2017 Financial Markets Conference—Policy Session 4: Identifying Risk: An Abundance of Potential Shock Waves

Large adverse shocks to the global economy and financial system remain possible even as we experience an uneven recovery from prior shocks. Indeed, it seems easier to list plausible adverse shocks—Brexit, Eurozone, China, Japan, and even the United States—than to identify plausible positive shocks.

Transcript

Alicia Garcia Herrero: Good morning, everybody. This is the last panel of the day—actually, of the conference—and I'm very happy to share with you our wonderful panelists. There was a change in the program, so we have Scott Evans instead of Robert Petroni—he's the managing director of Discovery Capital Management—with us. We have Robert Khan, the Senior Fellow for International Economics at the Council of Foreign Relations [CFR], and Ray Stanton, chief information security officer—and we hear a lot about that—at Redwood Technologies Group.

This is kind of an eclectic panel, as you can tell from the title. We're going to talk about identifying risks—what that really means, after all we heard at this conference. So we'll try to basically hover around all of the topics we've heard so far—although there will be a new topic in town, from Ray—and I hope you'll bear with us. We're going to start basically sharing our key views, and then exchanging views and taking your questions. That's the way we will go about it.

So, without further ado, I think Scott will tell us about what are the major risks in the economy.

Scott Evans: For those who don't know Discovery Capital, Discovery Capital is a $9 billion hedge fund. We're a global market fund. My boss, Rob, cut his teeth in emerging markets. He was one of the first emerging market bond traders at Fidelity. Back in the '90s, he went and joined Tiger, and then from Tiger, started Discovery Capital—I think in 1999. So he has a lot of experience dealing with emerging markets, I'd say.

When I joined Rob, I joined Rob in 2011. After that time, I had come from Millennium Partners, where I was five years at Millennium Partners. I joined Rob because he was used to dealing with politics in emerging markets, but now we needed to deal with politics in U.S. markets—I think we heard a little bit of that last night with Doug Rediker in his speech.

One of the benefits of being in a hedge fund is I get a chance to talk to some of the smartest people in the world, and I get access to all the greatest research in the world, from Goldman Sachs, from JP Morgan, and Morgan Stanley. I'm a client of a number of people here in this room as well. And my mandate is if we don't know something, go find it. Right? My job is to go find it, so I get access to just an incredible amount of research.

But there's one piece of research that I cannot live without, I cannot even do my job without. It comes in my email every morning at 6:30 in the morning, and it's a JP Morgan note that is basically called "The Day Ahead"—and all it is is a summary of the news over the last 24 hours, and a very simple calendar. And it starts like this: it says, "Catalysts for 2017: Big Events to Watch."

When you're dealing with political events, they tend to center and focus right around calendar dates. And so we can see coming up here, we have—today, actually—we have the South Korean elections, the Trump budget's coming up here, Iran elections, health care, U.S. infrastructure, PMIs, the ECB [European Central Bank] meeting coming up here, OPEC, Russia, Greece, G20. Right around here: August, Jackson Hole, German elections, debt ceiling, government funding, and then Chinese politics.

But all the way through this, basically, we're entering a period of time in the year where we've now hit a relatively light political calendar. Right? I know we've all been kind of running and running and running since the Trump election. We finally got to the French elections—this is why Rob wasn't able to make it today, because we were so focused on the French elections. But now, as we look forward, what's going to happen for this year? For the near term and the summer, we're looking at a relatively light political calendar. But what we're going to see is, come this fall, we're going to end up seeing a few things that are going to come on the docket.

So even though it's light now, we're going to be seeing the Chinese 19th National Congress is going to come through. So right now, all the Chinese care about is stability. But what happens when they solidify their power, they get through the Congress? Are they going to start cracking down? We don't know.

ECB is going to be discussing unwinding QE [quantitative easing]; that'll be interesting, to see how that goes. The Fed—we've had a lot of discussions about the Fed normalizing their balance sheet; that will be very interesting. On top of that, in the U.S., domestic politics. We're going to have to be dealing with potential government shutdown, and whether or not we're going to get tax reform this year.

So we're coming up at the end of this year—even though we're in a light political calendar now—we're coming up at the end of this year to something that could be very aggressive, and something is going to react. I mean, the only reason that Italian bond spreads are where they are right now is because the ECB is buying QE. If they start to unwind, what's going to happen to Italy? If we start to see spreads widen out, is ECB going to truly start to unwind their own QE? If the ECB does start to unwind their own QE, what happens to emerging markets? What happens to the dollar? If the Fed starts normalizing its balance sheet—and on top of all of that, and China starts to slow down—we could be in for a pretty disastrous market environment, risk environment.

Something is going to give, and it's our job to try to figure out what's going to give, because certainly, I think all those together just aren't going to be able to happen, if we're going to have orderly and efficient markets.

Thank you.

Robert Khan: I'm going to make a cautious argument for fundamentals. The calendar certainly matters, on a day-to-day basis—I take Scott very seriously on that—but I want to do two things. One is, thematically, I want to talk a little bit about, and give you a perspective on how to view the range of political and economic risks that we confront now. In a sense, I want to build on the remarks that Doug Rediker made last night, in that regard.

And then I want to, in a couple of cases, look at some of the specific risks we face, and make a few comments that maybe haven't been raised yet about the things I have particular concerns about.

So, my starting point is very much as Richard Haass, my boss at CFR, likes to say: that we are living in a world in disarray right now, that the range of political and economic challenges that we face are extraordinarily daunting. It's very easy to write an incredibly long list of reasons and risks that essentially represent a rewriting of the fundamental elements of the world economic order, going forward. This order served the U.S. economy very well since World War II, and no doubt an unraveling of that—shocks to that—are important.

Many of them are structural. We've obviously talked a lot over the last day and a half about the election and its consequences, but it comes on top of big changes, which we've talked about. I, in particular, would highlight the rewriting of the map in the Middle East. Borders that have served as stabilizing factors for a hundred years are breaking down. The view at CFR is that it will take probably 20, 30 years of turmoil to reset those borders. Obviously, accommodating China's rise and the tensions many people have mentioned in managing European economic integration are among the list.

And maybe most importantly for the Western industrial world is this rising sense of disillusionment, dislocation, and alienation that feeds in in different forms—the nationalism and populism in the Western industrial world, and there's a lot of causes for that—trade, technology, innovation, income inequality, and the like. But it clearly is a new challenge to policymakers to adapt and bring forward policies that are really outside the norms that they now see policy constrained by.

So, let me make a few comments about—we all know the economic risks, let me make a few comments about political risk more generally. So each year—I'm going to jump ahead for a minute, and then come back to this, if I can—each year, we do a survey at CFR, of several thousand foreign policy experts—so not the economists, but foreign policy specialists—and we ask them, "What are the risks you really worry about?" And they come up with a very long list, because that's what they do.

But there's always kind of a top bucket that is, in their view, highly likely to happen and having very material impact to U.S. interests abroad. This year they came up with four, and it may not surprise you. Military confrontation between NATO and Russia was at the top of the list, a crisis in North Korea (this is a survey done around the end of the year, so you wouldn't be surprised to see that), and the election obviously was influencing those decisions.

What was new this year was a highly disruptive cyberattack on U.S. critical infrastructure, the first time that has appeared on this list, and I think it reflects a growing concern, both of it as an independent—and Ray will come back to it—an independent source, but also as a kind of way in which conflict between, for example, North Korea and the U.S. could manifest itself as opposed to other, maybe more military-driven confrontations. And then, obviously, a mass casualty attack.

Now, not the Middle East—in previous years, the Middle East was always on there, and I don't think you could say that that has gone away as a concern, but somehow—and I think maybe this also brings into account some of the things we've talked about here in terms of the changing role of oil in the global economy and the like—not seen as having the same disruptive force.

Now, what do we do with all this, as economists? And this gets back to the point that Doug and others have raised about the market resilience. This is really, I think, for policy, the critical issue: the extraordinary disconnect between foreign policy and markets, that resilience of markets in response to the kind of shocks we've had over the last couple of years.

So we went back and looked at, just to see—we know what the response was to Brexit, we know what the response has been to some of the political uncertainties we've had in the U.S. and the like—so we went back and said, "Well, is this something that's more typical?" And so we just pulled a list of prominently featured political shocks, going back all the way to World War II. And we looked, in this case, just at U.S. equity markets—this is something, just a table we pulled together for a blog, that Jens Nystedt and Morgan Stanley and I did a few weeks ago—but we've started to look at other measures of volatility and risk appetite to see if it's more broad, and so far it's sure showing up.

The lesson I take from this is that in the majority of cases—actually, going well back, in very different market conditions and the like—what we've seen [is] that markets are not only resilient to economic shocks, they're resilient to political shocks, more often than not, in that if you look at the case where the percentage change—and then first day, the fourth column—is pretty modest in many of these cases, the bottom is often reached pretty quickly. And with the exception of a few very interesting cases, it doesn't take that long for U.S. equity markets to recover from political shocks.

And so, from that perspective, the resilience we're seeing is in many ways the norm, not the exception, and I think that is an important point, both for political and economic shocks. Now, there's obviously some exceptions. There is the Iraq invasion of Kuwait, which had a persistent effect. I think very much, most economists have always argued that oil is centrally linked to cycles in the U.S. economy. Jim Hamilton famously said nine or 10 of the last recessions were driven by oil. Is that still going to be true in a post-shale revolution environment? There's a lot of debate on that. Certainly we saw powerful effects of the drop in oil prices a few years ago, but it was different, materially, than what the historical model shows, so I think there's a question there.

The Nixon resignation is one we had persistent [effects from]—I think that touches on this point I'll come back to in a minute about policy resilience—and Lehman, or the Black Monday crash—you're all familiar with that—and obviously reflecting a shock in terms of our understanding of the system, and a pervasiveness shock that was very difficult to deal with.

As we've argued about what this all means, we keep on coming back to this issue of resilience of policy. And I would make the point that when you think about policy resilience, it has a broad range of dimensions to it. Certainly for economists; we often focus on the monetary and fiscal element, and the exchange rate elements—Draghi's saying, "Whatever it takes at a time of significant market stress," and the comfort we all took from that.

In Brexit, Carney's response, as well as the fiscal response by the government—pulling back on an earlier promise to raise taxes in the event of a Brexit vote, to a more sensible policy response, to not—macro responses are clearly, critically, an important part of resilience.

I think also, we believe signaling awareness and understanding of the risk is really important as well. If it's a shock that we believe policymakers well understand, we think it's going to be easier for us to absorb that. To cite Brexit again, I think that, both in England and in the U.S., policymakers went really out of their way ahead of the vote to talk to market participants and to signal that they understood the potential risks, and they were stress testing that event and well understood what the stresses of it would be. I think that is an important part of market resilience as well.

And I think also, for example, the debate over EU stress tests, which Larry touched on a little this morning, is also an important part of trying to signal to markets, "We get it." But, of course, when the shocks come that we didn't expect, or that we believe market policymakers weren't prepared for, that is obviously going to mean material challenge to this resilience hypothesis.

But there's also a very important political element to resilience, in terms of believing that your policymakers have the political skills and the framework and the ideology to address these kind of shocks in ways that are stabilizing. And obviously, so much of the discussion of this event and others is trying to assess whether or not that is challenging. It was interesting—last night, the question to Doug on the 1980s, and the whole debate then about whether or not a new team of Reagan advisers coming in, some with very unorthodox economic strategies, did have elements of that challenge, but also, as Doug emphasized, came in an environment where there was a more settled nature to geopolitical debate.

So, when does it—our summing up on an analysis we're doing here—when do these kind of shocks stick? When they call into question policy resilience? When the country doesn't have the space to react? When there's not the capacity for compensatory action? When there's demonstrable global effects, like the oil markets and the like? And, conversely, if it's something far away from U.S. markets, or something that's repeated. We saw, for example, with Russia and sanctions on Ukraine that each successive shock in that arena had less and less effects on markets—maybe not surprising, as we became somewhat inured to it. By the way, that's intuitive to me as an economist, not so much—the political scientists worry about cascading effects in politically destabilized environments, so they push back on that, but I think that's certainly what we're finding here.

Let me make a few comments on some of the specific shocks in this context that I worry about, specifically. The first regards European populism. The calendar doesn't drive things. We have weathered a major tail risk with the French elections on Monday, there is no doubt about that, but I am absolutely, fully in the camp of those that believe that we should not take too much comfort from it from a longer-term perspective, or make the judgment that populism has been defeated or is now going to be receding. In my view, the fundamental causes of nationalism and populism in Europe, in terms of economic discontent and dislocation, are still there. As long as they persist, we will be presented with a series of tests. Italian elections are ones we're going to worry about pretty soon. Awesome.

But even more important than those triggers on the calendar, to my mind, is the concern that this populism will constrain the policy choices that mainstream candidates make. And so while my European friends—and Alicia may disagree with me here, I know she will—may have hope that a strengthened Europe, headed by two pro-European leaders in the fall, could move forward on integration, potentially—or should, certainly—I am much less optimistic that that indeed will happen. And I'm concerned that it will become, if anything, harder to come together and make tough calls, particularly if they involve countries, the creditor countries, making decisions that benefit other countries at the narrow cost of their own citizens—whether that is a Greek debt relief deal, whether that is an outside-the-box solution on the Italian banking problem, or whatever the newer challenges will be.

And I think as long as that is the case, I'm pessimistic we can move forward on a fuller integration of the European Union that we know is needed to provide the kind of economic future people want.

Brexit—I was surprised by how well the U.K. economy weathered the initial storm. I think confidence held up. I think policy had a lot to do with that. The exchange rate depreciation fed through pretty powerfully. The best is behind us. The costs of de-linking from Europe are now, I think, going to be more powerfully felt through, in particular, the investment effects of the longer-term uncertainty associated with what follows.

I very much am of the view that the negotiations are going to be compressed into the middle of next year, that—as we've seen from the poisonous initial politics of the discussions, and the dinner at 10 Downing Street and the like—it's going to be very hard to move forward absent political leadership at the top. That's not likely to come ahead of the German elections, and even then there's a narrow window to get the divorce deal put together before the March 2018 deadline. I think it's virtually impossible that they will have worked out fully what the long-term relationship is between the U.K. and Europe, which means we'll need some sort of transitional arrangement.

And that means that you, as investors, are unlikely to know with much certainty where the U.K. is heading, for some time. And I think that disconnect between the political timeline, which is leading to more and more incentives to delay and put off these final resolutions, and an economic timeline where the costs mount if you have to make decisions about where to be and how to allocate your businesses, not knowing how that uncertainty—I think that disconnect is going to be increasingly felt. I think the hard stuff starts now. Estimates of the cost of Brexit range from 1 1/2 to about 9 or 10 percent. You know, over 10 years, that's less than they would normally have grown, so Britain will still grow—but it will be a poorer England, and it will be one in which you will have to deal with a lot of residual uncertainty for some time to come.

China hardly—I mean, there's better expertise on the table behind [me]—I just would emphasize that what we learn from people like Rogoff and Reinhart and others is that it is extraordinarily challenging to navigate the kind of transition this government is making, even in the best of times, without some sort of financial or banking crisis—and I think most economists believe, I think, that that will happen at some point. And while they have reserves to manage that at some level, they have the capacity to not manage it well. And certainly, most of the scenarios I find credible believe that at some point we would see a material hit to global demand that would have to be navigated.

Fourth: trade. In the U.S., I am worried—not so much in the very near term, where I see most of the trade actions of the sort we've seen recently as tactical, bilateral, and limited in terms of their macro effect—but I am very concerned that ultimately we could reach a point where this becomes macroeconomically significant. And related to that is maybe a political judgment. I know this is poor politics, but, with apologies for that, I think there is a concern that I have and some of my colleagues have that the administration is going to realize that it is increasingly hard to achieve their legislative agenda. And my best case is a narrow set of tax cuts in early '18—something the Observatory Group wrote about today—is about what you'll get. That will come at full employment, that will drive up interest rates. As the Fed responds, it will drive up the exchange rate, and that will create huge political pressures on an administration that will have realized that, really, they have little capacity to respond, other than through executive order and administrative action.

And as I've said to many people in the past, it's easier to destroy demand with executive order than it is to create it with legislation. And my concern very much is mounting political and economic pressures could lead to a point where trade action becomes the tool of choice, in the coming six to nine months. I think this is what we see as a major risk.

And, by the way, just as a sort of a footnote to this, there's a parallel debate going on [about] sanctions, where sanctions have become an increasingly central tool of policy. Some of us have written about the power of those tools, but with a concern that if they become overused, there is a threat to this big, open global market that has served us so well. And that long-term risk, we have to protect. I think the concern right now is that sanctions are going to become seen as an easier option, more aggressively used, and with longer-term implications.

Finally—and this is just a bit of aside, but something I find very interesting—keep an eye on Venezuela as a political risk. Obviously, for those of you in mainstream markets, it's not an investable asset for you, but it has the possibility to become—Venezuela's already in the midst of an economic, social, and humanitarian crisis. It's an extraordinarily painful thing to watch. As an economist, I will tell you, inevitably, it will lead to collapse, default, and, I would argue, based on my read of the way in which these rescue programs get put together, there's really only one way forward to help Venezuela get back on its feet, and that would be with a large-scale financing program, led by the IMF and backed by debt restructuring. That breaks to "boos" all around the board. It's going to be hugely precedential. And what is particularly interesting from a geopolitical perspective is that, aside from private creditors, right now the two largest creditors are China, and now recently Russia, who for strategic reasons has come in in ways that will leave it, after default, with a controlling interest in a major U.S. refinery and a controlling stake in joint ventures—this is with Rosneft, a sanctioned [by the] U.S. company—a major interest in a joint venture, energy exploration project.

These present huge foreign policy challenges to a new government. If managed well, I think it could be seen as a very positive step, in the same way that the Reagan administration, during the Mexico crisis, embraced multilateralism and came around to a more positive view of using these international institutions to try and affect local outcomes. But it also could be disastrous, and so it is something to watch.

So, in summary, just one last point on this, which is to say: so I've listed a long set of risks on the economic side. I think these are potentially very important. Timing—I'm really bad at that. As in, you take a case like Venezuela. You can tell all the economic arguments you want, but the politics are going to depend on the political pressures on Maduro, the military support for him, and the like. These things can take a while.

And so, while the calendar may be a set of triggers—whether it's a debt payment in Venezuela, or whether it's an election—I think in all of the economic cases, what unites them is that they are fundamental challenges to the global economic order, and that all of these will remain tail risks until either they're addressed more fundamentally, or until something happens, that—maybe out of left field—triggers it.

And in that regard, I go back to a famous quote by Rudi Dornbusch, talking about Mexico in '94: "A crisis takes a much longer time coming than economists think, and then it happens much faster than you would have thought." It takes forever, and then it takes a night. And I think that's probably the best way to think about the political and economic challenges we face now.

Thank you.

[applause]

Herrero: Thank you so much, Robert. Although you did list quite a number of risks, I was very impressed by the fact that we still hope, we have this policy and even market resilience, that we heard in your presentation. And I was wondering whether this will hold true given new risks that we'll hear about from Ray, in terms of cyberattacks and the like, because that's brand new in your list of risks that you just showed us.

So, Ray—the floor is yours.

Ray Stanton: Thank you. Good morning, good morning. I'm going to take an assertion I may be the only Brit in the room. Is that true? Ah, there's two of us.

So, it's two things. I'm acutely aware that this isn't your normal topic. But what I do want to do is bring some association to what you've been talking about. I have a couple of roles. One of those is working for National Grid—some of you may know them—and another for a technology company. I spent a lot of years at British Telecom, and dealing with this is a risk-based challenge that we had to deal with. It's something that I want to bring across to you.

So I've just got a few slides—going to take me, say, 10–12 minutes. These are the things that we're just going to cover.

But if anybody has any doubt [about] the impact that cyber has had—and the reason I bring out why I'm the Brit in the room, is because looking at what was going on with Brexit. It's like watching it from afar. You guys were all watching it from afar, waiting for that car crash to happen. The challenge with cyber and information security and protection, is, is this car crash waiting to happen? And if you're in any doubt, ask Yahoo how that has affected the valuation on their company. If you're in any doubt, you had the challenge with your own country and Russia interfering, France being interfered with.

So, you understand it—you're all intelligent people—but understanding how it affects policy, how you can affect what's going on with your organizations, and affect some change—and that's what I want to do, is just leave some commentary with you that you can go back and say, "Hey, these are three questions." And I've been reliably informed that people can't remember any more than three things. You walk out the door: handbag, keys—well, not me with the handbag, but you know? [laughter] Sometimes it's a man bag, apparently. In Europe, we have man bags.

So, the reason I love this industry—and I'm not going to read the words—is because of that complexity. And I've been doing this quite a long time. I was fortunate, coming through the forces and seeing what was going on, and I spent a long time dealing with this. But we have this real paradigm model, that—we have a challenge, that the resources don't exist that we need in abundance to support you and organizations. So it's real context—the technology skills, procedures skills, the policy skills—we just don't have them, so we have to be pragmatic.

I've given a definition of cyber there, because everybody has their own views of what that means, within organizations and around the world. But for the purpose today, it is around that digital challenge.

These slides—I've got a few more than what you probably want, but you're going to have them to take away. This is a risk landscape, and it's out of the World Economic Forum's global risk register—published in early 2017, January. And what I've highlighted there is the fact that the technology threats—cyber—has continued to move and now is in the top five global risks. They're actually brought out by organizations across the globe. Seven hundred fifty people from the private and public sector, various different research groups see this area as one of the top five risks. And that's why I think it's great that it comes to a group like this, because you guys can affect how we deal with this, and how we will manage this better going forward. It's a risk. It's all about risk management, really simple stuff.

This point—I love this statement. This is a long, long, very old statement, but collaboration is something that we need to continue to see happen, and will happen, because of growth, and business growth, and economic growth. That is just a straight fact, and I think this is about 10 years old, maybe a little bit older, this statement. But why do I bring that up? I think it's an important one for you to just dwell on, is when we look at this slide which comes from the World Economic Forum report. I spent a lot of time dealing with cyber resilience and cyber program for the World Economic Forum, and the reason I like the report is because it's quite independent. There's not somebody paying for it in a way that it gives you an inappropriate view.

And I apologize about the quality of this, but you can get this chart, and what this chart off the website shows you is the interconnectivity of all the different risks that happen. And all those respondents were asked, "What risks do you see that are interconnected that will affect"—I think it's [between] three and six risks are interconnected. And it's not transposing very well, but what it's saying is those risks that you see—you can see on the bottom left-hand corner, the technology threats, and those are security threats and cybersecurity threats—how they're connected into the topics that you've been talking about here—all these geopolitical challenges that we face.

And what I'm asking you—and I'm imploring you—is don't watch this from afar. Don't say, "Well, that cyber stuff, that security stuff—that's just somebody else's bag. I don't have to care about that." When it lands on your doorstep, you care. I care. And if you don't care about your organizations, then care about your home lives. Care about what goes on there.

I'm just going to bring some—because, I'm a security guy, right? It wouldn't be fun if we didn't have some ideas of the threats and challenges, just to excite you. Again, one of the five exacerbating factors: cyberspace [is a] domain of conflict. We see this. Robert's just mentioned it. Doug talked about it last night.

Asia Pacific, and what's going on there—it is a real hotbed. Just a few weeks ago, we saw this threat there—and I would urge you to go back and ask your organizations how this was dealt with—and this was an interesting, and really intelligent tack. This took place over five years, and the premise—and I just want to spend one moment talking about this; there is—and the report is available—they set up effectively a factory of people attacking the Western world. And what they did was, they aligned to our working patterns. So in the U.S., and even on the far coast—West Coast—they aligned to their working time, and the days—so they matched exactly how we were operating so that they could then undertake certain attacks.

And the basis was, they used—what you probably all have heard of—malware and phishing attacks. So they had these people matching each of the regions. And this took place over five years. They adapted their technologies and their approaches to undertake these attacks. What they did was, they attacked organizations—managed services providers that you all use to get access to us, to you. So it's the supply chain. So when you hear about supply chain security, this is exactly where they took the opportunity to explore.

We've heard about BRIC countries, just in different ways, and this is a growth economy for them. And it's an area that we're seeing really good skills and threats coming from, and there is some irony in that statement. One of the things that we're particularly seeing, and [that] is a global phenomenon, is attacks on the SME [small and medium-sized enterprises] and SMB [small and medium-sized businesses] markets. Now, just for the sake of this room, we'll say that's organizations with less than $1 billion. And what we're seeing is the tacks, and you may be aware of these, where people are being called, targeted, at the CFO and CEO level, to actually release funds. And so far we've seen the largest example of this in Europe, and that was €24 million.

At home, the largest one—here in the U.S.—that we are aware of that they tried to do, was Mattel, just a few years ago, and that was $30 million. And they were extremely lucky that it didn't happen, because the target happened, and the attack happened, on the Friday—the engineering, the social engineering, the calls, happened on the Friday—and it was a public holiday on the Monday, and the funds weren't released: $30 million. That goes straight to the bottom line, as we all know—not the place that you want to be—and the cyber insurance doesn't cover that.

Just a few different examples. I'm not going to spend much more time on those.

Big challenge, which is a big risk, along with the decoupling, as we talked about with Brexit, and all the systems and the interconnected systems—but the new privacy regulations, we're going to see some big fines. We are going to see some big fines. That is an absolute. The EU commissioner is looking to pin this on somebody. They want to make examples. Neelie Kroes, really—I was there as she walked through this, and I was involved in the working parties. They really want to make an impact, demonstrate that they have teeth. It's just some examples of information around it.

So, that's some of the negativity. I've given you a bit of a global trot around the world, and what we've been doing. But this is some of things that we're doing, because we're not sitting back. We are collaborating, we are moving forward to try and effect change and deal with these threats. This is the fastest-growing technology challenges that anybody has. The evolution is just huge.

So these are the things that we're dealing with. Many of your organizations in this room will deal with the CERTs—the activity to bring this together when there are problems. They look forward. We're using new technologies—Watson is a great example of this, and its ability to find the needle. You guys care about needles in haystacks. I don't. I care about a needle in a needle-stack. What they do is they look the same. They try to be the same. So I need to find—and how do you find a needle in a needle-stack? That is a massive challenge. That's what we're dealing with, so the new technologies are really helping us.

Some of those other areas that we've brought together, because there has been—and if there's one request for me, on a global basis—there is a lack of policy and lack of regulation globally on dealing with this stuff. I can't operate in all the countries I operate across, in the same consistent way. Regulators all operate differently, the governments all operate differently—I can't even trade, when I'm looking for fraudulent attacks, or I can't actually trade and give information to different government bodies, and that's really frustrating. So there's an "ask" from us as an industry.

These are the three questions. They're quite long, but they are written down for you to take away. Who's truly accountable in your organizations? Who's actually looking forward to deal with the new, ever-evolving threats? And then in your organizations—and maybe some participant in our activity here—guys, very quickly, how many of you have been involved in war gaming, or threat scenarios, in your organizations? Could I see a quick show of hands? So that's probably, maybe 10 percent? Maybe 10 people, 10 percent? [That's] something that you should really be looking at.

And then the metrics for measurement, to see how we manage this and how we deal with it and improve.

Some information to take away: a thank you. And that was my piece.

[applause]

Herrero: I have to give you very bad news. I happen to be a moderator, and a member of the panel, so I have to go through one more presentation, which is going to bring you all the way down from this wonderful, digital cyberattack war games world—all the way back to very simple banks, and that is Chinese banks.

We've heard a lot about China. Today, it was mainly about the stock market. And I just feel that the dinosaur in the room is actually Chinese banks. China's stock market today is about 6.6 trillion U.S. dollars—it's about 60 percent of China's GDP. Bank assets, according to BIS, are 35 trillion U.S. dollars today. And we used to talk about this in the early 2000s, when Chinese banks were actually much smaller. We used to read about Chinese banks having an NPL [nonperforming loan] ratio close to 40 percent of GDP—this was the Achilles heel of China at the time—and nothing happened. And we know why nothing happened. It was, at the time, a massive restructuring, recapitalization of banks—actually, IPOs—strategic investors being brought forward, and...by IPOs—and the magic power of nominal growth, which drastically reduced those losses, nominally.

And it so happens, we've been at a party—at least, that's the way I see things—from Hong Kong and China, not only since 2008. We've heard a lot about 2008 here, in terms of [the] fiscal stimulus package, as if it had ended. But actually, although there's not very good statistics on China's consolidated fiscal deficit, but the best we can have in town is just summing up local government deficits and central government deficits, to summing up the other 10 percent of GDP a year.

So through that party, you see the real growth numbers that aren't nice to see, but you also see that hugely increasing bank assets—that I'll refer to in a minute—to levels of, as I said, 35 trillion U.S. dollars. And that's larger, already, than the European banks that we've all worried about, and that we heard about from Larry Summers and others. For a GDP per capita, that is one-third that of Europe. So, if you were to believe in financial deepening, that line would bring us—if China is to, indeed, escape the middle income trap—and when they have those 30,000 U.S. dollars out there in terms of income per capita, you would have the largest, most bloated banking sector in the world, with something on the order of 100 trillion U.S. dollars in assets, if I just were to draw that line.

So the question is, what's going to happen? Because that seems to me inconceivable. And that brings me to my presentation. So, basically, to put back into the risk agenda for the session these Chinese banks that are now the largest global SIFIs in the world, that are not only massive—we think this is only a domestic risk for China. Well, if I were Latin American, I know that China today is probably the largest cross-border lender in the region, at least for some countries. We're talking about 200 billion U.S. dollars in cross-border lending from China—Venezuela being the largest recipient, but there are others.

So, I do think there is huge systemic risk in this. That might not have been the case in the early 2000s, when we were worried about it, and is the case today, and we seem to be less worried about it. So that's kind of the irony of the situation today.

I want to move forward to the idea that the party's over. So we heard it very clearly from Xi Jinping. I think the 24th of April, he stood up with all of his advisers on financial issues and said, "Party's over." Which is kind of strange, because we all thought he would only say that after October. Why now? Because I guess he's worried he might not have that stability after October. That's the only reason, in my humble opinion, why he would stand up at that level to call for financial stability and measures in that direction.

So, that idea of restraint from the State Council—before, we had expected it. And you can tell that all the markets, as we heard from the previous session, are not certainly working at full speed. There is still some signals that, some driven by U.S.—increased interest rates, but others basically in terms of credit risk—really coming from the precognition that something has to happen. What has to happen is the key question, but something has to happen because leverage is just astoundingly high.

Now, we seem to be relieved also from the external side, because we've seen reserves stabilizing recently, capital outflows stabilizing. But there is a lot happening for that to be true. So I think there was this idea that it's over with capital outflows—not only in terms of, of course, huge capital controls, but actually asking whoever has the right rating out there to go and borrow back from the offshore market. And that's a key reason why you have those stabilizing reserves in 2017, which you didn't have before. So there is a huge policy intervention, in terms of that as well. And additional external leverage that we had not seen for a while.

So this brings me to the bank, these massive banks I was talking about. And there is, I think, something that we should realize: that banks then, before they were restructured in the early 2000s, were old-fashioned banks. I mean, they were basically lending. Everything they were doing was lending domestically. As of today, these banks are becoming increasingly—they're called "investment banks." If you look at their books, their investment book is growing massively; their loan book is shrinking. And this is one of the channels we talk a lot about, in which banks are increasingly related to shadow banking. So they're basically themselves issuing off-balance-sheet wealth management products, but they are themselves buying those wealth management products, in the form of investment receivables that they hold to increase their, to decrease in profitability. So it's a way to solve that problem that has been growing since the balance sheet started shrinking—at least, the real balance sheet, not the off-balance-sheet, assets.

Beyond that, as you probably followed after the Chinese New Year, the PBoC [People's Bank of China] started—well before Xi Jinping called on the 24th of April—started to realize that it had to control liquidity. And that was a signal of the fact that it's not only about banks becoming more of an investment bank, changing their business model, or even trying to deal with asset quality by cleaning up their loans through debt-to-equity swaps that we've heard so much about. It's more than that, it's a liquidity issue.

The liquidity is generated by the fact that, first: one trillion reserves gone, so deposits are being reduced. Second: it must function in money markets—by which, only state-owned, commercial banks (the largest five banks in town) have real access—real access, in terms of their collateral—to central bank liquidity. And the rest is being reshuffled by the money market.

Now, this is starting to be very blurred, in terms of the collateral being used. There are a lot of wealth management products being used as collateral—these investment receivables I just referred to—which makes that contagion risk humongous. That's another thing that certainly was not there in the early 2000s. By that token, the banks that don't have easy access to liquidity are issuing huge amounts of uncollateralized paper. And these are, of course, joint stock options without...but it's not the largest state-owned commercial banks, some of which are as large as a global SIFI. These are not by any means small banks. And many are very exposed to Hong Kong. So they may not be large lenders in the world, but they're very exposed to a large, major financial center in the world. And they're paying an increasing amount of—they're funny, because it's increasing very, very aggressively, this year.

So, in a way, this is the double-edged sword. As the regulator is asked by State Council to find ways to reduce that leverage, and by imposing that is actually creating the liquidity problem itself—same with the PBoC. So it's really about, how long can it go? And where are the solutions out there? I already mentioned that profitability is worsening, solvency is worsening—notwithstanding the cleanup that is going on through debt-to-equity swaps. There's about 15 percent of those low-quality loans have been cleaned up, through debt-to-equity swaps. By the way, the risk is still there. It's in the system. This is just securitized and moved on to asset management companies, or insurance companies—and part of which is actually going all the way to the households.

But beyond that, the flow—if you can think about it, that's the stock—the flow of new lending is so massive still today. If you look at probably the largest spread by CBRC [China Banking Regulation Commission], which is their humongous coverage ratio—150 percent regulatory—and many, many banks being above that—that's only actually counting what is real NPLs. It's not even looking at special-mention loans, which is the bulk of those poor asset quality loans that we have in China.

So, I don't think they have either the huge profitability they had before, or even—notwithstanding the cleanup that is going on—the asset quality needed to go through these liquidity issues, and, most importantly, this action by the regulators to stop that leverage.

Capital indeed, it looks—we heard a lot about [that] from Larry, so I don't need to tell you—it looks fine, but it actually isn't. It's just there's no organic capital being created, notwithstanding that profitability that I just showed you—which is higher than European banks, by the way.

Debt-to-equity swaps, I just talked about. So, all in all, I think on the front line, yes, growth is there. The risks about the stock market, I think these are no longer—the main risk is really about Chinese banks, these humongous banks that are actually much more exposed to the rest of the world than they were when we were worried about them. And that they're also very intertwined with China's growing shadow banking.

So, given the size of the issue, I wonder whether this is not a major—it might not be an immediate risk, I would agree with that. There's still some leeway for the Chinese authorities to deal with this—but the question is, as you use that leeway, how much bigger the problem may get over time.

So this is for the chunk of risks that are not immediate, but are very, very important in our conversation in a minute.

Thank you so much.

[applause]

So, with my moderator hat, I think we move to questions, if you all agree. I just checked the voting system. So we have a question with four votes: "What about the impact on the financial system of artificial intelligence, and the changes to social role of finance, and ways to deploy it?"

So that's, I guess, going back to Ray, or anybody else who wants to comment.

Stanton: I like the way that comes to the non-economist in the room.

I think technology has a massive impact for us as organizations. I used to run a business line, and many of my customers, and my financial services customers particularly, were looking at this evolution. And I know that that is somewhere that we were investing very heavily in. So certainly, it's a growth sector. Certainly, it's a growth opportunity. The challenge, I think, is to the point, the impact on the financial system.

So if I bring that to life: a number of years ago I was working with a number of Australian banks who wanted to create these virtual environments, because they wanted to hit the millennials, where we heard the point in the other room.

So they created these virtual environments, with virtual banks. But then you've got into the challenge where, if they were going to actually take the lending from the bank—and this was Macquarie Bank—and it was interesting, they said, "This is something that we really want to do." But then you got to, "Well, what regulations—if you were going to take lending from a virtualized environment—well, whose regulations apply?" And it was one challenge that we particularly had. So I think this is really going to see a change in the way that you guys do lend money, and borrow money. But the impact for me is, how is it going to be also regulated?

Khan: Can I make just two kind of macro points on this? One is I take as given, not knowing much about artificial intelligence, but I take as given the potential for it to have hugely important and disruptive changes to the way our labor markets operate as well as our financial markets operate.

And so a couple points—one is, I think it does feed into the debate we're having about growth. Whereas we would expect to see these kind of changes have important effects on productivity, but not in the data, and it does feed into that.

But it also feeds into this whole disruption and dislocation debate, because a number of us have been talking recently about what a positive economic agenda would be in a world where our debates are less about "left/right" and more "open/closed." And we keep on coming back to the disruptions in labor markets and in the way we relate to each other being critically important both in terms of the dislocations people feel and also the fact that shocks now transmit very differently.

And so I think it's got to be, in important ways, a challenge to policymakers to anticipate these kind of fundamental changes in our markets, and adjust to it.

Stanton: Can I just...? I think the one thing that comes from this is, well, we have quite a serious problem—and I'll use the U.K. as an example—with same-day lenders. I don't know how much of a problem that is over here, but to me that would also play to that same problem—people who can't afford, they're using ways to get actual lending, and that's had a massive impact on our social climate in the U.K.

Herrero: Sure. So, I will go on to what has become the most voted question as we were speaking—which is really this idea about, why is volatility so low? If we see all of this, if you think about the number of risks we've listed here, then how come nobody is reacting, before the storm starts? I don't know who wants to take this question.

Evans: I mean, I think—as I pointed out earlier—it's all about the calendar. We've kind of gone through a period of heightened political risk. I do think that if you look back historically at political risk, markets—people, I should say—tend to overreact to political risk. The slide that you put up, Rob—we were just talking about the various geopolitical events, and kind of the subsequent event—if you look at those, those were all kind of "out-of-the-norm, out-of-consensus, out-of-the-blue" type of events.

I think what I'm talking about a little bit more of is that many, many political events are actually things that you could look at, you can analyze, you go out and find research on, and then you can make a decision. There's kind of an old adage: you want to buy the rumor and sell the news, so to speak, on political events, or when things happen that's kind of like we saw [with] Brexit. People had kind of factored in exactly what was going to happen with Brexit. I think we saw with Trump and the Trump election, people had kind of done their work and realized that maybe a Hillary election was a continuation of the same thing, and maybe a Trump election was a potential Chinese-like stimulus in the United States, and they kind of reacted accordingly.

So I think the VIX [Volatility Index] at this point is just giving you a signal that if we look forward, at least from the political perspective, we really have gone through a very uncertain time. And now we're coming out of that, and I think this spring and summer we'll see kind of a slowing down—or maybe the fundamentals will matter much more, and the fundamentals are pretty good—right?—if we look out there. If you take a look, you say, "My God, China. They want stability. They're stimulating." And they're cracking down a little, but we certainly know they want stability. You look at the data that's coming out of Europe. It's very high. You look at the way emerging markets are reacting—actually, one of the one of the weakest points right now in the world markets is the United States. We seem to be underperforming, our economic data as it comes in here.

And that's not terrible, because we have a Fed that has still set out. "Yep, we're on a nice steady path." We can anticipate kind of the path that the Fed is on. So I think the message in the VIX right now is appropriate, which is, as of now, we don't have a lot of risk out there, certainly not political risk.

Khan: So can I jump in with two questions? One is, in the run-up to the French elections, there was some discussion that there was a fair amount of hedging activity going on in ways that wasn't reflected in the VIX, and sort of a caution that you need to look more broadly. Was that something you saw?

Evans: Yes, very much so. I think a lot of the conversations I had, heading into the French election, were—and the World Bank/IMF meetings just happened to be in Washington, D.C., so I had a great opportunity to meet and catch up with a lot of my colleagues in London and Europe as well—and there were a lot of people just sitting on the sidelines, a lot of people just not invested. It was kind of a "chase-the-moment" type of thing. They were going to sit there, and they were looking. One of the ways that we look at political events, pretty seriously, is we try to find assets and asset classes and investments that, if an event happens one way, there'll be very little reaction, but if an event happens another way, there'll be an outsized reaction type of thing. Right?

So, what's the status quo if these things continue? If things happen as we hope, what's the reaction going to be? But then, we want to make sure we limit our risk to the downside, so to speak. And so I think you're right. I think there was a lot of just, people just sitting on the sidelines, quite frankly.

Khan: The other answer is that it comes down to this assumption of policy resilience, or the policy put...

Evans: Right; what's the real...?

Khan: ...is that there's just tremendous confidence in markets, right? They'll be backstopped.

Evans: Well, even if Le Pen wins—and, again: this is part of the process. I mean, as we say, "Okay, Le Pen is the risk. Let's go find out what that risk is. Let's try to quantify that risk." It turns out that France does have institutions. They have institutions that work. We still have a parliamentary election to come up here that will be important, actually, to Macron's ability to get things done—but realistically, if she is elected, if she pulls this out, what's the rest of the system going to do to kind of put her in check? And we've certainly seen that happen in United States, and I think most people thought that would happen also in France.

Herrero: Well, that's great. And on that note, that the VIX is certainly not a forward-looking indicator of risk whatsoever, we move on to questions related to Europe. So there are two questions. One is about Macron, and this idea that he's coming very strongly from the very beginning on federalism in Europe—so really on a strong Europe, going back to what Rob presented. Although he was very pessimistic about this happening. And in fact, we already hear of "Zumuntungen," from the German administration, in terms of, "We don't really want to go that far."

So, what's the way forward, if we don't have an alliance between the, what is, historically, the strong core in Europe?

Khan: From an economist's perspective, I would argue that, very clearly, the way forward over the medium term is greater economic and financial integration that involves a greater degree of fiscal transfer and banking union. I think, using Larry's paradigm of this morning: "The answer is known. The politics are very difficult." And I don't see the capacity to move forward in that regard, or, even on the German side, the interest in doing so.

I think in the near term [are] a couple of issues to watch. One is that the French will want further forbearance, in terms of meeting the fiscal criteria—and we've heard mixed things from the Germans. I've got to believe it'll be accommodated at some point, because—but I also think the real issue is the way forward right now, in the near term, is for the Germans to adopt—to use the fiscal space they have, because they have the fiscal space—to adopt a fiscal policy that, from a narrow national perspective, is irresponsible, but that from the broader perspective of creating some growth and giving people some more optimism and a better environment to do the needed structural reforms—that would make a whole lot of difference, and I don't see that happening.

Evans: [inaudible}...when you talk with them about freeing up fiscal space, and the need to invest, they turn around and say, "Why should we weaken ourselves? Maybe everyone else should come to us. That doesn't make any sense to us."

And I think that the answer is, what's the view forward? The view forward is going to be the European way, which is to muddle through. They just continue to muddle through. I think Macron even came out this morning and said, "We need to give Greece some debt relief." Right? That's certainly very anti-German. They don't want to do that.

Khan: But that's a great example, because if the muddling through is keep Greece on a short leash—don't make them pay a lot of debt, but don't give them debt relief—that's a toxic political environment in Athens, and we will have a series of triggers, just in calendar events...

Evans: They will kick the can.

Khan: ...but—and they kick the can until some day, in Greece, there is a decision made: "We don't want to do this anymore."

Evans: Right.

Herrero: If I may add, I think the problem with Macron's federal union proposal is that it's not even about... I wish it were—it's actually about permanent redistribution of losses, and that is a much harder proposal to swallow for Germany.

So I think he's going all the way, and maybe—for Europe's credit, since I'm in the EU, and the only European in the panel—I just think that the fact he's making this statement says it all. I've not seen a European leader, let alone Juncker's proposal for this multi-speed Europe, which is the most deceiving and unacceptable, in my opinion, proposal after what we've gone through, on earth. It is like, "OK, so where is the proposal?" This is already happening after Brexit, and you're only telling me that that's the future for Europe?

I think he's being bold enough to point to something we've not heard for so many years. And the fact he has, from the very beginning, means that, I think, at least the incumbents will see what happens with German elections, but assuming that it all stays the same, let alone Schultz would only be more acting to this proposal, so the risk is only on the upward side.

But I am just saying that, OK, it's Zumuntungen if you think about the German media, and the German vision of the world, that's what you would say. But the fact that he dares, that Macron dares say this, probably implies that there may be no other way out for Europe and that finally the Germans have understood it. Because I think Brexit is not only a wake-up call for the U.K., it's a wake-up call for the rest of Europe.

And I think this is the very first time I see that signal that goes all the way back to where Europe wanted to go from the very beginning, and then forgot about. So, it is very encouraging. How difficult it is I fully understand where you're coming from and I agree but before, no matter how difficult, it was not even an intention—there was not even a vision—to go all the way to a federal Europe, and I think that's the big change that we are experiencing. And I would say that, better than not even having that vision, whether you achieve it or how long it takes to achieve it, or—that's, of course, the question.

Evans: But change in Europe happens only when it's forced, right? Change doesn't happen in good times, right? The whole idea of going QE for the ECB, and the promise that was made to the Germans was, "If you let us go QE, then that's it. Then countries can no longer blame us. They can't say, 'Look, you need to do QE'"—and then they'll have no choice but to make the structural reform they need to make. They're not making the structural reform. They're not doing anything there. What's going to end up happening is that the ECB is going to start to unwind QE sometime this fall, and then the pain's going to come—and then we'll see the reaction.

Herrero: That's right. OK. So I've avoided a question because it was kind of methodological, and I just saw that we got more votes on something that I feel is more, slightly more, on the central part of the discussion—and that probably Ray won't like. [laughter] Because this is really about, "Are we spending too much money on cyber, and...?" I've only heard that we're not spending enough, but what's your view on this?

Evans: In other words, why do we have the growth of compliance? Is that productivity-producing?

Stanton: [laughter] So, it's an interesting... Can I just check—is this a question aimed at national defense, or is this just a generalized statement they've made here?

Evans: I read it as defensive, as just defending yourself.

Stanton: OK.

Evans: Investments that aren't necessarily going to be productive—unless defending yourself is productive.

Stanton: Well, no. I meant in the defense industry. So, OK. I've lived in this world for a number of years, and the way that we've invested in our cyber capabilities is about growing organizations and giving them the opportunity to actually grow their markets. So I find it quite an interesting point. And when I say "grow their markets," I also look at the growth in technology—security technology providers, for example—and, I think I said last night, [over] the last 18 months, I'd speak with a lot of investment firms, and they'd want advice on organizations and how they're dealing with, who they should invest with, but also, how are they dealing with cyber, whether they're a technology provider, and how they are dealing with the threat of cyber.

So, it's quite a complex question, really, because productivity—you wouldn't actually start to do some of the things that you've already done without cyber protection in place. Would you do your trading, for example? You think about how you do online trading, you think about how your traders—I think I mentioned the point around trading turrets—how you operate in that space.

So some of it you may see as a necessary evil—let's just put that out there—but if you're smart, and there's lots of organizations that are smart, that use this as a way to actually differentiate: "This is what we do. We protect your information." Take the point I said around privacy laws in Europe changing. We've seen huge amounts of investment by organizations in Privacy by Design—if you look at what's going on with Google and the "right to forget."

So, if you get it right, you can increase and grow productivity. I think it's about being smart and using it in the right way. There is absolutely the need for necessity of just doing this stuff, but if you're smart, as organizations—and we are—we can use it to differentiate and grow, and that should be good economic growth.

Evans: I think, if that sets you up—because I don't know why that sets you up to be more productive on the back end. I think the initial investment obviously is a knock on productivity, right? Because you have get up to speed, and do the kind of thing. But then once you're there, does that then free you up? Is it "one and one equals three?" Does that free up to make more money, to be more productive, when it's also—and certainly from a trading aspect. I mean, I was the 50th employee at our fund, and then I'd say that over the last six years I've been there, we now have 82 employees—by far, most of them are all just back office. We have three or four different tech guys. Their whole job—and they send us phishing e-mails all the time to try to test us, to make sure that we aren't clicking on random things.

But now that we've got that in place—right?—now we can move forward, we can actually expand our business. We can get other areas that maybe we've been a little bit concerned about getting into, other investment ideas as well.

Stanton: And you take a great example: PayPal. PayPal came about because there was no opportunity to do the type of trading online that people needed. They were the first and still (probably) one of the best secure ways to use a consistent method, that I can put some money in a wallet and use at any site across the globe, if they take PayPal. And that's a great opportunity. And that, I would argue, has stimulated growth.

Herrero: So, we're close to the end. We have less than 15 minutes, and I wanted to take this question—and not what we wanted to discuss about when we prepared this panel, which was really about, among all of that risks we've listed here—which ones are immediate, which ones are medium term. But, I'll make it even harder because it's not only about risks but what to do about them. What are the practical solutions for some of those risks? At least, the immediate ones, since we probably will all be more concerned about short-term risks, no matter whether others are larger, if they just don't come as quickly as short-term risk.

So, the question would be short-term risks versus medium-term risks. Pick, say, one or two for each and give us some practical solutions to the short-term ones, at least. That's the task for the next 13 minutes. So, who wants to start?

Evans: Mine is very, very simple. I like the risks. The solution is to get ahead of the risks and hopefully profit coming out of the other side of those risks. To speak about—you know, I'm not an elected official, but I will say this: ever since I started following Europe, I've really come to have a greater appreciation for the democratic process. Again, I keep harping on the calendar because the calendar is also very, very important for Europe. Europe is like herding cats—you can't get everybody together in a room. They can't just make a phone call and, "Hey, let's all get to the White House and talk about passing health care"—right? They work on a calendar schedule. They have to get together to do these types of things, and get leaders together—it's very methodical. And yet, despite all that, they're able to survive, and they're able to work their way forward. I really am impressed with how successful Europe is, quite frankly, despite its many, many challenges.

So, the risk in Europe, in our view, is that Italy is going to want to leave the euro. They're going to be incented to leave the euro. Now, whether that's a real risk or not, that's to be debated, but that's a risk that we identify, that we see as something potential in the future. And so the solution is for Italy—and Europe—Italy to pay off its NPLs, to fix its banking system, to make structural reform. Right? That's very, very difficult, and unlikely, and it's going to take pain. It's a process, but as long as they're committed to the process, you'll have these periods of pain, risk, and then they'll move forward. Pain, risk, they'll move forward.

I think in China, actually, we do see China as being stable for most of the year. We do worry, coming out of the 19th Congress, that they realize that they now have to finally make the structural form, and they're in a political position to make that structural reform, right? The whole point of this Congress coming up in China is to solidify Xi as kind of the third great leader coming out of this, where he's going to bring China into the global world. And then maybe he'll feel comfortable enough to just start to crack down on financials. Of course, the size is so big that tweaking the dial's hard.

The other risk, though, to that is that, what if we get through the 19th Congress, and they decide to have 60 days of gladiator games—right?—and "we're going to shower the people with goods, and say 'thank you so much,' we're your leaders..." So, I don't know that there's a solution to that, but those are certainly kind of how we're gaming things out in China.

In the U.S.: the U.S. is a fascinating place to me right now because what you read and what you see in the media, I think, is very different from what's actually happening in Washington, D.C. Again, I'd say that I don't think there was really much of a Trump trade. I think that Trump was just the removal of an overhang, and fundamentally the markets were in a great spot, and so we saw that reaction. I keep a simple chart of high-tax stocks versus low-tax stocks. And if you were expecting there to be a Trump trade, you would expect the stocks that are paying a high tax rate to outperform the stocks that are paying a low tax rate. You've actually seen the opposite. And it's been very consistent—it was barely a blip—very consistent. Certainly in infrastructure stocks, you saw a spike. And then they'll go down. The yield curve spike [will] kind of flatten out again.

So I think there's very little Trump trade factored in overall market thinking. Now certainly, if you read the press, it's all over the place, and even some of the folks I talk with in my industry think there's still somewhat of a Trump trade, but the expectations are very low. So now the expectations are so low that it should, potentially—or, could potentially—be easy for this administration, and this congress, to clear the bar, to actually exceed expectations, as we had at the end of the year. And I think that's something a lot of people aren't focused on, aren't looking at right now.

Khan: I'm less convinced. I think maybe I've lived in Washington too long.

Evans: Too jaded.

Khan: Too jaded—but I bet on gridlock, and some people view that positively.

Evans: It's the easy bet. You never lose money betting against government action.

Khan: And so that's why I think that the debate becomes, then, executive action, and it's people and policies. And particularly in the financial space, where I actually do think over a three-, four-, five-year period, we could see a material change in the regulatory environment confronting the U.S., but it could take a while to figure out exactly where we're going. It won't be through the Choice Act, or any of the other legislative vehicles.

But to the extent, as a policy guy, what I really would desire in the U.S. context is a reframing of the political debate that would allow for at least a degree of bipartisanship. I'd like to think...

Evans: And a degree of certainty, too. It would be nice to have some sort of a doctrine that we could all point to [and say], "This is where we're going."

Khan: But I'd like to think that policies formulated more in the middle, with a mix of Republican and Democratic votes, would produce better policy over the long run. But my sense from my market friends is they would view that pretty negatively in the short run, that given the relatively constructive interpretation of the current path—whether it's a Trump trade explicitly or not—and that's my sense, is that I think maybe they've overestimated, or at least, that sets you up for a pullback if there is expectations, if there is disappointment.

Herrero: Rob, may I bring you back to short-term risks versus medium-term risks, and what to do about the former, or at least the former.

Khan: So, as I said in my presentation, it's hard for me to really point to short-term risks. Whenever I try and predict timing, I was way out there in saying Greece was going to leave the euro zone in 2015. Good call. [laughter] And I think, fundamentally, the argument was right, but the timing was wrong. And around the same time, I thought that Venezuela was going to default. So you know I'm pretty bad on timing, and so I think in many ways, the short-term risks are going to be the ones that surprise us—which is why cyber is so interesting to me, is one that I think policymakers aren't well prepared for.

So it meets all my tests for persistent market effects, right? A surprise, something there's not preparation. Resilience could be tested, and that could show up in a lot of ways—although, I guess in the short term, North Korea is the one we're all really focusing on, where that could be the focal point of the response.

I do worry about Europe coming to the fore more quickly than we expect. I even do think that there's a possibility that we could get some sort of chaos coming out of these Greek negotiations in June. But probably more materially that we get surprised by an adverse banking system development. Italy obviously is the focus of markets. I've been struck by some of the work that they've done at NYU Business School on stress testing on American standards, which point to French banks as [being] in some ways more exposed to the kind of shocks we've been talking about today.

Evans: And some Austrian banks as well.

Khan: Austrian banks as well, exactly.

And so I do think that would challenge an ECB that's already, from a political perspective, somewhat stretched, in terms of the kind of instruments it's willing to use. So I think that would be very much what I would focus on in terms of near-term economic risks.

Herrero: Ray?

Stanton: Mine's slightly different to these. So short-term is two-fold. It's around the awareness and apathy that comes—it's that car crash. It's getting involved, not waiting for it to be the surprise—that preparedness—and understanding that. And the second one is the skills gap, and it cannot be underestimated that the skills gap is affecting everything that we're doing—every organization in this space—because the skills just don't exist. And with, particularly, the challenge that, most of our challenge is technological—those skills don't exist, [we don't] have the experience to be able to deal with the effects of what's coming out of all of the groups that are attacking us.

So, part of the solution is education and awareness—positive awareness—conversations, taking those three questions. It is about understanding how we meet that skills gap, and what we're doing to fill that within the short term—taking people from associated industries and trying to bring them in and up-skill them, while building long-term experience—so that's something that we're doing, and support there is welcomed.

And then the long-term risks—for me, I said it, is the global policy—global policy from regulators, national security agencies. It is about that engagement, and the effect that they have on how we operate when we have a challenge to deal with, whether it is a good old paper-based fraud that somebody has tried to move some money around and we're trying to find our way around it through to the highly complex frauds and money laundering that we're seeing, and being able to share that data to deal with a simplified denial-of-the-service-that-you-receive type, a denial-of-service type.

So, part of that is, how do we deal with that in the long term? And that is collaboration. It's events like this, asking for your help, us trying to communicate clearly what the problem is. And then the other challenge [that] comes with that is the technology evolution, and the exponential growth there, and how you can—and I've thought about that productivity thing, thinking about one more that comes with that—the evolution of technologies like blockchain, for example, and the effect that that's going to have on many of your organizations.

So, that's the challenge, and it's how we stay ahead and look forward to that.

Herrero: Thank you for...

Khan: Can I just interrupt? One other one, which is some sort of—it will have to be new but—strong, new political relationship between the U.S. and China for resolving conflict, right? While we can easily mock the economic framing of the strategic and economic dialogue in the so-called "G2 within the G20" that has framed a lot of the economic debate over the last several years, I think actually that the ties that it created, and that dialogue—and in some cases, settlement of issues, including climate, in the previous administration—has actually served quite well as an escape valve on a lot of geopolitical tensions. And we always have to rebrand, so S&ED [U.S.-China Strategic and Economic Dialogue] will now become the Comprehensive Economic Dialogue. This is natural stuff.

But getting back to a point Doug made last night, there's also an issue of people, and getting the people in place that can then build relationships, and then there have to be fora. And so if you do have an administration that, both because of a lack of personal assignments—maybe some ideology in some places, although in other places some very good people—but also a lack of belief in multilateral institutions like the G20, which may be temporary, maybe not. I do have a concern about who you make the 3 a.m. call to, if these kind of risks we're talking about...

So, certainly in terms of practical solutions, it's jargon. It's this what we call "variable geometry," but coming up with something that's politically saleable to the Trump administration to start to build those kind of ties is going to be critically important for us.

Herrero: We have just two minutes, so—or one minute left—I'd like to exactly go back to what you just said, and to get into what Doug said last night: what if the...system is over? And that was more from the point of view of Trump's own desires or, basically, the U.S. decision. But I'm actually thinking that we are less than a week—it's actually going to start this Sunday, this Belt and Road conference in Beijing, where you have more than 20 leaders of the 63 countries that make part of the Belt and Road, gathering in Beijing with Xi Jinping with the hope that those 5 trillion U.S. dollars that China has promised for them to come in the next five years, will actually happen—yeah?—and it will be the only way to finance their infrastructure—at what price?

If you think about, beyond the institutions that have already been created, but everything that is below the rudder is an international payment system. So, a lot of those transactions don't even go through SWIFT. So this parallel system, independent of the U.S. decision whether to opt out, is all about a new world being created, to which we don't belong.

So that might not be an immediate risk. You can't do that in a day, and that's not the way the Chinese are planning it. But the question is, what if there's a parallel world? I know we've seen this before. This is not going to be new in history. So, what's the risk, then? Are we going to understand how to deal [with] it? So, high economic dialogue is, of course, welcome. But this is in a world where we still have a dialogue, and we are basically following the same rules at the international level. What if there are parallel rules? And that's true for a cyberattack, that's true for everything.

So that divergence, rather than convergence, into a double world, kind of double standards, that I fear is increasingly a threat, at least from the perspective of this part of the world. So I do think that's kind of an understated risk, because we still think that we are driving, so we will decide whether we opt out or not. What if we're no longer driving? And that may happen anyhow, because it will be somebody else to decide for us.

So, perhaps I'll leave it there. We're right on time, 12 o'clock.

Thank you very much for your attention.

[applause]