Nobel laureate Michael Spence says fears of US recession ‘are receding, but I don’t think they’re over’

In an August 17 interview, Michael Spence, Nobel Laureate and Professor Emeritus and Dean of Stanford Graduate School of Business, spoke about the prospects for the US, Chinese and European economies and the impact of China’s slowdown on the world.

Spence, a senior advisor to General Atlantic LLC and chairman of the company’s Global Growth Institute, also commented on the top risks to the global economy.

Here’s a partial transcript of the highlights of the interview, slightly edited for brevity:

US economy

Q: Has inflation peaked?

A: Overall, I think inflation has peaked, but it may not settle down to acceptable levels anytime soon. There are different degrees of impermanence, if I may say so. A surge across a range of commodities is likely to flatten as the system adjusts.

But we have very big changes in labor markets and in the configuration of the world economy. We’ve spent more than two or three decades bringing more productive capacity online in developing countries. And every time demand increased, the supply side reacted. On the supply side, there is no longer that degree of elasticity, meaning that going from a demand-constrained world to a supply-constrained world is almost a regime change in the global economy.

Q: Are the fears of recession over?

A: I think the fear of a recession is receding, but I don’t think it’s over. There are still people who worry that inflation will be stubborn enough to force the Fed to really crack down. There is still a non-trivial possibility that we will see a recession or a dramatic slowdown.

The Federal Reserve has a responsibility to bring down inflation. So the pressure will be maintained, but the magnitude of rate hikes may vary.

They take their inflation mandate seriously. They’re probably worried that their lack of concern for inflation when it started hurting their credibility, so they don’t want to do that again. On the other hand, they have a dual mandate and definitely don’t want to crash the economy.

Q: Investor sentiment has changed significantly and markets are recovering. What are some of the biggest risks you see?

A: Financial markets are much more sensitive to interest rates, forecasts and forecasts. And we are in a world where asset prices have risen dramatically for a long period of very low interest rates.

The recovery we are seeing in financial markets is a recovery on fear of a very rapid and dramatic change in interest rates that would alter discount rates. And when there are signs that the extreme scenario may not materialize, then you get a pretty big reaction from the financial markets.

We are in a world where asset prices are resetting not only in the public markets but also in the private markets where valuations have fallen dramatically. There’s probably a whole collection of former unicorns that aren’t unicorns anymore.

I don’t expect these things to just collapse, but a rebound in asset prices seems pretty much inevitable.

Q: The US job market remains strong. What are some of the key changes you’re expecting?

A: There have been changes in labor market behavior. Some people who were willing to work a variety of jobs that were either low paying or relatively insecure simply don’t return to those jobs. Many people retire because they have the assets they feel are sufficient. And then there’s a whole generation of people, especially younger people, who think lifestyle is pretty important, and there are certain types of jobs that they don’t want to do.

Another aspect is that compared to the past, the working class is gaining in power and the pressure from employers is easing. Partly due to geopolitical tensions and also due to congestion in global supply chains. On the supply side, there is a real shift in who is willing to do what type of work and for what type of compensation.

So work is becoming more powerful, and I feel like these aren’t temporary shifts – there’s no longer an endless supply of low-cost labor. A fairly major regime change is beginning in the way the world economy is composed. And that would certainly affect the labor markets.

Q: What are the biggest risks to the US economy?

A: The biggest risk remains the escalation of geopolitical conflicts. Something going wrong in Taiwan would be catastrophic. This is accompanied by a growing number of climate-related risks. If I had to pick one more, it could be a complete loss of functionality in government. We’ve had a pretty good run lately thanks to some leadership and policy: the Infrastructure Act, the Semiconductor Act and the Science Act — encouragingly, they will all include investments critical to longer-term economic performance, including growth and productivity.

China’s economy

Q: How long will the slowdown in China last and how can it be managed?

A: The slowdown in China seems real. This affects not only global supply chains, but also domestic demand. The imbalances in real estate are large enough to create significant risks. I think they can do it, but if they do it will slow down the economy further.

And then there are the geopolitical tensions and disruption in trade flows that began on the US side with the Trump administration.

China is still doing many things right – it continues to invest heavily in things that have the potential to create a modern economy. The medium to longer term prospects in China are quite good, but there are quite strong headwinds in the near term.

Q: What are some of the key implications for the rest of the world?

A: If China slows, global growth will be directly affected.

It affects trading partners and investments. And now we are going through the delisting of Chinese companies and we could achieve quite a significant separation of the Chinese and Western financial systems.

That’s not good in the short term – it makes people nervous and discourages investment. But this is also a bad result in the longer term.

Q: When will the Chinese economy recover?

A: Barring bad luck, I expect it to recover in the next two to three years. We are moving into an era where technology and digital are regulated. China is on a similar path but has gotten very aggressive in regulation. As a result, I think it has reduced some of the momentum and sentiment in the economy in a way that could have been avoided with a more thoughtful, phased approach to regulating the tech sectors.

I think once the convention is over and the president has been inaugurated for a third term, there is a reasonable chance that you will achieve a reorientation of the political agenda towards a focus on the achievement of economic and social progress. While it was jostling in the geopolitical tensions and pandemic.

Europe, UK

Q: What are your biggest concerns for the European economy?

A: In the immediate future, it’s energy and Ukraine. The big shocks are likely to come this winter. If we run out of gas and start telling companies to shut down operations two days a week, there is serious potential to drag down the economy or even trigger a crisis. The depreciation of the euro tends to generate additional inflationary pressure.

Great Britain seems to be in a very difficult situation at the moment. When inflation is very high, many people get hurt.

The chances of a recession in Europe are still quite high, if not already there. It will be a tough time before the energy transition.

Global Risks

Q: What are some of the biggest changes in the global economy that concern you?

A: A very large part of the world is what might be called non-aligned. They don’t want to choose sides, be it Russia or China, and have made it clear they do not approve of the sanctions. There’s quite a large part of the world that doesn’t want to play the game that’s being played.

Whether that has a major economic effect or not is another question. But we’ve lost a sizeable chunk of the fundamentals of the world economy, and we’re really not starting to build a new architecture. And that’s pretty important for quite a large number of people on the planet, especially in a variety of developing and emerging countries.