Ken Rogoff on China's Stalled Boom, America's Coming Inflation Test, and the Luck Behind Dollar Dominance
Dwarkesh Patel
Ken Rogoff is a Harvard professor, a former Chief Economist of the International Monetary Fund, and the author of Our Dollar, Your Problem. In this conversation with Dwarkesh Patel, recorded at Harvard, Rogoff argues three things. China has overbuilt its way into a deep crisis that will take years to escape. The United States has a debt problem that will most likely end in a burst of inflation, not a Greek-style default or a Japanese-style financial collapse. And America's long run of economic and monetary dominance rests partly on luck, which Rogoff thinks may be running out.
Meeting China's leaders, and what changed under Xi
Patel opened with Rogoff's many encounters with Chinese officials, which the book describes as largely positive. Rogoff said Chinese leaders listen to everybody, and are "way better than we are at hearing a hundred different views." His own advice was one voice among many. He once lectured at the Party's training school, which rising mayors, provincial governors, and bureaucrats attend and which Rogoff compared to Harvard Business School for them. The officials there asked unusually raw questions, and Rogoff was told that anything could be said inside the school. His impression was that the system selected for competence, alongside the usual loyalty tests.
Rogoff believes Xi Jinping, president since 2013, has gradually dismantled that system and promoted loyalists who are less technocratic. The talk Rogoff considers his most important in China came at the China Development Forum in 2016. It was held in a giant hall with most of the top Party leaders present, along with tech figures such as Mark Zuckerberg. He told the audience that China appeared headed for a classic housing crisis, that its catch-up phase was over, that its demographics looked poor, and that power in the economy seemed to be centralizing. He added that, as a Western economist, he did not think that last trend would be good for growth. Patel noted that the book says Rogoff had submitted a milder version of the talk in advance. Rogoff said he never uses notes and decided in the moment to address "the elephant in the room." Afterward, a couple of top leaders came up to thank him. He recalled half-expecting to be jailed. Professors can speak this way, he said, because business people cannot afford to, and the worst the hosts can do is not invite you back. They did invite him again, though the second time he spoke to a tiny room rather than the main hall.
Rogoff is now less impressed with Chinese leadership, and he worries about competence on both sides. In his view, the average quality at the very top has declined in the US as well as in China, and if China's crisis deepens or US–China tensions escalate into an entanglement nobody wants, two less competent governments are "a recipe for having bad things happen."
The 2010 stimulus and the growth slowdown
Patel asked whether it is fair to blame Xi when the 2010 stimulus that sowed today's problems was launched under Hu Jintao. Rogoff answered that Hu started it but Xi's government kept it going. The key innovation was local government debt. Local governments lacked adequate revenue sources, so they were allowed to sell land and fund construction companies to sustain themselves, and this became an ongoing stimulus program.
When Xi took over, well-connected Chinese contacts Rogoff trusts, including a former IMF colleague, told him Xi would be a "Ronald Reagan" who would finally liberalize markets. Rogoff says that did not happen. Growth slowed noticeably once Xi came to power.
Rogoff walked through how China's growth is measured. Converting reported output at market exchange rates makes China's growth look spectacular. Purchasing-power-based measures, which try to capture how ordinary people and firms actually live, show less. By Rogoff's figures, from 1980 to 2012 official growth was almost 10 percent while the purchasing-power-parity figure was just over 7 percent. He said he did not have the exact numbers at hand for the Xi era, but that official figures of roughly 6–7 percent might correspond to something like 3.5 percent. Some slowdown was inevitable, he granted, but he thinks Xi's reluctance to take risks helped produce the current situation.
Ghost-town infrastructure in China's tier-three cities
Rogoff's central diagnosis is overbuilding in both infrastructure and housing. About 60 percent of Chinese income comes from what China calls tier-three cities. Rogoff compared them to Rochester, where he grew up, or to Cincinnati, Liverpool, or Rouen. China invested heavily there, and the cities have "amazing roads, amazing real estate, amazing housing," but Rogoff described a "feel of death" in them. He compared China to the Soviet Union, which was very good at building cement factories, steel plants, and railroads until that approach ran its course. Green energy, AI, and electric vehicles exist, but by Rogoff's account they remain tiny compared with infrastructure and real estate. By some measures, he said, real estate is a third of the economy.
Patel described visiting a town of half a million people outside Chengdu six months earlier. Its train station, residential compounds, and movie theater seemed far out of proportion to the population. A recently built Buddhist temple complex took perhaps ten minutes to drive through, with shrine after shrine arranged in concentric layers, and there were almost no visitors. Rogoff added that the young people he meets do not want to live in such towns and the jobs are not there. He admitted he could not fault the strategy in hindsight: in 2005, he says, he would have endorsed pushing development toward smaller cities to relieve overcrowding of the kind seen in São Paulo or Mumbai, and he would have been wrong. Reorienting an economy away from construction is hard because people are not that flexible, much as it would be hard if AI suddenly displaced large numbers of workers.
Low consumption, not just financial repression
Patel asked whether market-based allocation of China's investment, rather than financial repression, would have avoided the problem, given that China's huge savings have to go somewhere. Rogoff said the standard advice to China has long been that its saving and investment rates are astounding. He put savings at perhaps still 45 percent. US consumption is pushing 70 percent of the economy and Europe's is in the low 60s, while China's consumption is very low and much of the country lives on incomes around $200 a month. China could transfer income to households, let them consume instead of exporting, or allow the currency to appreciate at times so imports become cheaper. It has been reluctant to do any of these.
The key to getting households to spend, Rogoff argued, is security. China has nothing like US Social Security, so people must save for old age. Healthcare comes through large state-owned employers or not at all. Citizens are generally not allowed to invest abroad. The current situation is worse because housing, which along with low-yielding bank deposits was essentially the only savings vehicle, is falling in price, and people are cutting back. Rogoff believes China can dig its way out, but there is no magic bullet to deliver 5 percent growth. He noted that 5 percent is the official figure and said he does not think China is anywhere near it. The general goal should be rebalancing from investment toward consumption.
Which GDP measure matters for military power
Rogoff's book argues that nominal, market-rate GDP is the better comparison of geopolitical power, because you cannot buy Patriot missiles or oil with purchasing-power-parity dollars. Patel pushed back: for military strength, isn't it more relevant that China can build ships and munitions more cheaply and pay soldiers less? Rogoff agreed. China "just crushes us in shipbuilding," partly because of the symbiosis between commercial and military shipbuilding, and he believes China has about 50 percent of the global market. By contrast, a new US aircraft carrier takes years and enormous expense. Rogoff thinks one US mistake is trying to build everything domestically instead of relying on allies such as South Korea, which is very good at shipbuilding. The US advantage at the moment is technology, and if that dissipated it would hurt.
Why Rogoff doubts China will overtake the US
Asked for projections, Rogoff said he had thought China's nominal GDP was below the 75 percent of US GDP Patel cited. He had been going to predict 75 percent by 2030. At one point in 2024 it was around two-thirds, but the ratio swings with exchange rates, and a strong dollar makes the US look bigger. His estimate is that China gains perhaps one percentage point a year on the US, which means it would take a long time to surpass the US in absolute size, even though China has four times the population.
Rogoff pointed out that Goldman Sachs and others once projected that the US would soon be to China what Canada is to the US, and those extrapolations proved wrong. Economists consider themselves terrible at trend extrapolation, he said, and he cited the late Dick Cooper's list of failed forecasting commissions. His gut instinct is that China is following the path of Japan, other Asian economies, and the Soviet Union, while the US retains a dynamism and creativity that other large economies have not replicated. He added that the US may be "screwing it up right now" with tariff wars and deglobalization. China and France build excellent high-speed trains, he said, while the Boston–New York train is "no high-speed train," but the really creative work is where the US excels.
Patel called the forecast extremely bearish, since even China pessimists often expect China's economy to reach 125–150 percent of US nominal GDP by 2040. Rogoff replied that China is digging out of a crisis. Prices are falling, and not because of rapid innovation. Interest rates are being pushed to zero. He reads both as signs that demand has been crushed. Chinese statistics were historically accurate on average as far as anyone could tell, he said, but he thinks that has become less true under Xi.
Monetary warning signs of a Taiwan conflict
Patel asked whether there are financial signals, analogous to satellite images of docks, that would reveal Chinese preparation for moving against Taiwan. Rogoff does not expect any sudden moves. China's reserves are shifting steadily into gold. Moving into euros or Canadian dollars would not help much, because those countries might side with the US. China has not, as far as he knows, diversified into crypto, which a student of his studied. Officially China holds about a trillion dollars in Treasuries, but a student's paper that Rogoff finds persuasive estimates the true figure at about $2 trillion, held partly through proxies.
The bigger vulnerability, in Rogoff's view, is that the payment "rails" or "pipes" of the global system (the mechanisms that clear cross-border payments between banks) are disproportionately controlled by the US. China could live without its $2 trillion for a while, he said, but not without the ability to pay suppliers. So it is developing its own payment mechanisms, as Russia did before invading Ukraine. It might also be quietly selling Treasury bills, which Rogoff said he would advise if he were a Chinese economist. What China does not want is to be the one that brings down markets and causes a global crash. China can push alternative settlement onto African and Latin American countries, some of them almost client states, and Iran sells it oil despite sanctions. The important part is not the invoicing currency but how the books are cleared. Europe is building similar capacity too: Rogoff said its central bank digital currency is moving faster than he expected, partly with international payments in mind.
Japan: how US pressure and a financial crisis cost a generation
Patel asked how much of Japan's decline was due to specific policy mistakes rather than structural forces. Rogoff agreed demographics matter most obviously. Competition matters too, including from China and Korea, because Japan pioneered an export-led growth model that others copied. The model had an under-appreciated virtue: most countries are too small to sustain much domestic competition. Rogoff recalled that Mexico once had just two telephone companies, two bread companies, and two taco companies. Export sectors, by contrast, compete with the whole world, which drove innovation in Japan and to some extent Germany. Over time, imitators eroded that edge.
Still, Rogoff sees the financial crisis as a very big factor. Without it, he estimates Japan might be 50 percent wealthier per person. Later he allowed that 25 or 30 percent might be more accurate, but either way "a lot better shape." In the late 1980s Japan was richer than the US at market exchange rates, and even by more complex measures richer than Germany, France, and Italy. Now it is near the bottom of that group.
This is a subject on which Rogoff has changed his mind. In 2005, when he suggested China loosen its fixed exchange rate, then-president Jiang Zemin told him, in Rogoff's account, "That's what the United States told Japan. Look what happened to Japan," and Rogoff heard the same from many others. He used to dismiss this, because the Plaza Accord, in which the US pushed Japan to let its currency float more freely, came in September 1985, while he and Carmen Reinhart date the crisis to 1992. Recently he has concluded he was wrong: crises unfold slowly, and the US effectively forced Japan to open up and deregulate faster than it was culturally and politically ready for. Rogoff related that someone who attended the Plaza Accord's tenth-anniversary event in Tokyo told him that the man who had headed the Bank of Japan in 1985 symbolically apologized to officials, saying he had ruined the country and took responsibility. The general lesson Rogoff draws is that financial repression is bad, but liberalization must be gradual, because doing it too quickly causes many crises.
Why financial crises cause lasting losses
Patel asked how a financial crisis decades ago could still leave a country producing much less. Rogoff said Japan's case is unusual in magnitude, but permanent losses of 10 or 20 percent are typical. He recalled an MIT professor drawing the Great Depression as a growth path that fell and resumed at the old slope without ever recovering the lost level. In Japan's case, the crisis "blew up their business model." With functioning financial markets and freer borrowing, Rogoff suggested, China might not have overtaken Japan so quickly. Japanese consumption collapsed, and its consensus-driven society, which did not want anyone left in bad shape, struggled for a long time to work through losses. The US, Rogoff said, was far more brutal in 2008 but got out quickly, though perhaps not back to where it had been.
Asked for the equivalent US counterfactual for 2008, Rogoff hesitated because he may have published a figure. His rough answer was that the US economy is probably about 15 percent smaller than it would otherwise have been, compounded by the political crisis that followed, which he regards as still an echo of 2008. He allowed that the crisis may have produced some healthy cleansing but thinks the damage was greater. He pointed to Greece and Portugal, where growth returned but the lost ground was not recovered. In their 2009 book This Time Is Different, he and Reinhart argued that recessions following financial crises are longer and deeper than normal ones. He recalls being mocked, including in a two-page New York Times spread. There are exceptions, such as Sweden, which recovered in a year or two, but Rogoff says the pattern is the norm.
America's likely path: an inflation crisis, not a default
The book predicts another inflation spike within a decade and calls the US fiscal position unsustainable. Rogoff's general model is that crises come when debt is high, the political system is inflexible, and an unanticipated shock hits. In his view the US checks the first two boxes.
Japan responded to its troubles with financial repression, stuffing government debt into insurers, pension funds, and banks. Its central bank holds almost 100 percent of GDP in debt. Rogoff said he recalls the Fed's holdings as around $7 trillion, while the Japanese equivalent would be about $30 trillion. He thinks the US, as a market-driven system, would suffer more from such pressure than Japan did, and it cannot force foreign lenders such as French insurers to hold its debt. So he thinks the most likely outcome is inflation. He is not talking about hyperinflation but 10–20 percent inflation over a period, which works much like a partial default. The recent inflation, he says, knocked about 10 percent of GDP off the debt, but it did not fix the underlying overspending, and next time more may be needed. He expects markets to be unforgiving the next time, treating the US as untrustworthy, which would raise interest rates and accelerate debt growth. Citing the saying attributed to Churchill that Americans always do the right thing after trying everything else, Rogoff expects austerity to come only after other options fail.
Patel listed the four exits: default, financial repression, inflation, and cutting deficits. Rogoff objected to how progressives use the word "austerity," saying it pretends that higher debt has only benefits and no costs, and he cited Ezra Klein's Abundance as acknowledging tradeoffs. He was emphatic that the US will not have a Greek-style crisis. Greece used the euro and had no control over its currency, while the US can print money and never has to default. Japan, using its own currency, had a financial crisis, not a sovereign debt crisis, and did not default in that period (though it did during World War II).
Rogoff drew a sharp distinction here. A financial crisis breaks the banking system and cuts off lending to innovators and dynamic firms. He recounted how Ben Bernanke, his graduate-school classmate and office neighbor at Princeton, wrote a thought piece challenging Milton Friedman's explanation that the Great Depression was caused by too tight a money supply. Bernanke's argument was that if the problem were only money, wages and prices would eventually adjust, so why did the Depression last ten years? Bernanke conjectured that the breakdown of the financial system was the reason. Rogoff said there is still debate, but he reads the weight of evidence as showing that financial crises are very damaging. That lesson has made Treasury and Fed policy "when in doubt, bail it out," which he thinks will eventually cause problems as the financial sector grows, as Silicon Valley Bank's failure showed. On balance he considers an inflation crisis more likely than a financial one, while stressing that these things are hard to predict.
Overconfidence in Fed independence
Patel asked whether bond markets are irrational, given that history suggests inflation is coming. Rogoff's main answer is that markets place too much faith in the Federal Reserve's independence. The Supreme Court had recently indicated that Trump could not fire Chair Jerome Powell, but Rogoff thinks Congress and the President have many ways to override the Fed, especially if they declare some wartime or "war-on-pandemic" emergency. Patel suggested politicians may like Fed independence as a way to pass the buck. Rogoff agreed and said that is one reason Trump bashes the Fed: it gives him someone to blame for not lowering rates if a recession comes, though Rogoff believes Trump also genuinely disagrees with the Fed.
Rogoff cited current rates: about 4.5 percent on the 10-year Treasury, a little over 2 percent on its inflation-indexed counterpart, and about 5 percent on the 30-year bond. He expects them to drift upward, raising the cost of mortgages, student loans, car loans, and business loans. A shock, possibly one from AGI, could provide the occasion to temporarily take back the Fed's independence. Rogoff noted that he wrote the first paper arguing for independent central banks when almost none existed, so he is "talking my own book" in the sense of his human capital. He said the Fed fights for its independence every day. He hears senators call Fed officials idiots, and while such talk used to come from progressives, he now hears tech titans argue that Treasury Secretary Scott Bessent is smarter than Powell and should run things.
Can the Fed's model be copied?
Patel asked what makes the Fed work and whether other agencies could be run the same way. Rogoff credited its single, widely felt barometer, inflation, which the public perceives mostly through gasoline prices and which the Fed controls over the long run. Most government decisions create winners and losers and quickly become political, which is harder for an unelected body. Asked what he would tell the Pentagon if it wanted to be run like the Fed, Rogoff said that until now it has been run "pretty darn well." He acknowledged claims that Elon Musk can put a payload into space for a fifteenth of NASA's cost, but argued that military spending that looks wasteful may reflect the fact that you never know where the next blow will come from. He suggested crypto regulation as a better candidate for independence, since it has been overrun by politics. He called the Supreme Court position that the president can fire the head of any agency, and by inference perhaps anyone in it, a terrible mistake, because switching everything every four years is "very worrisome."
Rogoff disputed Patel's suggestion that the Fed has avoided mission creep. Its working papers in recent years were dominated by inequality, the environment, and social justice, and it was hard to find one on monetary policy. Part of independence, he said, is "bending with the wind" while keeping the core function intact. He pointed to Turkey, where inflation approached 100 percent and President Erdoğan repeatedly fired central bank heads who tried to raise rates, and said the US has been lucky.
On whether younger economists will erode the Fed's focus, Rogoff was optimistic. The recent inflation miss was a wake-up call. He cited a Hoover blog analysis finding that "inflation" had not appeared in the abstracts and titles of the American Economic Association meetings in 15 years until this year. He believes the academic market, with its competitive publishing and "ruthless" seminars, corrects large errors. Ten years ago, he said, he was a lone voice. Students listened to his inflation lectures as if he were teaching them the music of Fred Astaire, and American students assumed debt did not matter, although foreign students knew otherwise. That has changed.
Financial repression then and now
Patel asked how damaging financial repression would be, given that post-war repression coincided with America's fastest growth. Rogoff said the post-war situation was unique. The Great Depression had already wrecked financial markets. The war economy was command-and-control, and workers produced with genuine patriotism. Returning soldiers gave a huge growth lift. Repressed markets also meant no financial crises for a long time. Crises often begin when someone promises faster growth by removing all regulation overnight.
The decisive difference is private debt. Federal debt after World War II was about as high as it is now, but most private and state and local debt had been defaulted on. Rogoff suggested, while calling it slightly hyperbolic, that total debt was perhaps 50 percent of GDP. Today private and state and local debt far exceed federal debt, and financial repression would strike at the business models of the financial sector.
After the shock: slow adjustment and the question of AGI
Rogoff expects the eventual crisis to be a wake-up call: a shock arrives, the US wants to borrow heavily, bond yields rise faster than in past episodes, and the government cannot do as much as it wants. It would not be the end of the world. He noted that during the 2010–2012 European debt crisis, many countries raised retirement ages with changes phased in 10 or 15 years later. But it would be unpleasant, and because the global system is dollar-centric, it would hurt the whole world and the dollar's franchise, pushing US rates higher still. He said "hysterical is definitely within the realm of possibility," while stressing that his forecast is "more likely than not" rather than certain, and that high-skill immigration and faster growth could change the picture. Growth would pause, he said, because unlike a stock crash, a debt crash has no automatic way of allocating losses, and working out who owes what can take five or ten years. He added that the belief that China's president could simply dictate the allocation has proved less true than many thought.
Patel asked whether one can believe both that AGI is near, meaning all computer-based white-collar work is automated within 20 years, and that US finances are untenable. Rogoff said a fast productivity boom would be fantastic and could solve problems. But countries have often gotten into trouble even with growth above their interest rates, because fiscal policy is political rather than arithmetic. Nobody, he said, ever defaulted or inflated because they could not do the math. If AGI came that fast and that big, he thinks it would make today's populism "seem like nothing."
On whether AI-driven price declines should be fought with money printing, Rogoff said monetary policy can still work as usual. Demand can be raised so that prices of final goods, raw materials, and inputs rise even as AI cheapens some services. Productivity growth generally makes the Fed's job easier and reduces pressure to inflate. Patel then asked whether the traditional reasons for positive inflation, such as downward wage rigidity, still apply if AIs do the jobs. Rogoff called it a very good point. Keynes's key insight was that prices were not falling in the Depression when they should have, and that stickiness is mostly about human behavior, especially workers. If firms using "docile" AI are willing to let prices fall, falling prices would be tolerable, though Rogoff wondered aloud whether there would still be human workers.
Rogoff expects AI to push real interest rates up, which would make deflation manageable: the Fed could simply let rates rise a bit less. The problem after the financial crisis and the pandemic was that rates hit zero and authorities felt unable to go deeply negative, a topic on which he has written a whole book. He cited AI's enormous energy needs as one source of upward pressure. He also cited work by Daron Acemoglu and others showing that investment need not raise wages: if AI substitutes for workers, capital becomes more valuable and investment increases further.
Patel asked whether the government should lock in hundred-year bonds now. Rogoff said he would get to that but instead turned to where rates stand, and did not return to the bond question. Inflation-indexed debt is only about 10 percent of US debt but gives a reasonable read on real rates. The 10-year real rate hit about minus one percent after the pandemic and averaged roughly zero from 2012 to 2021. Rogoff regards today's higher level as a normalization, though he acknowledged that many younger colleagues believe aging and slow innovation will keep rates low. He expects long-term rates to rise, with AGI being only one piece. The other pressures he listed are rising debt everywhere, remilitarization, climate spending or climate disasters, populism, and geopolitical fracturing. In his view, rates will rise not just for the good reason that the world has become more creative.
Foreign equities, Europe, and the regression-to-the-mean bet
The book predicts a rebalancing from US toward foreign equities. Rogoff framed the claim concretely: when the dollar is very strong, expect the euro to rise. Exchange rates were the subject of his first important paper, and although they are very hard to predict, he thinks the euro will do well. Europe has much room to catch up. He wrote before Trump's election that Europe faced pressure to rearm, anticipating that a Harris administration would likely cut US defense spending. He argues rearmament would be good for the euro, European technology, and Europe's geopolitical weight.
He disclosed his track record for calibration. His mathematical textbook, Foundations of International Macroeconomics, argues for diversification. He once made a Merrill Lynch video on international diversification with Zbigniew Brzezinski, for which he was paid, and it circulated in half a million copies. Friends teased that he would have made more money not following his own advice. Still, he expects some regression to the mean in the US premium, "maybe not with AI all being in the US, I don't know." Pressed on whether he expects US stocks to slow or foreign stocks to do even better, he would only say foreign equities will outperform dollar equities. He holds a neutral portfolio because he advises policymakers, and he does not claim to be good at investing.
Patel raised the backtesting problem: countries persistently behind the frontier may be behind for deep reasons. Rogoff agreed. Asia's lower price-earnings ratios, he said, reflect governance problems investors do not trust. But he does not think Europe is hopeless, and he sees a dim awareness there, as in California, of overregulation. Referring to the Boston Celtics' recent loss to the Knicks with star Jayson Tatum injured, he said Europe need not improve to do better if the US is hobbling itself, which he thinks is happening to some extent.
No institutional fix for the debt bias
Asked about reforms to curb bipartisan deficit bias, Rogoff said fiscal councils have been tried widely without much success. He co-wrote a paper on them with Julia Pollak when she was an undergraduate. The UK has gone furthest: a fiscal authority set up under Chancellor George Osborne produces its own forecasts, so the government cannot invent its own numbers. The US Congressional Budget Office is very good, Rogoff said, but must accept Congress's assumptions, such as a tax provision that is supposedly temporary. Rogoff thinks the deeper fixes lie in the electoral system and campaign finance. Patel questioned whether term limits would help, suggesting that longer tenure might lengthen politicians' horizons, and that populism, not money in politics, may drive deficits. Rogoff conceded he has no magic solution. No country has found one, and the only encouragement is that these things come in waves.
He described the continuity problem: any president's policies are likely to be reversed by the next one from the other party. The US has sometimes done well precisely because its government is weak and the private sector works around it. He called these political rather than economic questions but offered Brexit as "democracy gone amok." He said he does not know whether Brexit was right, but that a decision like that should require something like a two-thirds vote rather than a simple majority. He noted voting experiments in Washington State and Maine.
On low-debt countries, Rogoff said debt is only one factor. Commodity exporters such as Australia and Canada face volatile income and tend to save for rainy days, and Norway is "in a whole other league." Canada, though, has large housing debt. He stressed that he remains bullish on the US. He recalled living alone in Europe as a teenage chess player in the late 1960s and not wanting to return after Nixon's election, partly out of fear of the Vietnam War draft. He said many young people now feel about Trump the way he felt about Nixon, but he thinks the US is great.
The exorbitant privilege: a real advantage, not a trap
Patel asked whether reserve-currency status tempts the US into unsustainable borrowing that must later be refinanced at higher rates. Rogoff said he has heard the argument but thinks the privilege is basically great for the US. With $37 trillion in government debt, paying half a percent to a percent less amounts to hundreds of billions of dollars, and private borrowers benefit too. The dollar network underpins much of US intelligence gathering and enables sanctions, which the US has at times used in place of military intervention. Not appreciating this, Rogoff said, would be "a terrible blunder that we might be making right now."
On whether the US is getting real goods for paper, Rogoff said the core benefit is that the US borrows by issuing safe assets and invests in risky ones. Charles Kindleberger, his professor at MIT, called the US "bankers to the world," earning something like the equity premium on its balance sheet. Dollar liquidity also lets US firms issue debt internationally in a way a French firm could not. Rogoff noted that the UK, no longer the dominant currency, still runs large current account deficits and is even more financialized than the US, which is why Trump could strike a trade deal with it. He addressed Stephen Miran, a former Harvard student who heads Trump's Council of Economic Advisers, whose argument is that global demand for dollars makes the US less competitive and hollowed out manufacturing. Rogoff sees "a little bit of truth" in it, but the dollar fluctuates, and US strength in tech, biotech, and agriculture also pushes the currency up and bids up costs, making manufacturing harder.
Patel raised Charles Mann's 1493, which describes how Ming-era China, after unstable paper currencies, absorbed vast amounts of New World silver in exchange for real goods. Rogoff compared this to dollarized countries such as Ecuador. The US effectively prints what they hold, and they accept low interest rates on Treasury bills. He noted that China invented paper currency long before Europe and then printed too much of it.
Good, but also lucky
In closing, Patel asked what explains America's durability against the Soviet Union, Japan, and China. Rogoff noted that even after Europe partly left the dollar bloc in the 1970s, globalization spread the dollar to China, the former Soviet Union, and elsewhere, making it bigger than the British pound at the empire's height, which surprised observers like him. America has done good things, but its rivals also blundered. Japan accepted US pressure. China, in his view, clung to the dollar too long. Europe should have delayed Greece's entry into the euro. He quoted chess grandmaster Bent Larsen, who, asked whether he would rather be lucky or good, answered "Both." Americans know they are good, Rogoff said, but forget they have been lucky, and if history were rerun it need not turn out the same way.
Patel compared this to the Fermi paradox: if it is so easy for countries to fall into a rut, perhaps there is a filter that makes continued success rare. Rogoff said he hopes not. He does not think Trump caused the dollar's "gentle decline," which he believes would have happened under Harris too, but he sees events like "Liberation Day" and the erosion of independent agencies undermining the rule of law. Foreign investors used to assume that even if their stocks or real estate lost value, they would be paid, and that assumption is now "in doubt." When he previewed the book's argument to academics, financiers, and tech people, they told him he was "nuts." He said he does not know if he is right but thinks it is worth considering.
Patel recalled Chinese venture capitalists who were depressed because investors feared the government could cancel the IPO of the next Alibaba. Rogoff concluded that Europe has a bright future as "the team that doesn't have as many injured players," while China will not be in trouble forever but, he expects, will remain so for five or ten years.
Today I’m speaking with Ken Rogoff, who is a professor at Harvard, recent author of Our Dollar, Your Problem, and former Chief Economist at the IMF. Ken, thanks so much for coming on the podcast.
Thanks so much for having me and welcome to Harvard, which is where we’re filming this.
In your book you have a lot of anecdotes of meeting different Chinese leaders, especially when you were Chief Economist at the IMF. It seems like you had positive experiences. They would listen. You met the Premier with your family, and he would listen to your advice. One, how does that inform your view about how competent their leadership is? Two, how do you think they got into this mess, with their big stimulus or whatever else you think went wrong? To the extent that when you were talking to them in the early 2000s, it seemed like you were seeing eye to eye, or that they would understand your perspective. Do you think something changed in the meantime?
First I want to be careful to say that they listen to everybody. The Chinese are way better than we are at hearing a hundred different views. Mine would be one of many that they heard.
I was very impressed by the competence of the Chinese leaders. I actually gave a lecture in the Party’s training school where, if you’re a mayor, a provincial governor, any bureaucrat on your way up, you go to this thing which for them is like Harvard Business School.
They really looked for competence. Of course there were various loyalty things. But when you met the leaders—and I met a lot of them when I was at the school—they actually asked really raw questions too. They said things I couldn’t believe they were asking. And I was told that within the school, you're allowed to say anything.
So they had that system for a long time. When you met Chinese technocrats—or even the mayor of Shanghai—they were impressive. I'm not saying ours aren't, but it's a mix. I think you know that.
I think Xi Jinping has really changed that. He’s been the president since 2013, and over time he’s pushed out that system and moved more toward loyalists, people who are less technocratic.
Probably the most important talk I ever gave in China was at what's called the China Development Forum in 2016. It's this giant hall that had most of the top leaders in the party. A lot of the elite of the tech world, Mark Zuckerberg and many others were there.
I said, “Okay, I'm looking at your housing. I'm looking at your infrastructure. It looks to me like you're going into a classical housing crisis problem. Your catch-up is over. Your demographics don’t look good.” I gave a list of things. “And by the way, it looks like power is becoming very centralized in the economy.” And I said, “I'm a Western economist. You're doing an amazing job. What do I know? But I don’t think that would be good for growth.”
After I gave the talk—I just figured you only live once, you just have to say what you have to say—a couple of top leaders came up to me and said, “Professor Rogoff, we very much appreciated your remarks.” I was thinking, “Oh no, they’re going to put me in jail or something at the end of this.”
I’m less impressed by them now. And I’m worried. Let’s say they get into a crisis—which I think they’re in now. I think they're still in a deep crisis—or somehow hotter heads prevail between the United States and China and we get into some kind of entanglement nobody wants.
I worry that we’re not as competent. I’m speaking about right now. We have some very good people, but the average quality at the very top, I think, has gone down. And China’s not as competent either. That’s a recipe for having bad things happen.
On that talk, you mentioned in the book that, before, you had to clear your talk. So you gave them a sort of watered-down version of what you were going to say. I have to say, it would take some gusto to go up to the top party leaders. Were you nervous while you were giving the talk, saying, “Oh, it’s too centralized”?
I mean I was pretty experienced by that time. I frankly never used notes, so the idea that I was going to read my speech didn’t even occur to me. Maybe it was a little bit spontaneous. But I certainly felt at that moment, what am I here for? What’s the point of coming to this? Why don’t I talk about the elephant in the room? Everybody knows this. I don’t know if everybody knew it, but it was clear to me and I’m going to say it.
I think a lot of people in that situation—even though they should or the logic makes sense—they often don’t.
Yeah, I’m a professor. So people who had a big tech company or a finance company, or all these other businesses, most of them can’t afford to do that. I think they know that when they invite a professor, they can’t cut your... They can stop you from going again. They invited me again, by the way. Although the second time I just talked to a tiny room instead of the big hall. But, I give credit to the Chinese for listening.
You’ve said that the seeds of their current crisis were sown in 2010 with their big stimulus. Is it wrong then to blame Xi Jinping for this? That was before his time. It was Hu Jintao’s government that launched the stimulus that’s causing all these problems now.
Hu Jintao did it, but they kept it going. The local government debt, that was an innovation put in with the 2010 stimulus. But they kind of left it running and used it as a stimulus program.
Long tangent, but the local governments don’t have enough ways to fund themselves. So they were allowed to sell land to start and fund these construction companies, get revenue, and sustain themselves. They let that keep going.
When Xi Jinping came in, I was told he was going to be Ronald Reagan. I had very good contacts in the intellectual sphere in China. Someone who had worked for me when I was chief economist at the IMF, other people I knew whom I really trust. They're really smart and well-connected, I don’t want to say their names. But they were telling me, “He's going to change everything. This is really the time we’re going to liberalize our markets a bit. We’re going to do the things we haven’t done.”
And he didn't do that much. If you look at China’s growth, it actually slowed down quite a bit when he came into power.
There are different ways to measure a country’s output because China produces completely different stuff than we do. They use their currency and we use ours. Nothing's perfect. But one way to do it is this. What do they report their output to be in Chinese currency? What do we report ours to be in dollars? Then we use the exchange rate to compare. We can look at growth that way and if you do for China, it’s been spectacular. It’s been very, very good. It’s obvious they're pulling it out of thin air.
But there are these approaches trying to control for how you’d really compare how an ordinary person lives or how an ordinary firm gets by. When you look at those measures, China’s growth is quite a bit less. If you go 1980 to 2012, the official growth rate is almost 10 percent. This purchasing power parity rate—forgive me for using those words—is like just over 7 percent.
If you look in more recent years, it’s really slowed down a lot. Even the official numbers have slowed down. I don’t know the number off the top of my head, but it’s 6% or 7% for Xi Jinping, and maybe only 3.5%. They’re starting from a very low base. Okay, things were gonna slow down. It’s not all his fault.
But I think he’s been reluctant to take risks and I think it’s gotten us to where we are. I think they’re in a lot of trouble. They’re overbuilt in infrastructure. They’re overbuilt in housing. Have you been to China?
I was there six months ago.
Where did you go?
Shanghai, Beijing, Chongqing, Chengdu, Hangzhou, and Emeishan.
So you saw a few of the medium-sized cities. At least one of them, I think, is the new tech center. I can’t pronounce it.
Hangzhou?
Yeah it’s a big tech center. Some of the smaller cities don't feel like the big cities. And 60% of Chinese income is from what they call their tier-three cities. I grew up in Rochester, that’s like a tier-three city in the United States. But you could pick Cincinnati, Liverpool. Rouen—I may not be saying it right—in France is an example of a tier-three city. And they have invested like crazy.
I’ve been to a few and I’ve studied the data on it a lot. They have amazing roads, amazing real estate, amazing housing. But the feel of death in those cities... They were very good at building stuff. The Soviet Union was very good at building cement factories and steel plants and railroads. But they’ve run their course.
They have other stuff: green energy, AI, electric vehicles. But believe it or not, that stuff’s still tiny compared to infrastructure and real estate. Real estate’s a third of the economy by some measures.
So I think they’re in a lot of trouble now in China. They let it go on too long. But again, I wasn’t running things. If things seem to be working and you try to change things, you get thrown out. It’s not easy to be in those shoes.
When I was in China, we visited a town of half a million people outside of Chengdu, so one of these tier-three cities. Arriving there, the train station is huge. Compounds are huge. Even when you’re driving around, like a movie theater is this humongous complex.
I realized things were bigger in China. I was used to that because I’d seen these other cities by that point. But I just thought, I’ve seen cities of half a million people. I live in a city of half a million people in San Francisco. This just doesn’t seem proportionate to the size of the population.
Then we visited a Buddhist temple that had been built recently as a tourist site. It was ginormous. You would go through one little shrine, and then behind it would be an even bigger structure and then another one concentrically for like eight turns. It would take you probably 10 minutes to drive through this thing. There was just nobody there. It was like me and three other white people.
It’s very much that feeling. And the young people don’t want to live there. I have a lot of young people here as students and I run into people. They don’t want to live in these towns, and the jobs aren’t there. I can’t criticize them for trying that.
If you’d asked me in 2005, “Should we try to encourage people to go out to the Rochesters and the Liverpools and the Rouens in France?” I would have said yes. There’s too much in the big cities. There’s overcrowding. Look what happened to São Paulo. Look what happened to Mumbai. But I would’ve been wrong. These forces are very powerful.
So a lot of their growth, and what they call their GDP, is this stuff. So they’re having to reorient and people just aren’t that flexible. It’s like when AI comes and puts everybody out of jobs. When construction jobs are gone, and all these indirect things are gone, it’s not that easy to move everyone.
If it hadn’t been for financial repression, and all this investment had been done through purely market mechanisms, would things have turned out much better? Even if China gets rid of all financial repression today, they save a lot. So this money has to go somewhere. Are there enough productive opportunities to soak up all these savings? Or could there have been in the past? If they get rid of financial repression, is this a problem solved, or could it have been solved?
What everyone’s told them forever is their saving rate and investment rate are astounding. It was higher before, but it’s still maybe 45%, their consumption rate… ours is pushing 70%. European countries are a little more temperate, but they’re in the low sixties.
Their consumption is very low. They have some wealthy people that you saw when you went to the marquee cities. But a lot of China is living on $200-a-month kind of incomes.
You could give them money. You could let them consume instead of exporting it. They’ve been very reluctant to do that. You could do things to encourage consumption. Actually, even just changing their exchange rate policy to allow it to appreciate more at times, would make imports less expensive. They have been very reluctant to do that. That’s what everyone tells them. That’s certainly what I said in 2016 also.
The ticket to getting people to spend more is to provide more security than they have. First of all, there’s nothing like our Social Security system. You need to save for your old age. There’s nothing like our health system. If you work at one of the big state-owned factories, they give you healthcare, but otherwise you’re on your own.
They’re not allowed to invest abroad. It goes in waves, but they’re not allowed to put their money abroad. So they’re trying to be careful about all of that and not do things suddenly. There’s nothing to do overnight.
But fundamentally, if you’re looking at China and asking what’s wrong, it’s that the consumer isn’t spending enough.
What’s happening right now is worse, because housing prices are collapsing. That’s the only thing they really let people save in. You could either save in a bank account, which gets you a crummy interest rate, or in a house. Now they’re going down, so people are cutting back.
They can dig their way out. There’s no magic bullet to make them grow at 5%. By the way, that is the official number but I don’t think they’re anywhere near that. There’s no simple thing, but the general goal would be to try to rebalance investment, and consumption.
Going back to your point about whether purchasing power parity is the right way to compare, or whether nominal is the right way to compare. I think in the book you say the nominal comparison of GDP is better because you can’t buy Patriot missiles or oil with purchasing power parity dollars. But if we’re trying to compare the strength of the two countries—their relative strength, especially in a military context—if they can build ships and munitions much more cheaply, and they have to pay their soldiers less, isn’t that actually more relevant if we were trying to figure out who would win in a war? Shouldn’t we actually be looking at the fact that they have a bigger PPP economy than us as a sign that they’re actually stronger?
Yeah. So in the book, I’m talking about your geopolitical power, where if you’re going to give money to somebody, what’s it worth and how much can they use it.
But no, you’re absolutely right. They just crush us in shipbuilding. It’s partly because they build commercial ships, and there’s a lot of symbiosis between commercial and military. I think they’re 50% of the global shipbuilding market. For us to build a new aircraft carrier takes years and years and incredible expense.
One of the mistakes we’re making is trying to build everything ourselves. Let our allies do some of this. The Koreans are really good at building ships. That’s another place we could be importing from.
You’re right about the soldiers. They’re paid much less. They have a lot of advantages in a conflict against us. We’re way ahead in your department, tech. That is our advantage at the moment. If that were to dissipate, it would certainly hurt.
What is your projection? Right now I think their nominal GDP is 75% of America’s, or something like that.
Yeah, in dollars, what we call the market terms.
What’s your projection by 2030 and by 2040, the ratio?
I didn’t realize it was as high as 75%. I thought it was a little lower. I was actually going to say 75% in 2030. At one point in 2024, it was around two-thirds, but it’s really volatile with the exchange rate. The dollar’s really high. When the dollar’s really high, it makes us look bigger. I think they’ll gain about a percent a year on us, maybe. I don’t think they’re going to grow way faster than the United States.
Wait, that means you think they’ll never actually have a bigger economy than us?
It’ll take a long time. We’re talking about the absolute size. They have four times as many people. There were these projections by Goldman Sachs and many others that we’d be like Canada is to the United States pretty soon.
Like all these extrapolations, they were proven wrong. That brings me to a big topic. A lot of people will look at some trend, whether it's growth in something, AI, China—
I was about to say. That's a common trend in AI.
—and just project it into the future. Economists at least consider ourselves terrible at that. You go back and look at any of these commissions that were supposed to figure out what was going on. They happen periodically. Maybe Brookings puts one together, maybe the government does. My former colleague, the late Dick Cooper, had a whole list of these. So it is very hard to know.
But my gut instinct is that what's happening to China is what's happened to Japan. It's what's happened to Asia, what happened to the Soviet Union. We have a more dynamic economy. We're not perfect. Maybe we're screwing it up right now with all the tariff wars and deglobalization. But we have this dynamism and creativity that other places—at least other large economies—just can't replicate. They can build stuff. The French have better high-speed trains than we do. I hope you don't ride on the train from Boston to New York. It's nicer than it could be, but it's no high-speed train.
You mentioned China. Oh my gosh, their high-speed trains are just incredible. They're good at that. But the really creative stuff? I don't want to say they don't have any. There are some amazing Chinese companies. But let me say that the US is really good at it. We've kept that in our DNA. I think it's very important, to preserve it.
The 1% per year compression is actually an extremely bearish forecast. Even people who are pessimistic about China will say, “Oh, by 2040 they'll be at 150 or 125% of US nominal GDP.” They think it'll be bigger, but only slightly bigger. The fact that you think even by 2040 they won't have caught up is actually very extremely bearish.
No, I think they're digging their way out of a crisis. Right now we know their prices are falling. It's not because they're inventing stuff really fast. We know that interest rates are being pushed to zero. All these are signs that demand has been crushed and the economy's not doing well.
Historically, they have given numbers which are accurate on average, as best as we can tell. I think that's gotten less and less true in the Xi Jinping era.
Going back to the subject of your book. People who are trying to predict when and how China might invade or blockade Taiwan will look at satellite photos of different docks and see how many ships are there. They'll look at military preparedness. From a monetary perspective, are there signs we could be looking for? For example, if they think a lot of their American-denominated assets will get sanctioned or they won't have access to them, could we see them liquidating those assets? Would there be any sort of preparations that we could see on the monetary side to let us know they're preparing for something big?
I don't think they're going to do it suddenly. But very crudely, on their reserves they're definitely moving more and more into gold. It doesn't necessarily help to move into euros or Canadian dollars because those countries might side with us. But they're doing what they can to diversify. I don't think they've diversified into crypto yet. I had a student do a paper on that. But who knows.
What they are doing very concretely is not just about what they're holding. That's the big fact everyone looks at. They officially hold a trillion dollars in Treasury reserves. But the estimate a student of mine did, in a nice paper—and I think others agree with it—is that it's more like $2 trillion. They hold a lot indirectly through proxies.
The other part of it is that the whole financial system runs through the United States. What we sometimes call the rails or the pipes of the system. Your bank gets a purchase and my bank gets that I'm going to get a credit. How does that take place? How does it take place when we're in different countries? The United States just disproportionately controls that. That, they can't live with. They could live without their $2 trillion for a little while. But they can't live without being able to pay suppliers and other countries. So they're working hard on developing their own payments mechanisms.
Russia actually did quite a bit in preparation for the invasion. We see China doing that. Maybe they're selling Treasury bills, we don't know exactly. I would advise that to them, if I were a Chinese economist talking to them. But I don't think it's going to be something they'll do suddenly. Maybe Trump will bring down the markets and then there's nothing to save. But they don't want to be the ones to bring down the markets and cause a global crash.
What would the alternative rails that they're trying to build look like? Are they buying oil from Iran in RMB? Will other countries they need things from accept that? In 2030, what is their goal?
Absolutely. There are a lot of countries in Africa and Latin America—some of them are almost client states of China—that they can force. Iran, of course, sells a lot of its oil to China even when there are sanctions. They're moving in that direction.
It's not just about what you invoice the payment in. It's how we acknowledge it, how we clear our books. That's what they're working on. It's coming. The Europeans are working on it too, by the way. Europe is not happy with the situation. They're actually forming a central bank digital currency. It's moving quite a bit faster than I thought it would. That's actually one of the reasons they're doing it, for international payments.
Let's talk about Japan, which you also cover in the book, or their crisis. You blame US pressure in advance of that crisis on the Japanese to raise the value of their currency, and the actions by the Bank of Japan. Zooming out, how much of the crisis is not caused by things like that, but just the fact that high-tech manufacturing as a share of world output was becoming less important? There are demographic factors as well. So something like this was bound to happen to Japan, even if there wasn't some big crisis that preceded it? South Korea's GDP per capita isn't that high either, at least in comparison to the US. How much of this is due to actions taken by specific actors?
South Korea had a crisis in 1983 and another in 1997. They haven't been crisis-free, by the way. There are a lot of factors. The demographics would be the most obvious one. The rise of not just China but Korea and other competitors too.
Japan invented a business model that a lot of countries have since duplicated. The model was export-led growth. Something people might not think about is it creates competition. Most countries aren't as big as the United States, and there aren't as many different firms trying to do the same thing. Of course, we have trouble with competition here. Famously, in Mexico at one time, there were only two telephone companies, two bread companies, two taco companies. It's very hard not to let monopolies sit and use their political power.
So how do you get around that? Japan did something that was really pretty innovative. Germany did it too to some extent. In the export sector you're competing with the world, not just with domestic firms. That created innovation and creativity. Japan did really well with that. But over time, others imitated it and started building the same things. So that's part of it. The aging is part of it. But I think the financial crisis was a very big part of it.
What is the counterfactual? Suppose that the crisis hadn't happened, how much wealthier is Japan today than it might have been otherwise?
Oh, I think 50% wealthier per person, way wealthier. That's where they started. It depends on which measure you use. But by market exchange rates they were richer than the United States in the late 1980s. Even if you use the more complicated measures, they were richer than any European country, richer than Germany, France, Italy. They've moved to the bottom of the rung now.
The financial crisis wasn't the only thing. It's a long story but we effectively forced them to move faster to open up and deregulate than they were culturally and politically ready to. I give that as an example of something in the book where I changed my mind.
I had looked at that for a long time afterward. Going back to 2005—that's long after the Japanese crisis—I would hear from people like Jiang Zemin, who was the president of China that I met, “We're not going to let this happen to us. There's no way.” We were discussing how I thought maybe they shouldn't have such a fixed exchange rate. He said, “That's what the United States told Japan. Look what happened to Japan.”
I didn't push back that much with someone like that. You talk to other people. But I heard that from many people. I used to think, how can that be? There's this thing called the Plaza Accord in September 1985 where we pushed them to make their exchange rate more free. But I used to say that you did that in 1985. Carmen Reinhart, my co-author on many things, and I date the crisis to 1992. That's seven years later. I continued to think that but over the years, particularly recently, I've started to think I was wrong.
These things unfold slowly. Crises don't happen overnight. Japan deregulated and it worked. But they didn't know what they were doing. I think it was a huge mistake for Japan to agree. I actually heard from someone who attended the 10th anniversary of the Plaza Accord, held in Tokyo.
The person who had been head of the Bank of Japan in 1985 gave a speech to officials. He went like this and apologized, very symbolically, “I have ruined our country. I did this. I take responsibility.” He told that too when he read my book.
Financial repression is bad. But financial liberalization needs to be done gradually. If you do it too quickly, you get a crisis. Many crises are caused by that.
Asking as somebody who obviously doesn't know the details, at a high level how would you explain it to a novice? How could a country be 50% less wealthy than it otherwise might have been, simply from a financial crisis? Whatever they could've otherwise produced, why can they still not produce it? A country's producing a bunch of things. Why are they producing 50% less just because of a financial crisis a couple decades ago?
Their case is very unusual, although having a number like 10% or 20% is very typical. In fact, one of my professors at MIT was teaching us about the Great Depression. He said, “Here's how to think about it. We were growing like this, then we get here and we go like this, and then we're going like this. We never got this back.”
There's a lot of economic models where, Solow catch-up…
Yes but what happened with a financial crisis—particularly in Japan—is that it sort of blew up their business model. For example, maybe China wouldn't have overtaken them so quickly if they'd been able to borrow more freely, if their financial markets were working better, if they had been more adroit. Their consumption collapsed. Japan didn't quite know how to deal with that. We in the US were much more brutal in what we allowed to happen than Japan, but we got out of it pretty quickly. I'm not sure we got back to where we were, but we got out of it very quickly.
Japan has a very consensus-driven society. They don't want anyone to be in bad shape. Their struggle with this held them back for a long time. Maybe 50% is too high and I should say 25% or 30%, but a lot better shape than they have been.
Just to put it into context, what do you think the counterfactual wealth of America looks like today without 2008?
Boy, that's a good question. I'm hesitant because I probably have some paper giving a number for that and I might say the wrong thing. We certainly cumulatively lost a lot. It led to this political crisis that caused us to lose a lot more. I don't know, probably 15% lower. It's a lot lower than it would be. We had this dynamic which we're living in right now. It's still an echo of that financial crisis.
Now, mind you, you're asking about our national income. Inequality matters and would we have done other things? In some ways, the 2008–2009 crisis was a condemnation of the system and people could see it. Maybe it led to some healthy cleansing. But I think it led to a lot more damage than healthy cleansing.
I think this updates me toward the view that financial crises are even worse than I think. It isn't just this bad thing that happens and you recover. If there's 15% lingering even after almost 20 years, then wow that's huge.
You're losing a lot of cumulative growth. Look at Greece today or Portugal. You kind of get back to where you're having a positive growth rate, but you're not picking up… They're very different from a normal recession. Actually in a normal recession, you go down and then back up. The United States had thought it was immune to financial crises. We really hadn't had one since 1933.
We had a different book that came out in 2009. I mostly write papers, but this was a book with Carmen Reinhart. It was called This Time Is Different. We had some papers published in advance. We said: “No, they're different when you have a financial crisis, it lasts way longer. The slowdown is way worse.”
And we were mocked when we were saying that. I think the New York Times had a two-page spread saying how ridiculous everyone thought this was. We could have been proven wrong and maybe if we'd done things better we would have. But it is the norm. There's a few exceptions, like Sweden got out in a year or two. But normally they really are different from a normal recession.
You say in the book that you expect there to be another spike in inflation within the next decade and also that the fiscal position of the United States doesn't seem sustainable. If you go forward 10 or 20 years, when we do hit this, when the piper comes calling, what actually happens? Is it going to be some acute crisis, like what happened in Greece? Or are we going to have some kind of Lost Decade like Japan? What will happen?
Typically, you have a crisis of some sort when your debt is high and your political system is inflexible. We've checked those boxes. Then you get hit by a shock you weren't ready for. You get caught on your back foot. It depends on what the shock is, and how we react.
The way Japan reacted was through what we call financial repression, basically stuffing debt into every insurance company, pension fund, bank. The central bank holds almost 100% of GDP in debt. We think we have a lot—I don't actually know the number off the top of my head for the Fed, but I want to say around $7 trillion. Japan would have the equivalent of $30 trillion. So they've done this. It's not the only reason they haven't grown, not by any means, but it's not good for growth. That's one option.
I think for the United States, that's tough. We're just a very market-driven system. If our financial system had that kind of pressure put on it, it would be worse than when Japan did it. And a lot of people lend to us. We can't do that to them. We can't force French insurance companies to hold US debt. We can only force US ones.
So I think the most likely thing will be inflation, which only lets off steam. Because inflation sort of pulls… well, it's like a default. And I'm not talking about hyperinflation. I'm talking 10–20% inflation over a period. We just went through that. That actually knocked about 10% of GDP off our debt. We might need more next time. So it lets some steam off, but if you're still spending too much and you haven't fixed anything you're back in the problem. That's what's going on now. We had some steam let off, but it wasn't enough.
I think when it happens again, markets will be very unforgiving about it. They'll look at us and say, “You are not to be trusted.” So it'll raise the interest rate more, our debt will build up faster. I think at that point… There's this saying about Americans attributed to Winston Churchill:
We always do the right thing after we try everything else. I suspect we'll try other things.
Just for the audience, there are four ways we could get out of the debt: We could default, which you don't think is likely... But really good for my book. Already you timed this one so well. I'll be shorting the market when your next one comes out. ...Financial repression. I guess you could actually cut the deficit. Or inflation.
You're saying if there's another round of inflation, then after that...
What everyone calls austerity. By the way, this word "austerity" that progressives use whenever you ignore debt building up and spend whatever you want, "austerity" is when you don't do that. I think Ezra Klein's book Abundance actually makes the point that there are costs and benefits to a lot of things. This "austerity" language pretends there are no costs to having your debt be higher and only benefits. So yes, that's what everyone else has to do. We've gone longer than most without doing it.
If it's going to be a financial crisis and financial crises are this bad…
Inflation crisis. A financial crisis is the private sector, and the public sector bails out the private sector. So, the government, we're not going to default. We're going to inflate, or do financial repression, or baby steps austerity or something. We're not going to have a crisis like Greece had. That's just wrong. But inflation's not pleasant.
Why wouldn't we? Because we can print money. We can honor our debts. We just never have to default. Greece was using the euro and didn't have control.
Japan was using its own currency and it didn't default. They had a financial crisis, not a debt crisis. They never defaulted on their government debt in that period. I'm not sure if they ever did. I'm sorry, they did in World War II. Of course, Japan defaulted on its government debt in World War II. That's an interesting story. But it was a financial crisis they had. Financial crisis is what's making your banking system not work, lending to innovators not work, lending to dynamic companies not work. Ben Bernanke wrote at the time a thought piece about this. He didn't really have numbers. He conjectured that was why the Great Depression was so bad.
When Milton Friedman, one of the great economists of all time, looked at the Great Depression, he said: "You didn't print enough money. You tightened the money supply too much." And Ben came along 25 years later. He was a classmate of mine in graduate school. I had the office next to him at Princeton.
He came along and wrote this amazing paper. Again, it was just a thought piece, which is not a typical economics paper. He said, "If it was just that you didn't print enough money, eventually wages and prices would adjust. Yeah, maybe it wouldn't happen in a year, maybe it wouldn't happen in two years, but the Depression took 10 years. How can that be?"
He made this conjecture. There's been a lot of subsequent work showing it. Again, there's a lot of debate about this, let me be careful. But I certainly view the weight of evidence as saying financial crises are really bad, which has led us to the situation in the United States where we've gotten a little happy-go-lucky about bailing everyone out.
I would describe Treasury and Federal Reserve policy today as, "When in doubt, bail it out." Because they saw what happened. But as your financial sector grows, that will lead to a problem someday. It did, of course, in the Silicon Valley Bank case. It continues to have echoes of that. But I think an inflation crisis is more likely than a financial crisis, although these things are very hard to predict.
You say in the book that we didn't outgrow our World War II debt. What happened instead was that financial repression after the war, and then the inflation of the 1970s made our debt-to-GDP ratio… It should have been 70-something, but it ended up around 20-something instead. Of course, we just had inflation recently. Do you think there's some irrationality in the market for US government debt already, given that we can forecast what's going to happen here? They can read your book and see that inflation's going to go up. They can look through history at what's happened. Do you think there's some irrationality in terms of what people are doing?
I think, number one, is that they have too much faith in the independence of the Federal Reserve. The Fed's been this amazing institution that's evolved. It's been the guardian of low inflation. We can argue about if it's the right inflation or not. The Federal Reserve insists it's very independent. The Supreme Court recently ruled that Trump couldn't fire Powell, the head of the Fed. But I think they're dreaming. There are so many ways Congress and the President could override the Fed, especially if they declare some kind of wartime or "war-on-pandemic" situation.
Though I wonder from the politician's perspective, maybe the independence of the Fed gives them a convenient way to pass the buck that they're actually happy about. They can say, "Ah, I'd love to do this irresponsible thing, but I can't because of the Fed. It's out of my hands."
That's for sure. That's why Trump bashes the Fed. It's not the only reason he does it. I think he actually disagrees with them. But he feels that bashing the Fed, if there's a recession which there might be, gives him someone to blame for not lowering interest rates.
It depends if we run into a world where interest rates start creeping up… Right now, the 10-year rate is around 4.5%. That's the nominal rate. The inflation-indexed one is a little over 2%. The 30-year rate is around 5%. I think those are going to drift up. And that makes mortgage rates go up, student loans go up, car loans go up, business loans go up. It's painful. The question is, at what point does that pain become real?
As I mentioned, this would be catalyzed if we're hit by a shock, where you can somewhat take back independence temporarily from the Fed. I think it's easier to do than people think. Given that I think shocks are going to happen—maybe AGI brings a shock we don't yet imagine—people trust in Fed independence too much.
Now, I love Fed independence. I actually wrote the first paper on why you should have an independent central bank back when there were virtually no independent central banks. I was a pawn at the Federal Reserve. I'm talking my own book when I say it's a great idea. I don't mean my "book" book, I mean my human capital. I like to say that the Federal Reserve fights for its independence every day. I hear senators say, "They're idiots." I hear people in Silicon Valley say, "They're idiots. We should bring them under the Treasury." I used to hear that just from progressives. But now I've heard that recently from some tech titans, that "Scott Bessent, the Treasury Secretary, he's smarter than Powell. Why don't we let him run things?" They could.
It does seem like the Fed works really well as it exists now. It's independent. Sure, there are people who criticize its actions as you say. But on the whole, it seems like a reliable institution that makes smart calls. They can be wrong, of course, but it seems so much more competent than much of the rest of government. If you wanted to replicate how the Fed works—if you wanted other parts of government to work that way—is there something we could do? Or is it more of a human capital problem than an independence problem? Like, bankers and economists are really smart. I don't know if you could replicate that in the Department of Education or the Department of Agriculture.
One of the things the Fed has is this simple barometer that everybody sees. They don't really see it, but they have a feeling. They see gasoline prices, that's probably how they decide what inflation is. But they have this simple barometer. Mind you, particularly in recent years, progressives have wanted the Fed to solve inequality, social justice, and the environment. But they have one barometer that they kind of control over the long run, not in the short run but over the long run. So that makes it a little easier to say, "You wanted us to have low inflation." Whereas so many other things the government does might be making everybody better off, but they're making some people more better off. Maybe some people aren't better off at all. It suddenly becomes very political. Nobody elected the Fed, so it's harder to make those decisions. I'm obviously a technocrat, or I side with technocrats. My students are technocrats. I think way more things should be like that.
But if you wanted to do that, suppose you get called by the Pentagon tomorrow and they say, "We want to run the Pentagon like the Fed." What do you tell them to do?
I was going to say, the Pentagon? I'm not speaking about the current Pentagon, but just up till now. I haven't looked closely but it's been run pretty darn well. The military's pretty efficient. There are people who tell me, "Okay, Elon Musk can take a payload into space at 15% of—or maybe one-fifteenth of—what NASA does. Why don't we let Elon Musk run the Pentagon?" There may be something to that. I think to some extent—and maybe I'm defending them too much—but you never know where the next blow is going to come from. It always looks like a lot of your stuff is wasted, you built up. But your enemy is looking at what you have. Where are you weak? Where are you strong? So I wouldn't have picked the Pentagon as the obvious thing.
But let's say crypto regulation, that would be a good example. Why don't we have something more independent there? Instead, as you well know, it's been overrun by politics. In fact, there's this huge thing going on right now. I don't know how it's going to play out. The Fed has been protected, though not as much as you'd think. But Trump got to the Supreme Court and was told he can fire the head of any agency. I assume, by inference, he can also fire anybody at any agency.
I think that's a terrible mistake. We need to have independent agencies. You have an evaluation process. They answer to Congress. If they go off in the wrong direction, you try to fix it. But to just have everything switch every four years? That's really very worrisome.
Before Trump—maybe for intrinsic reasons, maybe because of norms—it was really hard to fire people anyway. That didn't produce remarkable competence across the government. Let me try to consolidate some of the things you mentioned. Maybe it's really important to structure more of the government like that. If you're running a department, you have just one target like the Fed's 2% inflation target. That's all you have to do. Don't worry about anything else. I do think it's impressive that the Fed has avoided mission creep. It seems like every institution in the world falls into mission creep—companies, government departments…
Oh, they haven't avoided it. They've been under incredible pressures. Obviously, things have changed. But I talk about this a bit in my book. You go through the working papers and research coming out of the various Federal Reserves and it's all about inequality, the environment, social justice. You'd be strained to find a paper about monetary policy during that period, because they were under pressure. Part of being independent is bending with the wind.
But they've managed to keep their core competency, their core function of setting monetary policy independent.
No, it's been amazing. But it is a constant fight. You can go to a country like Turkey. I don't know what the inflation rate is today, but it hovered up toward 100%. And Erdoğan—the president of Turkey—would fire the head of the central bank every year. Every time they tried to raise interest rates, he'd fire them. You can find other countries like that. So we've been lucky. But you can't count on that continuing.
Apart from the political pressure problems from the outside, you mentioned watching your younger colleagues or younger economists writing working papers at the Fed about these other issues like inequality or climate change. From the inside, given what the younger people in this profession care about, do you expect the competence or the focus to just decline by default, given the new generation?
No, this was a wake-up call. There was a blog that Hoover did. They looked at the most-used words in our big annual meetings. There's this thing called the American Economic Association meetings. Everybody goes. They took all the abstracts and titles from the last 15 years and the word inflation had not appeared until this year.
But why are you optimistic about when they get in charge...?
There's an intellectual market. This was a huge miss and there's a market for figuring it out. One of the good things about the American university system—at least in the sciences, and I'll speak for economics—is that things drift off but if something is way wrong—and they were certainly way wrong about inflation, I believe, and way wrong about interest rates and debt—then there's some rebalancing. We have a very competitive system of publishing. We have a seminar system that's just ruthless. There's a debate around it. It's not settled, and maybe I'm wrong and they're right but it's definitely being debated now.
Whereas 10 years ago, I think I was like a lone voice in the wilderness saying these things might happen again. I would teach inflation to my students. They'd sit there patiently. It was like I was teaching them the music of Fred Astaire or something. They'd go, "Okay, it's the 21st-century, the Internet, that can never happen." Or I'd teach debt. If I had foreign students, they were all having problems. But the American students were like, we can just do whatever we want. But it's changed.
Going back to the potential future problems, if we do go the financial repression route and not the inflation route, how bad will that be? As you were saying, after World War II we had financial repression. But that was when we had the highest growth ever. On the other hand, China and Japan, it seems like a lot of their problems might be caused by the misallocation of capital that financial repression created. Do you have some intuition about how much we screw ourselves over with that route, as opposed to inflation?
We'll start with World War II but it's never just one thing, obviously. There were a lot of things. So with World War II first of all, financial repression was easy. The financial markets had been destroyed by the Great Depression. World War II became something of a command-and-control economy.
There are a lot of interesting papers about World War II that show that Americans just worked really enthusiastically. There was real patriotism in the production. I'm not saying we're not now, but back then they were able to fill factory jobs that we probably couldn't even fill today. As we emerged from World War II we had all the soldiers come home. That's a huge growth lift. We didn't manage it perfectly. We actually had quite a bit of inflation during that period. The financial markets, as you grew up in and as young people know them today, didn't exist back then. The world has changed a lot.
Does that mean US growth would have been even higher after World War II if we had just kept the government debt or figured out some other way to deal with it and let financial markets develop earlier?
Maybe. We didn't have any financial crises for a long time because the markets were very repressed. Oftentimes, when you get a financial crisis it's exactly when somebody comes along and says, "I know, I can make us grow way faster. Let's just take away all the rules and regulations overnight." That happened in one country after another. It works, until you blow up. So you'd have to say that, by and large, it was managed rather well. We grew. The rest of the world grew.
It took time for private markets to develop. One thing I should've emphasized was that our debt was very high after World War II, about what it is now.
But there was nothing else. There wasn’t all this private debt. That had all been defaulted on. I’m being slightly hyperbolic but maybe it was 50% of GDP altogether. Everything else, state and local debt, had been defaulted on. Now, it’s bigger than the federal debt by a wide margin. So it was a very different world, putting in financial repression back then, compared to now when that’s a big part of our business models in the financial sector.
Just to make sure we’ve completed the concrete scenarios, basically your prediction is that there’ll be some crisis, some surge of inflation, then there’ll be austerity. And then what happens? Is growth really slow afterward because the government can’t spend as much? What do the next few decades look like in your world?
I think it will be quite a wake-up call for Americans, having to adjust under difficult circumstances. Most likely, we get hit by a shock. We want to borrow a lot. The bonds are rising faster than they did the other times we did. And we're not able to do as much.
It’s not the end of the world. During the European debt crisis from 2010 to 2012, most European countries raised their retirement ages. They didn’t do it right away. They did it 10 or 15 years out. There’s stuff you can do. So I want to be careful here and say it’s not like the end of the world, but it’ll be pretty unpleasant.
This will affect the entire world, since the global system is very dollar-centric. It won’t be good for our franchise, the dollar being so used everywhere. As other countries start using the dollar less, our interest rates will climb even higher.
I’m an academic. I’m not trying to push my ideas by being maximally hysterical. But hysterical is definitely within the realm of possibility here. What I’m saying is more likely than not, not that it’s definitely going to happen. We could have growth. We could have a whole lot of high-skill immigration. We could make changes. There are a lot of things that could go well.
On the growth thing, Europe’s growth has been pretty bad after 2010. Japan obviously has had pretty bad growth after their crisis. Why will we be in a different position if we do have this kind of crisis? Why will growth continue apace?
No, it’s going to cause a pause in growth. The main reason debt crises happen is we don’t have an automated system of working it out. When the stock market crashes it’s painful, you’re looking around for who got hurt. But when you have debt crashes, we take five years, ten years, to figure out who owes what. It’s that process of allocating the losses that causes problems.
That, by the way, is why so many people thought, “China’s fine. The president will just tell everyone what it is.” That turns out to be not as true as they thought.
Is it possible to believe both that AGI is near and that America’s fiscal position is untenable?
What do you mean by saying AGI is coming?
Any job that can be done purely through computers is automated. So white-collar work, the work we do even, is automated within 20 years.
Anytime you get a big productivity boost, it’s fantastic. If it comes quickly, yes that can solve problems. I will say that historically, there have been lots of times when countries had good growth—even higher than their interest rates—and they still got into trouble because fiscal policy isn’t mechanical. It’s political. It’s about how much you spend, who wants what. It’s not an arithmetic question.
Let me say it another way. Nobody ever defaulted or had high inflation because of arithmetic, because they couldn’t pay, or couldn’t have called in someone who knew what to do. They do it because of political pressures.
I think if AGI came that fast and that big, it would make the populism phenomenon we’re facing now seem like nothing.
If AI is going to be massively deflationary—if it makes all these goods so much cheaper—should we be printing a bunch of money to still stick to 2% inflation? Or does that not matter anymore?
Well, we certainly can run monetary policy the same way. You don’t automatically get deflation just because some goods are going down. You can do things to increase demand so that there are upward pressures on final prices. Even if the AI workers aren’t demanding anything, you can put in a lot of demand so firms charge a lot, not just for the services that AI is replacing but also for the raw minerals and materials that go in.
Fundamentally, when you have productivity, it makes it easier for the monetary authorities—the Federal Reserve—to deliver low inflation and good growth. That’s what they’re trying to do. It makes their job easier. And I think it takes the pressure off them—somewhat—to inflate, because things are going pretty well. So there aren't the same pressures.
But should they be trying to fight the deflation at all, in that world? Because traditionally we need inflation to root out the rentiers and to fight downward wage rigidity. But now the AIs have all the jobs, so we don’t need to worry about that. There are a bunch of biases humans have that we need inflation to correct for. Do we even need that in a world with AI?
Okay, that is a very good point. Frankly, Keynes founded modern macroeconomics. He was an incredible Renaissance person, having both sides of the brain. One of his insights that just transformed things was this.
Before Keynes, we used what we now call general equilibrium models: demand and supply, prices moving to keep everything in line. But Keynes was looking at the Great Depression and said, “Prices should be coming down. But they’re not. Why aren't they?” That’s really a cornerstone.
At the end of the day, it’s mostly human behavior. It’s mostly workers. So if you have these docile AI workers—they’re not workers, they’re just firms—and if you have firms that are willing to let prices fall, then certainly you can do that. I mean, we’re still going to have some human workers? I don't know.
But here’s a question on what monetary policy should be. Do you think interest rates are going to go up or down? When we had deflation last time—from demand-deflation, like after the financial crisis and the pandemic—interest rates went down.
My intuition here is that interest rates would need to go up. I mean real interest rates, real inflation-adjusted interest rates. And then, deflation isn’t such a problem. You just don’t let the interest rates go up as much.
Last time, interest rates went to basically zero. That’s a whole other line of discussion. They felt they couldn’t lower them into significantly negative territory. So they were sort of paralyzed. There was this deflation, or at least too-low inflation. Monetary authorities thought they knew how to create inflation, but that’s always been by cutting interest rates lower. When they hit a bottom, they don’t.
I have a whole book about negative interest rates and that’s a whole other thing. If we’re imagining real interest rates going up, then it’s not much of a technical problem. You just let the interest rates rise a little less so you’re not getting deflation.
Do you expect interest rates to go up? Because one factor is that you want to invest in the future, the future has so much more potential. Another is that maybe you want to consume more now, because you know you’re going to be wealthier in the future anyway. You might as well start spending as much as you can now.
I think AGI and AI are upward pressures on interest rates for lots of crude reasons. The huge energy needs.
Traditionally, when you did a lot of investment it raised wages, but it’s possible—there are economists like Daron Acemoglu who’ve shown it can go both ways, it’s not difficult to show that—if you're really just substituting for workers, it’s making capital more valuable, you just invest even more.
The pressures on monetary policy will depend a little bit on that. In principle, it makes life easier. If it did push the interest rate down to zero, there are interesting questions around that, but maybe your audience might not be as fascinated by them as I am.
Let’s talk about it a little bit. If we expect interest rates to go up because of AI, what should the government be doing right now to be ready for that? Should they be locking in hundred-year bonds at the current interest rates since they’re only going up from here?
I’m going to get to that. But first, just where we are… I follow interest rates today all the time. Maybe a lot of people who listen to you don’t. But let’s talk about inflation-adjusted interest rates.
There’s a 10-year bond that’s indexed to the inflation rate, issued by our Treasury. Inflation-indexed debt is only about 10% of our total debt. There are tax considerations—it’s not perfect—but it’s a pretty good measure of what we call the real interest rate.
It had gone to minus one at one point after the pandemic. It averaged zero for about 10 years, from 2012 to 2021. And it’s higher now. That is, for a macroeconomist, the biggest question in the world. Because it affects asset prices, it affects risk, it affects volatility.
I regard it as just a normalization. I think it was likely to happen. If you go around and talk to some of my younger colleagues, or folks at other places, there’s quite a debate about that. A lot of people think, “We’re getting old, we’re not inventing anything...” I know you’ve just been arguing against that and good for you.
I tend to think interest rates are more likely to go up than down, going forward. I’m talking about these long-term interest rates—the Federal Reserve just sets the overnight interest rate—these long-term interest rates are set by markets, and I think they’re more likely to go up.
But I think AGI is only a piece of it. Debt is rising everywhere. There’s the remilitarization of much of the world. Needing to deal with climate change. Eventually if we’re not dealing with it, then we’re dealing with climate disasters. There’s growing populism, geopolitical fracturing, many things.
I tend to think interest rates are going to go up but not just for the good reason that we’ve gotten more creative and that everything’s going to be better.
You've said in the book that you expect a rebalancing from US equities to foreign equities. US equities have outpaced foreign stocks for the last couple of decades. You say you expect this to change or that there will be some rebalancing. What causes that?
What I say very concretely is that when the dollar is really high, you should expect the euro to go up. I feel strongly about that. My first important paper was about exchange rates. That’s why the book’s about exchange rates.
When Japan’s really weak or when the dollar’s really strong—it’s very hard to predict exchange rates—but I think the euro will do well. There’s a lot of room to catch-up in Europe.
I actually think I’m nuanced in what I say in the book. Trump hadn’t been elected yet, but I say Europe seems to be under pressure to re-militarize. I was aware that Harris was probably going to cut the US defense budget, so that would put pressure on them. Re-militarizing would actually be good for the euro. It would be good for technology in Europe. It would give them more geopolitical power in the system.
Now, just so your listeners can calibrate this, my first book was a very mathematical one, Foundations of International Macroeconomics. In theory, you should diversify. You shouldn’t put all your money in the United States. I did a video with Zbigniew Brzezinski, Mika Brzezinski’s father. For those who don’t know, he was Carter’s Kissinger.
I did a video with him that Merrill Lynch produced. It was about why international diversification could be good. What they got me to say was very, very limited. I feel quite fine about what I said.
I wasn’t doing any consulting at the time, just academic work. I didn’t do speeches, I didn’t do consulting. I talked to central banks a bit, but I didn’t do anything for money. But I did get paid for that. It circulated half a million copies of it. A lot of my friends teased me and said I would’ve made a lot more money if I hadn’t followed my own advice.
I can think of plenty of other examples like that. But yes, my instinct is that—this idea that our US premium should just keep getting bigger and bigger—these things have some regression to the mean. Maybe not with AI all being in the US, I don’t know.
Is it that you’re predicting that the S&P keeps growing at 8%, but foreign equities do even better?
I’m just going to safely say foreign equities do better than dollar equities.
But not because the growth in US equities slows down, it’s just that foreign equities do even better?
Look, you have a lot of friends who spend all their time doing this. I wouldn’t pretend to. I hold a very neutral portfolio because I talk to policymakers and world leaders even on occasion. I don’t want to be someone who’s talking about regulating Bitcoin and owning a lot of Bitcoin, to pick a random example.
So I wouldn’t regard myself as great at this. But yes, I think there’s a case for international diversification, particularly into Europe at this point because they have so much potential catch-up. Just as in California, where you’re from, there’s a little bit of dim awareness that it might be overregulated and you might want to do things differently, I feel that’s happening in Europe.
If you look internationally, if you'd been betting on catch-up, I wonder how you’d backtest it. There’s some intuition there that if you’re poor and you’re further from the frontier, it makes sense that it would be easier for you to catch up. But there’s another intuition that if you’ve been persistently behind the frontier, there must be some deep endogenous reason.
You’re absolutely right. For example, Asia has a lot more governance problems on the whole. There’s a reason that their price-earnings ratios are lower, because you don’t trust the governance. You’re right. That’s fair and a lot of people are just betting on that. But I don’t think Europe is so hopeless that it can’t pull it together.
I can make a comparison. I'm a basketball fan. The Boston Celtics just got crushed by the Knicks, just before we’re taping this. Part of it is because our star, Jayson Tatum, was injured. You may not have gotten any better, Europe in this case, but if somebody’s hobbling the United States—I do think that’s going on to some extent now—you do better.
Is there some institutional reform we could make that would get us out of this political equilibrium we're stuck in? Both parties, when they're in power, are incentivized to increase the debt and there's no institutional check on that proclivity.
There have been a lot of people who’ve tried this, for example by having what are called fiscal councils. I did a paper once with Julia Pollak, who’s a brilliant economist, when she was an undergraduate. That was quite a while ago. A number of countries experimented with fiscal councils, but it hasn't worked.
The country that's done the most with this is probably the United Kingdom. George Osborne, when he was Chancellor, set up this fiscal authority. The big thing they did is they made predictions so the government doesn’t get to make up different predictions. You don’t necessarily have to go by their numbers, but they got to say whatever they thought.
Our CBO does not get to do that quite the same. Our Congressional Budget Office is very good, but they are constrained to believe what Congress tells them. If Congress says, “We’re putting in this tax cut, but it’s going to go away after ten years,” or “We’re doing this policy, it’s all going to change,” then they’re forced to use those parameters. The UK version is more independent.
There are lots of complaints about it, but that’s a very poor man’s fiscal authority, just somebody who says, “This is what your deficit looks like.” It’s the same thing as our CBO, but with more independence. It helps. But I think it has to go to our electoral system, right?
Our campaign financing. Do we have term limits? You think that would help? I think, if anything, if you’re longer in office, you might have a more long-term incentive. To the extent that a lot of the deficit problems are caused by populism, I don’t know how much campaign finance would help.
Maybe you’re right. I don’t have a magical solution to this. It’s all over the world. Nobody's finding a particularly great solution to it. The only encouraging thing is that these things go in waves. So maybe this one will end. But we’re certainly in a really difficult situation right now.
Somebody asked me, “If you were advising a Republican president or something, what would you do? What problem would you face?” The biggest problem is that in a few years there’s going to be a Democratic president. They’re going to do exactly the opposite of what you wanted to do. It’s the same thing for the Democratic presidents. How do you have some continuity? How do you have policies put in place that the public can rely on? We’ve done well in the United States in some ways because our government’s been kind of weak and hasn’t been doing stuff. The private sector can work around it. I’m not saying it’s perfect. There are lots of things we should do.
But look, this is out of my paycheck, so to speak. You're the former Chief Economist of the IMF! All right, but that’s economics. These are very political questions.
Brexit’s an example of democracy gone amok. What a dumb idea. I don’t know if Brexit was right or wrong. I feel like we’ll know in 50 years. But you shouldn’t be able to do it with a simple majority vote. You should need a two-thirds vote, or something like that.
There’s a whole government department here with people specializing in what we should do. Actually, I think there are experiments. Washington State experimented with different voting choices. Maine did. There are these ideas out there, but we’re a long way from converging on anything.
If you think people are underweighting how big the debt issue is, are you especially long on countries which have a low debt-to-GDP ratio, like Australia or Norway?
It's not the only thing going on in the world, your debt is just one thing. Countries like Australia and Canada for example are what we call commodity exporters. They know that sometimes the sun shines and sometimes it's a dark winter. They don’t quite sell oil but they sell some coal, natural gas, and some oil. They understand things move around and that they need to save for a rainy day. Norway is in a whole other league.
But yes, there are lots of factors to whether a country will do well. The lower-debt countries have less of a problem. But Canada and Australia face very volatile income streams because of commodities, so they tend to be more nervous about debt. By the way, they also have a lot of housing debt, in Canada for example that's been a big problem.
But I’m bullish on the United States. Don’t misunderstand me. I’m not saying everyone should leave the United States and go to Canada, although my wife thinks that sometimes but for other reasons.
When I was playing chess in the late 1960s, I was living by myself in Europe. Nixon got elected. I felt about Nixon the way I think a lot of people in your generation or at least millennials feel about Trump. I didn’t want to come back to the United States. So there are a lot of people who talk that way. But I think the United States is great.
Countries that are smaller, that aren’t the reserve currency, that don’t have access to these deep pockets of domestic and foreign borrowing—and all of those countries fit into that framework, they need to be more careful.
This "exorbitant privilege," as you talk about it, is it possible that one way in which it's bad for us is that it allows, or incentivizes us, to take on more debt than it's wise to? And especially if this isn’t a permanent advantage we have. When you’re at the top, you take out this cheap debt. And over time you lose your reserve status, or it weakens at least, and you have to refinance that debt at higher interest rates. So in the short term, you’re incentivizing this behaviour which is not sustainable in the long run. Is there a political economy explanation for why that might be bad for us?
I've heard that argument, but I basically think it's great for us. It's not just the government. It’s all of us who borrow less. Do we wish we were paying higher interest rates? Probably most people who are getting a mortgage right now feel like our interest rates are plenty high. They don't need to see them higher. I think with the exorbitant privilege, there are some drawbacks we don't need to get into. But it's basically incredibly fantastic if you owe $37 trillion as our government does, to be paying half a percent to a percent less. We're talking about hundreds of billions of dollars.
Our ability to see what's going on everywhere. A lot of what our spying does is using our exorbitant privilege and the dollar network.
Sanctions. I mentioned, I was in my teens at the end of the 1960s when I didn't want to come back. One reason I didn’t want to come back was the Vietnam War was pretty terrifying. I had many friends get drafted. Their brains got fried by heroin even if they didn’t get killed. And, sanctions. I'm not saying that we've solved all our wars with sanctions. But make no mistake, we have used that in place of military intervention a few times. So that’s been great. I think losing that, and not appreciating how important that is, is a terrible blunder that we might be making right now.
This is a very naive question. I know you address it at length in your book. I’ll ask the question in the most straightforward way and then you can explain what's going on. How should I think about the fact that we are basically giving the rest of the world pieces of paper and we're getting real goods and services in exchange? Sure, at a high level you can say that they're getting this liquidity or they're getting this network and that's what makes it worth it. But I don’t know, are we fundamentally getting away with something?
So just to note, the United Kingdom is not the reserve currency. They're not the dominant currency. They used to be, a hundred years ago. They look a lot like us now, with big current account deficits. That’s actually why Trump was able to strike a deal with them. Because they weren’t really running a surplus against us, anyway. They’re over-financialized, even more than we are.
The core of the benefit we get is that we borrow by issuing safe assets—if you want to call our debt safe—and we invest in risky stuff.
Charles Kindleberger wrote one of the great books on crises. I had him as a professor at MIT. He called us bankers to the world. He said “Yep, we’re running this deficit, they’re holding a lot of our Treasury bills, but we are making money hand over fist.” It’s the same thing as the equity premium where you hold stocks and it’s not always, but on average better than holding bonds. So that’s been very good.
You have the fact that the dollar is very liquid, the markets. Say you're a Silicon Valley firm and you're big enough to issue debt internationally. I don’t know if any Silicon Valley firms ever issue debt, but if you did, people will buy it because it’s in dollars. If you're the same firm in France, forget it. They don’t want to hold euros. Even if you promise to pay in dollars, they’re not happy about it because your income isn't in dollars. So it’s been fantastic. This is something that's been debated.
Stephen Miran, who was a Harvard student, he's the head of Trump’s Council of Economic Advisers. Very smart guy. He's made this clever argument that because everybody loves our currency, it makes us less competitive in everything else. It partly hollowed out our manufacturing and that’s terrible.
There’s a little bit of truth to that. First of all, the dollar goes like this, so it’s not always high. Second, I mentioned the United Kingdom is kind of in the same boat. We’re good at a lot of things. We’re good at tech. Tech makes the dollar stronger, make no mistake. We’re good at biotech, agriculture. We’re good at a lot of other things that make the dollar high. And if you’re good at these things, it’s harder to be good at manufacturing. It bids up the cost of everything.
On the whole, we’re performing this banking function. That’s really the big thing. It’s been going on since the ’50s and ’60s. That’s the core of our so-called exorbitant privilege.
There’s a really interesting book by Charles Mann. I think it's called 1493. It’s about how during the Ming Dynasty in 17th-century China, they kept issuing different paper currencies and it was super unstable. People in China wanted a reliable medium of exchange. So tens of thousands of tons of silver from the New World, from the Spanish, would be exchanged for enormous amounts of real goods exported from China. So from the Spanish perspective, they’re getting shiploads and shiploads of real goods, and all they’re giving up is this medium of exchange. I don’t know how analogous that is to the current situation.
There are countries like Ecuador and others that dollarize. They literally use the dollar and they need dollars. We’re able to have them hold dollars. It’s not silver, but we print it and they pay very low interest rates. They’re holding Treasury bills, not physical dollars. Yeah, it’s fantastic for us. We definitely pay less on our debt because of that.
That’s a fascinating example you bring up. The Chinese actually invented the printing press. They invented paper currency way before the Europeans. But then, what do you know, they kept printing a lot of it and had a lot of inflation. I hadn’t read that book, but it’s a great example. I knew they were using silver, but that number is bigger than I had heard.
Final question. A big part of your book discusses the different countries which seemed at different times to be real competitors to America. You talk about the Soviet Union, Japan, China today. We've discussed why they didn’t pan out. We can go into the details on any one of those examples, but in the big picture is there some explanation that generalizes across all these examples of why America has been so competitive? Or why it's been so hard to displace?
It’s not just that we’ve stayed on top, we’ve just gone like this. Remember, in the 1970s, Europe actually peeled away from the dollar bloc. But the rest of the world started globalizing. China globalized. Eventually the Soviet Union, and the dollar just colonized all these places. They were all holding dollar debt, using dollars. It’s much bigger than even the British pound was when the sun never set on the British Empire.
So it’s been amazing and surprising to people like myself. If you read what everyone was saying at the time, it was just that it kept going up. That our share of everything kept getting bigger and bigger.
Definitely, to some extent, we’ve been lucky. We talked about Japan. I think China made a big mistake by sticking to the dollar so long. Europe should have delayed bringing Greece into the Euro, because their crisis wouldn’t have been so bad. So we’ve been fortunate with blunders by our opposition. We’ve done some good things. But I think the thing Americans forget is that we have been lucky a lot of times. I worry our luck is wearing thin.
I quote a chess player—the great Bent Larsen, who was number two to Bobby Fischer when I was playing. He was asked, “Would you rather be lucky or good in a chess game?” And he said, “Both.” So I think Americans forget. They know we’re good and we are good. We’ve talked about dynamism, this secret sauce that we’ve had so far. But I think we’ve also been lucky. If you ran it all again, it didn’t have to go the same way.
It’s a very scary kind of luck. If it’s so easy for these other countries to make some mistake that causes them to totally fall behind, it should update you in favor of the idea that, in general, it’s easy for a country to get itself in a rut. It’s like the Fermi estimate thing. The fact that you don’t see other alien civilizations is actually very scary, because it suggests that there’s some kind of filter which makes it really hard to keep your civilization going.
I hope not, but we’ll see. It’s certainly been amazing how the dollar’s done and how the US has done. I hope we continue, but we are doing a lot of things right now… I don’t think Trump is the cause of the dollar being in gentle decline. That’s just wrong. I think it would’ve happened with Harris winning.
But he is the president at the moment, and things like Liberation Day… I’ve talked to tech people who think it’s just brilliant. I understand that. We can debate it. I’m happy to debate it with them.
We look at the rule of law. Okay, I’m sitting at Harvard University. Naturally it feels that way. But also we talked about the president being able to remove all the independent agencies. It used to be that if you were a foreign investor and you invested in the United States, you thought you’d get your money back. Maybe the stock would’ve gone down. Maybe the real estate you bought would’ve gone down. But you’d get paid. I think we were more exceptional than most about that. That’s in doubt now. There’s no question.
The book’s about a lot of things besides exorbitant privilege, the whole arc of the US. But when I was telling people about the book, “I don’t know, I’m looking at the numbers, I’m looking at what China’s doing, I’m reading about Europe and their central bank digital currency. I think we’re going downhill.” I showed it to academics, I showed it to financial people, I showed it to tech people. They said, “You’re nuts.” They didn’t want to think about it. I don’t know if I’m right. But I think it’s worth thinking about.
When I was in China, I met up with some venture capitalists there and they were quite depressed in general. Even founders say it’s hard to raise money. I was asking them why, and they said investors don’t want to invest because even if you invest in the next Alibaba, who’s to say the government doesn’t cancel the IPO?
They’re in trouble. Yeah. I think Europe has a bright future in this context, of being the team that doesn’t have as many injured players. But yeah, China… it’s not going to be forever, but I think for five or ten years they’re going to stay in trouble.
Okay. Thank you so much for sitting down with me and also answering all my questions. I’m sure there are many misconceptions and naive questions and so forth. I appreciate your patience and you educating me on this topic.
No, it’s an honor to be on your famous podcast. I heard from so many young people when I told them I was talking to you. They were like, “You're with Dwarkesh? Just fly back from here! Do whatever you need to do!” So I’m glad you were able to come here. It’s really been interesting, and I’m glad to learn more about everything you’re doing.
The honor’s mine. It was great to be able to travel here and speak with you.
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