Matthew Klein on Global Trade, Inequality, and International Conflict

Matthew Klein is an economics commentator at Barron’s and is the author of a new book with Michael Pettis titled, *Trade Wars are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace.* Matthew is a returning guest to Macro Musings and he joins once again to talk about his book and the domestic roots of international trade conflicts – in the past as well as today. Specifically, David and Matthew also discuss the history of how industrialized strategies, in countries such as China, have set the stage for trade conflicts in the present day.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Matthew, welcome back to the show!

Matt Klein: Thank you very much for having me.

Beckworth: Glad to have you on. Now, you are a fellow veteran of the blogging years, of lots of writing. You were at FT Alphaville, you've also written for Bloomberg, The Economist. So we've interacted a lot over the past decade. Like I've mentioned before, you were on the show before, so it's great to have you back on.

Beckworth: But you've taken all this knowledge and you've really applied it in a new direction. You've written a book. It's an interesting book. I think it makes an original argument, and I'm excited to have you on to talk about it today. You wrote the book with Michael Pettis, who's in China. So you guys are in two different continents. And I'm just curious, how did this book project start? What motivated you, catalyzed you to get it going?

Klein: Sure. As we joke actually in the acknowledgement, this was a transpacific partnership because I'm in San Francisco and he's in Beijing. Essentially, we had known each other or known of each other's work for quite a while. I'd actually been introduced to Michael's writings in my first job when I was in finance and had been trying to follow him for a while.

Klein: And then when I was an intern at The Economist, he happened to read the Free Exchange blog, which I contributed to. And so sometimes he saw what I wrote about things that he'd been writing about, strictly in the context of Europe and China. We sort of got in touch a little bit, occasionally sending each other emails that way. And then Alphaville... When I was there, the Financial Times. Again, he regularly read that and so he saw when I did things.

Klein: He actually visited New York a couple of times when I was there and we met that way. So we kind of knew each other from that perspective. I have in fact learned a lot from him over the years, including a lot of the big ideas quite frankly in this book came from my reading and trying to think through a lot of his big ideas that he's expressed over the years.

Klein: Essentially, this book came about because at the end of 2017, he was thinking of doing a book about trade because obviously that was a really big issue then and still is a big issue. And thinking about what has changed since his previous book, which was The Great Rebalancing, which is also a really interesting book and similar themes and analytical style. But trying to put them in sort of more comprehensive context, not just updating it, but also kind of really making it something that can reach the broadest possible audience.

Klein: And much to my pleasant surprise, he reached out to me and said, "I have this idea for the book. Here's the basic argument we would do. Here's sort of a general outline of stuff. Do you want to work together and make this happen?" And I said, "Yeah, that sounds fantastic." Then I thought, "Well, actually, wait..."

Klein: I had done research... One of my earlier jobs was a research assistant for another book, The Man Who Knew. It's the bio for Alan Greenspan, which Sebastian Mallaby wrote. It's a great book. I strongly recommend it, but that took him six years plus having multiple research assistants continuously throughout that entire period. And I thought, "Man, writing a book sounds really hard." And that was his full time job, not-

Beckworth: Right.

Klein: So I kind of wobbled a bit. It turns out fortunately, writing this book was relatively less challenging than writing an in-depth biography of someone, so that was helpful. It was still a lot of work, but comparatively speaking, obviously you can just look at the chronology and this was a little easier task. So once I kind of wrapped my head around that, I thought, "We should definitely do this." And we did.

Klein: I actually spent, in October 2018, I spent about a week and a half actually at Michael's place in Beijing for intense work there, basically all day. I would write stuff, he would write stuff, we would send it back and forth, and that's how it worked.

Beckworth: From, start to finish. How long did it take you? I'm curious myself.

Klein: So one thing that's interesting about the book publishing industry is that there are a lot of lags, at least in the academic press, but a lot of lags between when you say you're going to start the book and when the book actually is done, and then when the book comes out and that's partly based on there's certain produce states that they want to target.

Klein: For example, if you finish a book in January, but they say they want, they're researchers, they'll basically have books come out sort of late spring and early fall, and those are the two windows. Then you're going to have the gap obviously. And then there's time to edit and things like that. So a lot of the work was done basically from April 2018 through the end of 2018 was when we wrote the first draft. And that was the bulk of it.

Klein: And then we did various edits and stuff throughout 2019, which were, some were substantial, but obviously the bulk of it was just writing the first part and then it was basically done by January of this year or so, and then, because there's also getting the printers and getting that stuff all done. So, that's part of another lag. And so, yeah, how you want to count that, as I said, the really intense period of work was basically from April through the end of 2018.

Beckworth: Okay. Well it was a great journey, a great amount of work for you to do, but you've turned out an interesting product. Again, the title of the book is Trade Wars are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace. So why don't you tell us the central claim of your book. It's in the title, but work us through the key idea you're trying to get across in this book.

Class Wars Lead to Trade Wars

Klein: So yes, with the title we tried... we had to needle that around, we thought that was, you know, to put the piece in the title.

Beckworth: Right.

Klein: The application of that is that a lot of people think about trade conflicts as being about countries versus countries that there's some kind of either geopolitical angle or there's some incompatible national interest or even it's a cultural thing going on. And the sort of underlying premise is that global prosperity is this scarce resource and you have to fight over it. And we're saying that's completely the wrong way of thinking about it. And that we really want to understand why there are things that look like trade conflict, why governments might even engage in the kinds of activities that we've seen, particularly the US and China, but not exclusively that. And you really have to understand what's going on within countries.

We really want to understand why there are things that look like trade conflict, why governments might even engage in the kinds of activities that we've seen, particularly the US and China, but not exclusively that. And you really have to understand what's going on within countries.

Klein: And that what actually is occurring in a lot of situations is that there are these dynamics within countries, you can call them class conflicts, you call them rich versus poor transfers of wealth and income. But regardless, the net effect is that these domestic issues that are generally being done by people within a country for their own reasons. They're not really actually thinking about the impact of the rest of the world, but because of the global economy is sort of a unified system, more or less, that those choices and those events in those countries will have profound consequences for people in other places. And that will show up, among other things, in the trade data. It will show up in financial flows, will show up in terms of debt and unemployment and all these other things that we describe in the book.

Klein: And that's what we want people to understand. And so putting it more concretely. In the US and China, if you're an American worker and you feel as if the Chinese government has done things that are bad to you, you're probably right. But to be clear, the reason that you're right is because the Chinese government did things that were bad for the vast majority of people who live in China. And it's a side effect of those choices that American workers have been harmed. So it's not as if there are Chinese workers are prospering at the expense of American workers. That's actually completely wrong. We would have done much better... Rather, if they had done much better, American workers would have been better off in the world. And that's really essentially what we're trying to convey here. And then there are applications for a lot of other places, most obvious... Europe is another area where we really try to hammer this home because it doesn't seem like it's connected but it's the same dynamics apply.

Beckworth: Yeah. And so when you say trade wars in your title, you're really talking about trade wars that have occurred over the past decade or so, right? Your context is the struggles we've seen between the US and China. Most recently, President Trump and his battles is maybe the most recent manifestation of that. But over the past decade, we had huge current account surpluses in China, created tensions back then even. Trump isn't the first one to this party. He's the most intense player at the party, but this has been going on. But I think the story you're painting is one to help us understand what's happened over this period. Is that fair?

Klein: Yeah, I would just say it's more than the US and China. So the bulk of sort of the detailed historical narrative is really actually the past 30 years and some of the events that occurred in the '90s, it took a little while for them to bear fruit, but you can go back to that period. And really by the time you get to the 2000s, that's where you're already seeing this trade dynamic, trade war, the harmful impact of trade, essentially. That's when it's starting to show up whether it's China or whether it's in the US.

Beckworth: Okay. Yeah, so it's been brewing for a longer time than the past decade, but maybe for most people they're seeing it during this time. And of course we've had two sharp recessions, which have exacerbated the pain from this tension. So, okay. So that's the central claim of the view that developments within countries, particularly China and also in Germany have led to the trade tensions, trade wars that we've seen. And you have a framework that you appeal to, the Hobsonian view, and the view of wars, if I'm saying that properly. So why don't you explain that to our listeners and how does it help you and Michael make sense of what's going on?         

Klein: Sure. So the funny thing about this thesis is that it's actually quite old. John Hobson was writing in the late 1800s and early 1900s. And he wrote a book called Imperialism that came out in 1902, and he basically makes a lot of the points that we make, but in a different context. So essentially what his point was that you want to understand European imperialism. You have to understand the internal dynamics of the distribution of income within the major European powers. And it's essentially that because Britain and Germany and France and so forth were such societies, the consequences of that meant that they necessarily had to go abroad to find markets and sell for their goods and to find attracting investment opportunities. And that was a driving force of imperialism. Honestly, people only drive a force imperialism, obviously there's complex social forces, but it was an important point, an important factor.

Klein: And that's the point he made. And it's really fascinating to go through step by step the argument and how it applies just as well. The principles he's talking about, the dynamics of the economy are not... Even though the world's a lot different now than it was then, they're just as applicable. And there was an economist of the United States Treasury Department named Kenneth Austin who actually wrote a paper, I believe in 2011. And basically, explicitly making this link that Hobson's view is legitimate. It's just as valid and you just need to update it. So instead of that, England and France and Germany as the imperialists, you have China, Japan, Germany again, and then the colonies instead of being India or Latin America or Africa, it's the US, the UK and so, obviously again, is the U S literally a colonial subject of China? No, obviously not. There's a lot more differences. But from an economic perspective, there are a lot of very interesting similarities.

So instead of that, England and France and Germany as the imperialists, you have China, Japan, Germany again, and then the colonies instead of being India or Latin America or Africa, it's the US, the UK and so, obviously again, is the U S literally a colonial subject of China? No, obviously not. There's a lot more differences. But from an economic perspective, there are a lot of very interesting similarities.

Klein: And so he made that point. It was published, I believe, in the Journal of Post Keynesian Economics. I'm not sure how widely read it was at the time, but it's actually right. And essentially what we are trying to do is say, you can take this framework and apply it really broadly and explaining it to people, it's very helpful to provide a lot of historical context, which is what we tried to do in the book.

Beckworth: Interestingly enough, I used to work with Kenneth Austin at Treasury and he actually sent me that paper. So I've seen it. So it was fun to read your book and see you quote him on that. So, yeah, he's an old friend that we go way back as well, back to my Treasury days. Okay. So again, the central thesis of your book or claim of your book is this growing inequality within countries is creating tensions between countries. And we're going to go into more detail, look country by country, look at Germany. What happened in Germany, what happened in China and see the details of these developments.

Beckworth: But just for a quick overview before we get into all that, are these developments, like people intentionally trying to screw things up, or is it just kind of how things unfolded? If you just step back, a 30,000 foot view, do you see the growing inequality maybe inevitable or could things have been done differently? I guess is my question. Were we destined to experience some of this pain before this all gets sorted out?

Klein: That's an interesting question. And I'm not sure what the answer is. I think that there definitely were deliberate choices that were made and that's part of what we've tried to trace out. Was it something where someone had a grand plan at the beginning of this as this is what the consequence is, I don't think so. But you can look at the individual countries. Every country has a very different story. The reason we focus so much on China and Germany, by the way, it's not just because those are two of the most important economies, but also because between the two of them, you can cover a lot of the bases for other major surplus economies we don't discuss. So North Korea, Switzerland, Sweden, places like that, the Netherlands, they all have different stories. One could imagine writing about all of them, but China and Germany are the biggest and you can sort of between them get a mix.

The Case of China

Klein: And essentially, there's a couple of different factors, and again, depends on the place. But in China what happened was you had... They're very much tied to the problem, essentially. So it really began in the early 1990s. And what happened before the early 1990s is I think, relevant to understanding this, which is that China had been, for a very, very long time, we're talking well over a hundred years, basically increasingly impoverished, both in absolute terms and relative to the rest of the world, basically since the early 1800s. And it got tremendously worse in the 20th century with civil wars and foreign invasions and all of the consequences of that. And by the time you get the 1970s, it was a true poor country, and in fact, truly poor relative to where you think China would have been given its history.

Klein: And that created a lot of opportunities for some quick easy gain. And what happened by the time you get to the late 1970s is Deng Xiaoping and his colleagues, come into power after Mao has died, after the gang of four has been removed. And they try to liberalize various aspects of the economy. And they focus first on the agricultural sector because A, that's where most Chinese people live as most trans people live and B, because it was considered less strategic. So there was less fear of losing control, whereas the industrial sector, heavy industry, the military connections, that was something he wanted to have more of a tight control of. And so that actually worked quite well initially. You look at the 1980s, growth was quite rapid because essentially there's a lot of... You remove all these restrictions and people can get back to where they should have been quickly and productivity in agriculture increases quite rapidly.

Klein: People in the countryside start doing light industry things, there are surpluses they can invest in. And that's great, but the downside is because they didn't have the similar changes in the city, then the industrial sector's economy ended up having some near price distortions where some prices are still capped and other prices are set freely. And the net effect is by the late 1980s, you have pretty rapid food price inflation.

Klein: So if you live in the city, then suddenly your standard of living might not be going up as much as you thought it would have been or finding it's going down. And that obviously leads to instability. There's obviously also at the same time, because of the economic liberalization that had been occurring and during this time, also political liberalization that was occurring. It was not clear what the limits of that was going to be.

Klein: So you get all these factors interacting with each other and one of the consequences of this is sort of mass protest by the late 1980s. So actually there was a first wave of this in '87 that did not end the way we're familiar with it, but there was another one in '89, which is not just in Beijing. It was really all across China. And it wasn't just students. It was also workers and so forth because essentially they had... There were a whole range of grievances. I don't want to say it was just about food prices or anything like that, but there was essentially expecting change and quite frankly, I think initially many of those people, this is somewhat speculative, but based on reading secondary accounts and stuff, I don't think most of the people actually did want to overthrow the system, but there was in fact, the reason that you have the mass gathering in Tiananmen Square in Beijing was to celebrate, not celebrate the death, but really honor Hu Yaobang and his death.

Klein: Where he was a member of central committee and he was considered a champion of the liberals so there wasn't... But anyhow, it was interpreted as being a fundamental threat to the regime by Deng and others. So then they come in and violent pressure. Then what's interesting as a consequence is that this essentially this credits within the Chinese leadership, the liberalizing [inaudible]. Then you have Deng himself, he was a really powerful figure, but he was influenced and then you have a period of '89, '90, '91 really where the Orthodox communists come into power.

Klein: They want to essentially roll back a lot of the changes that have occurred in the 80s. But that doesn't work very well. So it doesn't look like a recession strictly speaking in the data, but it is significant, significant slowdown in GDP growth in that period, it developed into what it was, either before or after and that discredits them. So then by the time you get to '92, Deng comes back with a Southern tour and essentially you start seeing the real shift in China's economic policymaking.

Klein: So then what happens is essentially you want to have a situation, or they wanted a situation where they could have really rapid growth to bolster their legitimacy or who doesn't? But at the same time, they also wanted to generate that growth without simply doing the liberalizing stuff they did in the 80s. They wanted to have degree of control because and again, you could argue this goes back to when this ideology, but essentially if you think, if you have alternative centers of power in society, which can include just people who are economically prosperous who aren't directly affiliated with the regime and that's a problem.

Klein: So one of the things that you can do to achieve that outcome is essentially an off the shelf model, more or less that they use, which goes back to Alexander Gerschenkron described it in the 50s, he's a Ukrainian economist, and essentially state lead, investment lead broke. What that means in practice is you squeeze workers and household consumers as much as you feasibly can to generate in common and provide cheap resources for governments and government affiliated businesses to invest.

Klein: If you do it correctly, that will lead to quite rapid growth without having to wind up inflation and all of that. That's what they did. At first, it worked out really well because the conditions for where that works is that some combination of the following: either a lot of good investment opportunities are available and so you're easily going to find them, even if you don't have a good screening mechanism for what's a good assessment.

Klein: Or you're doing a good screening mechanism for investment, which is much harder because smoking crack is really bad, it's poor. In the 90s it worked out very well for China because the country had been deprived of investments for so long. Like I said, basically, you go back to the 1830s, at least everything was downhill from then until the 1970s. There was a lot of opportunities to make good investments. That starts to become problematic by the time you get to the 2000s.

Klein: This is where Michael really brings in his level of expertise and he's been living in China for almost 20 years. His theory on this, but I think it's very interesting. The amount of investment and the total amount of capital stock in a society that's optimal really depends on this intangible soft, cultural capital, and such, and social capital features. In his view, I think, you can also see it born out in the data that China had hit the limit by the time you get to the early 2000s.

The amount of investment and the total amount of capital stock in a society that's optimal really depends on this intangible soft, cultural capital, and such, and social capital features. In his view, I think, you can also see it born out in the data that China had hit the limit by the time you get to the early 2000s.

Klein: So that meant that there were still good investments to be made and some of those investments were being made. But the amount of investment that's actually occurring was in excess of that. What you should have had happened in China was a redistribution from the elites that were benefiting because of as if anything was happening. Right? Whether it's local government provincial officials or the heads of state of enterprises, or what have you, they were the ones who were getting the spending power on their behalf and also showing up these various benefits of personal direct benefits and giving it to workers and consumers in China. That didn't happen.

Klein: The initial impact was to create a massive glut of goods that was exported. That was the story really of the 2000s up until about 2008. But then 2008 happens and suddenly China's main export markets are relatively less receptive, not certainly able to grow as quickly and capture and absorb China's excess production. So then essentially the government decides to go into an overdrive and boosting domestic investment even further. That's when you start to see, again, this is a clear financial market signal that the investment was excessive is that before that point, China's overall year total debt to GDP ratio was pretty flat in the 2000s. Then the GDP was rising outside of China as a constant.

Klein: That was really how it spread abroad. But once you get past 2008, suddenly all of that wasteful debt accumulation upon unnecessary purchases was directed inward in China and the debt ratio total debt in China goes from roughly 100 ish percent of GDP to almost 300% GDP in a span of roughly 10 years, which is essentially unprecedented, especially in a period when growth is actually quite rapid.

Klein: That suggests obviously that the value of those investments, the incremental value was quite low, which is consistent with Michael's interpretation that despite being relatively poor in one perspective with a capital stock per person compared to advanced economies, that maybe the capital stock person is actually excessive in China relative to their ability to maximize. I mean, that's probably a function of some other things of the political and social system.

Beckworth: So just to summarize, in the case of China, the communist leadership led the country down this path. Intentional choices were made and it led to this outcome, which is now being born by the rest of the world and has been born by the rest of the world over the past decades. So I guess my question going back to original question is, was there an easier path or a better path to communist leadership could have taken?

Beckworth: I mean, it would have been just more liberalization, more privatization, less control? I mean, was there a feasible, actual different path that they could have taken maintain their path? I don't know. I guess that's my inevitable question, and I know that's a hard question to answer. You're not God. You don't know what else could have happened, but is there something like Michael Pettis would have called forth for them to do that would have maybe eased some of this?

Klein: So one thing is interesting, and this is the point that Michael has made is that initially it works really well. Initially it's probably the best thing you could do in the short-term. The problem is that once you adopt this model, it becomes increasingly difficult to change it, and it will almost always go.

Beckworth: Oh, you're hooked.

Klein: The reason for that is that by definition, you're empowering a selected elite group of people and enriching them. That makes them obviously very vested in the perpetuation of this model. A lot of times, especially in a situation like this, they have direct political power, even if it didn't, they'd probably be able to exert a lot of influence. So, that means that you're inevitably going to run. It's going to be challenging to change those things.

Klein: You need a really decisive [inaudible], and it's quite rare for that to happen. Usually, as I said, these things will go [inaudible]. There are other countries that have had experiences like this in varying degrees. So Brazil, for example, the military dictatorship there for the 50s and 60s, in many ways, that was kind of like what happened in China.

Klein: That was the miracle economy at a time. It went well past its sell-by date and then it ended quite poorly for them. You could also arguably talk about the Soviet Union, actually. They had a situation as well, but this was in the 60s and 70s and then again, it hit its limit. Then it's not that, that's a challenge, it's an inherent danger of adopting this model and arguably the countries that have done the best with it were Korea and Japan.

Klein: Even then though, Japan, people talk about stagnation. I think that story is somewhat overstated because you have to look at their demography. But regardless they were able to at least get to a very high standard of living before that happened and that was helpful. Korea is interesting because they, as well, managed to get to a higher standard of living and they're economy is still conversion to a degree. But in both Japan and Korea, well Japan is basically always to varying degrees during its development story, a somewhat liberal democracy.

Klein: You could argue about how much of it, but it basically it was. Korea was not, but when it ran into trouble with its development model in the 80s, it became a democracy. So it was an authoritarian regime, military dictatorship in the 60s and 70s and 80s, but then it transition and it actually transitioned relatively well.

Klein: Then that helped. I mean, so there are issues still in the Korean economy that we don't talk about in the book that's related to this, but they were able to I think. So I think that there is a connection between the political system and the economic system. So if you're asking what China has differently, I don't know, to be honest how the communist party would have done things differently in a way that they would have felt comfortable with, in terms of retaining their political dominance. So, I mean, I think that's why I didn't end up going down the road they did. That's part of me speculating, but I don't know. I mean, there are other things that could have been done in theory in China, but you might've had a very different political system of an outcome.

Beckworth: But the point you and Michael making the book though, is that this can't go on forever and there's going to be our day of reckoning sooner rather than later. Right?

Klein: That's right. Although, there's interesting what that means can be a lot of different things. So the idea that China's going to have some imminent financial crises or collapse, I personally think it's going to be like, I know Michael does not think that's likely. The likeliest outcome from that perspective is you're just going to have a long period of stagnation and slow growth, which would be quite dramatic for a society that's used to having an extremely rapid growth for the past several years.

Klein: But it wouldn't be a Latin America style collapse in the early 80s that the alternative people might think of. It wouldn't be that probably. But yeah, it's not sustainable. I mean, obviously the other way around it is, as we say in the book, there are plenty of changes that can be made. In theory, those changes have all been endorsed by the communist party of leadership.

Klein: That would really shoe the income towards Chinese workers and help them [inaudible] people and would allow for the kinds of changes that would be sustainable and lead to higher living standards in China, and also help rebalance the global economy. The problem is, even though the Chinese leadership has repeatedly endorsed this, it hasn't happened. So that speaks to the power of these... I believe it was Premiere Li Kequiang called it ‘The Best of Interest’ in a speech in, I think it was 2013.

Klein: Talking about that's the reason why it's hard to make these changes and that's the consequences of the development model that in spite the commitment of people at the top, unless you make that your overwhelming priority except for everything else, there's still politics in an authoritarian system and you still have to negotiate with different individuals to get what you want. Apparently it's hard for them to do that. Or it hasn't been enough of a priority. But either way, that's the troubling situation there that they haven't been able to make those changes.

Beckworth: Yeah. It's interesting to think about this day of reckoning. Again, you say it may be a more of a gradual stagnation day of reckoning. But they also have demographics going against them too. Right? So they build up a lot of debt. There's cronyism, there's a dynamism and you throw in a lack of new young workers, you're really asking for trouble.

Klein: That's absolutely right. It's something we don't really talk about in the book for said. But the fact that the Chinese working age population is already falling and is set to fall quite dramatically over the next few decades is something that's definitely going to be challenging for them to deal with and also the productivity. It depends how you measure productivity. It's always a tricky thing to define in any society.

Klein: It's certainly harder in an economy like China. But there are estimates that are reasonable that project that productivity growth in China has a subject of zero for the past while. After subtracting the gains that you would have expected from the immense amount of capital investment, the underlying of total factor productivity, or whatever, has been essentially zero for decades. If that's the case, then that's obviously going to be a real challenge as well, especially as fixed investments have-

Beckworth: Yeah. I mean, that's something we should all be watching and mindful of. Now let's circle back and talk about, again, the economic implications of all of this. So, the real easy to make the case that China, for example, was manipulating its currency in the mid 2000s. It ran huge current account surpluses, 10% of GDP, which is huge. I mean, a rule of thumb I've heard is if you're running over 3% of GDP, current account surpluses, then you're probably intervening in an artificial way. So many of those indicators are now gone. Right? So China's ran a small current account surplus, it isn't manipulating its currency, despite president Trump's claims by most measures. Are they still doing things though that are creating problems for the world? I think you alluded to this in your book, are they still running surpluses in certain areas that cause distortions elsewhere in the world?

Global Impacts of China's Economy Policy 

Klein: Yeah. So I think there are a couple of ways of looking at this. One is that I'm not convinced that the rebalancing of the Chinese economy that we've seen relative to the rest of the world, as you've mentioned, is something that's sustainable. The reason is because what we were just talking about that if domestic investment is going to stagnate or I mean, it's already slowed down tremendously.

Klein: Right? The rate of fixed asset investment growth in China had been 20 to 40% for a long time. Now it's, before the Coronavirus it was five to 6%. Already you had that and that's shown up in the slow down in the growth rate. So if that happens and if that accelerates, then at some point, you're going to have a situation where Chinese total domestic demand, other words, is going to be falling back.

Klein: Then that's going to lead to a situation where if there's, unless they put their production as well and higher unemployment, it doesn't seem to be something that they would choose to do. I don't blame them for that. That's going to lead to a reemergence of the imbalances. So the challenge, there's essentially a trade-off between their external position, their domestic indebtedness position, and this question of the distribution of income. That they can, as we saw before 2008, they were able to keep their domestic indebtedness quite under control because their external position and essentially their trade partners bore the brunt of that with higher debt.

Klein: Then after 2008, China bore the brunt of higher debt and their trade partner relatively speaking did not. Although, China did still surpluses during this period. But they are much smaller. At this point, if they conclude or forced to be in a situation where they can no longer increase their indebtedness rapidly in order to support the message demand, then you have to think that you're going to have some kind of reversion to the pre 2008 scenario.

Klein: That would be quite troubling. You're already seeing hints of where that could be an issue. So you mentioned different sectors of their trade balance. So if you look at their current account balance as a whole, it's calmed down tremendously and that's obviously great progress. Some of that, however, is probably a little bit misleading. So for example, if you look at the tourism trade account, there are a lot of issues with the number and they'll be revised routinely in different ways.

Klein: Basically, no matter how you count it, the tourism or the travel trade debts in China is truly overstated. What that really means is that actually their overall trade balance is higher than it was. Then there's obviously people trying to move the money out of the country, as much as probably what is being counted instead. The other thing is that he [inaudible]  on manufactured goods, which is arguably the main source of what the displacement that China [inaudible] anyway.

Basically, no matter how you count it, the tourism or the travel trade debts in China is truly overstated. What that really means is that actually their overall trade balance is higher than it was.

Klein: That trade surplus has actually is big as it's ever been. The reason it's as big as it's ever been is because the Chinese government has been very successful at curtailing imports. So the idea that China is being a major export led growth stories, not really seen anymore. Exports in share of GDP in China have come down pretty steadily over time. But imports have come down more. That's partly because they don't need to import as many foreign components in their exports, and part of it is also just their own uses of imports have gone down, and so they've become much more self-sufficient. This is exactly the goal of government policy, ‘Made in China 2025.’ They don't highlight that as much anymore, because obviously, it attracted a lot of attention from the US and Europe. But it's still basically part of the strategy.

Klein: And so, again, you can sort of see them laying the groundwork for a world where, if domestic demand in China falls, they're going to essentially try to shift that so the burden is going to be borne by people in the rest of the world rather than produced in China, which, again, from sort of a narrow perspective, that makes sense. But it would have significant impact on foreigns.

Klein: And just one more point on this is that if you want to understand China's Belt and Road Initiative, I think it helps to put it in this sort of pocket that, again, people talk about it in terms of geopolitics, and there might be something to that. It probably helped people sell that internally in China.

Klein: But the economic perspective, I think, is more useful, which is that if your main export markets, traditional export markets, are not growing very much, not able to absorb, and you're worried about a situation where your external position is going to be needed to help you deal with an internal rebalancing, then it helps to find new markets.

Klein: And so instead of you taking on a lot of debt internally to make wasteful investments, you essentially find people outside of your country to take on a lot of debt and make wasteful investments that are built by you. And that is, I think, one way of interpreting how the Belt and Road Initiative is sort of fitting.

Klein: But to your original question, I think that despite the progress we've seen, they're not manipulating their currencies well the way they used to. The current account deficit is smaller. There are a lot of fundamental problems there that pose a danger to the rest of the world.

Beckworth: Okay. Let me ask this question. Again, we're looking at the problems within China and how it's given rise to the challenges outside China. And you mention this in your book, that even though consumption is suppressed, it still has risen in an absolute sense, right? You hear this claim, and I believe it, I think you do too, that China's been the greatest cure for poverty around the world. There's been a billion people lifted out of poverty, so Chinese are better off than they were.

Beckworth: But your contention, and Michael's contention, is that they could have been even better off than they were, not only lifted out of poverty, but everyone having a middle class lifestyle. Is that the argument?

Klein: I don't know about everyone having a middle class US lifestyle, but I do think it's definitely fair to say that living standards should have been higher than they were.

Beckworth: Okay.

Klein: The simplest way to look at it is that as a share of total national production, that household consumption went from being sort of 50 to 55% in the '80s to below 40%, which is a dramatic decline. And so presumably, now, unless you think that that was absolutely necessary for raising absolute living standard and that there was no other way to raise absolute living standards, and that means that household locked up tremendously. And there are a lot of specific things that we point to that suggest that living standards could have been improved.

The simplest way to look at it is that as a share of total national production, that household consumption went from being sort of 50 to 55% in the '80s to below 40%, which is a dramatic decline.

Klein: But one thing, obviously, is just that they're making a lot of wasteful investments. If you have a choice of making a wasteful investment or actually giving someone a consumption good or service that they like, clearly, they're worse off if you do a wasteful investment instead. And so that, I think, is probably the simplest way of looking at it.

Klein: I think, also, the question of China reducing poverty, it's definitely true that Chinese growth since the 1970s has reduced global poverty tremendously. But I also think it's true, and this sort of gets back to what we were saying before, to the extent that you're essentially having [inaudible] version, that it was artificially depressed in terms of productivity and output and living standard for a very long time up through the 1970s. How much credit does the particular development model have or the government policies have, versus essentially not doing the things?

Klein: It's amazing what you can accomplish when you're not constantly being invaded or having civil war or cultural revolution or anything like that. I think that that is a large element of it, and I think that people should recognize that as being a major driver, I think, of the progress that we've seen.

Beckworth: Okay. Yeah. It's interesting to think of China as a true case of what Austrian economists would say is malinvestment. You didn't use that term in your book, but I couldn't help but think of it when you talked about the different and poor uses of funds and stuff. But, yeah. Definitely clear.

Beckworth: Well, let's switch gears. We'll come back to Germany in a bit, because China is, I think, a big part of the story here. And let's talk about the transmission of China's suppressed consumption, therefore, its enlarged savings, how that gets channeled into places like the US.

Beckworth: Walk us through that. And then, but along the way, I want you to answer this question for me. Sometimes you hear the story, and I believe what you're about to tell, because I've said it myself, but one of the questions you get is, in what sense was China's savings forced into the US?

Beckworth: Could the US have said, "No, we don't want your savings?" From an accounting perspective, it has to balance somewhere in the book, but was the US like a force? Were they a slave to the savings coming in? Could they have said no? Could they have done policy differently to offset it?

Beckworth: Maybe walk us through how it works, and then, what could the US have done differently, if possible?

Chinese Savings and US Consumption

Klein: Sure. I think the easiest way to explain this is to just zoom out for a bit, and what is the global problem here? And the global problem is that there's a certain amount of production capacity, and there's a certain amount of global demand for what that capacity is able to produce. And there's been essentially a mismatch for quite a while. I don't know when you'd put a date on it, exactly. Probably on the order of 40 years or so.

Klein: And that has shown up in the form of, A, falling cost of capital, and essentially deflation, disinflation, whatever you want to call it, very not really meaningful price pressures on consumer goods, and in the form of rising indebtedness by people who don't have the income growth they had before in order to consume enough to prevent the complete, essentially, collapse of the global economy given the sort of mismatch between production and global demand.

Klein: That's the basic picture. And so, then, the question is, okay, how do these different forces get distributed across countries? And our point is that we can point to sort of specific places where policies have directly contributed to underconsumption relative to production, including China and Germany.

Klein: And then, we say, "Okay, well, given that that's happened, but we haven't been in global depression for the entire past 40 years. The corollary must be that there are other places elsewhere that are consuming relatively more in terms of what they produce, and that they are financing that consumption through increasing indebtedness."

Klein: And so that happens to be, among other places, the United States. It's really the entire English speaking world. The UK, Canada, Australia, and New Zealand have very similar patterns of behavior here. But the US has a much bigger economy, so the US is sort of the dominant story.

Klein: And that's sort of the big picture, which is also [inaudible] bring it back to that, that if you have a situation where in countries like France and Germany and so forth, you have an excess of stuff, it has to go somewhere, and because that excess is a function of the fact there isn't enough domestic demand in those countries because of the distribution of income.

Klein: Most people consume everything they earn, but if they don't earn that much, then they can't consume it. There were not consumer credit markets back then that could have offset that, so that meant sending it to the colonies. And the US is a little different, but the modern world is, in many ways, kind of similar in how this works.

Klein: That means that you're going to have both an excess of stuff and an excess of demand for financial assets. Those things necessarily are going to go together. And where they end up is going to affect the people in those societies.

Klein: The US is a major recipient, has been and continues to be a major recipient of excess production and excess savings, which is essentially two sides of the same phenomenon. There are several reasons, but the biggest reason is the US maintains a relatively open financial system and has a legal system that is very accommodating to foreign investors, including the fact that it's in English, which is obviously something we can't change.

Klein: But what that means is that if you are an entity or a rich person or what have you in the rest of the world that has excess savings, and you're looking to put it somewhere that you think is really safe, the US is a very attractive place. It's not the only place, but it's a very attractive place to do it, because you know that you'll be protected a certain way. You might lose out in terms of dollar depreciation or something, but the risk of catastrophic loss is essentially zero, and you can access it when you want, and that's useful.

Klein: And then, on top of the fact is the US is a very large, diversified economy. It produces a lot of things, so if you have dollars, it's a pretty good place. It's a good currency to hold [inaudible]. People in the rest of the world, for that reason, they will often price their stuff in dollars, so the value of holding a dollar is much larger than simply you can buy US made stuff. You can buy stuff in Thailand and wherever. And so that creates a lot of incentives for people to put their money in US assets.

Klein: Could the US have done something differently to prevent that? We'd essentially have to change our legal system, and we'd have to introduce capital controls or something, would be the way to do it. Maybe that's an approach.

Klein: It is something we talk about as a potential response to the problems that we highlighted as coming up. And we've already seen some places, not in the US so much, but in sort of Canada, Australia, and New Zealand, putting in restrictions on foreign home purchases. There's a little bit of that, but not really to the same extent.

Klein: If you did that, though, you simply redirect this flow somewhere else. It's not really a permanent solution. I guess on the margin, it's better for the US, but it would just mean that some other country, other society would have to deal with this excess of stuff.

Klein: Another thing that people say you could do is, "Well, you'd have a countervailing flow." Maybe the People's Bank of China is buying trillions of dollars of treasury and agency debt, so the US can go out and, well, you can't buy Chinese assets [inaudible] because their capital markets are close, so I don't know. You buy every single French government bond or something? That doesn't seem like a very... That's what you would have had to have done, essentially.

Klein: It's not even clear how well that would have worked. And of course, again, that creates the problem of, at best, you're redirecting the excess elsewhere, and at worst, you simply just depress your own domestic demand without increases anyone else's. And so the whole world is just in a much worse situation.

Klein: I think part of what we talk about in the book is that if you're the recipient country, the choices are limited, and they're not particularly attractive in any case. There are certain things you can do differently that might help, but ultimately, the problems are stemming from the places that are underconsuming. And so if you really want to have a sustainable solution, you have to fix the policies there.

Beckworth: I'm thinking about this, Matt, from maybe a cyclical versus structural perspective. You could still run the economy at full employment and have an issue here, right?

Beckworth: Like the late '90s in the US, we were running the economy at full capacity. Unemployment was relatively low. But the argument is that China is still affecting the structure of employment, what type of jobs are available.

Beckworth: My question is, if we tried to offset this with monetary policy, with fiscal policy, so people are still employed, even though they may lose their job in a factory, they get a job somewhere else, at the end of the day, I think your argument and Michael's argument is that it's a different job. And maybe it's not the same job. Maybe it's not as good of a job. Is that the point you're making?

Klein: Kind of the point. Certainly, I'm not saying we want to preserve the structure of the economy completely and ignore... There are evolutions you'd expect in terms of productivity and so forth and-

Beckworth: Yeah.

Klein: But I think that in certain cases, you do want to preserve certain industries from what seem to be clear distortion coming from abroad.

Klein: One of the things we said might have been an improvement, in retrospect, in the 2000s, really, would have been, okay, if there's going to be a lot of debt generate one way or another in the US, it should be government debt, first of all, not private debt. In other words, you think about it in terms of fiscal and monetary policy, that's essentially the choice you're making. Is it government debt or private debt?

One of the things we said might have been an improvement, in retrospect, in the 2000s, really, would have been, okay, if there's going to be a lot of debt generate one way or another in the US, it should be government debt, first of all, not private debt.

Klein: And then, if it is going to be government debt, you should be spending it on things that are going to, as much as possible, they'll either offset the impact and help the economy.

Klein: One thing that obviously could have been done differently is there's a special need for better infrastructure in the United States. That would be helpful.

Klein: The other thing, too, which is kind of another idea, which I'm not going to say it and flesh it out in detail what it would have meant, but if you can preserve demand for US made manufacturers to the point that you wouldn't have had the obliteration of a sector for what was essentially a one off shock, which is what happened, that would have been very helpful. Of course, they can't go back and undo that completely, but that's the kind of thing that might have been helpful.

Klein: Your point about fiscal and monetary policy, in many ways, one of the implicit trade-offs that you have is that you're seeing that the economy is going at full employment. But if the economy is going at full employment, then your choice is rapidly rising debt for the rest of the world and the consequences that come with that and the question of how sustainable is that.

Klein: You're talking about the '90s and the 2000s, are two very interesting examples of how you can have that go differently. In the '90s, what happened was, and this is really sort of before China in a lot of ways, but you had a massive corporate investment bubble. And if you look at sort of, well, you can break down the changes in the US current account based on households, governments, and businesses, those data that are published. Ideally, you want to go more granularly in what kinds of households, but that is much better defined.

Klein: But at that level, you can see very clearly that there was a massive current account deficit in the United States that emerged in the second half of the 1990s, even during a period when the US was practicing, essentially, fiscal restraint. The budget down at the federal level was basically zero by the time you got to the end of the '90s, if not a slight surplus. But that was more than offset by the fact that corporations went on a very large borrowing binge and investment binge.

Klein: And the problem was, a lot of those investments turned out to be duds, and a lot of the companies that did them then went bankrupt and defaulted on their debts. And so you have this massive cutback in the investment [inaudible]. And so that suggested, A, that wasn't a sustainable way of absorbing the foreign savings.

Klein: And then, you get to the 2000s, and what's the choice? Well, again, you mentioned sort of the fiscal versus monetary, and there was a bit of both in the costs of that downturn and this massive collapse in business investment. But monetary is an important thing, and it's hard to know exactly what people were thinking at the time.

Klein: I think it's fair to say that some people at the Fed were thinking that part of what would have happened was you would have had a reversal of the dollar appreciation that had occurred after 1997, and that would have led to a sort of shift in the trade balance, and that would have been helpful.

Klein: But, A, that didn't happen for a variety of reasons, including China's currency inflation, although not only that. But the other thing that did happen as a consequence is that you had a very large increase in household indebtedness, in that American consumers borrowed tremendously in order to sustain consumption. And again, that wasn't sustainable, either, because you're borrowing to consume, like borrowing to buy housing. It's not going to increase your future income. And so-

Beckworth: Sure.

Klein: - your debt servicing capacity, and maybe you can refinance and lower and lower rates, but again, there's going to be a floor there somewhere. This is not a sort of sustainable long-term path towards prosperity. And so then you end up with 2008. Again, that's the trade-off. There's no good way around this.

Beckworth: Yeah. Now, let me think about this whole China development from a broader perspective. As you mentioned, past 30, 40 years, this phenomenon's been going on. We saw maybe the most intense manifestation of it in the past decade. And definitely the leaders in China made things worse through these policies you've mentioned.

Beckworth: But shouldn't we have expected some kind of radical change, given what has happened politically during this time? The fall of the Soviet Union. You suddenly open up a whole big labor supply that didn't exist. China. Massive surge in labor supply to the world. India opening up, used to be a more closed economy. All of these things, you'd think, would have had some huge change.

Beckworth: All these things you think would have had some huge change, and no matter what had happened, the perfect benevolent dictator in China, dream team of leaders there, there still would've been some ramifications for the US. And, I think of, for example, going back to turn of the century. You talk about this in your book, but there was a huge structural change in the US.

Beckworth: The US was growing from an agricultural-based economy to an industrial one. There were definitely transformational pains that occurred, no matter what policy you would have pursued. I'm wondering if there's some of that story in the background here, too, that the US inevitably would have moved to more service-driven sectors. Not just sorry jobs, but high-end ones, all this literature about how the creative class and big cities. And I'm wondering if the China shock and these policies in China maybe just hastened what was coming? Maybe made it a little worse. I mean, what are your thoughts on that?

Impacts of Structural Economic Changes

Klein: Well, I'm inclined to say no, and the reason is sort of gets back to what I was saying at the beginning, which is that global prosperity is not a scarce resource. So it's true, there was a massive increase in labor supply, and that was a good thing because you have all these people who were essentially behind that and who were unable to participate in global economy and now they are. That's good for them.

Klein: We also should have had a commensurate increase in demand. In fact, the increase in demand should have actually been higher, right? Because if you have all these countries in societies that have been artificially repressed and living essentially below their means because of communism and things like that, and then they become not that way, then that should actually mean that you have in addition to people being able to consume more, because they're participating in the global economy, that means that returns on investment should be high and they should be getting more of an influx of demand that way. So you should have had a really large increase in global demand.

Klein: But that's not what happened. And the problem is, and by the way if that had happened, then you might've seen some change in the composition of, so for example, US manufacturing, or something. I'm not saying that it would have been static, but you would have had a situation where maybe sectors that competed with imports would have shrunk, but sectors that exported would have grown. And so that would have balanced out, for example.

Klein: The key thing here is that if you hire labor supply, people who are paid less, that doesn't necessarily mean that you're going to have to lose all your jobs in that society. The only reason that happens is if they're paid less than the value of what they produce, that's sort of a key distinction, right? Wages in the world are not, the lowest wages in the world are in Sub-Saharan Africa. Like Burkina Faso or Madagascar.

Klein: That's where you're going to find the lowest wages of all, by far. Not China. It never was China. In China, wages have gone up a lot but, and they were relatively low in the nineties, but they were never the lowest in the world.

Klein: What matters is the difference between the wages and productivity. And, this is also why, for example, you look at Northern European companies that have relatively large manufacturing sector. Again, the wages there are quite high. The wages in Japan and the US are high and we still have plenty of manufacturing. What matters is that balance. And the thing that was really destructive about China's policies in particular, although not only China's policies, was that workers were paid so much less relative to the value of what they produced.

What matters is the difference between the wages and productivity. And, this is also why, for example, you look at Northern European companies that have relatively large manufacturing sector. Again, the wages there are quite high. The wages in Japan and the US are high and we still have plenty of manufacturing. What matters is that balance.

Klein: And that meant that if you are an American or a European company, or a Japanese company, whatever, that moving production or outsourcing production to China would automatically boost your profitability. Which is what they did. That was essentially the problem. Now, moving production to China isn't inherently bad. But the problem is you're moving it to a place where you're increasing your profitability and not really the domestic consumption of the people there.

Klein: If people in China had gotten paid commensurate with their work and then spent more money, we wouldn't have had to pay them more, yeah, you might have had less foreign investment there in the first place. But it wouldn't have been, but even if it had been an equivalent amount of foreign investment, it wouldn't have been bad for the US. And going back to the nineties again, during the 1990s, before the Asian financial crisis for sure, so pre 1998, the US manufacturing sector was doing fine. We had all the globalization forces you were talking about, that really began in 1989, but the US manufacturing sector was fine.

Klein: Output was rising rapidly. Employment was basically flat. So if there was, I mean, but there were productivity increases going on, so it's not a problem.

Beckworth: Yeah.

Klein: No one was complaining about any of that. It was only after you have this massive collapse in demand as a consequence of the Asian financial crisis, and then people's response to it in the rest of the world, that then you have the problem of the collapse of US manufacturing.

Klein: And I think that's really an important talk is to have here, that it's not, there is no reason why the industrialization of China or India or anywhere else, should to have to come at the expense of Americans. We can all do better and all prosper.

Beckworth: In this counterfactual world that you've just described, I suspect you think that there would have been less populism over the past few years had we had that outcome? I mean, did those things tie together?

Klein: I would think so. I mean, Michael and I are not political scientists, so this is a bit of a touristy observation here. But I think that's, makes a lot of sense. I mean, people who have looked at this stuff and we mentioned it at various points of the book on occasion, like David Autor at MIT and his colleagues have looked at these things. He's trying to correlate manufacturing job losses to changes in voting behavior and stuff.

Klein: And yeah, you can see that there's a clear relationship there. So you can imagine that if there hadn't been those kinds of manufacturing losses and the associated social devastation when all those good paying jobs disappear, that, yeah, populism in the US would have been less of a thing. And probably in other societies as well, for that matter.

Policy Implications

Beckworth: Yeah. Well, let's move to the policy prescriptions. We're running out of time. So I don't have time to talk about Germany. I encourage the listeners to go check out the very fascinating chapter on Germany. I want to move to the policy prescriptions because it ties into some of the events we're seeing right now. You've written a piece about this, about how to pay for the virus ensuing debt. You've already touched on this earlier, but I'm going to spell this out for our listeners a little bit more.

Beckworth: I mean, you touched on how the US is the banker to the world. They provide the safe assets everybody wants. And then there's this almost insatiable demand for what we provide. And many times Americans look at the amount of the debt, in fact this year it has been forecasted, I think the CBO has it forecasted to reach about a hundred percent of GDP when this year is over. May have been, may have changed since I last, I looked at it.

Beckworth: But it's going to go really up this year, and it alarms a lot of people. And yet Matt, we see historically low interest rates, right? So the world is not viewing us as a credit risk, despite the run up in this. So what does this all mean for policy prescriptions and how should we think about the US debt, if it is a part of the solution?

Klein: I think in general, you're absolutely right to highlight that interest rates are extraordinarily low. Both in nominal terms, and in real terms. And that is a clear market signal that there isn't enough debt being issued.

Klein: Now, whether that's government debt specifically, or other kinds of debt, I don't think industry, the people in industry care about that. But the fact of the matter, there's still a variety of reasons private debt is not rising. And so therefore you have, the government debt should be [inaudible] to rise, especially.

Klein: Unless of course you're just satisfied with a world in which real interest rates are negative 30 years out, which is indicative of extremely poor growth expectations. And I think that that's why Barron’s readers don't like that either. Even if they, stepping through all the consequences takes a little bit of effort and that's what I try to do in my day job.

Klein: But I mean, I think in some ways the focus on government debt is really the problem here. And people think about that because, well, you're a voter or a taxpayer. That's a thing you can sort of try to control, or something you’re most exposed to. But what matters to the economy is really total debt. And total debt is rising now because the economy, essentially we're having a sort of, this freak economic event that means a lot of people can't do things and that makes everybody poor.

I think in some ways the focus on government debt is really the problem here. And people think about that because, well, you're a voter or a taxpayer. That's a thing you can sort of try to control, or something you’re most exposed to. But what matters to the economy is really total debt.

Klein: There's going to be a financial loss somewhere. Now, you could have a financial loss more entirely by the private sector, and that would show up in the form of basically everyone defaulting on their mortgage and not paying rent, and so the landlords default on their mortgages. And people go run down all their assets to try to sustain their consumption, and they'll go bankrupt and then businesses shut down. I mean, that's one way to do it.

Klein: Or, the changing net worth shows up on the public sector balance sheet and essentially, housing and business don't have to do that. But the public sector becomes a lot more in debt and then that means issuing a lot more treasury debt. And I think if those are your choices, then issuing government debt is quite attractive. For a variety of reasons.

Klein: And, I mean, to the extent that I think that's just the way things are. Everything has to add up and if someone isn't going to be borrowing the way they were and someone else has to borrow more, if you sort of satisfy the demand for fixed income and things like that. And so, if the people who were borrowing, people were getting second mortgages and new houses for example, then that wasn't good for anybody long-term.

Klein: So having the government borrow in the way that they don't really have default risks. They don't have rollover risk in the same way that houses do. So, it's a way to cool the superior trade, and is really how I think about these questions.

Beckworth: Yeah. I mean, if you think about how low interest rates are now, imagine where they would be if President Trump had not run the large budget deficits over the past few years. Right? I suspect many of the same people who worry about the size of the debt also worry about artificially low interest rates.

Beckworth: And I just imagine now what the perfect storm would be, is we'd have negative interest rates or close to them in this crisis if we hadn't run up that deficit. So, I mean, one of the ironies of all this is that President Trump's fiscal policies, his tax cuts may actually be ameliorating some of the potential stress you see right now. Because there are real costs of negative rates for financial firms, for some entities.

Beckworth: It's kind of a bizarro world, but you have to think through this carefully, otherwise you can lead to the improper policy conclusions.

Klein: Yeah. I mean, I guess I would just clarify briefly that I think the tax policy, part of the reason why the impact on rates was lower than some people had anticipated was because a lot of the beneficiaries of those tax cuts then turned around and essentially saved the windfall. And so, in other words, it's sort of a direct reinvestment of, the deficit was bigger.

Klein: I do think it's fair to say that there were other fiscal policy changes that were definitely helpful. So for example, there had been a long period of essentially austerity on the military spending side, and whether or not you think the US military should be spending more or less than equipment, the fact of matter is at least in the short-term, that had definitely had an impact on GDP and in manufacturing for them.

Klein: You can see very clearly, starting in the end of 2016 until basically last year, there was this massive increase in military spending. In the monthly durable goods stuff. You look at shipments of defense capital goods, tremendously. And that was also helpful as well.

Klein: There was a whole bunch of things that were going on in terms of fiscal policy changes. I think a lot of people overstated what the impact would have been, but instead if there was an impact, it was basically beneficial.

Beckworth: But your point is, financing costs are really, really low. Again, historically low. And we could use this to invest in fighting the virus. We could also use it to invest in infrastructure. Our country would benefit long run, make us more productive. And the world is effectively begging us for more debt. It's not like we are going on a spending spree and enforcing this on the world. The world's coming to us and "Hey, please give us more debt." And we should look around. And of course the key is, use it wisely. Don't just willy nilly spend here and there. Use it wisely. I think that's a fair observation.

Klein: Yeah. We're leaving a lot of money on the table, I think is the way of looking at it. That even before the virus, interest rates were very low relative to expected growth rates. So I think, I believe the real interest rate on 30 year protected securities, peaked at like one percent or something? I think, before?

Beckworth: Yeah.

Klein: If you think of our long-term growth trajectory, Real GDP of the US economy is one percent. That's quite, that's basically worse than anybody has forecasted.

Klein: Basically, you’re leaving money on the table right there. And, so yeah, if you can do, and especially if it turns out that you could borrow money to make investments that will actually increase your trend growth rate when you do need money on the table. And so all of us are making ourselves unnecessarily poor because, I guess not fully thinking through what all the signals mean, and what these numbers are telling us.

Klein: But, it's absolutely right. I mean, there's a clear, I think even independent of foreign demand for US treasury debt, that I think that, although that's certainly there as well. That the domestic need of the US economy, I think that it's quite clear that we are leaving money on the table and it's still on.

Beckworth: Well, on that note, our time is out. Our guest today has been Matthew Klein. Matt, thanks so much for coming back on this show and discussing your book.

Klein: Thanks very much for having me.

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