IMF’s Gopinath Says Risk of ‘Severe Oil Shock’ Exists

Summary

In an interview at the IMF headquarters, Gita Gopinath, the first deputy managing director, discusses the current state of global trade amid geopolitical tensions. She notes that while the ratio of global trade to GDP appears stable, there are underlying signs of fragmentation, particularly in trade between US and China-centric blocs. This shift is also evident in foreign direct investments. Gopinath highlights the emergence of countries like Vietnam and Mexico in rerouting global supply chains, which could potentially increase the cost of goods and lead to higher inflation. She emphasizes the IMF's role in promoting diplomacy and pragmatic solutions to slow fragmentation and rebuild trust among nations. The conversation also touches on the potential for an oil shock due to escalating geopolitical tensions, the impact of US sovereign debt on global borrowing costs, and the possibility of a higher inflation target in the future, though Gopinath stresses that the immediate focus should be on bringing inflation back down to 2%.

Takeaways

• 📉 Trade between US-centric and China-centric blocks has decreased significantly compared to trade within geopolitically aligned groups.
• 🌐 There is a shift in foreign direct investments, with countries like Vietnam and Mexico emerging as key players in global supply chains.
• 💰 The new era of fragmentation could lead to higher costs for goods and potentially higher inflation rates.
• ⚖️ The IMF sees its role as crucial in promoting diplomacy and pragmatic approaches to slow the process of fragmentation.
• 🛑 The recent attacks in Iran raised concerns about oil prices, but the market has remained relatively stable so far.
• 📈 If geopolitical tensions escalate, there is a risk of a severe oil shock, which could drive prices up to $100 a barrel.
• 🇺🇸 Concerns about sovereign debt, particularly in the US, have implications for global borrowing costs and debt servicing.
• 📊 The US cannot sustain a deficit of 7% of GDP and needs to reduce it to avoid negative spillovers to the rest of the world.
• 📉 The IMF expects interest rates to come down as efforts to bring inflation back to target continue.
• 🎯 Central banks should focus on bringing inflation back to 2% before considering a higher long-term target.
• ⏳ The current conversation should prioritize stability and predictability in monetary policy rather than changing the inflation target.

Q & A

What does Gita Gopinath discuss regarding the current state of global trade in relation to GDP?

Gita Gopinath mentions that superficially, the ratio of global trade to GDP appears to be stable, suggesting a healthy state of global trade. However, deeper analysis reveals signs of fragmentation in trade, particularly between U.S.-centric and China-centric blocks where trade has significantly declined.

How does Gopinath describe the effect of geopolitical shifts on foreign direct investments?

She observes a noticeable shift in foreign direct investments due to geopolitical alignments, with changes in trade and investment flows between major economic blocks.

What concerns does Gopinath express about inflation in the context of economic fragmentation?

Gopinath expresses concern that ongoing economic fragmentation and shifts in global trade dynamics could structurally raise the costs of goods, potentially leading to higher inflation rates.

What role does Gopinath believe the IMF should play amidst increasing global economic fragmentation?

Gopinath highlights the IMF's critical role as a multilateral institution in facilitating diplomacy and pragmatic approaches to maintain cooperation in areas like services trade, debt management, and climate issues, helping to rebuild trust and mitigate fragmentation.

How does the ongoing geopolitical tension, specifically attacks in Iran, relate to global oil prices according to the discussion?

Gopinath discusses the potential risk of an oil shock, similar to that of the 1970s, if geopolitical tensions escalate, although current market reactions have been relatively stable due to de-escalation talks and sufficient supply capacities from non-OPEC countries.

What potential economic impact does Gopinath foresee if the U.S. continues to run large deficits?

Gopinath warns that sustained high U.S. deficits could lead to higher interest rates and debt servicing challenges not just for the U.S. but globally, as heavy U.S. borrowing could crowd out other countries' access to capital, raising their borrowing costs.

What is Gopinath's view on the current U.S. interest rates and their future trajectory?

She suggests that although current interest rates are high, the IMF does not expect them to stay elevated. The rates are anticipated to decrease as efforts to control inflation succeed.

Does Gopinath think central banks should consider raising their inflation targets in response to a new economic reality?

Gopinath advises against discussing higher inflation targets at the moment. She emphasizes the need for central banks to first achieve the existing target of 2% inflation before considering adjustments.

What does Gopinath imply about the possibility of the U.S. facing a sovereign debt crisis?

While she does not currently see a debt sustainability problem for the U.S., Gopinath indicates that the high level of U.S. borrowing could lead to economic issues, both domestically and internationally, if not addressed.

How does Gopinath describe the role of emerging economies like Vietnam and Mexico in global trade?

Gopinath notes that countries like Vietnam and Mexico are becoming increasingly significant in reshaping and channeling supply chains around the world, highlighting their growing importance in a fragmented global economy.

Outlines

00:00

🌐 Geopolitical Tensions and Economic Fragmentation

The first paragraph discusses the current geopolitical tensions and their impact on global trade and economic fragmentation. Gita Gopinath, the first deputy managing director for the IMF, explains that while the ratio of global trade to GDP appears stable, there are underlying signs of fragmentation, particularly in trade between US-centric and China-centric blocks. This trend is also observed in foreign direct investments. The discussion also touches on the rising costs for countries due to reshuffling of supply chains and the potential for increased inflation. The IMF's role in promoting diplomacy and pragmatic approaches to slow the fragmentation process is highlighted, along with concerns about the impact of escalating geopolitical events, such as the attacks in Iran, on oil prices and the broader economy.

05:02

📉 Inflation, Debt, and Monetary Policy Outlook

The second paragraph delves into the concerns about inflation, sovereign debt, particularly in the United States, and the implications of the US's heavy borrowing on global financial markets. It is mentioned that the US cannot sustain a deficit of 7% of GDP and needs to reduce it to avoid negative spillover effects on the rest of the world. The potential for higher interest rates affecting corporations and households is also discussed. Gopinath expresses the expectation that interest rates will come down as inflation is brought back to target. Regarding the era of fragmentation leading to a higher inflationary regime, she advises against changing the central banks' inflation target from 2% until inflation is stabilized, emphasizing that monetary policy can control inflation levels and that volatility in inflation statistics could be problematic in a shock-prone world.

Keywords

💡Geopolitical tensions

Geopolitical tensions refer to the strain and conflicts between different nations due to their political, economic, or strategic interests. In the context of the video, these tensions are highlighted as a factor influencing global trade and investment patterns, contributing to fragmentation in the global economy.

💡Fragmentation

Fragmentation in this context means the division or breaking up of economic activities, such as trade and investment, along geopolitical lines. The video discusses how current global trends are leading to a more fragmented world, affecting supply chains and potentially leading to higher costs for goods.

💡Offshoring, nearshoring, reshoring

These terms refer to business practices related to where companies choose to locate their production facilities. Offshoring involves moving operations to a different country, often to reduce costs. Nearshoring is offshoring to a neighboring country, and reshoring is when companies bring production back to their home country. The video mentions these practices as part of the observed fragmentation.

💡Global trade to GDP ratio

This is an economic metric that compares the value of a country's or the world's trade to its Gross Domestic Product (GDP). A high ratio can indicate a strong trade sector relative to the economy's size. The video uses this ratio to argue that while it appears stable, there are underlying signs of fragmentation in trade patterns.

💡Foreign direct investments (FDI)

FDI refers to an investment made by a firm or individual in one country into business interests located in another country. In the video, FDI is mentioned as another area where signs of fragmentation are observed, with shifts in investment patterns aligning with geopolitical affiliations.

💡Supply chains

Supply chains are the networks that businesses use to produce, transform, and deliver a product or service. The video discusses how supply chains are being rechanneled through countries like Vietnam and Mexico, reflecting the broader theme of economic fragmentation.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The video raises concerns about the potential for structurally higher inflation due to the new era of fragmentation.

💡Multilateral institution

A multilateral institution is an organization founded by three or more states, which work together to achieve common goals. The IMF is mentioned as playing a crucial role as a multilateral institution in addressing the challenges of fragmentation and promoting a rules-based trading system.

💡Diplomacy and pragmatic approaches

Diplomacy refers to the profession or tactics of managing relationships between states or organizations, often through dialogue and negotiation. Pragmatic approaches are practical and realistic strategies. The video emphasizes the need for diplomacy and pragmatic approaches to slow the process of fragmentation.

💡Debt issues

Debt issues pertain to the problems that arise from borrowing money, which can include difficulties in repayment and the impact on a country's economic stability. The video discusses the IMF's role in addressing debt issues as part of its efforts to rebuild trust and mitigate fragmentation.

💡Sovereign debt

Sovereign debt is the debt issued by a national government in order to finance its spending needs. The video expresses concern about sovereign debt, particularly in the United States, and its potential impact on global financial stability and inflation.

💡Inflation targeting

Inflation targeting is a monetary policy strategy where a central bank sets a target for inflation and uses tools such as interest rates to steer the economy towards that target. The video discusses the importance of bringing inflation back down to the target rate of 2%, emphasizing the role of monetary policy in controlling inflation levels.

Highlights

Gita Gopinath, the first deputy managing director for the IMF, discusses the current state of geopolitical tensions and their impact on global trade.

Despite global trade to GDP ratio holding up, there are underlying signs of fragmentation in trade and foreign direct investments.

Trade between US-centric and China-centric blocks has decreased significantly compared to trade within geopolitically aligned firms.

The role of connector countries like Vietnam and Mexico is increasing as they help rechannel supply chains globally.

The current shifts in trade and investment patterns could ultimately raise the cost of goods and structurally increase inflation.

Gopinath expresses concern about the potential for higher inflation in the new era of fragmentation, with implications for economic policy.

The IMF's role as a multilateral institution is crucial in promoting diplomacy and pragmatic approaches amidst moving away from a rules-based trading system.

Progress in services trade is happening, which could be a key area of agreement among countries to slow fragmentation.

Geopolitical tensions, such as the attacks in Iran, raise concerns about oil prices and potential shocks to the economy.

Gopinath discusses the risk of a severe oil shock if there is a serious escalation in the Middle East, which could lead to oil prices reaching $100 a barrel.

The IMF is concerned about sovereign debt, particularly in the United States, and its potential impact on global economic stability.

The US's large deficits and borrowing could lead to higher rates, affecting not just the US but also global corporations and households.

Gopinath suggests that the US does not currently have a debt sustainability problem, but the heavy borrowing has global implications.

The IMF expects interest rates to come down as efforts to bring inflation back to target are successful.

The era of fragmentation may lead to a higher inflationary regime, prompting discussions about adjusting central banks' inflation targets.

Gopinath emphasizes the need to bring inflation back down to 2% before considering any changes to the inflation target.

Monetary policy can control inflation levels, but volatility in inflation statistics can create problems in a shock-prone world.

The conversation about potentially adjusting the inflation target is deemed premature and should be revisited at a later time.

Transcripts

I am here at the IMF headquarters with Gita Gopinath, the first deputy managing

director for the IMF, at a time of highly fraught geopolitical tensions.

All this discussion about fragmentation. You wrote a paper that was fascinating

about fragmentation. Just how much of it is actually

happening? The offshoring, near shoring, reshoring,

etc.? Yes.

So, Lisa, if you look at the data and if you look at.

Just a superficial number, which is the ratio of global trade to GDP.

So that number is holding up really well and you think everything looks fine.

But if you look under the surface, you're absolutely seeing signs of

fragmentation. And if you look at trade between US

centric blocks, this is a China centric bloc that trade has gone down by much

more than trade within geopolitically aligned firms.

That's also true for foreign direct investments.

So we are seeing these shifts, but at the same time, we're also seeing the

role of connect to countries like Vietnam and Mexico that are coming in

and reads channeling supply chains around the world.

And all of this can raise the cost ultimately of goods for countries, which

is really the key question here, which is how much structurally higher is

inflation in this new era of fragmentation?

This is a main concern and these are numbers that we have to determine.

Now, we're still at an early stage. So we we are looking at very dramatic

movements over here. But if this process continues, it could

lead to much more inflation in the process.

I do have a weight in mind about is it 3% or 4%?

Is that the kind of rate we can imagine in this world right now based on the

scale at which is happening? I wouldn't say it will be that large.

But again, the risk is if it heads in a much worse direction, it seems like this

is the path of travel. Everyone's talking about the

fragmentation, everyone's talking about protectionist policies in an era where

so many countries seem to be rejecting free trade.

What's the IMF role? We have a really important role to play

as a multilateral institution. You know, the world is moving away from

a rules based trading system. So what needs to happen is diplomacy and

pragmatic approaches. And that's what we're trying to push for

it through this meeting, getting countries together to work at least on

areas where they can agree on on services, trade, there's much more

progress is happening on services trade. We need to work together on debt issues,

on climate issues that will hopefully rebuild trust and slow the process of

fragmentation. We also see an increase in geopolitical

tensions, and we saw this overnight with the attacks in Iran.

There were some real questions around what the price of oil would do.

It did nothing. But that's as people were talking about,

de-escalation, as you're done yesterday was talking about the possibility of an

oil shock akin to the 1970s with oil prices going to $100 a barrel.

Should this escalate? Do you foresee a similar type of thing

happening? This is a risk we worry about.

If there is a serious escalation, which means a much more wider regional

escalation than what we've seen so far, then yes, we could have a severe oil

shock. But we're not there yet.

And as you can see in terms of oil prices went up somewhat, has come back

down. We have supply excess capacity in Saudi

Arabia. We have non-OPEC countries putting a lot

more oil out on the market. So there are other sources of supply

that can, you know, buffer these pre shocks.

But if there's a large scale escalation in the Middle East, that is the problem,

is that the line in the sand, $100 a barrel amount would consist of the

shock. I think you're going up $100 a barrel

would be problematic. But even going from here to $100 a

barrel would be very difficult for countries to deal with.

We're still fighting the last inflation fight, which is to bring inflation back

down to target. One thing that the IMF has talked

extensively about is concern about sovereign debt, in particular in the

United States and the overhang there. What's the outcome of that?

Is the fear of some sort of sort of slug flirtation or just sort of a sluggish

growth kind of picture because of the overhang?

Is it higher rates and potentially a Liz Truss moment, which I've been talking

about, get shot down all the time in the US, but is there something like that

that could potentially happen in the US is running very large deficits for a

country where demand is very strong and there is still the last mile in terms of

bringing inflation down. So for all those reasons, the deficit,

we can't have a deficit of 7% of GDP. It needs to be lower.

And if you project out, it's going to stand those high levels for a while.

That has consequences, of course, for debt servicing in the U.S.

But you sense the bigger problem is in terms of spillovers to the rest of the

world, because the rest of the world, when you have so much of death being

issued by the US that can crowd out the lend and borrowing from other countries,

their costs of borrowing goes up and their debt servicing costs go up by much

more. So, you know, I wouldn't say the US has

a debt sustainability problem now, but at the same time when the US is

borrowing that heavily, that causes rates to be that much higher.

It has implications for the rest of the world and for, you know, corporations

and and households in the US. How much higher I mean, could you see

rates staying here between 525 and 550 for the rest of this year for even into

next year? That would not be our baseline.

We would expect to see rates coming down.

So, you know, right now there is a fix for getting inflation back to target.

So we expect that to come down. You know, it's going to take a little

longer, but we expect that to come down. The question is whether it comes back

down to what we saw in the decade after the GFC.

And there you know, right now that doesn't seem to be the case.

One thing that you talk about is this era of fragmentation is going to lead to

a higher inflationary regime. Do you think it's appropriate for

central banks to have a higher inflation target long term as sort of their goal,

say not 2%, but two and a half percent or somewhere between two and 3% just

because it is a different reality now. So firstly, that's the conversation we

should not be having now. We need to ensure that information comes

back down to 2%. You know, monetary policy can pin down a

level of inflation. Yes.

If you're going to have a lot of volatility in that inflation statistic,

that could create problems because we are in a much more shock for a world.

But again, you know, that is a conversation for later.

For later. But it might be.

Yes.