 Welcome to the Gap, the podcast for enterprise leaders delivering timely insights for today's global economy and tomorrow's competitive advantage. I'm Chris Kane, president of the Center for Global Enterprise. And today we have a timely and critical discussion for business leaders about inflation and its effects on global business. Sam Palmosano will be our guest special host today and he's joined by Kevin Warsh and Michael Spence, both renowned economists and business experts. Countries around the world, you're experiencing the highest rates of inflation in decades. In fact, it has been more than 40 years since current inflation rates have been this high in the United States. Current CEOs and business leaders have little direct experience to draw upon about how to manage through this kind of general economic environment. With the exception of Warren Buffett, no current Fortune 1000 CEO has been serving long enough to have this kind of muscle memory. Sam, thank you for piloting today's discussion and I'll turn it over to you. Thank you. And Kevin and Mike, thank you for joining us today. We really appreciate your time. It's been a lot written, as we all know, given the inflationary environment and how we got there and maybe consensus is being formed. But if you don't mind, I'd like to start with where we are today versus how we got here and get your perspective on the issues that we face from a macroeconomic perspective, as well as your perspective or your view as to where you see us headed. So Kevin, let's start with you. I'd say inflation is, as we sit here today, continues to eat the real economy, almost everywhere in the world. There are a couple of exceptions, Japan, parts of China, but inflation is eating the real economy, eroding business and household confidence. And the funny thing about inflation, Sam, is it camouflages the work that it does. Nominal growth for companies and revenue appear to be okay. And if you didn't know that this inflation monster was out there, things might have the appearance of being just fine. But the truth is that the variability and volatility of price levels is making it harder and harder for businesses and households to make decisions. In some sense, the oldest definition of inflation is my preferred one, which is, when every kitchen table and boardrooms talking about prices, it's too late. And so, unfortunately, fiscal and monetary policymakers around the world really missed the plot on this one for a very long time. And so the harm to the economy is something that we're seeing and feeling it is showing very little evidence of moderating anytime soon. Mike, I don't think there's any solution in the short run to the inflation problem. I mean, that's an open question how aggressive the central banks can be or will be. But I think it's with us and I think you can confidently expect a sort of continuing and reasonably lengthy global slowdown. So I would build that into my plans. There may be sectoral and company specific exceptions. There always are in various environments, but this one is pretty massive headwind. If I had to put a time horizon on that, Sam, I'd say the next 18 months for sure. Longer term, there are both at the company level and at the economy level potential solutions to this. We need productivity. We need unblocked supply chains. We need a whole bunch of things that change the equation, the underlying macroeconomic equation. I think one of the reasons that central banks lost the thread here, and Kevin may not agree with this, is we lived in a demand-constrained world. Basically, the supply side was so elastic every time demand went up, the supply side responded. We had virtually no inflation and sometimes inflation below targets. Quite suddenly, we shifted to a dramatically supply-constrained world. The labor market is not behaving the way it used to, etc. So I would just keep that in mind when one's framing one's strategies and policies. Kevin, do you see this going long-term as well? Do you see it as an 18-month kind of horizon that companies will be dealing with this inflationary environment? The national security gurus counterparts to Mike and me and the national security realm have an old saw, which is the price of stopping a dictator goes up over time. We see that evidence to the situation and the Russian invasion of Ukraine. Same is true of inflation. It is more expensive and more difficult to dislodge in the inflation risks now than three, six, nine, 12, and 18 months ago. That requires harder decisions and gives fewer degrees of freedom for policymakers. So I think even though we see some headline prices of things like energy falling, there's a temptation to think that the peak of inflation and the problems of inflation are in the near future. But if you look at the data, what you see is a broadening of products and services that are evidencing changes in price levels that would have been impossible to imagine several years ago. So this new level, the new sort of inflation problem, this new era of price instability, I think, is with us. And it will require much more global coordination by monetary policymakers, better coordination between fiscal and monetary policymakers in countries to solve this. But like Mike, I'm not optimistic that there are any short-term fixes. And I think the other piece that Mike brought up is what are the sources of this? And I share his view that central bankers assume supply would always be there to match demand. And I also share his view that the turmoil of the last year with flag and war and the rest made that harder to believe. But my own judgment is that the sources of this inflation have actually quite well been making. I'll just give two simple points on that. In Jackson Hole in August 2020, the Federal Reserve announced a regime change in policy. But there was a shiny little toy that they called Fair Average Inflation Targeting, which they rolled out. But the bigger story, which some commentators overlooked at the time, was what they basically said is monetary policy will be inert. Monetary policy will wait until we achieve full employment. We'll wait until we achieve our 2.0% inflation objective. And then and only then will we consider doing something about it. And in so doing, I think the Federal Reserve and many other central banks decided to cast aside the one principle that we had agreed on the last 40 years, which was monetary policy works with long and variable lags. So we should not be waiting. We should be acting a bit preemptively. They decided as a matter of new doctrine to wait. And that was the catalyst. That was the proximate cause of the surge of inflation. But again, it's like the assassination of the Archduke causing the war. That was the catalyst. But I think the broader reasons for the global inflation problem are around the notion that Mike talked about. It was an intellectual error by many economists and many central bankers. That is, they assumed that the supply side would always be able to react to the demand side. They misunderstood that the period of about 30 years of a great moderation and inflation was going to be there forever. And in so doing, I think what they didn't appreciate was that there were long structural forces that were keeping prices down, in and around globalization, in and around an emerging middle class. But those were not preordained. Those were not going to happen forever. And so as a confusion about what inflation was, how it came about, it was intellectual in origin. And there was a series of other things done like in Jacksonville in August of 2020, like problems of their own decision making at these organizations that made it true. How could it possibly be? That only in March six months ago, interest rates in the United States were still at zero and the Federal Reserve were still buying treasuries and mortgage backed securities. How could it possibly be that only about a year ago, the 19 members of the FOMC think that there would be one rate increase in 2022. And that 18 months ago, they thought there'd be no increases in the federal funds rate until 2024. That is a dangerous aggregation of views. And for institutions that we care about as much as Mike and I care about the Fed, we need to ask ourselves how the decision making process, how the openness to risks and different ideas can be brought to the table. I mean, what about fiscal policy? I know the Fed has had a challenge here. I would agree with the statements that you're making about their management system missed the mark. But having said that fiscal policy clearly has caused a lot of demand increases, as well as policies of zero COVID in China has hit the supply side. Do you have a perspective as far as the role of the governments and the environment we find ourselves today? You know, we, I think, needed fiscal responses to buffer the shock of the pandemic, but to kind of summarize over a fair amount of territory, roughly speaking, my take on the macroeconomic situation is that after the great financial crisis, we underutilized fiscal and got the balance between fiscal and monetary support to try to make the economy recover wrong in the direction of excessive reliance on monetary policy and then excessively prolonged assault on asset prices via quantitative easing in its various categories. And this time we just sort of did something different, but the fiscal side kicked in, both with respect to buffering the shock of the pandemic and now with some important investment programs. But as Kevin just said, the monetary side didn't do the rebalancing in the other direction. And so we had sort of two relatively powerful stimulus engines running at the same time. And that's not the right balance. There had been historically a very real division since 1951 and something called the Treasury Fed Accord between Fed policy and fiscal policy. During the OA crisis in which I sullied my hands, those distinctions were less obvious as the fiscal and monetary authorities were working together. We'd say, well, that's because it's a crisis and we have to. But we go back to 2021 as an example where the economy in the U.S. was frankly booming. Real economic growth was 5.7%, unemployment rate came down among the fastest rates in modern times. What did we find amid that economic boom? Not only that interest rates were kept at zero, but the Federal Reserve bought 54% of all the debt issued by Janet Yellen and the Treasury Department. If anything, that's a conflation of fiscal and monetary policy, not just in moderate economic times, but in boom times. Look how far we've wandered from the crisis of 08 or the crisis of 2020. So like your question suggested, Sam, I put blame on fiscal and monetary policy much as Mike did. But there's an old quote from Justice Scalia, which comes to mind when he was asked about the Supreme Court in its role. He used to say, we're not last to decide a case because we're right. We're right because we're last. That is the Supreme Court eventually gets to look around and decide what to do. Again, I'd apply that to the Federal Reserve. I blame fiscal authorities for excessive spending that overly goose demand was not fiscally responsible. The Federal Reserve gets to sit there last and observe what's happening. And here in this case, not only did they encourage, stream, call for the fiscal authorities to write these checks, they monetized it. They bought that so that the markets would never see that paper. That's the QE they did in 2021. So while I think fiscal policy deserves an inordinate amount of blame for irresponsible spending, well beyond what we needed to cushion the blow from hardworking Americans that were in tough times. To me, in some sense, I'll go back to Milton Friedman. Inflation is always and everywhere a monetary phenomenon. And I would put an asterisk in applying that to this moment, especially when the monetary policy is cleaning up the fiscal mess. I want to go to the corporate world and what you'd advise CEOs to deal with. But clearly, I think both of you are suggesting that the system that we have today is not coordinated. I could use a harsher term like it's broken, but I know that that's inappropriate. But nonetheless, it's not coordinated for whatever sense of reasons. And that's within the United States. And then you talk about coordinating the world to get through this thing. It becomes even more, I think, complex to try to solve that problem, which leaves me to. Now, if you're advising and you guys do this all the time, so I know I'm not taking you out of your conference zones here. But if you're advising the CEOs, what's happening in this business cycle if you're running the company or anywhere in the world is you're setting the budgets for the next couple of years, both from the expense side of the house and capital allocation perspective. That's what's going on right now. So they're making decisions and they have some planning assumptions. So what would you advise our colleagues to do? The first thing I would do is go look at your accounting systems and make sure you actually can deal with inflation. I've just run into repeated accounts by CEOs and founders saying there isn't anybody in the company that's ever experienced inflation. And when I looked at the accounting systems, they all presume there's relatively little inflation. Now, this varies from business to business. So that's item one. Second, I would anticipate a major, major slowdown in the global economy. I mean, go scrutinize the cost structure, set priorities with respect to absolutely critical investments that you need to make, but otherwise tighten the belt. I guess it's the sort of simple way to put it. And the third thing is I would look all over the place for productivity increases. We're going to have wage and price inflation at the current prices. We can't hire enough teachers, nurses, airline personnel in various categories. I mean, this isn't just going to go away. Those folks have disappeared. They're retired. They don't like it. It's dangerous and unpleasant work, et cetera. And so I think the long run solution to this and I think corporations that line up with this will succeed better than their peers. Because people really go after productivity as you well know, Sam, because you talked about it all the time. You just got powerful tools, including the digital ones to get that done. So those are my three. Expect a slowdown. Go look at your accounting and make sure you're not going to get fooled by your own information systems. Tighten the belt and go after productivity. It varies from company to company. Some of it will be in supply chains. Some of it will be at the airport, et cetera. But still, I think that's where I'd go. Well, my good sage advice, I'm going to add one little comment. The reason why there's no muscle memory on this thing is because CEOs and corporations, their stock price evaluated was appreciating based on revenue growth. So the dynamic of capital allocation or investment alternatives all drove the top line. Right. And that's what happened. And then you would say to people, you need to be focused on productivity as well. And their point of view was they didn't care. Money was cheap. They leveraged up their balance sheets. They drove revenue growth and got rewarded for that by the investment community. So that's over, in my opinion. So I'm going to pass to the Kevin. Now that that's ended and all these young people, not like the old guys like myself who had to deal with this, but these young guys have never dealt with this. What are you going to tell them to do? Because they have a culture that they've created that the most important thing is spend for growth. So how would you advise them? They got to somehow change their culture and their management system like Mike's saying, to now adjust to the new realities that they're facing. So some posts, most policymakers in Washington, central bankers there and around the world, they seem to have as their baseline forecast softly. The unemployment rate moves up to the low fours in the U.S. Economic growth comes down a little bit, but stays positive. Interest rates only have to go up another hundred basis points from here. We have a soft landing, in which case they're right. Most of our friends in the business world don't have to make major adjustments. I would not bet on that forecast. I would take the alternative and I'll build on a few of the things that Mike said. One is we've never seen this kind of radical fiscal and monetary policy create an inflation that looks like this. So Mike and I have to be humble about what our economic forecast looks in the next few years. But my own judgment is when we get to the bottom, when this economy on a global basis falls into a recession in which there's every bit of evidence to suggest that parts of the world are already there and the rest are playing catch up. I tend to be of the view that this period of weakness won't be as short lived as most recessions have been the last 30 or 40 years in part because fiscal and monetary policies exhaust. Fiscal and monetary policy won't be able to cushion that blow, won't be able to change the amplitude very quickly. So like Mike, I think there's a global recession on the come and I tend to think that it'll be longer lasting even if I'm not sure how dark and negative it turned out to be. So what to do? I would say in the near term, I would act with the urgency that Mike suggested. We don't have perfect clarity on what quarter global GDP turns down the rest, but it's coming. And I'd say my first bit of advice is act soon. The place where I'm surprised financial markets haven't yet adjusted is their view on 2023 corporate profits. History is not a perfect teacher, but for US multinationals when the dollar strengthens as much as it has when energy prices have moved as much as they have when unit labor costs and employment compensation have moved as dramatically as they have since the 1970s. And interest rates, albeit from a low level have moved up with this speed. Those all tend to be very bad for corporate profits. Yet the expectations for most US multinationals in 2023 show corporate profits will be a 5% or 10% from here. Well, it certainly could be true for those that can drive productivity as Mike suggested, but in aggregate that's a very benign profit picture, given our sense, my sense of the state of the world. So I think that's why I would act early and aggressively. And the final bit of advice is the overwhelming free money that's come since the OA crisis to the most worlds companies, they tended to have a leveling effect. Sure, the companies that are best in the sector have been able to drive more productivity, but we've really been in a period with virtually no insolvencies. So most companies have had access to capital and been able to hang around. That is not the world that I would expect in front of us. That is, those that are able to drive productivity to distinguish themselves, their cost of capital will be relatively considerably better than the rest of their peers. And they'll have an opportunity in this period of economic weakness to really redefine their category and their company and their objectives. So I don't mean to sound like this is just some counsel despair from Mike and me. There's probably more hope, more upside, more opportunity among these dangers than there's been in a decade or two. And the best companies are going to seize this period of distress and distinguish themselves by reallocating capital as you and Mike have said, and driving the efficient frontier of that productivity, which I don't think will creep down to the median company in their sector as quickly in this cycle as it has in the past. I would agree with you. I mean, if I was still working for a living, I would be doing exactly what you say. And I'd build on what Mike was saying, which is fundamentally, there are more tools that you have available today than we've ever had before. Now, the issue with tools that drive in productivity, you know what's going to happen is that means you're going to reduce your workforce. And you're going to adjust your compensation systems. You can't separate the two. I think fundamentally, a lot of these issues that corporations have faced with these demands that have been placed on them by their workforces, whether we agree or disagree, and many people supported those because that's what their employees wanted. I think that's going to get back to reality. Because when you have your face with the alternative of kind of having a job and not having a job, maybe some of the issues you have that you've voiced an opinion on might become a little more muted. Not that that's good. I'm not espousing that, but that's about the reality we're going to face. Because companies at the end of the day, I'm with you, are going to act in their own best interests and their own survival. And I'll reflect a little bit that worries me is the balance sheets. I mean, the money was free. A lot of these people stretch their balance sheets to invest in top-line growth, whether it yielded or not, who knows, maybe inflation may have some of that would have you, right? And maybe there was some pricing power because of the supply issues and those sorts of things that they were dealing with. But as that ends, that balance sheet in their accounting system, as Mike referenced, has become every bit as important as we used to say, cash is king. Well, let me thank you guys. We've had two incredibly intellectual colleagues with us today. They are the best in their fields. They were nice enough to spend their time with us and to help you all learn as much as I did. We have been listening to the get, sponsored by the Center for Global Enterprise, celebrating 10 years of convening global enterprise leaders around the most important business transformation issues.