A Conversation With Ken Griffin and Mohamed El-Erian

Good afternoon, ladies and gentlemen. I hope you all enjoyed lunch. My name's Gerry Baker. I'm the Editor-in-Chief of Dow Jones and the Managing Editor of the Wall Street Journal. It's a great pleasure for me to be here, and thank you all for coming back and getting back from lunch so promptly. We have a terrific panel, as they always say, but we can certainly say with confidence that it's absolutely true for the next hour. I'm joined by Ken Griffin, founder and CEO of Citadel. Needs no introduction, you all know him. And the same can also be said for the gentleman on my right, Mohamed El-Erian, Chief Economic Advisor at Allianz and Chair of the President's Global Development Council. Our topic is just generally headlined, 'A Conversation with These Two Gentlemen,' so we're going to start off talking about the weather, if that's okay, and maybe the NBA playoffs, we can get onto that in a little bit.

But I thought I'd start, Mohamed, if I may, I'd start with you. Pretty unusual times in the global economy and markets right now. We have the US economy, you know, having—everybody's expectations at the start of the year were for a year of strong growth. We had a very disappointing first quarter. Maybe it's going to get a little better as we go forward. But markets, equity markets have been very strong, breaking new records again in the last week. Meanwhile, that long-awaited normalization of interest rates, once again, like, you know, waiting for Godot, seems to have been postponed once again. Fed doesn't seem likely to raise interest rates anytime soon, certainly not in June. You look at Europe, Europe was expected to have a very weak start, actually had a slightly better start to the year.

And there you've gone, now you've got this increasing likelihood of Grexit, you've got this extraordinary phenomenon of negative yields—about roughly half of Eurozone sovereign debt that's been issued has been issued at negative yields. Extraordinary modern phenomenon. And then you've got China obviously slowing down, shifting to a different growth path. But again, there you've got very strong equity markets in China in particular. Is this the new normal?

No, the "new normal" was a period of persistent low growth that was generalized among the Western countries. What we're seeing today is something different. We're seeing divergence. We're seeing divergence in monetary policy in terms of prospects. We're also seeing divergence in economic performance. The example I like to use is, suppose all of us were schoolteachers and we're starting the year and they tell us, "We have good news for you." "What?" "Your class is slightly better. The US will end up doing slightly better this year. Europe will do slightly better this year." Our immediate reaction: "That's great news, because a slightly better class is a more engaged class." And then they say, "Oh, but divergence, dispersion within the group is much more."

"...so the people who are doing well will do better, companies included; those who are struggling will struggle more. And by the way, you have four complete wild cards that can mess up your whole class. Now, how do you feel about that?" Right? So, that's what we're looking at. We're looking at a world that is becoming less uniform, more divergent, bigger wild cards. Markets for a while are not going to care because the markets right now, rightly, are focusing on two issues: central banks that remain very stimulative—and it's the Fed, the ECB, the Bank of Japan, China—and a ton of cash, a ton of cash that's being put back to work in the market. And as long as these two things dominate, then everything else that's happening over here that you cited that is really fluid and uncertain is going to continue happening, but the markets are going to be somewhere else.

Let me ask you, Ken, that's my point in a way, that although what Mohamed describes as divergence may certainly have described how we looked at the global economy at the start of the year, and it certainly seemed to be driving differential movements in the exchange rate movements. In particular, we've seen a dramatic movement in exchange rates. But the fundamental underlying reality is this extraordinary continuing stimulus from central banks, isn't it? ECB is committed now to doing QE, Japan is going to continue doing QE, Bank of England doesn't look like it's getting any nearer, and even the Fed, which again, we've all been waiting for this shrinking of this balance sheet, started to a little bit, but certainly not normalizing interest rates anytime soon.

Isn't that the common denominator that's driving so much of global markets right now?

There's no doubt that the accommodative policies of the central banks are driving markets today. And remember, one of the goals of quantitative easing is to explicitly raise all asset prices, to encourage people to take risks they wouldn't otherwise take. But I think that you hit the nail on the head. The changes in exchange rates we've seen this year do represent the quickly diverging paths the market forecasts looking forward. The Fed has stopped quantitative easing in the United States. No, we haven't shrunk the balance sheet, but we have disengaged from this practice. And the Fed's on a path to raising rates, whereas Europe, Japan, and China are all clearly in a full-scale press to increase liquidity in the markets and to drive asset prices higher.

So we really do have this divergence that Mohamed referred to taking place in the markets today.

But let me go back, again, as my slightly provocative point about the new normal, both of you, Mohamed in particular, is that, as you said, one of the defining characteristics of what you characterized as the new normal was sluggish growth, growth over a longer period, in particular, that was significantly below what we've been used to seeing, arguably perhaps significantly below trend, and certainly perhaps significantly below potential. That's still the kind of reality, isn't it, here? I mean, you look at the US. And again, we had some excitement about a run of very good employment numbers. That seems to have tailed off. We again seem to be in that kind of 2.5% growth level. What does this tell us about

the underlying structural changes that there might have been in the US economy in particular? I particularly want you to address the question of—the familiar question that Larry Summers and others have raised, which is this risk of secular stagnation—that we're seeing something way beyond cyclical challenges, or way beyond continuing to work through the consequences of the financial crisis, and a much deeper and longer-term structural problem for the US and the developed global economies.

Okay, and he hates secular stagnation, so just so you know, so this is a trap, which I'm going to go right into.

Well, this gentleman's just hired a man who's taken public issue with secular stagnation, so I certainly want to hear about that, but yeah.

Okay, when my PIMCO colleague and I came up with the concept of the new normal, it was 2009. And it's important to remember the response we got. The response we got was, first, it's idiotic, because after all, Western economies bounce right back. They are cyclical in nature. All this structural stuff, that doesn't happen in the Western world. It happens in the emerging world. So the first response we got was, it's idiotic. The second response we got was fatalistic. So it was neither idiotic nor fatalistic. Then suddenly in 2014 and 2015, the new normal took on two different labels. One was secular stagnation, and the other one was the new mediocre, as Christine Lagarde of the IMF called it.

My problem with running the new normal forward for another five to ten years is that I'm not sure that the capitalist system and the political system will be able to navigate such a long period. It's going to flip one way or the other. So we are approaching this T-junction where this period of low growth, artificial pricing by central banks, is going to hand off. And it can hand off to one of two things. It can either hand off to a true recovery, and that means that we deal with some structural impediments to growth, we deal with a demand problem to growth, and we get better policies out of D.C. Or it can hand off to something much worse, which is not just low growth, but the return of financial instability.

And I think that the probabilities are relatively equal. But I do not see this path continuing for another five years. There's just too much tension. Central banks cannot continue to be the only game in town. There's a limit to how negative you can take yields. A capitalist system will start breaking at negative nominal yield. It will break. Exchange rates—that, Ken rightly said, in history there's not been often a period where you've had the dollar move by 20%, 25% without breaking something. Inequality—whether you think, whatever judgments you have about inequality—has become a political issue. The growth of non-traditional parties in Europe, all that is a direct function of this road that we're on, and I'm not sure you can run it forward for another five years. So I'm not a buyer that this can continue for much longer, and I'm uncertain—and I don't like saying that, but I'm uncertain—as to whether it hands off to a much better world, because after all...

The micro of the U.S. economy are fine. There's some really exciting stuff going on at the micro level that haven't gone macro yet. And there is a massive boost in terms of lower oil prices, or alternatively, we end up somewhere much worse.

Ken, do you agree that we have a fundamental structural problem in the U.S. economy and that it needs to be addressed, or do you think we're just maybe continuing to work through some, you know, the deleveraging and all of the other consequences of the financial crisis?

So, digesting what Mohamed just said is going to take me the next hour. Ouch. And you have 50 minutes now. We've got 50 minutes left, so I'm in trouble here. Let me take a step back. I think there's one observation I'd like to make about the comments that were just made. Japan has struggled with growth for 20 years. But if you go to Tokyo, I don't think the average person on the street feels the misery that one would expect after 20 years of poor growth because the growth per capita has actually been reasonably good. And one of the sea changes in the world today, particularly in Europe and in Japan, is the diminution of the population that is unfolding before our eyes. Japan will lose about a third of its population over the next 50 years.

And none of us have any historical reference for what this means for markets or for economies. So I do believe that in Europe and Japan, we are looking at a very long period of lower growth, but per capita growth could be a very different story. In the United States, 2.5% growth, with the headwinds from abroad, is reasonably good. It's not great. We're not going to write home about this as being a great moment in U.S. economic growth. But we must remember that the headwinds from abroad are not constructive for our economy. As we move into a period, I think, of lower political uncertainty, which we are today, I think we have a better backdrop to encourage capital expenditure and to encourage the growth of the demand side both at the household level and the corporate level.

So I think that one of the things that we're seeing in the exchange rate adjustments around the world is the perception that America is truly in a much stronger place on both an absolute and relative basis than many of our contemporaries around the world.

So you're right, obviously. For example, the labor force in the U.S. is growing at a much slower rate than it was in the 1990s. But the other key determinant of GDP growth, productivity growth, is also weaker than it was. And we went through this strong period of productivity growth in the beginning of the mid-'90s up until the financial crisis. In the last six or seven years, we've had historically very poor productivity growth in the U.S. It's that, ultimately, isn't it, that's going to determine, ultimately, standard of living? What's driving that, and what can be done to address it?

It's interesting you bring that up. We're at the Milken Institute's conference, and one thing that Mike Milken is just incredibly passionate about is human capital. If we want to put America on a profoundly different path for prosperity, we need to fix K-12 education. And that's a problem that we just really haven't addressed head-on over the last six years, or frankly, the administration preceding this administration. But if we're going to compete at a much higher level of growth against the Europeans, against the Chinese, we're going to have to fix something that's really hard, which people are almost tired of talking about.

We're going to need to fix our schools. That clearly is a long-term structural challenge that I think everybody agrees, both taking on vested interests, unions, all of that kind of stuff, very, very hard to do. What can we do? What else do we need to do in particular to get... Your fear, Mohamed, is that this can only go on as we are for another few years. How do we avert what you describe, which is something radical in either direction? Dramatic changes, called-for dramatic changes, or something, I think you're suggesting, slightly ugly on the social and political level. What can we do in the meantime to change it?

So if the U.S. were an island, I would tell you it's just a matter of time. We can grow at 2.5%, we can grow at 3% with what we have in place right now. Why? Because the private sector can get there despite dysfunctional government that impacts education reform, labor market reform, corporate tax reform, immigration reform, infrastructure reform. I can give you a whole list of things that actually there's quite a bit of agreement. It's just that people don't want to be seen in public to agree. If they were to do this, then we would look at higher than 3%. But we can get to 3% on a stand-alone basis given how much the private sector has healed and given what's happening in terms of innovations. But as Ken rightly said, we happen to be in a world in which—and this is where this notion of a great dispersion in the global economy, whereby because we're doing better and the rest of the world is doing worse, our exchange rate has appreciated and I think will continue to appreciate.

I want to come on to markets and things, but since we've gone down this interesting byway, let me just push it a little bit further. We're at the start of a presidential election cycle. Do you have any optimism, either of you, that whoever wins the presidency in 2016 and whatever happens in Congress, we're going to see the kind of changes you're talking about? Education reform, corporate tax reform, immigration reform, infrastructure investment, all of those. I'm sorry to sound so cynical, but I'm the journalist here, so I think that's my role. What gives you any confidence from what you see right now that any of these things will be addressed? It's a little bit like the definition of insanity is going on doing the same thing and expecting a different result.

I live in the middle of the Midwest. And over the last several years, we've had a number of governors brought into power in the Midwest who are Republicans, who have worked with both Democratic and Republican bodies of legislatures, and they have made real reforms. We see it at the state level across the United States. A number of states have really made a redoubled commitment to improving their schools, to reforming their tax policies, towards trying to really improve the commercial environment here in the United States. And I'm with Mohamed. I believe that between the left and the right, there's actually a smaller gulf than is ever portrayed in the press. We know what we need to do as a country.

We're going to need to start to address those problems head-on rather than just talk about them in backrooms.

Let's move on to broader—I want to also talk about obviously the broader global environment, but let's just look at the markets right now. "I'm just going to interrupt for just a moment." "Go ahead, please." "Michigan's a right-to-work state." "It is." "Governor Snyder. Think about that."

Michigan is a right-to-work state. If you had asked, "Could our politicians make a difference?", could you imagine 10 years ago talking about Michigan as a right-to-work state?

No. So those kind of reforms, you're right. And, you know, you've seen in Wisconsin some pretty dramatic reforms and, you know, Governor Kasich in Ohio. "It's true." There have been some things done. I'm not sure that they're—at the national level, with a—especially with a Democratic president and a Republican Congress, I'm not sure that you can expect dramatic progress, but maybe you can.

Okay, so first, if the Republicans sweep all three—so, have the Senate, the House, and the presidency—then you will expect changes. If they don't get the presidency, it's interesting whether cohabitation, which is the French concept of you can have a president from one party and the National Assembly.

There will be cohabitation with the Clintons, which will make it particularly interesting, I think.

It would be interesting. Cohabitation with President Obama was really hard—really, really hard. And I don't think there was anything he could have offered to make that cohabitation easier. I'm not sure about cohabitation with Senator Clinton. That may be a little bit easier.

Let's move on to the markets. Obviously, as I said at the beginning, markets have had an extraordinary run-up, equities breaking new records—off a little bit, I think they were earlier today, but the performance of the equity market has been generally pretty remarkable since the low point in 2009. Valuations looking a little bit stretched by sort of historic measures. You know, trailing earnings, say, the trailing P/E, I think now is at its sort of second-highest level. Trailing, you know, your average P/E is at its second-highest level since, you know, since in the last 50 years. And of course, the previous one was 2000, and we know what happened then. You've got this extra, you know, another run-up, significant run-up in technology, in technology stocks, and—

All against the frame, all against the background of this remarkably still accommodative monetary policy and very, very, very, very low yields in fixed income. How long does this go on, Ken? How long is inflation at roughly 1%?

"Well, that's the key question." "That's the key question." "What's the answer to that?" "I don't have any idea."

You just hired Ben Bernanke to work for Citadel.

Surely he's a man who should be able to advise you on this. He's got a point of view, and it's his point of view. But I think it's very hard for anyone to forecast where inflation is going to be five years forward, particularly with some of the negative demographic effects in the world.

Well, the market five-year forward inflation predict forecast is roughly around about one and a half, I think, right now, isn't it?

And that's going to lead to a pretty strong stock market. Inflation picks up, what we're going to see is we're going to see companies have a harder time passing through price increases. Right now, we already see the impact of the lackluster productivity. Companies are having to grow their employment base at a faster rate relative to revenues than they did three or four years ago. That puts pressure on the bottom line. If we see inflation start to pick up, I think we're going to see a hard time for companies to pass through price increases to consumers around the world. That's going to put pressure on the bottom line. But the wild card here is really not interest rates; it's really what is inflation going to be.

Mohamed, you think inflation seems to be suppressed because of this excess supply in the global economy or weak demand, whichever way you like it, but it's still there, right?

Yeah, I don't think we're going to have an inflation problem anytime soon. What I worry about, and Ken is in a better place to talk about this, is whether we collectively are mispricing liquidity, where we collectively have fooled ourselves to believe that we are being paid for the difficulty we will have to reposition ourselves if and when the paradigm changes. We've already had some evidence of this: the Taper Tantrum, what happened in January of this year, and there has been a fundamental structural change in this market. In the old days, the broker-dealers were big, and the end users were relatively small. Today, the broker-dealers have been shrunk, and the end users have gotten a lot bigger.

So if everybody believes in the same paradigm, the paradigm of central banks, it's fine. The minute that paradigm changes and we try to reposition ourselves, then we discover that there's almost no price at which we can reposition ourselves fully. And the thing I worry most about is not whether we're going to get the equity risk wrong, it's whether we're going to get the liquidity risk wrong. And I remember the frantic phone calls that we received from central bankers in May saying, 'I don't understand. How can one word—this is May 2013—how can one word change the paradigm so radically and pressure the functioning of markets?' And the reason why is because everybody was on the same side of the trade.

And the minute you change the paradigm, there is no counter-cyclical risk absorption in the system. Now, this is why lots of people have that concern.

Although, the markets did better this time around, right, when the Fed finally essentially removed forward guidance and gave rise to the expectation that it would raise rates at some point? Initially, June was expected. Markets seemed to take that in stride pretty well, right, this time? Right.

The reason why the market took it in stride is because, exactly like Ken said, while the Fed is easing its foot off the accelerator a little, the others are pressing the accelerator even harder. So collectively, we are still in the central bank trade. And that is the paradigm. That's the paradigm. There's two paradigms right now: central bank trade, and companies have too much cash and they're going to have to give it back to the marketplace. If those paradigms change, then I don't think the system has the ability to absorb the amount of repositioning that will be desired.

What about the specific question Ken raises about inflation? Japan was in deflation for 10 years, pulled out a bit. Now, it might be slipping back into it. Half of Europe is in deflation. I think that Ken's right. That's going to be whether or not we get that inflation rate back up to 1.5%, 2%, 3%. That's going to be maybe bad for equities, but that's going to also determine...

I can tell a story like Ken has, which is inflation is going to be relatively well-behaved. Therefore, central bankers are going to continue to be the market's best friends. Where I worry more is the collateral damage that results from that, the unintended consequences of pushing financial asset prices further and further away from fundamentals that aren't improving. That's my concern, right? And if the fundamentals improve, which is a nice way out of the T-junction, that's fine. But if it doesn't, if they don't, then we are going to have a major adjustment coming there. And I'll just tell you that I can tell a good story and I can tell a bad story. And normally I have a very strong point of view.

Here I don't. I think it's really ambiguous.

Let's look at one of the factors that's been contributing, at least in the short term, to price change, to the downward price pressure, which is the energy prices. We've seen a dramatic fall in oil prices over the last nine months, started to come back a little bit. Take us through that, Ken, if you would, in terms of the implications for the US economy, for the US growth, for inflation expectations, generally speaking, for the way in which the US, which has become a significant energy producer, what impact it has on the US economy.

So first of all, for the world, in the short run, it's a huge windfall. It's a huge windfall for the Western world in the short run. For the United States, it's a bit more of a mixed story as compared to Europe because of the energy revolution that's taking place here in America. And we have seen a just dramatic collapse in CapEx in the energy space in America over the last few months. I mean, corporate America moves at lightning speed today in reaction to new information, and we've dramatically reduced the amount of exploration and development of in-place resources. That's caused a considerable loss of jobs incredibly fast. Now, for the U.S. consumer, this has been a big windfall, and we see it in sales at fast food restaurants, at convenience stores.

We're not seeing it up the value chain perhaps as much as we might want to, but there's no doubt this has been a big win for American consumers. So, for the Fed, this has given us several more months of low headline inflation, which has allowed them to continue to push out their date of exit from this zero interest rate policy. Does it push us out to September, to December? I don't know. But it certainly has pushed out the exit date by some considerable period of time.

So first I agree it's pushed back. I think it's September. But what the Fed really wants is for the Journal to stop writing about when the first hike is going to be and write about the journey. Dream on. And what they'd really like to do is they'd like us all collectively not to focus on the timing of the first rate hike and not to focus on the terminal value. They want us to focus on a very gradual—I call this the loosest tightening that we've ever seen. So they tighten, but they don't really tighten. They're very loose, and they'd say they're data dependent, et cetera. If the market jumps to the terminal rate, then they'll remind us that that terminal rate is going to be much, much below. I think the other interesting thing on oil, on energy, is the supply pattern has changed.

And that has—in the old days, OPEC played the role of the swing producer. What OPEC has discovered is, with the energy revolution, that is not a good role to play because you lose market share, which you never regain. So OPEC is now saying, 'You know what? They want lower oil prices, they can have lower oil prices.' There's a fundamental change in how OPEC and Saudi Arabia operates. Because of that, as Ken says, the supply destruction is very large. Because that's a different paradigm. And OPEC is no longer there to support energy prices, which means that the risk involved in these investments is much higher today than it was in the past. So it is a fundamental change in how we think about the supply paradigm.

To add to that commentary, I think that's a strategic decision by OPEC to dramatically increase the risk premium people demand to engage in high-cost energy production. Whether it's offshore in Brazil, whether it's some of the projects in Canada, OPEC has made it really clear to the entire investment community: you drill at your own risk. And you can find a project that you spent a billion dollars on worth nothing in a matter of weeks. I think there was a strategic call by Saudi Arabia to really change the entire cost of capital for the energy industry, which will deter new development around the world. Secondly, I think that you cannot underestimate the possibility that OPEC has brought down oil prices to help discourage the development of renewables.

They have 100 years of oil in the ground. I've had a chance to sit across the desk from the head of natural resources in Saudi Arabia. Very clear: they think about Saudi Arabia as a 100-year producer of oil, and how do we maximize revenues over 100 years? The most far-reaching, far-thinking thought process that I've almost ever heard from a member of the body politic. Really thinking about 100 years in the ground. It's nice if you don't have to worry about elections every four years, I suppose, isn't it?

It has its advantages. Yes, yeah, yeah. What about corporate profits? Let's turn to corporate profits quickly before we get on to the rest of the world. We've had this very strong position for corporate profits. Despite generally weak final demand for quite some time, you've had essentially very weak wage pressure, benefited from some of these things like falling energy costs, particularly in the last year, very strong balance sheets, very, very low debt service costs, very, very easy to raise money. And that's obviously been a big factor in what we were talking about with the strong performance of equities. Where are we now there with all of those variables? Are they heading in the wrong direction from the perspective of corporate profits?

So I'm smiling because I knew that at some point you were going to push me from being courageous to being stupid. And I'm about to cross that line. And I'm not sure why you're sitting to my left. I think you should be sitting to my right. Corporate profits have gone on an amazing secular run. I mean, the numbers are dramatic, and they've done so for all the reasons you've cited. There is, in my mind, a question mark whether, for corporations themselves, we've gone too far. Okay? Because in addition to having a systemic issue with corporate taxation and immigration and everything else, we also have a demand problem. We have a fundamental mismatch around the world between the will to spend and the wallet to spend.

You see it in terms of Europe. Germany has the wallet to spend but not the will. Greece has the will but not the wallet, and they can't solve that. And you're starting to see it in this country in terms of what income inequality and what repressed wages have done to the ability to stimulate aggregate demand. So we end up by going into—the only way you can stimulate demand is by pushing financial asset prices higher, which of course makes inequality worse. So suddenly we have cyclical, secular, and structural issues all pushing towards greater inequality. And I wonder whether this amazing run for corporate profits hasn't gone too far for the well-being of corporations themselves. And I think that is a fundamental issue.

We know, for example, in Europe, that it's gone too far, that they're finding it enormously difficult to solve Europe right now, because it has gone too far and the problem has festered too long between the willingness and the ability to spend. And I worry a little bit on the same thing on corporate profits. Now, it doesn't mean labor will suddenly regain pricing power. It won't. For all the reasons that Ken said, it won't. But there's a question in my mind as to whether what Walmart did, what others are thinking of doing is not going to become more general as people realize that you simply can't push inequality too far.

Mohamed is firmly in the Marxist-Leninist camp there, I think. Ken, I'm going to assume you take a slightly different perspective. Seriously, on this issue of labor, labor share has shrunk pretty dramatically. Share of capital has risen. People have been saying for a long time, how much longer can this go on? This has been a remarkable secular run for essentially 20 years now. Is it coming to an end? Are we going to expect to see stronger labor? I think I'm about to get trapped here.

You're both looking way too happy. He called me Marxist-Leninist. I caught that. So first of all, I think that there are... There's a really sad story to tell about corporate America, which is we went through '08 and corporate America went into a cost-cutting jihad. And unfortunately, some of the worst economic policies in the last six years were those proposed right after the election. In particular, dramatically increased the power of the NLRB. So when you have Boeing build a brand new billion-dollar plant in the Carolinas and they can't open it because of the NLRB, every single foreign company in the United States and every domestic company goes, 'Do I want to spend a billion dollars building a new plant in the United States or do I build it in Mexico?'

And so post-'08, the US goes into a cost-cutting jihad. We let go of millions of American workers. And then as we start to rebuild corporate America, we hire millions of people who are not in the United States of America. The United States did a tremendous job export program post-'08 into Mexico, into South America, into China, as corporate America rebuilt its capabilities abroad. Now, in recent years, the last two or three years, we're starting to see this tide turn on that. We're seeing more come back to the United States. But I really do think that '08 was a one-two punch for the American worker.

But you just pointed out, if I may say so in slightly kind of celebratory manner, that Michigan is a right-to-work state. It just happened. The advance of right-to-work states, in other words, the continuing pressure on labor unions, hasn't abated. Is that turning around now?

I think it is. Just as I said a moment ago, the last two or three years, we're seeing this pendulum shift back. And ultimately what this does is this creates jobs in America which most importantly gives labor pricing power. The biggest problem we have in the United States is the average worker doesn't have the power to demand a wage increase that they had seven, eight, nine, ten years ago. As we get back towards full employment, we will get higher wages on the back of the merits of the workers being in a position to rightfully negotiate that with their employer or to go down the street to a better, higher-paying job. That's how we want to get to higher wages in this country. A lot of jobs, low unemployment, and good opportunities for the average American worker.

What do you think, Mohamed? I mean, this issue of income inequality, particularly the stagnation of middle-class wages, is a serious issue. It's becoming a serious political problem, but a serious economic problem too. Since I accused you of being a Leninist, I'll say what is to be done?

First, there's some fundamental issues that enhance productivity and will enhance earnings. I completely agree that education reform is a key issue, absolutely key. Let me give you statistics. It doesn't exactly speak to what Ken was saying about K-12, but according to the March employment report, if you had left school and did not go to college, your unemployment rate was 8%. If you had gone to college, your unemployment rate was 2%. That's a huge difference. Our educational system is not training people with the skills they need for this world. So there's a lot of reforms to be done, and I think most people would agree on that, that if your labor force becomes more productive, yes, they should get paid more, because it's a win-win situation.

So I think there's a lot of low-hanging fruit that can be achieved. My concern, and again, this falls into what you would call Marxist-Leninist, I was provoking you a little bit. That's fine. I would call it, it falls into us being parents, which is that the extent of income and wealth inequality has become so large that it now speaks to an inequality of opportunity. And we can disagree on what is too much or too little income or wealth inequality, but if I tell you there's a fundamental inequality of opportunity happening, that changes the culture of the United States. And there is concern that it's not just about income and wealth, but it's about opportunity. It's about the next generation.

And that's why this issue is attracting so much attention. That's why it's going to feature in the campaign. And I suspect that there are a few things that both parties are going to agree on. And then as they go down the list with more controversial stuff, they'll completely disagree on. But there's a few things they can agree on.

Let's move on. We're in the final third of our discussion. Some global risks now, and let's look at the global outlook. Let's talk first, obviously, about Europe, which continues to be a hot topic for everybody. Ken, is Greece going to stay in the Euro? Does it matter if they do?

That's a great question. Which one? Both. Both. So here are the two issues. Number one is Greece. I don't care how much the Germans want Greece to honor the current status quo. In the long run, Greece can't. Their debt-to-GDP is simply unsustainable. So now you have this problem from the political perspective that no matter what Greece does, they can't abide by the current status quo. And the Germans don't want to admit to that because when they bailed Greece out last time, they sold it to their population as if Greece reforms, this is a sustainable path to Greece reintegrating with the EU. And it's just not reality. Greece needs to have its debt haircut either through a dramatic decrease in interest rates, an extension of maturity, or through just a flat-out write-off of the value of that debt.

And unfortunately, the political process in Greece put into place individuals who are so awash in rhetoric about how Greece is going to ignore the troika that we've now created this unbelievably difficult dynamic in Europe where what should be done won't be done and what shouldn't happen may happen. And that means Greece may leave the European Union. The problem with Greece leaving the European Union is it will create a modest blowback into the European banking system. One that's certainly survivable. But it will call into question in the future when a Portugal or Spain or Italy hits a road bump. Will we see the sovereign yield spreads in those countries reach stratospheric levels quickly, making a second exit a more likely event?

Mohamed, markets seem to have increased the probability that Greece is going to leave the Euro and have seemed to be completely sanguine about it. Two years ago, this was regarded as a potential disaster. Another Lehman moment, everybody talked about this stuff. Now people just think it's going to be brushed off with barely a scratch to the European economy or the broader global economy. Is that right?

There are three sources of contagion from Greece to the rest of the world. Two are insignificant. The first one is economic. Greece is simply not big enough to have an impact on the rest of Europe. So I think the market is correct in that. The second is financial. Most of the private sector investors have used the last few years to transfer their risk to the European taxpayer. So the financial risk has come down a lot. There's a third element of contagion that I'm not so sure about, which is the technical contagion, that you somehow disrupt the payments and settlement system because the system is not built for an exit. So that's the risk. Is it overwhelming? No. I think you will find that the ECB will do even more QE.

It will flood the system. I think that Europe has built a lot of organizations to be able to help other peripheral economies navigate this. So I don't see this as a major disaster.

It will cause a shock. But Ken's right, isn't he, that what it will do is it will break the sort of psychic certainty that the Eurozone is an unbreakable single currency area.

It's going to break anyway. So I completely agree with Ken. Greece cannot do what it has to do within the Eurozone. It just can't. So we can continue this extend and pretend, and we'll see again on Wednesday the ECB will meet. It will continue to provide emergency liquidity assistance. Does anybody really think that this is liquidity assistance? This is solvency assistance. So we will continue this, but let's understand why we're continuing this. We're continuing this because nobody wants to go down in the history books as having caused the exit of Greece. No one wants to take that decision. No one in Greece wants to take that decision. No one in Germany wants to take that decision. No one at the ECB, no one at the IMF.

So everybody will pretend, will extend and pretend. But meanwhile, depositors are taking the money out of the country. The government now has by decree tried to put its hands on the cash that's elsewhere in the system. It's a matter of months before they start defaulting. It's a matter of months before they have capital controls. And it's a matter of months before they have an IOU currency. So the risk is that we stumble into an accident that is very hard to contain. So right now, this path is leading to an accident. And you need exactly what Ken said. You need some really visionary thinking and go one way or the other. Either fully subsidize Greece, and that's the cost of minimizing the risk for others, but do it all in, reduce debt,

give them some austerity relief, but insist on structural reform, or alternatively, pull the plug and find a new association agreement for Greece with the EU and move on. That's what should be happening, but it's not.

There's another European exit that's being mooted, which is British exit from the European Union. As you know, the British general election's next week. If the Conservatives are returned, they're committed to holding a referendum on membership in the next two years. As the polls stand right now, the British will probably vote to pull out of the European Union. I say this with a heavy heart as a Brit who grew up and spent most of his life, however, in the United States. Does anybody care? I think you should answer this. No, you tell me. Should the world care about whether or not Britain is in the European Union? Does it matter? Tell the British people. They're going to vote on this, in a sense, next week.

So I don't think they exit because I do think that if Cameron wins and when he holds the referendum, he will do so after getting a minimum amount of concessions, and then there will be quite a consistent message from the political parties that we've gotten concessions, this is different. I do think that there's a fundamental issue. You have the Eurozone and then you have the slightly larger EU. The Eurozone is looking to get more and more integrated. The rest of the members of the EU that are not members of the Eurozone have no interest in getting more and more integrated. They want a single market and a free trade system. That's it. Don't give me anything else. And I don't know how stable that is.

So, it's not an exit in 2017, but take me to 2020 or 2025, and I'm not sure that's a stable thing, because I think the Eurozone will get more integrated.

I want to get on to Asia, but can we, just as we move a little bit eastwards, talk about the political risks? And again, we've seen, it's been a remarkable couple of years, the extraordinary bloodshed in Syria and the growth of ISIS, the events between Russia and Ukraine, this nuclear deal or maybe not deal with Iran. None of this—these are all potentially very big, very large geopolitical developments. Again, none of it seems to really factor into—doesn't seem to disturb market confidence or consciousness. Is that basically what you think? These are just geopolitical events that in the end are going to have significant market impacts?

First of all, I think the Ukraine really did rock markets last year. That's fair. I think we've, in a sense, come to grips with this idea that the Ukraine currently is in a state of disarray but not deteriorating. I think that the Middle East is a wild card that we're acting like ostriches on. We just don't want to think about it. We don't want to think about what could possibly happen because some of those possibilities are actually unimaginable. I just don't think we want to think about that, either from the political realm or from the markets realm. It's just really something that is pushed off the table in terms of dialogue.

Robert, are there economic market risks from the geopolitics?

Gerry, again, at the risk of being really idiotic and stupid.

You've avoided it so far very admirably.

We're five-sixths of the way into our talk, and we've talked only about risks, about only what can go wrong. And that's fun to talk about, but let's not forget that there's a ton of other things happening that is really exciting. I think it's fascinating that today's technology empowers people with core competencies from somewhere else to come and disrupt traditional industry and make everybody better off in terms of the consumer. Airbnb, Uber, they are bringing to traditional industry core competencies. In the process, they're empowering people in a way they've never empowered before. We haven't even scratched the surface of that. That's going to spread like crazy. We are going to see disruptions where there's been excessive slack in the system.

We're going to see massive rises in productivity. Why? Because you're getting disrupted from another world. And I think that is really exciting. It's really also exciting that there's a ton of money on the sideline, and that money has been deployed defensively, share buybacks, dividends, defensive M&A. If it gets deployed in a positive fashion, it can change things in a big way. I also don't give up totally on politicians. Illinois, Chicago is a perfect example where, when there is agreement on some of the basics, there's a chance of things coming together. So as much as I worry about all these risks, and I really do worry about them, I'm a worrier by nature, I also am really impressed by the upside that's there.

And it's a really exciting upside in terms of what can be achieved. The hope is that you enable all this, and it doesn't take much from the political system to enable all this. And if you do, then you build in resilience of the system. Yes, Ukraine is going to be a mess. Yes, it's going to be a mess, but at least you have internal resilience. So we are less exposed to the spillovers.

I was going to take the last three minutes to ask about opportunities. So you've taken care of that. We can go back to the risks now. So that's how you sell newspapers, right? Another risk, if I may, which is China, which is a risk in both senses of the term. It's been an extraordinary upside for 30 years. Economically, one of the most extraordinary economic transitions that we've seen in modern economic history. Rapid economic development for a massive country, still growing at, who knows what, 5%, 6%, 7% a year. Clearly, the government of Xi Jinping is implementing significant reforms, significant reform to change the structure of the economy, and also taking on corruption. Again, I think the general view reflects your view, Mohamed, that things are basically going to be fine, right?

The markets don't seem to be discounting any really significant risk of anything going wrong. Is that right? Is China going to transition smoothly into this sort of slower growth, better-balanced growth economy?

From the outside, it'll probably look pretty smooth, and from the inside, it's going to look pretty rough. I mean, there is a huge amount of debt that will come due over the next couple of years, particularly from the local governments, that will not be, will not be able to be paid back in part unless the central government intervenes. And I think we're going to see the central government intervene. They're going to use their $3 trillion war chest to selectively prop up both parts of their local governments and parts of their economy to maintain a level of social stability. So China, big picture, the data looks pretty poor. It's 7% growth at best and trending lower, but they'll use their $3 trillion war chest that they've accumulated during the sunny days to take care of some of the darker days ahead.

Mohamed, you agree? Absolutely. I think that if you want to bet against China, understand that you're betting against a war chest, a massive war chest. Understand you're betting against a closed system, which means it's actually very hard to impose market pressure. So you cannot force China to delever, which is very different from a Western system. And understand you're betting against a regime that has a history of learning and course-correcting. Is it going to grow at 10%? No. I think 6% to 7% is what they're going to get. But I think it's going to be a soft landing. It's not going to be the hard landing, the collapse, the economic disarray leading to political disarray.

I'm sorry to play the role of the journalist looking for the bad news or the risk, but I was in Beijing just last week. The place is rife with rumors about Xi Jinping. Xi Jinping is taking on a lot of very powerful vested interests. He's getting rid of a lot of his political enemies. He's starting to tackle corruption in the military, which is massive and widespread and a really serious problem. There's a little more political risk there than I think perhaps people are kind of...

So, is it China ruled by a person, or is it China ruled by committee? Because depending on how you answer that question, it has a huge impact on risk. Do you think it's by a person or by committee?

Right now, it seems to be by person. Xi Jinping is probably the single most powerful leader of China, certainly since Deng Xiaoping and quite possibly since Mao Zedong.

Does he have the committee with him or not? You probably can't run a country with 1.4 billion people on your own, but I don't know.

I don't know, and that's what people... Nobody knows because it's an incredibly... hermetically sealed system.

If you want to go to the bad news, he's going through the middle-income transition. There are only five countries that have succeeded in that middle-income transition. None of them have been as large and as complex as China. So, does it mean that it's hard, it's difficult? Yes. But at the end of the day, do they have a history of adjustment? Now, you brought in the political issue. If somehow the political consensus disappears, then it's a completely different story. It's a completely different story.

Consider the improvement in long-term stability of the party and the regime by rooting out corruption. He's taking the painful medicine now to ensure another 15, 20, 25, 30 years of maintaining the current form of government in China. If he had not fought back the corruption, that's where I really think you sow the seeds of very difficult-to-control civil unrest. But I think he's making a very bold move to put behind China some of the problems that were arising in the years prior.

He has a tiger by the tail, I think, right now. Anyway, just quickly, we do have a few more minutes. I really do want to give you an opportunity to talk about opportunities. Very quickly, one issue that we haven't discussed in the US context, which I do want to get both of you on, is one of the biggest, most important phenomena in the last year in investing has been the rise of the activist investor and the impact that that's had on companies. Some people think it's a wonderful thing and that it's really improved accountability. Some people think it's been baleful and focused on the short term and has damaged the US economy. I know it's a broad question, but as you look at it, what's your sense of... More and more companies are falling prey to these activists?

I think Mohamed and I might have a chance to disagree here today. Good. I think that the role of the activists in the U.S. equity markets, which really is a story that goes back to the days of Drexel—we're at a conference run by the man who really liberalized our financial markets with high-yield debt—the role of the activists, the role of the leveraged buyout firms, private equity has been to profoundly improve corporate governance in America. We can debate the merits of each run by activists at a given company and at a given board. Did they make the right call going against this company's direction? Are they pushing for the right thing here with this company's use of cash? But big picture, corporate governance in the United States is better than pretty much anywhere in the world.

It drives down the cost of capital. When you drive down the cost of capital for a country, you increase the amount of investment in that country. So I am all in favor of liberalizing access to the boardroom by activists and giving large shareholders a greater say in how companies are managed. They will govern themselves better with the possibility of a threat. And that benefit accrues to everyone in society.

So I'm surprised that you said I was going to disagree with you. I said you might. Okay, so I'm going to disappoint you, I won't. He's right. A positive, a net positive, wholly positive? A positive overall, not positive in every single case, but positive overall and an advantage that the US has vis-à-vis the rest of the world.

Okay, that was quick, that was good. Very quickly then, in the remaining three and a half minutes, Ken, let me start with you. What are you most excited about? What most gives you optimism about the next year or two from a financial or economic or even, if you like, from a political perspective?

So first of all, we spoke about how the political pendulum in the United States is moving back towards overall free markets, which I think is great. I think one of the sad facts in the United States is the rate of new business development, particularly amongst the youngest generation, has plummeted the last couple of years. We need Americans to be entrepreneurs again. And if we change the rhetoric to be less against business and less against success, I think we're going to increase the amount of entrepreneurs in America again, which is really important to the long-term vitality of our country. The second important change is the unbelievable increase in computing power available to every single company.

You know, we'll go to Google today and use 50 to 100,000 processors at a time to solve a problem. This is more processing power than was available to the entire planet probably 20 years ago. We can apply to one problem right here, right now, any day we want. That access to computing power—I talked to a young man at Harvard. I'm involved financially at Harvard, as you are probably well aware, going to my belief that education is so important to addressing income inequality. He was using Harvard's supercomputer to analyze organic molecules to ascertain which ones had the highest possibility of being effective in the commercialization of solar power. And they can go through hundreds of thousands of molecules on Harvard's grid computing system.

That type of technology available to a college student is going to profoundly change our lives over the next 15—over the rest of our lives.

I'd only say, and to come back to my point about not to be a curmudgeon, but all of that's true, and everybody's amazed at the amount of computing power we have. It hasn't actually shown up in the economic—as somebody famously said, 'Computers are everywhere except in the economic statistics.' There's been no increase in productivity. In fact, productivity has slowed down. How long does it take to get a cab? How long does it take you to get a call answered at Amazon? You look at the numbers, it doesn't actually seem to show up in workers, at least in terms of labor productivity. But anyway, Mohamed, what gives you optimism?

It's related to what Ken said. This is a great time to be an entrepreneur. It's a great time to be an entrepreneur. You have the power of technology like you've never had before. Funding is relatively easy. I think we underestimate how much is going on at the micro level. And part of that relates to, I think, what is a fundamental change in society, which is the empowerment of the individual. The individual is empowered today by digitalization, by social media, by the internet in a way that they've never, never been, they've never been empowered before. And I'm a great believer that that can lead to lots of good things. Okay, I'm better off because I can use Uber. I am better off because I can use Airbnb. I'm better off because there are people from the tech world that want to improve the provision of

consumer credit to low-income people. And they think they can do it much better. And we as a society are starting to be better off because these disruptions are happening at lots of micro level and they're going from being company-specific to being sector-specific, and it's just a matter of time before they become economy-specific. And that for me is really exciting.

Thank you very much indeed. Ladies and gentlemen, great way to end, very positive note, very upbeat note. Please, we've been very lucky to have two of the brightest stars in the investing firm. Please, thank you very much indeed.