Conversation with Jeffrey R. Shafer, Vice Chairman of Citi Global Banking and Senior Asia Pacific Officer in New York
Interview by Keith W. Rabin
Hello Jeff, thank you for speaking with us today. Before we begin can you give us a little about your background and tell us about your role and responsibilitiesat Citi?
I was trained as an economist and spent 25 years in the public sector, working for the Federal Reserve Board, the Federal Reserve Bank of New York, the Council of Economic Advisors, the OECD in Paris and the US Treasury before joining Citi 13 years ago. This has given me perspective from both the public and private sectors. Earlier in my career I was mainly focused on advanced OECD countries, though starting when I joined Treasury and since I have been at Citi I have been more focused on Asia and today I am the senior NY anchor for Citi's Asia-Pacific business. We define the region to include Japan, Korea, China, India, ASEAN, Australia, New Zealand and other economies east of Pakistan.
A little over a decade ago we used to speak fairly regularly in the aftermath of the Asian financial crisis as we brought through Asian government clients seeking foreign investment or undertaking research studies concerning how the US had balanced its budget and initiated a "productivity miracle" during the latter stages of the dot.com boom. A lot has changed since that time. What happened?
I think the kinds of things mainstream economists at the IMF and elsewhere were telling people then were right. For example, fiscal discipline is important to sustain growth, as is inflation control, a sound financial system in which abuses are policed, an environment in which business is free to innovate, expand, contract and even to fail, and reducing trade barriers, What we found out, however, was that we ignored too many of our own lessons. That is the result of hubris, as despite the real concerns of people like myself, we acted as if we did not have to worry about budget deficits and financial soundness.
So, for example, I remember talking constantly in Asia in the late 1990s after their financial crisis about the need to create a strong well-regulated financial system. We fell short on that ourselves and the authorities ignored what was developing in the mortgage markets, which created a mess on a scale that far surpassed anything I saw in Asia in 1997. So it is a matter of the US having to learn the lessons we used to teach other people. This is not the first time that has happened. I used to spend a lot of time in China in 1998-2000 giving presentations on corporate governance to prepare for public listings of state-owned enterprises. Then we had the Enron/Worldcom debacles and I remember going back to China and saying that our failures in the United States reinforced the need to get corporate governance right.
There is a lot of debate these days concerning the effect of stimulus and need for further quantitative easing. At least on the surface financial markets seem to be recovering yet when you talk to people focused on the real US economy they remain highly nervous and many doubt a recovery has taken hold. What is your view on the current environment in the US and world at large? Are you more worried about prospective inflation, deflation or a stagflation scenario? What do you think of the argument the US is following a Japan-like path?
If you look at the US today we have come through a deep cyclical downturn brought about by the problems that were uncovered through 2007. The right solution to that was to use monetary and fiscal tools aggressively and that is what happened. Governments around the world became both spenders and lenders of last resort. And that has pulled us out of the tailspin. The US and Global economies are growing.
But beneath that there are major structural imbalances in the US, Europe and Japan that are not easily dealt with through the fiscal and monetary tools that can be used to address cyclical downturns. I think it is still important to use all of the tools that are available and it looks like the Fed is ready to commence quantitative easing again, but I am not terribly optimistic that it is going to pull us out of the fire and put us back on the growth path. For me to say that is quite a change as for thirty years I thought the notion of "pushing on a string" was not right and that monetary stimulus always worked, but we have reached a stage where I no longer am confident that the monetary transmission mechanism will work. More fiscal stimulus is not the answer. We need to improve the growth trend of the economy, not give it a short term boost after which it will fall back to where it would have been anyway but with a bigger and more dangerous debt overhang.
The US needs to deleverage both our national and local governments and households are rightfully seeking to reduce their debts. This process is unavoidable if we are to resume sustained growth. Europe and Japan are not so different though there the emphasis is more on government than households.
Interestingly, corporations are generally in strong financial positions. Debt is not high, they are cash-rich and there is potential for more investment if there is confidence, though the other two sources of domestic demand remain a drag on our economy. In these conditions, deflation is a much bigger risk than inflation, although a flat or very slowly rising price level is the most likely path.
The Emerging Markets are very different. They suffered from the abrupt inventory adjustment and slowdown that hit in 2009 but bounced back quickly because they initiated strong stimulative action and also because their financial systems proved strong following earlier reforms. China and Korea were foremost in undertaking stimulus and they have done well. They are back, showing real strength.
There is real growth more widely in Asia. India is reducing the growth gap between it and China and Indonesia was one of the few countries in the world that did not see an output decline last year. The strong growth in Asia is also creating conditions where, when combined with support by good economic policies, we are also seeing relatively strong performance in Latin America, the Mideast and Africa. This is very different from the impact strong financial downturns in the developed world have traditionally had on the emerging world. To some extent that is because growth in India and China is much more commodity intensive than here and Latin America, the Mideast and Africa are major suppliers of needed inputs and materials.
We've seen big differentials between developing countries and emerging markets in the past, but going forward we don't have the same capacity to absorb their exports and run up larger trade deficits given the deleveraging that needs to occur here. So the only way we can sustain growth in these markets without putting further strains on the developed economies is if they raise demand within their own economies. More balance is essential.
There are elements that are similar in the US to the Japan experience. Deleveraging and wealth loss, to name two factors, continue to be a drag on the US but there are many differences as well. We still have a more innovative business culture and an inclination to take risks. This mindset has not been completely driven out of the system as it seems to have been in Japan, and the process of repairing the financial system has gone more quickly here than there though we need to do more work before we can relax.
Many would argue current efforts to stimulate the US economy have focused too much on monetary initiatives to liquefy the financial system and prop up banks rather than investing in infrastructure, education, development of alternative energy and fiscal incentives to boost demand, jobs and US productivity. While that was perhaps unavoidable after the collapse of Bear Stearns and Lehman, is there validity to this thinking and do things need to change? If so, how can we generate the bipartisan debate and consensus needed to carry out programs of this kind? What will it take to put the US back on a path to sustainable economic recovery?
The extraordinary Fed actions, the support from TARP and the stimulus were absolutely essential to restore liquidity to financial systems and stop the downward spiral after September 2008, and there would have been no bottom if that had not been done. Most of what was done was to restore stability and liquidity that was badly needed. It was not a transfer of income from Main Street to Wall Street but loans that are being repaid. Most, if not all, will be repaid and this should come out when the final accounting is done. Infrastructure involves a very different demand on the public. Many kinds of infrastructure take government funding and both our national and state governments do not have the capacity to provide that without adequate cash returns from the project, so we need to find other ways to do this. For example that might require greater reliance on tolls and user fees. And that will work for some kind so infrastructure but not for others. As for a bipartisan consensus, this does not appear to be on the horizon. This means increased uncertainty and higher capital costs. It is unfortunate that the country is so divided when business and households are looking for direction.
We read all the time about how banks are filled with cash but do not wish to lend and US companies have stronger balance sheets than ever but remain reluctant to step up hiring and fund new investment initiatives. Is this an accurate view or is it more that US firms and financial institutions recognize that US and other developed markets are relatively mature and they are better off focusing their attention on emerging markets where living standards are starting to accelerate and consumer demand and demographic trends are far more positive? If that is true, won't US stimulus and quantitative easing measures simply result in higher fund flows into the emerging markets with little to show for these efforts in the US? What can be done to create a more balanced scenario?
It is partly true that Fed liquidity is backing up in the financial system and it was true as early as 2007 that what the Fed was doing to respond to the crisis in the US was stimulating other parts of the world. That is what we termed decoupling at the time. It is still true that creating larger credit capacity is important in the US, particularly in the housing markets. This is needed to sustain the relative stability in housing prices we have had over the past 18 months. Large corporations have access to a bond market that is wide open. This channel is working well, but, small to mid-sized enterprises are more dependent on banks for credit. So the problem is partially that there is not enough demand but it is also true that when credit demand reverses there are likely to still be capital constraints on the regional banks that supply much of the credit. This will constrain lending even if liquidity is ample. This is also a problem in Europe, particularly in the small to mid-sized enterprise sector.
Despite the massive dislocations and excesses we have seen in recent years, there seems to be a continuing general acceptance in the US and much of the world of the Reagan/Thatcher notion that government is not really capable, the less it is involved in things the better and that as much control as possible should be placed in the hands of the private sector. As someone who has spent a lot of time in both business and government what is your view on this? How also do you view the movement toward asking companies to initiate more of a "stakeholder" than a "shareholder" focus taking on more social responsibility and green and other priorities which may be culturally biased and contrary at least to their short-term profitability and are generally hard to quantify?
As someone who has looked at many economies around the world, I am convinced that the idea that America has advocated globally -- that the source of innovation and real sustained growth is within the private sector (in no small part because you can allow failure there) is not the same thing as saying government is not useful and needs to disappear. It is important to recognize that there are things that governments do best. Private sector businesses should be the players in the economic game, but the game needs referees and government needs to play that role. When I look back, there are things they could have been done better in that regard. For example, there was a need for more consumer protection in the mortgage markets. So you need rules of the game and an enforcer. There are also other areas where markets don't work well and the government needs to play a larger role. Health care is one example. However, that said, when the US economy gets back on track it will be due to innovators in the private sector who have access to capital and are able to make things happen. If they fail, they shut down and someone else can try.
As for the shareholder-stakeholder issue, I find the idea of companies serving stakeholders rather than shareholders difficult to implement. It is tough to have multiple objectives and easily leads to confusion. At the same time, I believe companies should have an enlightened view of shareholders' interests and look beyond the short term. This requires sensitivity to environmental and social issues. Indeed I am co-chair of the Environmental and Social Responsibility Policy Review Committee at Citigroup. We seek to sensitize the businesses within Citi to the environmental, social and sustainability issues that carry market, credit and reputational risks (for us) and to advise on best practices.
What is your view on emerging markets these days? Is growth sustainable in these markets? Even if fundamentals are sound over the long-term, won't the tsunami of funds from hedge funds and other investors create a potential bubble-like scenario given that the supply of available foreign capital will push down returns and easily exceed demand and the availability of good publicly listed investment opportunities in these markets?
The growth in emerging markets is sustainable though there is a risk and that it won't be sustained if governments don't take care to develop the environments needed to develop strong domestic demand. That is what we saw happen in Japan for decades after it emerged as a strong economy and that experience can't be repeated, as we simply don't have the capacity to absorb increased trade deficits in the United States.
The leadership of the countries that are now emerging though do seem to recognize this need and we saw China take steps to stimulate domestic demand during the global recession and lately to allow the RMB to appreciate a bit at least partly for that reason. It is easy to fall back to prior patterns and cater to the needs of exporters who hold a lot of power in these markets. But if leaders take steps to support rebalancing and continue to develop domestical demand, growth can be sustainable. Given the higher demand for commodities this will create, will broaden growth to a wider range of emerging and frontier markets. The macro fundamentals are good and inflation is not a problem.
There is, however, a risk of bubbles. These require two factors to be present. First, you need a lot of liquidity, and the Fed is going to make sure we have that. Second, you need a good story, and the emerging markets certainly have that as well. This can lead to complacency and unsustainable valuations. So the authorities have to be attentive to counter that, and not to start believing the story is better than it is -- allowing asset values to rise to unsustainable levels. The emerging markets also need to make sure bubbles are not fed by excessive domestic credit expansion.
Credit bubbles are especially damaging. We had a bubble here in the dot.coms in the late 1990s. That, however, was more driven by an exciting story rather than by highly leveraged investments. So, while it was very painful to many of those who were in the middle, it was not that bad for the overall economy, given it did not involve high debt as the more recent housing bubble did.
As Asia and the emerging markets increasingly transform themselves from supply and sourcing platforms to primary sources of incremental consumer demand we are seeing a transformation of the traditional model where US, Japanese and European companies came to these economies to make things for sale back in their domestic markets to one where they need to design and sell products into these markets themselves. At the same time while success in President Obama's desire to double US exports by 2015 depends on their cooperation, many of the companies and investors we speak with lack the scale of large multinational enterprises. They recognize the importance of international expansion but don't really understand how to get started and are too consumed with their day-to-day activities to develop and implement viable expansion strategies. How do you view this challenge and what would you tell a small to medium sized US firm that is seeking to expand their presence in international markets?
When you pose the question that way you recognize that the engine of exports is likely to be mainly from the larger companies. I don't mean solely the giants, but those with some scale as these companies can plan, sustain and mount the required marketing and distribution efforts. Hopefully, as suppliers to these companies, smaller firms will also be able to benefit from these efforts.
At the same time I think there is an entrepreneurial opportunity similar to the role that Japanese trading companies used to play when they spread out over the world, and worked to profit by showcasing and selling the capabilities and products of promising firms, many of them smaller firms. American young people are more global than ever before and the Internet will also allow much more cross border activity. Perhaps they will invent a virtual trading company model that creates affordable opportunities for smaller firms and make profits for themselves.
This month's annual IMF/World Bank meeting in some ways signaled a further shift to a new era where developed nations no longer hold almost monopoly control over global decision-making and emerging nations -- in recognition of their increased economic importance -- are demanding a greater voice in the international financial system and other key issues such as climate change, security, diplomacy, public health, etc. At the same time while the global economy is increasingly integrated and technology allows instantaneous flows of information, multilateral institutions and regulatory architecture -- which are more important than ever before -- do not seem to possess the authority or capacity to keep up with these developments. How do you view the outlook for multilateral cooperation moving forward? Is it time for a comprehensive reevaluation of the Bretton Woods and other international regulatory systems and institutions? If so, where would the impetus and leadership come from to make it a success? If not, what can be done to enhance international cooperation?
Clearly there is a shift taking place, though I think it is progressing too slowly. We recognized the need to bring Asia more into the system 15 years ago when I was at Treasury. The shares in the IMF make it still a very Euro-centric organization. The shift is happening but it is happening slowly. I don't think, however, that voting shares -- the critical issue. It is the voice at the table that matters. And, if like China, you are now the world's second largest economy, you have weight. There are others that are also becoming more important as well due to their size or importance for other reasons.
I think the G20 is a very important innovation, rising from a not very visible financial ministers organization into a new structure that was given more power and importance in the midst of the current crisis. It is not perfect or universal and having 20 people (or 40 with the central bank governors around the table) is too many - but they have systemic importance and weight and have performed very effectively to motivate a global effort in the midst of the crisis.
The G7 could fulfill this role at one time before the emerging powers became systemic forces. It is important to remember that it was more effective in dealing with immediate problems than in getting agreement to head off future problems. When the prospect of a problem is on the horizon but it is not yet here, it is almost impossible to get the political focus to do things that might have short-term costs . We nevertheless need to make a commitment toward greater multilateral cooperation and the US is doing this. It is still true that, while we may have lost the hegemonic status that was often ascribed to the United States, we are still the preeminent force. If we don't take the initiative on matters such as this, nothing will happen even if the views of other powers need to be recognized.
At the same time, the idea of giving power to a central supranational power is not realistic so long as it is national governments that are accountable to their people. So we need to make due with what we have and at the moment the G20 seems to be the best vehicle available. The G20 participants can go back to the IMF and other organizations, which can be effective implementation vehicles. The fact that the IMF came to address the Euro sovereign debt crisis last spring is a good indicator that it can respond and help resolve problems when it has clear instructions.
The ascension of China as a global economic power is one of the most important developments in the world and while economic growth in China is a positive development that provides new markets and demand and important support to the global economy - there is a lot of concern over the value of the Renminbi, environmental degradation, social stability, shifts in military power, the effect of China's development on commodity prices, its control of rare earth metals and other possible tensions and problems. How do you view China and its potential to deliver ongoing stable growth moving forward? If it needs to cool down and digest the torrid pace of a long period of double-digit growth, what can take its place and absorb large amounts of fixed investment? Is India a possibility, which seems to now be on a faster growth track and recognizing the need for major infrastructure development? What about Indonesia and ASEAN?
The emergence of China's economy is the most amazing economic development in my lifetime and possibly since the English industrial revolution. It is tremendous what it has done to improve the lives of people, These rapid changes do not come without ups and downs. The development of China's capacity to play a new role in the world is also a challenge. But I think the world will be a better and more prosperous place with a developed China. If it is already the second largest economy, and if it stays on course, it will surpass the US in output in the next decade. China will be a global economic force comparable with the United States. But per capita income in China will still only be about a quarter of ours. That will make it a very different place with many unique challenges. I think the US and China are destined to be the two primary economic powers. Possibly they will be joined by India, with other pockets of importance such as Brazil and Indonesia. The EU, of course, is a larger economy but it does not have a single strong voice.
A metaphor which I have also used for some time is that the relationship between China and US is like a game of street basketball. There is no referee and there is some pushing and holding. But both sides want to play so they will keep rough play within bounds so the game can continue. In this view, the tensions and problems we are seeing are likely to go on for decades. It will be complicated, though I remain optimistic it will be managed so that we can continue to have a close economic relationship and prosper from it.
It is almost a cliché to talk about how the Chinese symbol for crisis combines both danger and opportunity. As you look out at the world where do you see the biggest dangers as well as opportunities both for major multinationals and large financial institutions such as Citi as well as the small to mid-sized firms who constitute the bulk of the global economy?
I am worried about two dangers. The first is that we do not bring about the rebalancing where the developed world deleverages while emerging markets build demand within their own economies. If that happens it will mean a failure to sustain growth in the emerging markets and heighten risks of trade protection and confrontation. The second danger is that in fixing the problems exposed by the crisis we go so far that the financial system is not capable of funding needed growth and development. We need to have a more stable system, but financial institutions need to be able to continue to take risks and fund the companies that will create growth industries and new technologies moving forward.
Thank you Jeff for your time and attention. Before we conclude do you have any final words you would like to leave with our readers?
We have covered a lot of ground. Good to talk and speak again soon.
This interview is part of an ongoing series highlighting Asia-related business, trade and investment opportunities and issues.