And then tell us, you know, what is this 2.0 version and who's kind of in the way in the firing line as China continues to make waves in the global economy?

Yeah, I think you're right to start with the first China shock, by the way.

So this is again, I'm going to take you back to the kind of early 2000s here.

China's just joined the WTO, is integrated into kind of global supply chains.

It's becoming the workshop of the world, quote unquote.

At this point, it's responsible for five to eight percent of global exports through through the mid 2000s.

And the prevailing view then, you mentioned at the start I was at the UK Treasury, the prevailing view at the UK Treasury and across the G7 economies was that this is something we should embrace.

Is that because the economic heat is increasing? cooling down, that investment is cooling down, or is it just you think the markets have got ahead of themselves and there needs to be some sort of correction to expectations there?

When we talk about the first China shock and China shock 2.0, how do we see them as two distinct shocks? Or is it as with those world wars, there are the same sort of underlying issues bubbling away beneath the surface?

It's a really good point.

And there are clearly some similarities, not least the fact that they are rooted in the similar structural issues within China's economy that have not changed for the past 30 years.

That is to say, this growth model that rests on very high savings rates, very high investment rates, therefore prioritizes the development of the supply side of China's economy over the demand side, and so generates very strong exports and large external surpluses, trade and current account surpluses.

So that was the essence of the first China shock, and is the essence of the second China shock, too, that in some ways, the kind of structural drivers of these shocks have not changed.

The fact that it's been driven by the same forces in China and it's manifesting itself in the same way in the global economy, that is to say through a large surge in China's exports, I think means you can view it through a similar lens.

I would argue that this shock is different in at least three important respects.

So what are the risks that these imbalances get resolved painfully?

How much does this, what we've been seeing in energy markets, the resurgence in oil prices, in gas prices, in refined product prices, indeed, how much does that change the outlook for these economies? Maybe, Neil, you want to talk about the UK and Europe, but Stephen, I'd be very interested to hear what you have to say about what's going on in the US in terms of gas prices and the like.

I think that the first point to say is that in general terms, higher global energy prices is a headwind for Europe, and by that I mean the Eurozone and the UK, in a way that it's not in quite the same way for the US, because the US is a small net energy exporter, but Europe's still a large net energy importer.

So higher global energy prices, economic headwind for Europe, less so for Europe.

the US.

Now, of course, in reality, it's a bit more nuanced, a bit more complicated than that.

The big development, I think, over the past few weeks has not necessarily been the resurgence in oil prices, but so much natural gas prices.

And that's particularly an issue for Europe, because Countries like the UK price utility bills, price household electricity bills off of the natural gas price.

week or so, that's shifted

Neil, first of all, I mean, how exceptional are current borrowing prices and what's driving it? If you look over the last 10

years, then currently the level of bond yield, so the interest rate that governments across the developed world are paying on their debt, is extremely high.

So at the 10-year rate that the UK government is paying, that's the highest that we've had since 2008.

In Japan, it's the highest since 1996.

So relative to recent history, extremely high.

But actually, if you take a longer... view.

If you go back to, say, the early 2000s, the 1990s, the 1980s, governments back then were paying much more to borrow from the market.

So also, we don't see pump prices that high, do we? How is that feeding into the bond price? Is it is it a broader question of geopolitical uncertainty? Is there no simple linkage between energy supply and that price? Just color that in a bit more for us, if you could.

Which economies, this is another question that lots of people have been asking, which economies do we see the greatest risk of a fiscal crisis?

Well, I think the first point to say here is a really good question, and it's one that we get all the time.

But I think the first point to say is that there's no kind of magic number or magic threshold for what constitutes fiscal sustainability.

It means different things in different economies.

If you look through the broad sweep of time, you've had sovereign debt crises, albeit in emerging economies, when government debt to GDP has been as little as 15% of GDP.

But that's because of the characteristics of that debt, lots of foreign currency debt in the system, and then the currency peg breaks and you get a fiscal crisis.

On the other end of the spectrum, we've had Japan, where the gross government debt burden has been in excess of 200% of GDP, net government debt well above 100% of GDP for decades, and yet nothing has broken.

I don't know if you want to call it financial repression, but just using the Scott Besant's intervention, this increase in buybacks as an example, is that the kind of thing we can expect going forward? Is it effective? What's your take?

So let me ask you, why do you think that Zhu Rongji's death has had such an impact on the debate among people who are watching China's economy?

I think for a couple of reasons.

One is that, um, as you say, you know, Zhu Rongji was most notably associated with China's push to join the WTO, put real impetus into that, into that process, uh, that had frankly been stalling before, uh, he became premier.

So the, you know...

When China joined the WTO in 2001, actually it was at the end of a 15-year process, the, of China trying to join the WTO, undertaking reforms, America being concerned, uh, that China wasn't doing enough on the reform front.

Actually, parts of the, the, the party in China also being concerned about, uh, the, the, the wolf is coming was, um, what, the, the phrase that was used, that the idea that you let America in through the back door and that this would be bad for, for China.

So he was credited really with putting renewed impetus into that accession process and, um, and leading that from China's end.

So how does this all develop then?

What do you make of all of this speculation?

Well, there's possibly something in all of this.

I have to say, there's been a hundred hot takes on this coordinated intervention, and I'm not sure I necessarily buy [laughs] any of them, if I'm being, being honest, uh, uh, that we've seen over the past week or so.

Very often, when we see these, these kinds of interventions, quite quickly the commentary descends into the weeds of the market mechanisms of how it works and the significance of different instruments that are used and mechanisms that are being used, uh, and what we might interpret from the, uh, from, from that.

And I think often, um, there, there's a lot less to this than, than might meet the eye.

Um, so yes, possibly the use of euros might signal a bit of concern that by selling dollars into this market, it puts a bit of upward pressure across the curve.

But as Jonas has just said, the numbers involved are pretty minuscule when it comes to the, to total global flows in capital markets.

Presuming we're not gonna get a joint US-China mission to appreciate the renminbi, what's the answer there in terms of its sort of widespread understanding of how undervalued it is and what that undervaluation is doing, uh, in terms of fueling global imbalances?

So how is it going to play come September, do you think?

There's an awful lot, I think, to unpack there.

The first point, as you say, we've not talked about other FOMC members.

All the focus has been on Walsh.

But of course, he's one voice in 19 on the committee, an important voice, but only one of 19 and one of 12 that votes.

And three of those 12 voting members actually voted for a hike at this week's FOMC meeting.

Although Walsh seems to be equivocating and sending muddled messages and mixed messages, other FOMC participants are not waiting around.

Very quickly, give us a flavor of which side we're on on this particular question of whether a stronger Renminbi would fix China's surplus.

Is it any clearer what the goal is for the Trump administration? And can we expect tariffs to rise much further from here to the point that perhaps global trade is harmed?

As ever, it's as clear as mud, I'm afraid.

There were three broad justifications from different parts of the administration that were given for the imposition of tariffs.

The first was that these tariffs were supposed to be going to help to combat global trade imbalances.

uh we're always very skeptical on that and so it has proven to be the case the second is that the imposition of a tariff wall would help to reshore manufacturing back to the us equally we were skeptical on that basis we said there's perhaps scope for some limited reshoring in certain sectors like semiconductors and high-end advanced manufacturing some evidence that it's happening in those sectors but certainly not on a broad and widespread level.

So second objective and justification certainly not met.

And then the third one was that it would bring, as you say, some revenues into the treasury coffers.

How important is this AI investment boom in terms of what's going on in global trade, in terms of the US growth story, in terms of the China growth story as well?

So I guess my question to you to kick off is just things are clearly getting spicier again, but how spicy?

Yes, indeed.

I think there's a couple of questions here.

Indeed, I wrote a note, published a note earlier this week, trying to unpack exactly what's going on.

First question is really what are markets? It's helpful to kind of benchmark where we are in terms of what markets are currently anticipating.

And if you look at, say, options pricing in the crude market, it's clear that the contracts, say, three months ahead, prices have increased.

By a bit, not by a lot, but by a bit.

So in terms of just practical policy applications, how is this testimony going to translate into action?

So if that has peaked, why then do we think that the Fed is going to be more hawkish than market pricing suggests that they will?

It's peaked, but let's get this into context.

It's currently running in the May data that we just had that you referenced at 3.4% year-on-year core PCE.

The monthly number, the monthly increase was 0.32%, if you want to get very precise, to two decimal places.

Clearly, both of those numbers are inconsistent with the Fed inflation target of around 2%.

So it's one thing believing that core PCE has peaked, but it's running well above the Fed's target.

And I think more importantly... is going to be quite slow to fall back.

So what happens then for the macro picture? Is this a big risk to our forecast?

Now, Without just resorting to, oh, the outlook's incredibly

uncertain, difficult to see what happens from here, let's try and organise a framework for thinking around how central banks might direct policy over the coming months.

I think you can basically place central banks into one of four buckets.

The first is central banks, particularly those in the emerging world, that were going to have to hike interest rates really for defensive purposes because they were either concerned about inflation expectations becoming very unanchored or because they were worried about pressure on their currencies via the balance of payments shock.

So into that mix, you would put countries like Turkey, Pakistan.

Actually, Indonesia would probably fall into that category.

In those central banks, I think we're going to have policy on hold now.

So I guess my question is, how far is Europe going to go to counter the China shock? And to extend that question even further, are we heading for an EU-China trade war? Well, if you look at what the EU's

Would a deal, if this time is for real, if we are going to get a deal, would that provide pause for thought for those bankers thinking we must act now for these so-called insurance hikes to get inflation pressures under control? Or is it the case that the inflation genie is sort of out of the bottle, as it were, and that there's still inflation coming through the system, they can't take any chances, they still need to raise interest rates?

Well, I think central bankers are in an incredibly difficult position.

I think it's quite easy to criticise central banks, and they do obviously make mistakes, but I think this time they are faced with a number of challenges, because this is inherently a stipulationary shock, and they can't do much about the inflation part of that, because it's coming through the energy channel.

uh and rate hikes nobody's expecting rate hikes to do anything to bring down energy prices in and of themselves so they're in a difficult position the objective here has to be to keep inflation expectations anchored and to damp down non-energy inflation pressures core inflation pressures in in the economy to prevent second round effects from taking hold and getting a kind of vicious cycle of higher energy prices to be getting higher wage wages and and therefore underlying core inflation going up, and therefore another round of price increases further down the line in the core part of the CPI basket.

So the question is, how do they respond? The ECB, as you say, has already moved.

I think it's easy to kind of criticize the ECB and say, well, they've moved prematurely.

They did the same thing in 2008, and they did the same thing in 2011, in both cases tightening into the global financial crisis and then the European sovereign debt crisis.

What happens if a deal doesn't get done or if a deal gets done and it collapses? In terms of the global economy, with regard to oil supplies, what's the outlook if we can't secure the flow of energy back through the strait? Well,

What are the growth considerations when central bankers think about whether or not to raise rates in this environment?

The key here is to really step back and think about the, the strength of aggregate demand in, in the economy and the, the degree of capacity in the economy.

Because it's possible that you could have relatively weak aggregate demand, but it also, if there's not much capacity in the economy and the supply side is, is growing and expanding at a relatively slow rate because productivity growth is weak-That can still generate inflation pressures of, you know, inflation rates of two, 2% or more just because the supply potential of the economy is weak.

So you've gotta balance the supply side and demand growth and aggregate demand, and of course, the way that this really kind of comes to bear is through, through labor market dynamics.

Lots for central bankers to, to consider.

In the case of the US, of course, it's not just the energy crisis from the war in Iran that we need to think about when it comes to inflation and growth, but also the continuation of the investment boom around AI.

Now, in the US, the US economy grew by just over 2% last year.

But they'll get it in the neck if, you know, they raise rates and growth takes a hit.

Is it a similar story for in- for what happens now with inflation?

Well, it's certainly the case that we've yet to see the full extent of the rise in inflation as a result of the energy shock that's emanated from the, the war in Iran.

So in a sense, just as if the Strait reopens, we won't necessarily see full normalization of global energy markets, nor will we start to see, uh, immediately see a, a big dropback in inflation.

I think whatever happens, we're in a world where inflation, particularly in the, the Eurozone and the UK, is probably heading towards 4% or so, uh, because of the lagged effects of previous increases in global energy prices that have yet to feed through.

Uh, but also, as David says, uh, particularly in gas markets, perhaps we've yet to see the full effect play out in the physical markets there, too.

So I think the markets should still be braced for a further increase in inflation, headline inflation.

However, with that all being said, I think there are a couple of things that have happened over the past, uh, week or so that perhaps, uh, do justify walking back some of the rate hikes that had been priced into markets.

I mean, how, where would we be seeing that? Where is it coming through the system?

Mm.

Um, and these are not just in cargo planes.

A lot, uh, me- very often it's the case that goods are shipped in the, in, in, in the, in the, um, i- in, in the holds of a commercial passenger plane.

So for as long as the p- passenger traffic between the Gulf and the rest of the world is disruptio- disrupted, it becomes much harder for firms to transport in the hold, holds of these, the- these commercial passenger, uh, planes, and therefore we start to see disruption coming through supply chains in that way too.

Um, now what type of goods are those? They have to be kind of light, uh, l- lightweight and therefore easy to, to ship via, uh, via, via air.

So we're thinking of things like consumer electronics, iPhones-

The economy contracts." How much do vibes have to do with this? That if we think we're going to be paying more for gas or for air travel in the months to come, we're going to spend less now and that that impacts the economy down the road?

Well, I think vibes is another way of putting, uh, uh, framing consumer confidence, and confidence does matter in, in an economy.

Okay.

Uh, and my bet is that the market's got a bit too carried away with the idea of Fed rate cuts next year.

US economy is holding up reasonably well.

Yes, employment is slowing, but productivity growth is accelerating.

Uh, inflation's still probably a bit too high for comfort.

You've got a fiscal deficit of 6% of GDP.

Um, so my bet is that the Fed does not cut by the four, uh, that the 425 bips that they've currently priced into markets.

Do, from where you sit from a distance, how, the uproar over Kevin Hassett right now, i- i- if you look at, if, if you look at the debate, can the presidents and the governors push against any given new chairman?

So couldn't that, in fact, fragment trade even more beyond these areas?

I think he could.

That's certainly a risk.

I think that we just need to keep some things in perspective.

When we say that there certainly is no coherence to the Trump trade agenda, I think if we're looking for some kind of coherent policy here, we're going to be looking for a while.

But if you look at the tariffs that have been levied on different economies, actually they're not quite as arbitrary as some of the headlines might have you believe.

We've done a lot of work trying to map the world into these two blocks.

What would your answer be to that? Aren't there going to be multiple Poles? Couldn't the Europeans suddenly feel the weight of their tension strength economically and leading into it militarily with the Germans borrowing a trillion dollars and so on? Couldn't there be a slightly more complex scenario?

So that bit isn't true.

Exactly.

The genesis of the book really was in some thinking that we started at Capital Economics probably five or six years ago in the first Trump administration, where there's lots of headlines about the US imposing tariffs on the rest of the world and China in particular, other countries pushing back, countries turning inwards.

We obviously had the Brexit vote in 2016 here in the UK.

In a sense that the countries were turning inward, they were pushing back against globalization, lots of kind of images of the 1930s being invoked, and this idea that the world was de-globalizing.

The rhetoric was everywhere, but we saw no evidence of this in the data.

So like all good ideas really, it started by challenging the consensus.

There's all sorts of things here that could feed into a very volatile inflationary environment.

What is the distinction of this fractured age that's not in the zeitgeist now? All the blo- the 18 newspapers, the media, people like us, what are we missing of this fractured age?

I, uh, so I think that the genesis of the book was the, the rhetoric of de-globalization was everywhere, right? Tariffs going up, trade barriers going up, this idea that we're returning to the 1930s, countries are turning inwards.

And when we at Capital Economics looked at the data, we saw global trade volumes going up year on year on year.

So this idea, the thing that everyone's missing is the idea that the world isn't de-globalizing, but clearly something is changing.

And as I argue in the book and as we've written about at Capital Economics, the thing that has shifted is the relationship between the world's two major economies, the US and China.... they've become superpower rivals, and that's causing those economies to both pull apart, or fracture, and then other economies to have to pick a side essentially.

Can the global economy truly be global if there is this seemingly gr- broadening divide between China and the West?

Well, there's, there's gonna be greater frictions within global trade, in capital flows and technology flows, maybe people flows too.

Um, as I argue in the book, the key, uh, economic, or the key driver of the economic consequences of this fracturing is gonna be twofold.

Yeah.

I think it's certainly the case that Trump's re-election has posed some challenges to not necessarily the thesis in the book, but the form that fracturing takes.

You could have a much bigger divide, not just contained to these strategic sectors between the US bloc and the China bloc, Another way that you could have a different form of fracturing is if the US block itself fragments and fractures, which is what you're alluding to.

Now, I think that's arguably the greater risk here, frankly.

But there's some early evidence, I think, that the economic gravity, pulling all the binding together, all these complex parts of the US block still hold.

So if you think about, for example, the trade tariffs that have been imposed.

far higher on China than, for example, on the EU, on Japan, on the UK.

How do you see that relationship playing out? Where does Europe come down? Does America make a Europe choose between Chinese inputs and Chinese tech over time? How does that play