are close to the edge, but that's not India, it's not China, it's not Brazil. We're not talking about an emerging market financial crisis, we're talking about a significant number of relatively small countries that are close to meltdown.

What I don't see happening is the kind of contagion that we've had where all of the emerging markets are suddenly seen as in deep crisis. That doesn't seem imminent when I look at what some of these economies are experiencing.

David Bailin: I think that's exactly right. We're not talking about an emerging market debt crisis at all. In fact, if you were to look at the larger emerging market economies, they actually took proactive steps to protect their economy quickly during the COVID crisis by increasing rates locally and making sure that their balance of payments look better by keeping their own currencies more cheaply valued by having higher interest rates internally. So what I would say is, when we take a look at the global economy from a debt standpoint, most of the world can service its debt effectively, and there are outliers to that as Ian outlined. One of the things we're going to be advising our clients, in fact in 2024, is emerging market debt because these healthier economies and the dollar going down in value will turn out to be beneficial to them. And we actually think that the companies operating in those areas will be benefited by what will take place in 2024.

Shari Friedman: Given a lot of the different factors that we've been looking at in a lot of the data that can seemingly be contradictory and what you've called the rolling recession, how are you advising investors?

David Bailin: You've just touched upon I think the hardest thing, which is, when you have information that is truly contradictory, you have to then look at the larger macro picture. And this is what I think is kind of exciting, which is the world tends to grow all the time. We see new technologies like generative AI coming out that are going to have a profound beneficial impact in terms of economic impact on the efficiency and the ability to produce more. We have the inherent growth of population. We have the fact that there's constant innovation. This is all ultimately causing us to have a positive growth rate, which allows markets to grow and opportunities to be created, and ultimately portfolio wealth to grow. And that's the backdrop that we're actually in.

A good example is the reopening of China, right? Even as the U.S. is slowing, China is growing. Ultimately, when the U.S. starts to grow again a year from now, they'll both be growing together. And it's that counter-cyclicality that I think ultimately allows portfolios to be more resilient, but it requires a different attitude by investors. And a lot of investors have money sitting on the sidelines. There has never been more money than right now sitting in money market funds and deposits around the world. They're all waiting to do what? They're waiting to decide whether there's an all-clear whistle that's actually been blown, and it's okay to go back into markets. Ultimately, that's a tailwind. But right now it indicates that the ultimate positivity that I just expressed is not being experienced by most investors, and that's what I hope will change over the next six to nine months.

Shari Friedman: Let's turn to some of these issues that we've touched upon on prior programs. Ian, let's start with you. In January, you ranked rogue Russia as the top geopolitical risk of the year. Now in June, do you still feel like that?

Ian Bremmer: It's not even close? Nothing else remotely on the global stage is close to the kind of danger that the Russian war against Ukraine and increasingly proxy war against NATO experiences for the global markets. Just a few months ago, there was a British reconnaissance plane flying in international airspace over the Black Sea. It was providing intelligence on the disposition of Russian forces in the Black Sea and in Crimea to NATO and to the Ukrainian military. A Russian jet fighter locked its missiles on the reconnaissance plane. The pilot misunderstood the order from his superior officer. He fired the missile, and thankfully, the Russian missile didn't work, it malfunctioned. Otherwise, 38 British airmen would've been dead, and we would've been in a 1962 Cuban Missile Crisis. We were that close.

And that is a reality every day with only more military equipment being sent to the Ukrainians, with the Ukrainians not only starting a counter-offensive, but engaging with drone strikes inside Russian territory, including in Moscow itself. This is unprecedentedly dangerous, we have seen nothing like it since the Wall collapsed in 1989. If I could have something higher than the top risk, I would put it there.

Shari Friedman: David, given what Ian had just said and how volatile this situation is, what impact is this war having on the global economy?

David Bailin: Well, it is definitely having a dampening impact on investors. It is one of the reasons why people have so much of their cash on the sidelines. And it has definitely altered the shape of the global economy, potentially permanently because we've taken a look at the change in energy distribution and delivery, a closer relationship between China and Russia, and really the intensification of what we were calling this sort of G2 bifurcation where now business policy, security policy are coming together and are actually changing the contours of the global economy and technology. So I could not agree with Ian more that this geopolitical risk, this war is by far and away the single largest risk that the world faces, and therefore then investors in the economy face as well.

I would point out that its resolution, now, if and when it occurs, I think will be a huge relief for the global economy and will allow for a lot more effective use of resources around the world.

Ian Bremmer: I just want to add one thing to that, which is I talked about the tail risk, which is profound and something we need to spend more time thinking about than we have. But there's also the structural risk for Europe, and this is a baseline, which is that Europe going forward is going to have to spend for the foreseeable future, not just months, but years and years, far more on their own defense than they had been willing to before a year ago, February 24th. They will have to pay far more for their energy than they had been before the invasion started, and they will also have to face asymmetric warfare from a rogue Russia. In other words, more espionage attacks, cyber-attacks, critical infrastructure attacks, and the like. So this is a structural dampener for the Europeans, particularly frontline European states in terms of NATO, but for the EU as a whole, and frankly is a really geopolitical advantage for the United States.

Shari Friedman: Moving on to something that I think is an up-and-coming issue, and one Ian, again that you've written a lot about is AI, and it's dominated the headlines for the last several months. So Ian, given that you're looking so much into this, what concerns you the most about AI? And also there's upsides as David had noted, also, what excites you the most?

Ian Bremmer: Well, maybe start with what excites me the most, which is I think this is the most important invention since the internet, maybe since the semiconductor. It is going to affect the advances in virtually every scientific field that we know as AI allows you to turbocharge, reduction of waste, increase in efficiency, and understanding how to advance these fields, whether we're talking about biotech and new drugs and new vaccines, or we're talking about transition to new energy sources, or we're talking about moving towards autonomous driving, I mean all of these fields. And so I see AI as driving a new globalization, increasing productivity, displacing workforce, but creating far more jobs and increasing growth. So I mean, AI is a really staggeringly positive story.

What worries me, I think first and foremost is the fact that people are taken in by AI very quickly, very easily. They develop relationships with bots. They think that what they are hearing is true when it is not. So the disinformation that comes from AI and its proliferation and propagation into the hands of any tinkerer or bad actor with a laptop and a little bit of programming skill, I think that's very dangerous. We saw relatively recently an AI-generated image of an explosion outside the Pentagon and markets were hit by $500 billion for half an hour as that was reported. Anyone that looked closely at this explosion would've known that it was fake, and yet it went so viral within months. You won't know if it's fake because the improvements in text, audio, and video AI is moving that quickly. So I just don't think we have the regulatory structure either in the markets or in our political systems to handle the risks that come from the exploding technologies, particularly of large language models and generative AI.

Shari Friedman: David, Ian just described this incredibly fast-moving situation around AI, and you've identified generative AI as an unstoppable trend. What do you see is the economic benefits? And when you're looking at your client portfolios, how do you expose your client portfolios to this?

David Bailin: So generative AI is going to have profound impacts on all businesses, and it's going to have it sort of sequentially. So first, you're going to have the development of the technology. We've seen a handful of stocks do well that are either providing the superconducting power to actually deliver it or the platforms to actually begin to use it. In terms of how it's going to roll out, I think there we're going to see a couple of different notable impacts. Industries that are heavily data-intensive and heavily not automated, labor-intensive, finance being one of them, are going to be beneficiaries of this type of technology, which take enormous troves of data and allow for faster and better decision-making. Companies that serve large client bases are going to be able to deliver better service at a much lower cost to those large client bases.

And the companies that decide to move quickly into this area and use generative AI, I think are going to be advantaged to those that lag. And that advantage is something that we can actually measure. But one of the lines I like to use is that generative AI will actually track the use of generative AI in industry. Even things like basic stock research and looking for search terms as to what companies are doing or not doing, all of that is going to allow for the gathering and use of data far more quickly. And then we have all of the things that can be automated, literally how warehouses function, optimization of supply chains, all of that which now is being done either manually or with some level of computer technology. The speed and accuracy with which that can be modified, I think is fairly extraordinary.

I describe it as anything where you're trying to connect point to point to point will ultimately be impacted. So one of the nice things about this is that, again, putting aside the risks that I think Ian properly outlined of how it can be misused, is that every time we've seen a technology come along, the computer itself, the internet, which is supposedly going to destroy labor and make it very hard for people to find work, the exact opposite has happened. It creates an enormous innovative environment which allows for the redistribution of that same labor to higher-value tasks.

Shari Friedman: I think it's very easy for people to see what they have and what might disappear and very difficult for people to see what's not there that might be a benefit. It's an interesting point you're making. So Ian, China's economy has reopened from its COVID shutdown, yet in spite of the improving growth, its stock markets are performing poorly and the company valuations are reminiscent of those at the beginning of the pandemic. Do you think that international investors are really ready to trust Chinese markets right now? And do you think there's larger issues that people just aren't seeing?

Ian Bremmer: I don't think that we're looking at an end of West trade with China. Companies that are there want to stay there, but I think that they're much more cautious. Most CEOs I know are much more cautious about putting additional money into China, and part of that is driven by the toxic political environment in the United States, Democrats, and Republicans towards all things Chinese. We see that in the House with a lot more legislation. We see it in rhetoric coming from the White House and from Republican candidates for the nomination of the presidency. We also see a lot of people concerned that Xi Jinping as he has ordered raids into Bain & Company's offices in Shanghai and other Western corporations, consultancies, others, for alleged espionage, cyber crime without rule of law, without an independent judiciary. I think that those behaviors are putting a chill on people wanting to spend a lot of additional capital on the ground in China.

I also think that the reality that China has a lot of corporate bad debt, they have a workforce that is shrinking, and they increasingly have a political leadership that is much more directly loyal to Xi, but not necessarily as technocratic in their economic orientation. All of those things are making people feel like they need to be paid a lot more for the risk that they are taking in China going forward. So yeah, I'm not surprised that we're seeing more caution from some of the big players that have been promoting their China investments of late.

Shari Friedman: David, kind of moving onto a broader issue, I've read that you're worried that investors have too much cash, so how can cash be a bad thing given how uncertain the markets are?

David Bailin: Well, it's a great question because right now there's more cash sitting on the sideline, sitting at banks, sitting in money market funds than in any time since they've begun measuring this since 2007. And it is very easy for people to get lulled into a false sense of security if they're earning 5% every day just having their money in overnight funds. But that turns out to be a bad long-term decision for almost every investor because ultimately the yields that will be earned on cash will go down, and ultimately they'll go down to less than the rate of inflation based on all of our economic history over the last 20 years. So that is what's going to happen for most investors, and that will actually benefit banks and other financial institutions that actually will then go out and earn more.

What we want investors to do is to obviously have some amount of money in short-term investments, but right now is a time when they should be moving money into immediate duration bonds, into emerging market debt, into preferred shares, lots of different things that will sustain these levels of income for longer. And even though it's uncomfortable, they have to begin putting money back into the equity markets before the recovery of 2024 begins. Just to give you an example, just right now, if we were to look right now at the markets, a 60-40 portfolio might be up approximately 6%, but a client who kept their money in cash would've made just 2% for the year. Nonetheless, they're feeling really good about having cash in the bank, and that's the misnomer and why we think that for people who are just stocking money underneath their mattress, this could be ultimately a very bad portfolio decision.

Shari Friedman: We're going to have to wrap up soon, but before we do, I want to ask you both to predict what do you think is going to be the biggest headline in the second half of the year. Ian, what are you going to be watching in geopolitics?

Ian Bremmer: I don't know that I want to say one thing, but I would say a couple I'm watching for will be where the Ukrainian counter-offensive goes. It's been the most watched and anticipated counter-offensive all year now. How successful is it, and do we move towards any sort of negotiations after it's over? That's for the end of this year. Another one would be in the US-China relationship specifically, what kinds of additional military incidents do we see as well as efforts to further decouple in strategic sectors, in particular, high technology. How do the Chinese respond as that starts to bite? And then the final one, a good one, is I think we're going to see an announcement of a Saudi Arabia-Israel normalization that will be added to the Abraham Accords, which the Trump administration negotiated. This one will be negotiated by the Biden administration, one more place that shows that actually both parties can be aligned in some areas, and it's quite significant for stabilization in the Middle East.

Shari Friedman: So David, what surprises do you think are going to be on the horizon for the economy?

David Bailin: Well, I think we are going to see the end of the Feds raising rates before the end of the year. I think that's going to be very good news for the markets. They'll be able to now anticipate ultimately, a lower cost of capital to look toward 2024. I think that the end of the war, to the extent that it actually happens, will be big news. And then I think the wild card for the end of the year has to do with whether or not the Chinese stock market matches the performance of the economy. There is an enormous crisis of confidence that you see right now in China and among investors in Hong Kong and China about the ability for that economy to recover fully after the COVID lockdowns.

And it is sort of unexpected because unlike the U.S. which is actually coming out, and now we're having to curtail its own growth, everyone thought that the Chinese stock market would go up and the Chinese economy would rapidly rebound, and that has not taken place. The market's gone down and the economic rebound has been really quite moderate. So that's the sort of wild card that we see out there. I do think that we are coming out of a period of uncertainty, really that relates to what was a pandemic and the responses to it. And we've all been thinking it would go much faster than it has, but I would just point out that in the event we get to a more normal economy in 2024, given how vastly impactful COVID was, I think that that's a pretty fast outcome and that we've actually gotten to the good side of what could have been a very, very destructive incident.

Shari Friedman: David Bailin, chief investment officer at Citi Global Wealth, and Ian Bremmer, president and founder of Eurasia Group and GZERO Media, thanks to you both as always.

David Bailin: Great pleasure to be here.

Ian Bremmer: Good to be with you.

Shari Friedman: And that's it for this episode of Living Beyond Borders. Check out all of this season's episodes by heading to gzeromedia.com and click on the Living Beyond Borders tab. Or you can find episodes in the GZERO World podcast feed wherever you get your podcasts. For GZERO, I'm Shari Friedman. Thanks for listening.