“A Huge Problem for Everybody” | Paul Krugman on Currency Devaluation, Artificial Intelligence, Kevin Warsh Nomination, & More

Today's episode is brought to you by the PICTAE AI Enhanced International Equity ETF, Ticker PQNT. You'll hear more about their using AI to enhance international equity returns later in the show. For now, let's get into it. Very pleased today to be joined by Paul Krugman, Nobel Prize-winning economist, distinguished professor and publisher of the Paul Krugman sub-stack. Paul, welcome to monetary matters. How are you? I'm good. It's good to be with you. I know there's a lot of changes in the global trading order over the past year. I want to ask you about that. But first, what about the US dollar? You, many other economists, have long looked at the very large chronic current account deficits of the US dollar, and thought, at some point, this has to adjust. The dollar should weaken in order to level things out. It hasn't. Why is that? It's certainly possible to run substantial credit count deficits forever. I mean, there is a, first of all, there's the usual, the arithmetic of growth. So once you have a net debt position, you can continue to run deficits as long as that debt position doesn't worsen as a share of GDP. It has worsened substantially for the US as a share of GDP. But we're not yet. I mean, if we're thinking about what is the burden of net investment income payments by the US to the rest of the world exceeding payments by the rest of the world. To the United States, it's still not a huge negative number. So in terms of sheer external debt, that's not a, that's not a killing constraint. The only thing you can say is that this cannot go on forever. Herbert Stein's law is something cannot go on forever. It will stop. And this requires that the United States be an attractive investment destination. And how, you know, how much does that continue? So look, I don't think that the balance of payments is the biggest issue for the dollar. It is true that at some point, the United States does need to sort of mostly pay its way in world trade. But that's not an acute thing. It's much more a question of the, you know, the uncertainties about the US domestic scene, the role of the dollar and international finance and so on. So it's about the domestic scene and its role in the dollar's role in international finance. What do you mean? How do you measure that? The dollar is very special in the world. It's a, it is, you know, if the dollar is the money of monies, it's the international medium of exchange. If you want to exchange peruvian stalls from Malaysian ringgit, you don't try to find a trader who wants to do the reverse. You basically, it either you or your bank goes via the dollar, the dollar is the vehicle currency. It is the currency in which, in which transactions are mostly settled. It's an invoice currency. So it's the, it's the unit of account for a lot of trade and international finance. It's a store of value. People hold dollars. You know, official reserves, but much more important private investments are often dollars and or dollar denominated because they, it's the most, it has been, it starts the review scene as the safe haven. So all of that means that there is a little bit of special treatment. Now it's also true. You know, when the United States is not unique in having run persistent trade deficits, the UK has done that. Australia has done that. But the, but we probably get some extra edge from all of that. And there is some question. It's certainly a fun thing to talk about. I think maybe too much fun, but the international role of the dollar, it sounds interesting, sexy, global. So a lot of people like to talk about it a lot. Defroning the dollar is actually much harder than people imagine. I mean, when people say, oh, you know, will they, they're in the, replace the dollar and I say, well, how soon do you think that? Mandarin will replace English as the language of international business, right? And that's that's, and those are very similar things. Fantastic 60 year old essay by Charlie Kenkelberger about exactly that, that, that analogy. And the point is there's so much, so much of world businesses and dollars that if you try to, even if the US, you became a hopeless, the untrustworthy partner, which we're working on, but anyway, the, the dollar would probably persist for a long time anyway. But it can be a road it. And there is some sense that it's just. Just between uncertainties about. The United States and uncertainties about, you know, is how much do people want to commit to doing transactions in a currency that we're to some extent at least they, they fear that maybe weaponized. We do see at least at the margins some shift away from dollars. And that I think is is those things are what's weighing on the dollar now. You're talking about not how foreigners around the world are selling dollars, buying the ring gets buying gold, but that the marginal reserve dollar is going into a pool of assets that on the margin has a slightly lower US dollar US treasury content and higher diversified. Yeah, I mean, there may be some people selling, but the mass flight from the dollar, it would take a lot. It we are mean, it takes years and years of of extremely irresponsible policy to turn yourself into Argentina from that way. And there's a tremendous weight of accumulated credibility, which you know, it is, is we can talk about that, but it's it's not easy. It would take a really sustained campaign of self destruction to undermine the dollars role and that there's this huge thing with just the lack of alternatives. The the Reminbee is really not suitable. Chinese capital controls, among other things, the euro is still too fragmented. You know, Bitcoin, there's a little bit of fun on the Bitcoin front lately, but it's really just not not at all in that universe. So the biggest cause in the worst case scenario, actually, the issue is not that the dollar might be replaced by something else, but that the dollar might be replaced by nothing else. That we just have a chaotic fragmented international monetary system, which is, you know, if things go really, really badly, that's where we end up, but that's not tomorrow, not next week. What do you think moves currencies? Like if we look back from the dollar bear market from 2000 to 2008, what you might be the proximate cause, because you do have these huge chronic deficits that you could say cause it, but we also have these huge deficits now. Yeah, look, I've been on I've been in this international monetary theory business for an alarmingly long time. And way back when I was I was just I was in graduate school when we were just transitioning to floating exchange rates and there was a whole industry of people trying to develop equations that predicted the value of the dollar, you know, prediction exchange rates. And after a while, there was actually a sort of landmark study, it's ancient history now, but that showed that none of the models out there did better at predicting exchange rates than a random walk. So the answer is fundamentally, we don't know. It's it's it's market expectations, which can come out of anywhere that caused the dollar to move. And I don't think that there's a really mean there is a very good turns out there is a measurable impact of interest rate differential. So if you have a period when the US has relatively low interest rates and other advanced countries have relatively high interest rates, you do quite the dollar to weaken on average. But it's it's it's it's there it's clear it is clear if you if you use enough data as a clearly statistically significant relationship, but it's not all that strong. And then other stuff. You know what's happening. I don't think we know what what what has caused that there was clearly a point in the. Uh, you go back to the plaza cord was again, we're going back to ancient history. There was clearly a point where the dollar really look clearly overvalued and and that got corrected. There was a period that when the dollar was weak, that sort of post post dot com bust and pre housing bust when US interest rates were fairly low, but in the end. It's it's a lot. It's sort of a currency version of the. Old Paul Samuelson remark about the stock market that predicted nine of the last five recessions. I think the dollar has predicted probably nine of the last five economic crises. You talked about the move to floating exchange rates. The end of Bretton Woods. I think the IMF originally was set up to address those imbalances of payments. Now it is kind of serving to lend to countries around the world that need or kind of a debt that stress. Um, do you think that IMF or are global financial institutions like the IMF or World Bank or the BIS are they powerful enough to sort of create the change that is necessary. Like if the world economy needs the Chinese you want to weaken and you are global institutions, you're powerful enough to get the Chinese officials at the table and kind of have them agree to something some kind of accord. No, not especially a current. There's always been a problem of asymmetry in the system, which is the surplus countries. Uh, there's a lot of leverage over deficit countries, at least the deficit countries in trouble almost none over surplus countries. And, uh, you know, a principle the IMF is will, but it'll do article four consultations on all that and tell you, you know, you're running an excess of surplus and countries will say, no, we don't think we are in. than what's the leverage. And my view of the IMF, I think the IMF is extremely useful, sometimes harmful, but not because it lacks power, but what the IMF really does is it does provide some money to countries in trouble. It's not that it's so much a source of money, although it can be significant, but mostly because it's a signal to other lenders that you've got an IMF seal of approval. And often, very often, the IMF is a useful villain that actually a country's own economic official is no perfectly well, that needs to take some hard measures, that need to take some steps. But they need somebody else to say, they're forcing us to do this. And that's really, you know, IMF in Britain in the '70s, or in many cases, IMF in many developing country crises, the IMF is just a useful, universally disliked authority figure that is helpful to sort of shift, to do what you need to do. Now, sometimes it can be, I think we can say that the IMF played a role in imposing excessive austerity on Southern Europe after the Euro crisis, although really the IMF was actually the nice guy, the good cop in that and the bad cops were more than the European social bank and the European commission. So anyway, but the, so the world of international finances is kind of, it's kind of subtle, and so it says a lot of, there's a lot of surface appearances are not exactly what is really going on, which is okay, up to a point. - If let's say the Chinese you want is so weak, relative to the dollar, and it's just so much more efficient to manufacture products when you pay people and your capital expense is in Chinese you want, rather than the expensive dollar, I mean, are we doomed to not really make that many things in America and on your poker, you've been sub-stack, which is excellent, we can put up a chart of the Chinese you want real exchange rate and how basically, we're fighting uphill. If you want to make things in America, you're really fighting uphill. And we're getting to ongoing trade with the US current administration as well, but regardless of who is in charge, it is just talk about how challenging it is to try and produce things in an overvalued currency. - No, that's right. Well, the yuan is clearly, well, it's a little bit of, overvalued, undervalued, given the lack of the inadequacy of Chinese consumption demand, then in some sense the macroeconomic says, well, they're going to export their excess savings. So they're going to run huge trade surpluses. And in some ways, the weak yuan is a reflection of that gap. What is really not sustainable is for China to be keeping their economy going without sufficient domestic demand by exporting the demand deficiency via trade surpluses. That is a huge problem for everybody. It's actually a waste for Chinese as well. They're devoting a lot of resources to very low return investments by running those trade surpluses, but the check to that will not come from international financial markets. It will not come from the IMF for sure. It will come from protectionism in the United States. And I think equally important in Europe. The fact of the matter is that you can do all the like in terms of academic arguments to say, well, better to take the cheap stuff, those cheap electric vehicles, the Chinese are doing something that is actually, it's great, they're giving us cheap electric vehicles and return for IOUs that yield a very low rate of return. But it's just unacceptable in terms of the domestic political economy. So the Chinese in their own interests should really turn this around. They should basically live a better life and not run such big trade surpluses. And if they don't, then there will be a backlash. It's just the world cannot go on this way for very long. What do you think is going to happen if it does? Oh, I think that the Europeans have, I mean, we already, the United States already has, mostly very ill-considered, poorly designed, but the United States has to run up a lot of tariffs against China. We have an average tariffs ready, you guys China, something like 37% right now from around 10 before 2025. The Europeans haven't done that yet, but they have the capacity to do that. And the thing about Europe is disunited on many things, but the European Union is a customs union with a common trade policy. So there will not, maybe not 2026, but soon and for the rest of our lives, there will be a big European backlash as well. So I think that China is basically going to run into a wall of tariffs by everybody, not just thought just Trump, but everybody, because the disruptive effect of those huge trades are closest to large. Now, obligatory, I'm not defending the Trump tariffs, although China, I'm relatively a hawk on China policy, but that doesn't explain why we had massive tariffs against Brazil or India. So in a way, I think what the United States should be doing and should be doing a concert with the Europeans and others, but especially the Europeans, is that we should be presenting the United front to China saying you cannot do this. You cannot run trades through a pluses that large. We just, our societies can't handle it. And one way or another, maybe in an uncoordinated inefficient fashion, that is what's gonna happen. I'm curious your view on the similarities between tariffs and currency weakening. Is the US putting up tariffs somewhat similar to the US dollar weakening? And well, you know, what are the similarities? What are the differences? And if I'm just making up the number, the Chinese you want is undervalued by 30%, is putting a 30% tariff on China to level things out, is that sound economic policy? Well, the usual argument is, there are really two arguments for currency depreciation against relying on tariffs or protections in general. One of them is that tariffs don't provide an incentive for exports. So you're doing it all on the side of input compression, which is his inefficient, and means sacrificing the ability to sort of concentrate on what you're pretty good at doing, which is what you export. And the other is that tariffs tend to be very uneven, that their or protection is in general. You end up giving some sectors get more protection than others. There's a tremendous potential for rent seeking, seeking getting exemptions or selective protection based upon political influence. In some cases corruption, that's the generic thing. We've been talking about rent seeking and economics for more than half a century. And then I'd add that if you're going to do the tariff, the United States dollar is not clearly undervalued against, overvalued against the euro or the Canadian dollar or whatever. It's, so if your problem is visa V China, then cross the board tariff, which is, we do have highly uneven tariffs, but they're still a lot of tariffs on countries that are not named China. And that's a bad thing. I would add one other thing that is an interesting point about tariffs, which is that on the one hand, it's a problem that the tariffs are being imposed differentially. On the other hand, the differential tariffs are themselves a source of costs, Richard Baldwin, my old student, although now our approach of retirement age himself, but anyway in Geneva, had an excellent analysis, where he pointed out that one of the things that the current structure of US tariffs does, is it encourages, instead of encouraging production in the United States, it encourages sourcing our imports from higher cost countries. So we buy something from Vietnam or Mexico, even if it costs more to import it from there than from China, which ends up, doesn't actually do anything promote US manufacturing, but it does mean that we pay more for our imports than we would otherwise. So it's just a pure loss. So the current, the right way to do this, and it's not just currency values, right? The currency value in some ways is endogenous, some finding it hard not to do economy speak, but the currency value is endogenous, a realignment of macro policies, which is definitely China needs to consume more. There are, you cannot save 40% of GDP when your growth rate is no longer 9%. And to a certain extent, the rest of us need to bring our own consumption in line with our incomes here, the United States, mostly fiscal. We have large fiscal deficits, the Europeans do as well, the not on the same scale. So. kind of macro realignment, which would necessarily be a company by a currency realignment, all of which is going to happen. Well, as soon as we have sensible people running all the world's major economies, so how long is that clock? It's often that a con I find economists will say that the source of the chronic chronic out deficit is really you got to look at the fiscal deficit. But why do you start with the fiscal deficit and also haven't you been someone who's been on the side for 20 plus years saying actually fiscal deficits are sustainable and in you know, they can be good things when the economies need stimulus. Yeah, they definitely can be good things when the economy needs stimulus. Right now we don't. And one thing that is still not fully, I don't think anyone does is that if you go back to pre-COVID, it was very clear that our star, the sort of sustainable real industry was very low and well below the economy's growth rate. And that situation debt is really not a problem. That is no longer the case. We're now looking at the interest rates are much much higher than they were. They're clearly higher than the sort of law we're on growth rate of the economy. And we're not in a recession. So that's telling you sort of on a PPE basis as a proof of the putting is in the eating that our star has moved way up. Now why that should be the case is an interesting question. But the arithmetic that was pro that basically said relax about debt and deficits in 2019 does not say that in 2026. There's still. Because interest rates are so much higher relative to growth. Potential growth has probably slowed. Although let's see what what AI actually does for us, potential growth appears to have slowed. Interest rates are way higher. We are not in a recession. We appear, you know, it's possible that actually the the tech building boom, maybe that goes away. But also we have moved from a fundamental level deficits are now looking much more persistent and ingrained than fiscal deficits than then they did in the 2010s. So it's a quite different world. And they all I could say is that if you kind of have to go with with what the numbers are telling you and the numbers are not telling it all the same story that they did in 2019. I want to want to ask you about our star in later, but just you said that the math does not support large deficits like it did in 2019 because interest rates are higher. That's very interesting to me. It kind of sounds like you're kind of the CFO of oh, when interest rates are at 1%, we're going to borrow as much as possible. And when interest rates are at 15%, we're going to make sure that we don't we don't have to borrow as much. Is that tell us about that view because there are those who say interest rates don't matter. And if interest rates are high, but the economy needs deficits, it should have deficits. And if you know your your Germany and you don't be you're in a surplus is what's needed, even if interest rates are zero, don't borrow. Okay, so you know, if interest rates are high, that tells you right away that if the economy is stimulus, you'll at least have some room for monetary stimulus. I mean, the whole point of the sort of post global financial crisis world was that we had cut interest rates to zero and we still had persistent weakness. And that we really needed fiscal stimulus there. And the same condition that says monetary policy doesn't has is very hard to get any traction is also the situation on that which deficits are not a big problem because borrowing is so cheap. So that was a world in which fiscal deficits for stimulus made a lot of sense. It's also the case and the CFO story is kind of right. And if you ask, look at the look at the situation in 2013 say when the US economy was still quite depressed, employment was low, monetary policy was added, certainly conditional monetary policy was at its limit. The interest rate was at its zero lower bound or its lower lowest bound. And we also had lots of public investment needs as we still do. That would be a great time to borrow a lot of money and invest it on infrastructure and invest it on actually and a lot of other things that amount to invest child nutrition and health care is an investment as much as roads and bridges are. So but we and we didn't do that. We were constantly being lectured about the evils of deficits at exactly the time when we should have been running deficits and investing them. And Germany, wow, Germany is a it's actually a it's a cautionary tale because they were is he congratulating themselves on their discipline on the the charts on the low, the black zero and and now we're getting all these stories about how you know the trains in Germany are worse than the trains in Britain, which is true and it's kind of astonishing because I I haven't done a lot of traveling on German trains, but I've done a lot of traveling on British trains and it's not great, you know, it's really terrible. So the Germans have really clearly they they ran the balance budgets to kept their debt burden down and they're clearly worse off as a result. They've allowed their infrastructure to to deteriorate quite badly. So that there are times certainly when you have a low interest rate environment and and a weak economy, yeah, that's when depth suspending is a good thing to do. As soon as AI tools begin to wow the world, investors started asking when will AI driven strategies become more common? The answer is that they're already here sophisticated quant hedge funds have been using machine learning strategies for many years largely only for the benefit of institutional investors paying higher fees. Now with the barriers to usage coming down, AI machine learning approaches are being made available to you through products like the PICTAE AI Enhanced International Equity ETF ticker PQNT. 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You mentioned RSTAR, the theoretical rate that is neither stimulative nor contractionary for the economy. Why do you think that RSTAR has moved up? I'm a little baffled. I mean, I have some stories, but they do run. They are problematic. So it seems pretty clear that RSTAR has gone up. The fact that we've had, I mean, when the Fed began raising interest rates in 2022, a lot of people said, "Oh, and that leads to a recession." The famous Bloomberg model that said the chance of a recession was 100%. And it didn't happen. And the fact that interest rates came up so much, he didn't have a recession, it's part of the phase. You have an illness that RSTAR was higher than it had been. Now, why? That's. I mean, we had a story for a while, but I have to say, right now, a lot of the. When we talked about secular stagnation, which is terrible term, but basically means RSTAR very low, right? When we talked about secular stagnation, one of the big stories we gave was democracy, that the combination of aging population, basically aging populations, very low or negative growth and working age population, certainly in primates working in population, that that meant limited investment opportunities, and that was leading to a low RSTAR. That situation has not improved. Certain in the United States, prospective growth in the working age population has flatlined, not because. Not because there was a big drop in the birth rate 20 years ago, but because our policies and immigration have radically changed. And we appear to have gone from a really large immigration surge a couple of years ago to depending. The numbers are flaky. Keeping accurate numbers on undocumented immigrants are sort of my definition hard to produce, but depending on your estimates, either way down or as actually turned, net migration may even have turned negative. And the. So that the demographic story would say if anything RSTAR should be down. Now, maybe we certainly have a lot of investment spending being driven by AI. And that might be a source of excess demand, of increased demand for funds and a strong economy, although some doubts. There's a lot of import content in that spending, and manufacturing construction, that's only part of it, but certainly that has actually turned down since late 2024, mostly because of green energy subsidies. So exactly what's happening. I don't know. No, and actually, the most nihilistic version I've seen is that the economy is not actually the all that responsive to interest rates and therefore it's really very hard to pin down where our star is or maybe we've just exaggerated that the precision of all of this coal along the way and it's an interesting question. We're all, me too, are saying, you know, it would be deeply irresponsible to do the 300 basis point cut interest rates that the president wants, but how much difference would that make? Actually, we don't know. But I have to say that there's a lot of fog. The reality that we've had much higher interest rates than we did in early 2022 and yet the economy is still trucking along is clear. We have had a huge boom just before we had this conversation, I'm reading headlines about the massive spending that hyper scalers and AI are planning to undertake all this tremendous cat-backs, which you would think would be a major source of stimulus. I mean, it's a little bit like, I've been in the business too long, but I remember in the late 1990s, there was a bit of a puzzle was why is business investment so strong? And the answer is it was actually very much tech, not so much comms as telecoms. It was just a lot of spending on the new technology, much of which turned out to be at any rate premature, but there was a, and there could be something like that going on. I'm a little unnervous because some, though not all of my, the people I trust on these things, are estimated a very high import content for AI related spending. There's an awful lot of chips produced in Taiwan and even in China in those data centers. So it may not be as much of a stimulus to the US economy as the headline numbers would suggest, but on the other hand, the construction is real and the until the few days before we had this conversation, the stock valuations were certainly boosting high consumption by high wealth individuals. So it's possible that will wake up a year from now or two years from now and say, well, that's thing about higher R star. That was all, that was all the AI bubble, but we don't know that. Just going back to immigration, I kind of hadn't been paying enough attention to it, but I think it really is important. So the, there was a large influx of migration into the, the US from 2020 to 2024. You know, and that is has sharply reversed. Are you saying that the more the population goes up, the higher the natural interest rate should be because there's just more, more demand and overall GDP is higher. And so, yeah, what do you think? I actually, now you're saying that because net migration is down and maybe even be negative, that our star might actually be lower, I've got to say, Professor Kruem, and you are actually in agreement with the Fed governor, Myron or former Fed governor, Myron, who actually made that argument on this very show. So you do agree with him that the Fed should cut interest rates because migration is so negative now. Well, the problem is we don't know enough to be to go that way, but it's certainly not what you see in the economy right now. So the point is right now, we have, if we look at the macro situation right now with GDP, apparently still growing pretty fast and not labor market, you know, it's a weird labor market, but it doesn't look like it's a, it's a weak labor market by the conventional definition and inflation kind of black that's at a, you know, the macro situation would not call for large interest rate cuts. Looking forward, so I don't think this is helpful in deciding monetary policy now. I don't think the FOMC should be looking at at that immigration just yet, but if we try to ask what will, what will our star look like two or three years down the pipe? There's a reasonable case that sharply reduced immigration should reduce it because it's, go back to the, what determines investment? And there's this very old logic, which is still I think correct called the accelerator principle, which says that investment demands should depend less on the level of GDP than on the rate of growth of GDP because if your economy is growing, then you need new office buildings, new, new investments in services. It should depend on GDP level on GDP rate of change or the rate of change of the rate of change. No, the rate of change, not the rate of change, the rate of change, I mean, it could slip either over there, but two to go, there's his is too far. But, um, and look, Japan entered the world of very low interest rates, you know, 10 years, 10 plus years before the rest of the advanced world. The reason they did the usual story, which is the story that makes a lot of sense is that they, that Japan had the demographic apocalypse sort of well ahead of the rest of us, that Japan between low fertility rates and, and a historical aversion to immigration, Japan's working age population began shrinking in the 1990s. And if the working age population is shrinking, then you don't need a lot more office buildings, you don't need more factories, you don't need more new houses because household formation is not rising up. You still have some of that, you need to replace stuff that wears out and as, as living standards rise, people want bigger houses and more comfortable offices. But the, the level of a desk that you can justify is substantially lower in a, a low population or a zero or negative population growth environment. By the way, that's, we were talking earlier about China. If you asked, what's, why is China having a problem? What, they have a very low consumption, high saving society, and which was workable when their economy was growing rapidly and when their working age population was growing because that, that meant that there was a lot of demand for building new stuff. Now that China has had a working, shrinking working age population and now a shrinking overall population for quite a while, very hard to justify the investment. So the same, China is in some ways one of the most acute victims of this demographic issue. So I think that's a, that, if you had asked me, if you talked me about what was happening to US Demography in 2025, I would have said, well, that should, that should mean that the issue of low R star has secular stagnation will become even more intense. Now it has not, at least not so far, is that just a blip? Is it a bubble? I don't know, but I have to say that, that I'm a lot, I thought I had this thing fairly well understood back at, you know, on the eve of COVID and now I'm not, no, it does look kind of puzzling maybe. I'm sure there are people who are quite confident that they know what's going on, but I'm not. The relationship between demographics and debt and debt to GDP when the society is older and having fewer kids, the working age share of the population goes down. So there's more pop, increased population percentage who are on things like social security. Does that mean basically as the world ages that debt to GDP is just kind of in a secular bull market for many, many decades? And you know, I mean, the UN, again, what do you, what the forecasters know? Although actually forecasts about Demography are actually far more aggregate than accurate than forecast about many other things, you know, particularly in economics. And they forecast, I mean, things like, you know, in China by 2100, there's going to be more senior citizens than non-singer citizens adults. Where are we going? And I also want to say, there have been tons of people doom and glooming about the US debt to GDP, particularly like 10 years ago, and you were saying, hold on, not so fast, it's not that big of a deal. There's not going to be a crisis. And in the short term, you were wrong, they were sorry, sorry, you were right, they were wrong, you know, Paul Kruehn won them zero. But like long term, what are you seeing? And you know, is the Paul Kruehn of in 2080 going to be, you know, be saying, hey, I mean, you know, debt to GDP of 500%. It's sustainable. And will he be right? Okay. So generally speaking, debt to GDP is kind of secondary in these discussions. It is, it is there. But again, historically, advanced countries, advanced countries that are seen as having mostly responsible governments and stable societies can get away with a lot. Britain, after World War II, had debt to GDP of 250%. And there was no crisis. Now, are we? Does America look like that to you? Well, that's that's a question that probably outside the scope of this discussion. But the, but the demography thing is less about what happens to the debt GDP ratio that it is about just the, if you like the transfer burden, we have a, you know, every advanced economy has a fairly extensive welfare state. Even the United States does, although ours is less generous in many ways than than than than than other countries. And all welfare states, although ours is in exceptional in this talk, involve a lot of taxing of working age people to pay benefits to older people. And that, you know, that's, that's going to be inherent. partly retirement benefits, partly that it's cost health care, even for a healthy senior citizen cost, an awful lot more than it does for a 25-year-old. So there's always a problem. If you, there's always a question of how many workers are there to support the retiree, or at least senior citizen. And that's not the level of debt. Even the interest payments on the debt are actually quite small compared with the burden of just providing income and health care to older people. So that is a demographic thing is an issue. It's not quite. Well, I haven't seen revised, I don't think we've been able to revise the projections right now, the numbers that we were looking up before we were looking at even in 2024 said that the demographic shift was going to be significant, but not killing, that the rise. If take the social security, the age dependency ratio, right? The dependency ratio of social security beneficiaries to people paying into the system, a lot of that rise has already happened. And so people started. The baby boomers started hitting 65 or even more 62 when a lot of people do retire before 2010. So a lot of. We're already well into that transition and there isn't that much more to go for sure at the biography, but if you. Or there wasn't. And then if you include. If we were able to limit the rate of growth of health care costs than it wasn't that severe. But if you reduce working age population growth from 1% to 0, then those issues become a lot more severe. So the long term sustainability. And the United States Medicare, Medicare Medicaid and Social Security because Medicaid, although most of the recipients are young, most of the benefits go to the elderly. Those are. That becomes a much more problematic thing. And I don't think it's. If you could suddenly wipe out half of US federal debt, that would make almost no difference to the sustainability of the system. Fundamentally, weak democracy is a problem for any system that has a lot of beneficiaries who are getting on in years. But I want to ask you about AI. You referenced it earlier. The huge amounts of catbacks, I've seen estimates of maybe $500 or $600 billion for the US in 2026. Honestly, I think it could be a little bit higher. That is, I don't know, roughly 1 1 1/2% of UF's GDP. When you look at the history of giant catbacks, booms, whether it was the dot-com telecom boom, railroads or other things, what tends to happen and why? Okay, so there's a pretty consistent story, which is that these big, big booms and catbacks generated by optimism about new technology do end up in some kind of grief that there's a. And so what we're looking at right now is something that is grasped, it's only getting up so far relative to GDP to be something comparable to the late 90s, mostly telecoms catbacks boom. So it's not, despite the immensity of the numbers, it's not completely out of bounds. It's not remotely on the set scale as the railroad booms of the 19th century, which were sometimes 6% of GDP. So, but what has typically happened is that even when the technology is really, really does pay off, I have no independent judgment on AI. One thing I will say is that while mostly I personally find it annoying people who tickly people in the doing coding are really, really think that that claw is revolutionary. So maybe it's a big payoff, but is it a payoff to the company doing the catbacks? And that's the problem, the telecoms was for real, because no question that that and the internet was a. It's not weird that they didn't show up more in productivity growth, but nonetheless the internet was clearly a valid, important technology and our lives were all very different because of it, but the companies that did the big spending in many cases did not survive. So it seems, you know, historical precedent is that that's going to happen again. I would particularly, and this is just subjective, what do I know? But you do have the feeling that these kind of eging behemoths of the tech industry, I'm referring to the companies, not the leaders of all, maybe that too, but these, that they are spending the estimates attempt to hang on to their, to their youth away to that they it is kind of amazing. It's just very different from the telecoms, the big spending that was coming from companies that were already in transient components that are trying to practically dig their most deeper. And that doesn't sound that doesn't build very well. It doesn't build very well for society maybe, but in the fact that the biggest and most profitable companies are the ones doing the spending might that mean that this is, you know, in the short term, a little more sustainable, they're not just having to, you know, borrow tons of money to do that, although that's happening too. Yeah, that's happened. That changed in the last year. It beginning of 2025 because it, well, this retained earnings and it's not great if they're wasting a lot of their retained earnings, but no threat to financial stability. But now a lot of it is debt. So it really is starting to look problematic. And, yeah, I mean, I, I worry again, what do I know? But the subjectively it does feel as if the, there's a, a lot of money is being sunk into very large sort of universal models in the United States. While the Chinese are working on sort of smaller or more application-specific models. And it looks like there's a pretty good chance that the Chinese have got it right and we've got it wrong. And that's another reason to be skeptical about where we're going. But again, I shouldn't even weigh it because what do I know? That's, um, this is one of those areas where I want to consult the genuine experts. And the problem is that this is one of the situations where you can find a genuine expert to tell you whatever it is you want to hear. So anyway, very, very true. Um, Kevin Warsh, president Trump, he nominated him to, to be the next chair of the Federal Reserve. You wrote on your sub-stack Paul Krugman, this is a humiliating day for the Federal Reserve. Why? Okay. Previous Fed chairs, even liberal conservative presidents had been clearly, they've been chosen with an eye towards competence towards reassuring the business community. Um, Warsh, you know, among the front runners in the Trump beauty contest may have been the least alarming. But that's he's not anybody that I think anyone would have named as a desirable Fed chair, worried not for his political credentials. And he'd been very much political animal. I mean, I threw up some scrappy charts on my sub-stack. The economist now has a much more carefully done chart that says the same thing that Warsh very clearly his views on, he's not a, he's not a whole, he's a hawk when a Democrat is in the White House. He's a, he's a dove when a Republican is in the White House and he's angling at the job of Fed chair. That's not a happy record to have someone going into. And I have actually read some of Warsh's speeches on monetary policy over the years. And it's not so much that I disagree with his conceptual framework as that I can't figure out what the conceptual framework is. I don't think there really is one. I think it's kind of a a lot of free-floating criticism and, and, uh, and, uh, difficult language that ends up being, uh, a smoke screen. Now, you know, we, this is, nobody was, I have, mostly I know people who are X-Fed staff who were in the central banking world and almost everybody is really quite unhappy that we've come to this. Now, probably, um, Warsh won't do that much damage at least to monetary policy, but this is, this is a real degradation in, uh, in, in, in the process and the criteria for selecting a Fed chair. This is the most important economic position in the world or, or would be in, in the hands of somebody who had a lot of credibility at the Fed. And, um, the idea that, that, um, fealty to, to the president of the United States, it was clearly a key consideration. That, that is a big humiliation for the Fed. And if there is one coherent principle that, that, Warsh has been very steady on it, it certainly is, you know, Kevin Warsh has been associated with, with the view that the Fed's balance sheet is too big and they shouldn't be in the business of having a, a big balance sheet. What is your view of, of, of that claim and might this be a world where he's going to be very hawkish on the balance sheet, which will allow him to cut rates in a way that that the president will approve of. Well, I don't think it. Okay, my general of you, first of all, it is important to understand how did the Fed get this big balance sheet? It wasn't that there was this imperial driver. This was the Fed trying desperately to cope with the post-financial crisis world in which the economy was depressed despite zero interest rates and fiscal policy was not coming to their aid. So the Fed was trying to get some trends. It did so by with large skill asset purchases and quantitative easing. Now, I'm a QE skeptic. I don't think the QE was very effective. And in some ways the fact that we're still debating whether it was effective is kind of an indication that it certainly wasn't decisively effective. But by the same token, then I don't think that SARS-The-Fed's balance sheet matters very much. If buying $2 trillion of longer term assets didn't do very much to stimulate the economy, then having the Fed hold $2 trillion of longer term assets doesn't really do a lot of harm either. So my take on the intellectual history here is that people who warned that QE would be dangerous in inflationary back in 2010 when that didn't pan out, just to say, "Well, okay, maybe I was wrong." The QE is terrible because at least of the bloated balance sheet that is really more of an attempt to keep the same policy recommendations even though the facts had changed. So, yeah, the idea that I just don't think that the Fed's balance sheet is effective, very important economic issue. I wouldn't be terribly upset if it struck because I don't think it mattered that much. But then I don't think for the same reason, I don't think that shrinking the balance sheet would give you a lot of leeway to cut the Fed funds rate. Maybe not true economically leeway, but politically I think it might. Well, I don't know if politically who's politics? I mean, we're really not talking about the electorate, which doesn't know about any of this. And we're really not talking about Donald Trump who has his own views regardless. We're really talking about convincing the rest of the FOMC. And I don't think that the FOMC mostly would be happy to sharply cut target Fed funds rate in an environment where inflation is above target, no matter how much quantitative tightening takes place. Professor, it is. I was not an adult during this time, so I fortunately wasn't able to say something potentially stupid about it, but you were saying quantitative easing was not going to be inflationary. There were those saying Fed expanding its balance sheet would be. We know you were right, but was it obvious at the time? I think the central bank monetary base going up by so much, I think it turns out you were right, but was there an economic law that you would be? Well, on your territory, right? Well, there was this analysis of Japanese policy on Krugman 1998, which predicted that large increases of the monetary base would basically achieve nothing, would do nothing, would be completely sterile in a zero-interferate environment. We did have. There was actually some sort of defect. There was a big increase in the monetary base in the 1930s that did nothing. There was a. The Japanese a little bit after I wrote that paper, but the Japanese did their overs in a quality of easing with. Well, at the time seemed like a big increase in the monetary base and nothing happened. So we had a fair bit of historical evidence on a theoretical framework. There was a technical question, which is what is the elasticity of substitution between long-term and short-term assets? How much did the Fed buying. Yes, departing from its historical practice and buying a lot of longer-term bonds, how much did that change the margin? You could. There was some possibility that it would have a big effect. In fact, there was also. There were. Around the time that we were all talking about Japanese policy, there was another. Another guy named Ben Bernanke, who thought that you could get substantial traction by buying longer-term assets. So it was a debatable point. But I think in reality, the scale of those purchases was enormous. No question. We saw a huge expansion of the monetary base via the. Purchase of long-term assets. It looked like it's. It was a lot closer to my view, which was that. Funnily, you should think of the long-term rates as expected future short-term rates. Then it was to the view that there were really distinct asset classes. And that by changing the qualities on the open market, you could get substantial changes in rates. Final question for you, Paul, is about the inflationary impacts of tariffs. During April, many economists specifically, on many news channels, were saying this is going to be so inflationary. The actual stated inflation rate has remained fairly stable. I know you've been looking at some work showing that actually the prices. You may have gone up. Is it a conclusion of that? That had there been no tariffs? The inflation rate would be about 2% now? Well, yeah, I mean, it's. That's what the. There's a lot of slippage. I wouldn't stake my life on any of these estimates. And microdata suggests that tariffs have raised prices by about 1% relative to what they would have been without them, which does say, "Yeah, inflation rate would be something like 2% without them." And the. People were making claims about runaway inflation. That's not what the models ever said. I mean, imports of goods are about 11% of GDP. The actual increase in tariffs, effective tariffs, is like 10 percentage points. It's not a. It's less than the headline number, because there are a lot of car vows and ways for firms to avoid. Different between the words of void and they bait. A lot of ways for firms to avoid. I don't think it's smuggling as big as you, but avoidance in one way or another is an issue. So, you know, talking about 10 percentage points, a 1.1% of GDP, 11% of GDP, that would be like a price hit of 1.1%, even the Yale budget lab says 1.2%. Actual is one, or if you compare inflation in 2025 with forecasts made in late 2024, it's 0.8, 0.9, percentage points higher, because people were expecting continuing disinflation. There's not a huge gap. Basically, there was, I think, people don't know how all of it, inflation will skyrocket, because of tariff stuff. That was a little bit of hype. The numbers are not wildly off what you would expect. The numbers are not wildly off, and yet there was inflationary. My only inflationary of. My only. 0.9%, 1%, which still is pretty big. Paul, thank you so much for coming on monetary matters to prepare for this interview. I read a lot of your work on the Paul Krugman substacks. It's very good. Already one of the most popular substacks. Tell us what are you ready about? Obviously, you're an extremely accomplished economist, but you also have a political commentary. What is kind of the split between politics, economics, and what. What kind of audience. My audience definitely subscribe to the substacks. What kind of audience member are you looking to write for? Wow. I mean, I'm trying for a 60/40 of economics versus politics. It varies with the time. My audience is mostly relatively. It's not mostly technical people, but I will go wonk here now and then. At some level, I thought of it as originally as being a wonk here thing that it has turned out to be. Because more than 500,000 subscribers, I feel to some extent, I got to serve my readership. So it's a mix. Thank you again. Appreciate everyone watching. Leave a rating and review for monetary matters and Apple podcasts and Spotify until next time. Thanks for watching. Curious about harnessing AI to access international equity? Check out the link in the description to learn more about the PICTAE AI Enhanced International Equity ETF ticker PQNT. Until next time.