Gita Gopinath on Why Interest Rates Have Surged All Around the World

24:34And you barely see that price being priced in markets. So that's frankly more surprising than just looking at what's happening with just the level of, you know, of the stock market. So, OK, we keep talking about the stock market and, you know, debt issuance in the corporate bond market and how everyone wants a piece of AI. Does that basically mean that we're seeing, I guess, maybe scarcity of capital versus the global, we used to call it a global savings glut in the early 2000s, right, which ended up, per Bernanke, pushing yields lower. Does anyone still talk about a savings glut or should we all be talking about, you know, like capital scarcity?

25:16No, we don't have a global savings glut anymore. And proof of that is real rates going up, interest rates going up. So that's that. What we certainly seem to have in the U.S. is, I don't know what to call it, but gluttonous demand for U.S. equity coming both from domestic investors, but also from foreign investors. I mean, we're at$40 trillion in terms of foreign holdings of U.S. equities. that is at a historic high. Even if you look at it as a share of the rest of the world's GDP, it's about twice as high as what it was just before the 2000 dot-com bust, I guess, at the peak of the dot-com. The world has never been that invested in U.S.

26:02equity markets. It's like it's the only game in town. So if there's a gluttony, rather, I would say it is for U.S. equities. We're all in this together. And as we know, in terms of what's coming into the markets right now, I mean, we have some very big IPOs and that will make us even more all tied at the hip when it comes to AI and stock markets.

26:26Tracy Alloway:Speaking of big IPOs, Tracy, this reminds me and I'm saying this to a message to our producers. We should really do an episode soon about. Are you including voice memos to producers? I'm now including voice memos to producers. No, I really want to do an episode soon about the fact that all the big index funds are going to have to include companies at basically their peak, where you think like historically, OK, like a company like Apple, like it enters the S &P 500. I don't know, maybe a$20 billion market cap, and then it's a multi-trillion dollar market cap. This will be the first time that the index fund owners are going to eventually have to buy these really big companies without having ever experienced any of the gains from the run-up.

27:17Tracy Alloway:And I think that's going to be a historic moment for both markets indexing and ETFs. This has been one of my long running criticisms of the big benchmark index providers, which is like they always say that they're not making investment judgments. They're just holding up a mirror to the market. But like actually a lot of these decisions are like incredibly embedded with judgment calls and they do end up having an impact on the entire market. Yeah. This is this is I think going to be a historic time for sort of index investing. Anyway, I know that this is a divergence. I just needed to get that voice memo into our producers.

27:50Yes. I mean, but you know, hey, there are now more ETFs than there are actually companies being created on the market. So if you want to spend a lot of time picking and choosing, you could be selective too.

28:04Tracy Alloway:Yeah, I want to switch ETFs, but then I have to take a capital gains hit. So I can't, you know, this is the, anyway, we're getting pretty sidetracked here. I want to talk more. I mean, there are many phenomenons or many things going on at once. But when we think about these pressures, and it relates to AI, but it also relates to commodities itself, is this idea of essentially national resource hoarding and the decline of sort of free trade. And so the fact is, it's like maybe at one point we could say, you know what, a country could say, you know what, it's great that America is building a bunch of fighter jets so we don't have to have our own indigenous fighter jet industry, etc.

28:44Tracy Alloway:How much when you look at what's going on with the rates picture and pushing up inflation and so forth, is this phenomenon in which no country fully trusts other countries to deliver goods for them? And therefore, there's a lot of replication or duplication of capital investment happening in every country all at once simultaneously. We're seeing a lot of that. I mean, we moved squarely, firmly, decisively away from a pure efficiency-based model of I'm going to buy from the cheapest place and I'm going to sell if I'm the cheapest source to one where everybody is building up their own capacity as much as they can.

29:28And, of course, depending on the country and depending on how much of fiscal space you have, that can be a small group of things or a big group of things. For sure, energy security is everybody's paying attention to it. How do we make sure that we don't have to import fuel from the rest of the world? And how can we have our own fuel at home, either three renewables, whatever we need to do, or maybe just returning to coal for now? that is we're going to see we're seeing that defense expenditure we need to be able to not just spend more on defense but make sure that we can actually produce more of the weapons that we need semiconductor chips rare earths yes there are you know i think there's so little trust in the world right now in terms of relying on your trading partners yeah that countries are just going to be spending a lot more on this.

30:21It's just that it depends on whether you're a country that can afford to raise the finances for it or not. But everybody is heading in that direction. So if you look at the list of all the sources of demand for capital, that is a very, very long list. And if you look at the sources of supply of capital, there's just one category, which is aging demographics. I mean, that's, you know, we often tend to blame old people for the fact that we need to spend so much on retirement and on health for the future. But the truth is, the reason interest rates are not much more high than they would have been is because of the supply of savings coming from aging demographics around the world.

31:00Well, you mentioned fiscal space, and I know you've talked previously about the need to, you know, reduce some entitlement spending if governments are going to be serious about reducing deficits. And yet we've seen numerous attempts in the developed world to actually cut back on government spending. And it seems very, very hard to do in elected democracies, right? Like it is not a popular platform to be elected and say what we really need is austerity for the longer term. And all of you are going to have to suffer in the near term. How are policymakers like realistically supposed to navigate that tension, assuming that they're up for election every two to four years?

31:40I mean, we have the additional problem that I think policymakers actually are not really keen or particularly worried about where their debt to GDP is. If you look around the world, again, except for places where the bond markets are simply just not letting you do more spending, even in the U.S., I don't believe there's anybody in Congress who's truly worried. There are a couple in Congress who are worried about the U.S. debt level, but not enough given where debt levels are and given the foreseeable path of spending that's happening. But again, to step back and see, it's helpful to look at what has happened historically and when have countries been able and how have they been able to bring their debt to GDP levels down.

32:24It's a couple of things. One is just a spurt of growth that has come about either because you are some sort of a commodity exporter and you just had positive terms of trade shock. And because of that, your debt to GDP comes down. You hit the jackpot, basically. Yes, exactly. You got lucky. Or productivity growth, a boom, above average growth. And I believe that's what we're betting on this time with AI. The hope is that with AI, we will get growth from 2 % up to 4%. And then that will certainly solve all of our problems if we have that on a persistent basis. Countries, especially developed countries, have tended to rely on that.

33:05And then you have inflation. If you go back even further, and also obviously right after the pandemic, inflation helped bring the GDP levels down. And then, of course, the third is what we see with developing countries is you end up with default and restructuring and crises. And then again, you bring debt to GDP down that way. So those have been the typical path. We've never had to worry about debt crises in developed economies. But now more and more, and I think this is also a new feature of the world we live in, is the developed world is moving into that space where their debt costs and their borrowing costs are far more volatile, far more sensitive to market conditions.

33:47I mean, the stock case is the UK where you see that on a day-to-day basis. But you see that in other countries too, in Europe and some of it in France. And more generally, even Japan, where for the longest time, we didn't have to worry about borrowing costs. Those have squarely moved up. The tenure rates have moved up. Germany's 10-year rates have moved up. So everywhere we are seeing developed economies also now having to face higher borrowing costs. The US, I think, is still the exception in the sense that even though 10-year yields are at, say, 4.5 % right now, just given the level of supply of debt and what's expected to come out in the future, Markets are still treating it as giving it some privilege, even if it was not as big as it used to be in the past.

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37:41Tracy Alloway:What does, in your view, a debt crisis look like in a country that borrows in its own currency? because obviously, like politically, you know, maybe the debt ceiling doesn't get raised. There are certainly political ways to default. But economically, the U.S. never theoretically has to run out of dollars per se. In fact, I would say it's the same thing with the UK. You say it's the same thing with Japan. They can't run out of yen the same way in the same way that, say an emerging market that borrows in a foreign currency could theoretically run out of dollar reserves, which is why we watch reserve levels when we talk about sort of on the edge emerging market.

38:28Tracy Alloway:To you, what does a debt crisis look like in an advanced economy in which all of its debt is denominated in its own currency? A crisis in a developed economy would look more like a credit crunch that then leads into a financial crisis. So we would see a sharp increase in borrowing costs that will affect many other asset classes. You would see a slump in investment, the economy. So it's this debt overhang, high levels of debt and that you have to roll over on a daily basis, that overhang, which slows growth, slows dynamism. That is what a typical crisis looks like. And yes, you can have financial crisis.

39:13One of the wonderful things about the last several years, despite all the shocks, we haven't had a financial crisis in the developed world in an emerging market, any big emerging market. And that has been very helpful to bring back a fast recovery of the world economy every time after every shock. And we talk about resilience. So in a case where we end up with just debt levels that are really high. It's just costs going up everywhere. And that will eventually slow down economies, if not just trigger financial prices right away, given how sanguine financial conditions have been.

39:50Tracy Alloway:You mentioned that one of the things that's changed pre to post pandemic has been the change in marginal position of central bankers with respect to the bond market and the fact that they've gone from being, although even in the US, I mean, quantitative easing ended in the 2010s, et cetera. But what happens if, say, we talk about a central bank and one of these developed markets, and they say, you know what, we're going to cap the long end. We're going to buy bonds until the rates are, you know, they don't go above 2 % or 3 % or et cetera. Seems very plausible that something like that could happen in the developed market before too long.

40:30Tracy Alloway:What would be the sort of fallout if a central bank explicitly came out and said, we are going to buy government debt and just hold down the rates in a very explicit manner like that? If a central bank comes out and says that we are different from our mandate of price stability and full employment, regardless of what's happening there, if we are going to go out and buy long-term debt, then that's what's going to happen is you're going to see inflation expectations drift up. And then the nominal rates are going to go up. And real rates will also go up because of the risk associated with inflation.

41:11Premium will go up. And that will be the end of the wonderful era that we've had of central bank independence. and that's helping to keep interest rates low. So that strategy just doesn't exist. You can play with it for a little while, but eventually it gets priced into markets. So, I mean, unless, of course, it is a tool for monetary policy because you've hit the zero lower bound. Sure, sure. And you still need to simulate the economy, then you do that. But right now we're far from the zero lower bound.

41:42Tracy Alloway:Right, we currently have the opposite. We have the opposite. So it is, countries have tried it in the past And these are usually the countries that the IMF works with because they eventually find themselves in crisis. But what typically happens is you get a tiny period when it looks like this is helping, and then you just get much higher interest rates and you just don't get any of the benefits of the central bank buying your debt. You know, you mentioned earlier that we haven't really had a major financial crisis in recent years. And if we could just broaden that idea out a little bit, I think that the resilience of the global economy and certainly the U.S.

42:21economy has been surprising to a lot of people. We've had multiple shocks, but overall, certainly in America, people just keep spending. Everything kind of keeps ticking along. Is there something that economists are maybe like underestimating when it comes to why it seems like, again, the global economy to a lesser extent, but certainly the U.S. economy seems so resilient in the face of all these once in a lifetime shocks that we keep seeing? There have been a combination of things that have helped, and some of it have been surprises. Again, since we're talking about debt, that increase in debt has come about because of the very large amount of support that governments around the world gave during each of these crises.

43:11So during the pandemic, I mean, advanced economies spent about 25 percent of GDP. If you look at the combination of not just outright support, but all kinds of loan guarantees and equity infusions and so on, that was huge. Those were much higher levels than anything we'd seen in recent times. And because of that, households and businesses came out of the pandemic with stronger balance sheets than they did going in. And that has helped hold up demand also and also has helped, therefore, helps hold up profitability in a lot of businesses because of that strength that came from all that large amount of support.

43:53That was one. Second is the AI boom is a big player right now. If we didn't have AI and if we didn't have the increase in demand coming from AI, we would be looking at just much lower growth rates in many parts of the world at this time. And we would also see trade being much weaker. I mean, trade is being held up a lot by AI inputs flowing around. That's also been a big contributor. So we've had these positive, upsetting events. Now, the question is, what happens in the next crisis? In the next crisis, countries do not have the fiscal space to provide that kind of support. And we may see much less resilience than we've seen the last few years.

44:37I mean, I think that's something we should keep in mind. I don't think we should take this resilience as some sort of an absolute structural shift that keeps economies growing at their long term trends, regardless of how big the shock is that's affecting them.

44:52Tracy Alloway:Yeah, you wrote a piece, I think, recently for the Financial Times, which you talked about the bliss trade, I think, as you called it. And can you clarify, because it sounds like expand on this idea that there is this assumption of state support. There's an assumption of a backstop. Things go bad. The government will be able to do something. And this is seems to be the core of your idea that this is mistaken. We have this mindset right now in the policy world, and therefore people who are investing in markets, that the state is there to fix a lot of the problems. And we see it right away. But now what's happening with energy prices going up is that there are many countries that are capping fuel prices, that are cutting energy taxes.

45:40The instinctive reaction is to protect households and protect their spending power. And when you do that, that helps corporate profitability, and that is going to be favorable for markets. So we've been in this environment now, either explicitly or implicitly. And there has to be this notion that the economy has been resilient. And it is a reflection of what I call bliss, which is big, lasting state support, which has helped economies all over the world, not just in the US, but in many other countries. So the expectation is that that will continue. And going back to where we started with this conversation, just given how high death levels are, that's just increasingly questionable, which means that I think governments are going to move towards far more unorthodox approaches, including price controls, financial repression, the kinds of things that we haven't encouraged in a long time.

46:43Tracy Alloway:You know, we've talked about some of the big structural phenomenons in the global economy, the AI boom, demographics, certain things with trade. There's one thing we haven't really talked about, which is something I think about, which is that if a country makes something physical, there is a very good chance that either right now or in the future, China will be able to make it cheaper and better. And this is no matter what it is, there are still some things that aren't the case. The most advanced semiconductors aren't manufactured in China, Boeing and Airbus jets and stuff. There's a few examples.

47:17Tracy Alloway:But by and large, when you think about the stresses that are being placed on economies all around the world, how much is this particular dimension a factor? The fact that like any almost any tradable good might at some point be most efficiently originate from China? Yeah, I read a lot of pieces on this that somehow China will continue to run trade surpluses because everything it wants, it produces for itself and produces for the rest of the world. And so that's that. I mean, that makes little sense to me. Firstly, if you just look at China's spending behavior, they run a surplus on their goods trade front, but they run a deficit on their services trade front.

48:07And so one of the reasons why China's overall deficit, current account deficit or trade deficit, is around 3 % of GDP as compared to 10 % of GDP before the great financial crisis is because they are big consumers of services around the world. Chinese tourism has been a big contributor to incomes around the world and the service deficit that they run. So just that, right? So there's nothing, there's no sense in which China ultimately gets to do everything. Secondly, usually if you get to a point where if you're so good at manufacturing, making everything, you ultimately are going to have very high levels of investment.

48:51Given the level of savings in your country, that usually means that you start running trade deficits, right? So it cannot be a story of China being very successful in its investment and being very productive because any kind of high productivity investment boom story means the country running deficits. What has happened in China is basically a lot of consumption suppression. Because of that, you're seeing surpluses that the country is running. And we're also now seeing all the problems of very high levels of investment that's come from the crash in the property market, which despite the last four years of interventions and government policies is actually looking quite bad.

49:36So the weakness in the property market, weakness in consumption. If China is running surpluses at this point, it is because investment has dropped in China. That's come both from the property market crash, but also because of all the excess supply and the overcapacity that they've created, you've seen a decline in investment. So 2025 was the first year when investment in China actually declined. That explains why it's running a big trade surplus. Now, yes, there are a lot of exports coming out of China. Forget about the surplus deficit part, but just the fact that they are sending a lot of goods out of their country is a source of competition for manufacturers around the world.

50:22I believe that this is not sustainable. I don't think Europe or other Asian economies in East Asia are going to just say, well, that's okay. We are okay with China dumping all these goods on us. They're going to put tariffs on China. China is aware of that, which is also partly why they are trying to, you know, see how they can manage their own exports to some extent, they will move in that direction. But I am not a buyer of the whole China produces everything and does everything on its own. And somehow we still continue buying from China. That makes a little sense to me. You know, just going back to the beginning of this conversation, I mentioned a bit of a deja vu feeling because we do have these bond sell offs from time to time and we often record podcast episodes on them.

51:10And the idea of a debt crisis has also been a popular theme on many podcasts, not just ours. Do you have any sense of what a catalyst for this actually exploding into a real life debt crisis could be? Or are there certain levels or numbers or behaviors that you kind of watch out for from here? I think it's very important what's going to happen with AI and the productivity boom that we are hoping for, that is going to be very important. If it turns out that there is very little showing up in productivity from AI, or we have a setback that comes from just discovering that, oh, there's so much of hallucination that you can't really use it for anything very important.

51:59If that's the case, then I could see a situation where the pricing of debt, it drops even more it's a lot more concern about what's going to happen in terms of government's ability to repay all the debt that they have and not just now but that's expected to come into the future so for me that's one thing i mean what's it is important that there is growth in the economy and that that growth is coming from good places at this point it seems like the growth is coming from ai investment and the hope that it's going to generate all that productivity growth if that story goes away, we have a problem in terms of the concerns around fiscal positions around the world.

52:41All right, Gita, thank you so much for coming on All Thoughts. Truly the perfect guest for this moment in time. We really appreciate it. Thank you. It was a lot of fun.

53:02joe here is my overwhelming takeaway from that discussion there is so much riding on ai

53:08Tracy Alloway:yeah right like like honestly no i know it's all the last answer is like whoa it kind of all depends on economic growth and whether we get that productivity boost via ai yeah like the idea that the entire sort of Western economic model and I guess social compact with governments is now dependent on whether AI actually does what it says on the label, on the tin, is nuts. Yeah. I mean, the numbers are obviously just extraordinarily big and they're affecting everything. And obviously it shows up in financial markets, but it also shows up in the real economy. It is a major force of sustained upward pressure.

53:46Tracy Alloway:Yeah. I think there's no dispute of it. It's like we're all watching along sort of like eating popcorn and knowing that our fates will somehow and i'm serious you know so gita said it really well which is like we're all basically in the ai trade together whether you want to be or not no i know and it's like you know i look at my like very passively diversified um retirement money and i'm like i'm such a genius these days you know because it's like because you don't even have to be an ai star conversely though do you feel pressure to keep spending on tokens in order to support equity market valuations?

54:22Tracy Alloway:Yes, that's right. I keep like thinking of more tests than I could do with AI because like, oh, I need to make sure the tokens are boosted. No, it's really wild. It really is everything. And then you, the whole conversation is like, man, the last six years have been crazy. Crazy. Like seriously, seriously. I have a voice memo for producers, which is we need to clip that quote of Joe going crazy. No, seriously. You just think of all the things that have happened in the last six years. And so I guess I'm not surprised. Well, that also regime shift during that time. I mean, that also gets to Gita's response about this idea that like there is this assumption in markets that what we got through the last like 18 once in a lifetime.

55:03Yeah. Just fine. And so we'll manage to get through the next one. But then the question is fiscal capacity and I guess political will.

55:10Tracy Alloway:It's both of those. And it's like, you know, the way I think about it, and Japan, I think, is an instructive example here, which is that like when I think of fiscal capacity, I don't think of like a sort of like, oh, if you have 80 % debt to GDP level, you have fiscal capacity. If you have 120 percent, you don't, because we don't know if there is that number. But what you do know, what we can say is that in a period of high inflation and in a period where resources are already constrained and governments have made a commitment, say, to seniors that their, you know, that their standard of living will be X.

55:50Tracy Alloway:and governments have made a commitment to so-and-so, the defense that it's not going to drop below X, that once a lot of these certain sort of commitments have been made, if you get another shock in which you say, OK, let's just, God forbid, let's just say there were another pandemic in which a bunch of people temperate. We tried to do the same playbook again. And it's like, OK, we're going to replace your lost income for a few months. Well, at a time in which we're already very like resource constrained, You see how that just becomes, you know, there's a lag period where like instantly inflationary because we're already sort of that's the difference of in early 2020 and late 2019.

56:31Tracy Alloway:We were not pushing against our real resource limits in the way that we appear to be right now. Yeah, I think that's right. OK, well, on that happy note, shall we leave it there? Yeah, let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Allaway. You can follow me at Tracy Allaway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our guest, Gita Gopinath. She's at Gita Gopinath. Follow our producers, Carmen Rodriguez at CarmenArmand. Dashiell Bennett at Dashbot. Kale Brooks at Kale Brooks. And Kevin Lozano at Kevin Lloyd Lozano. And for more OddLots content, go to Bloomberg.com slash OddLots.

57:05Tracy Alloway:We have a daily newsletter and all of our episodes. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash OddLots. And if you enjoy Oddbots, if you like it when we talk about bouncing bond yields, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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