Managing Director and Chief Economist
of CME Group.
The economy is on the mind of virtually every American these days. CME Group Managing Director and Chief Economist was on hand Tuesday at the Milken Institute Global Conference in Beverly Hills, Calif., to participate in the “U.S. Overview: Will Recovery Prevail?” panel (scroll down for video of the session). SmartBrief caught up with Putnam after the panel to talk commodities and other factors that are bound to impact the U.S. and global economy.
What impact will the strategic plan released recently by Saudi Arabia have on global oil markets?
What we are learning about the Middle East is that they planned for $80-$100 per barrel oil prices forever. Now with prices at $40 or $45, they are really hurting. The Saudis actually had to go borrow money, and that hasn’t happened in forever. These countries are basically producing flat-out and we are going to see even more production with Iraq and Iran coming into the market. U.S. shale producers are really emerging as the swing producer. Twenty years ago it was the Middle East, today it is the U.S. industry that can ramp up or ramp down. U.S. industry does it on cast, not for other reasons.
Oil is probably going to stay in a trading range for quite some time. In 2015, we were worried about how low the price could go. That’s done. Now we are just trying to figure out what range it trades in. I am pretty comfortable with $35-$50 per barrel. That’s a wide range. The fall is over, so it’s not going to go back to $20. And it’s not going to go back to $80 or $100 per barrel for a long time.
The Saudi plan includes a greater shift toward energy and economic diversification. What do you read into that?
It’s all about how different energy sources compete with each other. Surprisingly, they don’t compete as much as you might think. Seventy-five percent of refined oil is used for transportation. Only 3% or 4% of natural gas is used for transportation. Natural gas in the U.S. has become more of a fuel for power generation. Some buses and a couple of locomotives run on natural gas, but cars don’t right now. But that is going to change because technologies that allow energy sources to compete on each others’ turf are emerging.
Another thing that is affecting energy from a technology standpoint is that we are getting better and better every year at fuel efficiency. As cars and planes get more fuel efficient, 1% growth in GDP is going to generate a smaller increase in energy demand.
The third technology thing that is happening in the energy space has to do with extraction. It is getting cheaper and more efficient.
The future of the energy markets will be all about how different energy sources compete and that includes solar and wind. If we could solve industrial strength batteries for the power grid, that would be another sea change in the world of energy.
What is your view on the steps Chinese regulators recently took to cool commodities markets?
It might be a good solution for China in 2016. China is not a market economy. It’s an economy that dabbles in markets and has a lot of market activity in some places, but it’s still a heavily government-influenced economy. The government controls the lending and can make all kinds of decisions that can’t be made by regulators in Japan, the U.S. and Europe.
So when their economy starts to decelerate, they can’t depend on the robustness of that economic system to help it bounce back. In the U.S., when we have a problem, we might get a little bit of help from the government, but either way the economy will come back. I’m not so sure that will happen in China because the way they regulate and the way it has developed. They’ve greatly expanded new loans to their private sector and provided a solid base to try to influence the deceleration and make it smoother so there isn’t a hard landing. They are probably doing the right thing. But it wouldn’t work here and what we do wouldn’t work there.
You made an interesting comment during the panel about how increased financial regulations are making it harder for the Federal Reserve to achieve its primary goals. Can you expand on that?
Central bankers are typically charged with keeping inflation low and in the U.S., they are also charged with encouraging full employment. But there is also another agenda having to do with financial stability.
The kind of things that various regulatory agencies in the U.S. and around the world do to prevent the financial system from having a problem appear to limit the effectiveness of the things central bankers might do to encourage economic growth. Here’s why: The more we use capital ratios and capital ceilings for banks and financial institutions, it means that if the Fed buys $2 trillion of Treasury securities and another $1 trillion of mortgages, are U.S. banks going to lend any more money for consumption and spending? No, because they are at their capital ceilings.
The banks can grow their capital, but that’s not related to what the Fed does. It doesn’t matter if interest rates are near zero or how much quantitative easing you do, the linkage between central bank policies and inflation and economic growth has been broken. We have many more controls over systemic risk in the financial sector, but we’ve limited the effectiveness of central banks. I don’t have a view on that trade-off, but I am observing it and watching how the pendulum swings. It has swung away from the effectiveness of central banks to do macroeconomic management, but now they can do more prudential management.
When you read the economic tea leaves, what frightens you the most about the next couple of years?
If I look out and try to identify something that is a huge risk that has a very low probability of happening – what we call a Black Swan – it is a trade war. So many of the candidates on both sides of the aisle have gone into a populous framework of being anti-trade legislation, anti-trade partnership, anti-trade-treaty.
Flashback to the 1929; we had a stock market crash and massive financial problems. What did we do as a country in 1930? We passed the Smoot-Hawley Tariff. We don’t know how much that impacted the economy and propelled it from a recession to a depression, but we are pretty sure it was huge. I am very, very worried about political trends I am seeing in the U.S., in Europe and in Japan. If the more isolationist and nationalistic flavor that we are seeing in the politics of mature countries leads us down the path of pulling back from trade, it’s going to be very bad news for the global economy.
Most people analyze trade one country to another. That’s the wrong way to analyze it. Trade is all about the entire ecosystem of the global economy. It’s a network. If you mess that network up, the network implodes. All this analysis of bilateral trade flows is all wrong. You are underestimating network influence, which are huge. The trouble is that they are impossible to measure, which is why people ignore them. But they are huge.
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