Episode Summary
Executive Summary: This New Year’s Macro Musings episode reviews 2023’s biggest macro surprises and looks ahead to 2024. Guests highlight the unexpected U.S. soft landing, spring banking turmoil, weaker-than-expected China, persistent geopolitical conflict, and the rise of nonbanks and interest-rate risk. The discussion centers on how Fed policy is shifting from fighting inflation to managing downside risks, while elections, defense spending, AI, and de-dollarization shape the coming year.
Main Topics: U.S. soft landing and the missed recession call (Priority: 5/5): The panel agrees the biggest 2023 surprise was that the U.S. avoided recession despite rapid Fed tightening. They discuss why forecasters erred, emphasizing post-pandemic labor-market resilience, labor hoarding, and stronger-than-expected demand. Banking turmoil and the rise of financial stability concerns (Priority: 5/5): The March SVB/Signature crisis is examined as a major stress test for the Fed and FDIC. Speakers debate how much was predictable, the significance of the Fed’s par-value lending response, and the broader shift toward nonbank intermediation. China’s weak recovery and geopolitical frictions (Priority: 4/5): Gerard argues China’s lackluster rebound was driven more by structural/property-sector weakness than by discrete events like Balloon Gate, though U.S.-China tensions compounded sentiment problems. He also notes Huawei’s chip surprise and growing de-risking pressures. Interest-rate risk and central bank balance sheets (Priority: 4/5): Interest-rate risk emerged as a cross-cutting theme affecting banks, central banks, and the broader financial system. The panel notes that higher rates exposed losses on balance sheets and increased the visibility and cost of large central bank holdings. Geopolitics, war, sanctions, and defense industrial capacity (Priority: 4/5): Gerard frames 2023 as a year of war and strategic strain: Ukraine, Gaza, Sudan, border clashes, and defense supply constraints. He argues sanctions have clear limits and that the U.S. and allies face growing defense trade-offs in a higher-rate environment. 2024 outlook: Fed cuts, elections, and framework review (Priority: 5/5): The conversation turns to 2024, with expectations of easing inflation, potential rate cuts, and a Fed that wants to avoid hiking again. Elections, AI-driven misinformation, and the Fed’s framework review are highlighted as major sources of uncertainty.
Key Arguments: The U.S. economy proved far more resilient than expected in 2023, with labor supply improving enough to support growth and lower inflation without recession. Forecasts failed because historical models did not account well for the post-pandemic labor market, labor hoarding, and the unusual disinflation path after a massive inflation surge. The banking turmoil was not just about unrealized losses; it became a deposit-retention and liquidity problem, especially for banks exposed to innovation-sector funding. The Fed’s par-value lending response in March was credible because it prevented fire-sale dynamics and restored confidence before markets opened. Nonbanks and private credit continued to gain market share as higher rates and tighter bank regulation pushed activity outside the traditional banking system. China’s weakness is rooted primarily in the property sector, which transmits through household wealth, collateral, local-government finance, and employment. Geopolitical shocks increasingly matter because many are unintentional; incidents like Balloon Gate or a possible South China Sea collision could rapidly escalate and consume diplomatic bandwidth. Sanctions have limits, especially against large interconnected economies like China, where broad financial sanctions would be extremely costly and likely only useful in the event of imminent conflict. The 2024 policy debate is likely to shift from “how high do rates go?” to “how soon and how much do they come down?” as inflation trends lower. Elections and anti-incumbent sentiment may drive policy uncertainty in 2024, with the U.S. election, Taiwan, India, and others carrying broad macro and geopolitical implications.
Data Points: U.S. GDP growth: Above 5% annualized - Third-quarter 2023 GDP print cited by Colby as a major upside surprise despite high Fed funds rates. Unemployment rate: 3.7% - Referenced as evidence that labor markets stayed unusually tight in late 2023. Fed funds rate: At a 22-year high; above 5% - Used repeatedly to underscore how restrictive policy remained while growth and employment stayed strong. Banking failures: $300 billion of bank failures - Stephen cited this as part of the backdrop for the Fed’s resilience and rate hikes earlier in 2023. Banking failures: $500 billion of bank failures - Stephen contrasted this larger failure total with continued rate hikes, emphasizing economic resilience. Labor force participation: Improving - Colby pointed to working mothers, older men, and immigration as supply-side contributors to disinflation. Immigration: Record high during the Biden administration - Colby argued immigration helped expand labor supply and rebalance the labor market. China property sector share of GDP: From about 25% to about 18% - Gerard used this to explain the scale of China’s property-sector deflation and its macro impact. China trade settled in RMB: 15% at end-2021 to 27% in Q3 2023 - Gerard said this increase shows gradual RMB internationalization driven partly by geopolitics. RMB share of increase attributable to Russia: About 27% - Gerard noted most of the RMB-settlement increase was not due to Russia alone. Private credit market size: $1.6 trillion - Stephen cited this as evidence of the growing nonbank credit sector. Private credit projected growth: Could triple by 2030 - Used to argue nonbank lending will remain a major theme in coming years. Share of world population in 2024 elections: 43% - Gerard highlighted the extraordinary breadth of 2024 election cycles. Share of world GDP in 2024 elections: 44% - Gerard emphasized the macro significance of many simultaneous leadership elections. China’s broad trade settlement in RMB: Potentially up to half over time - Gerard suggested RMB usage could keep rising depending on geopolitics. TIPS real 10-year Treasury yield: 1.7% - David used this to suggest real rates had fallen back into a range below expected real growth. Expected real growth: 1.8% to 2.0% - Compared with the real 10-year yield to support the point that r < g may have returned.
Pivotal Quotes: "The economy gaining, you know, at an annualized pace above 5%." — Colby Smith: Describing the third-quarter GDP surprise that shattered recession expectations. "It's sort of the year of the non-banks." — Stephen Kelly: Summarizing the structural shift toward private credit and shadow banking after the March crisis. "The theme is war and the defense industrial base." — Gerard DiPepo: Framing 2023’s geopolitical backdrop and the strain on munitions and defense capacity.
Implications: Listeners should expect 2024 to be shaped by falling inflation, possible Fed cuts, ongoing private-credit growth, election volatility, and elevated geopolitical risk. The episode suggests policy makers must balance disinflation with financial stability and national-security constraints.
About Macro Musings
Hosted by David Beckworth of the Mercatus Center, Macro Musings pulls back the curtain on the important macroeconomic issues of the past, present, and future.