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Rebecca Katz: Well, good evening and welcome to this live Vanguard webcast. I’m Rebecca Katz, and we’re so glad you could join us tonight. You know, it’s a little past the halfway point in the year, and we thought it was time to take a pulse check on the global economy. Where might we be headed? What are the implications of a Brexit, which we’re going to talk a lot about tonight? Are emerging markets like China still emerging? And what’s next for central banks across the globe?

Now, that may sound like a lot to cover in the course of an hour, but, luckily, I have with me two experts who are going to help us sort everything out. Joining me tonight are Vanguard’s chief European economist, Peter Westaway, just in from London and Jonathan Lemco of Vanguard’s Investment Strategy Group from here in Valley Forge.

Jonathan Lemco: Valley Forge.

Rebecca Katz: Thanks for being here.

Peter Westaway: Thank you. Looking forward to it.

Rebecca Katz: So as our viewers know, we spend most of the hour answering your questions, and when people registered, they sent in hundreds of questions literally and we’ll take some of the representative questions from that group. But you can continue to send questions our way either through your computer or you can tweet them to us using the #VGLive. And I’ll make sure to ask some of the live questions as well.

A couple of housekeeping items for you. On your screen, you may see a few icons, or widgets as we call them. The blue one there is for technical support so if you have any problems with the broadcast, click on that. We have people at the ready to answer your questions. And then also a green icon gets you to pertinent Vanguard research on the topics we’ll be talking about tonight. So we hope you’ll check that out.

Gentlemen, before we get into our discussion, we’re doing this pulse check on the global economy, but I thought we might first take the pulse of our audience. So on your screen you should see our first polling question. And what we’d like to know is what do you think the U.S. federal funds rate will be by 2020? So you have to prognosticate a little bit here. Will it be between 4.5 and 5%, kind of the old normal; will it be 2.5% to 4%, which is the new normal; or will it be between 1 and 2%, which is secular stagnation? So vote now, and in just a few seconds, I’ll have those results and we’ll come back to you.

But in the meantime while we’re waiting for the results, I thought we could just jump into some of the questions that have been asked. Yes?

Jonathan Lemco: Great.

Rebecca Katz: So our first question is from Daniel in Fort Collins, Colorado. Thank you, Daniel. And he asks, “What are the main systemic risks to the global economy and what can investors do to mitigate that risk?” I know you both have some things to say on this so, Jonathan, why don’t we start with you.

Jonathan Lemco: The first thing I would say that’s pertinent just to this week, of course, is the Brexit. And that’s all I’m going to say about it because I think Peter is a real expert on this particular topic, but it’s moving markets this week. Let me stress this and Friday will be a very big day in our markets no matter what the result is.

If I were to rank order, after the Brexit, I think at present I would say the continued slowdown in China. China’s growth is somewhere in the vicinity of let’s say 5.5% or so. At least that’s what they claim it is and that’s what the IMF believes. But the reason this matters is, one, China is the second-largest economy in the world. And in the event of a continued slowdown, this remains problematic for emerging markets around the world. China buys commodities from countries throughout Latin America, Southeast Asia, Africa, and indeed developed economies like Australia and Canada too. And so as China slows that is problematic for many of these countries that sell commodities to that country.

Now China at 5.5, 6% growth is still, along with Indonesia and India, possibly the fastest growing country in the world. It’s just that we got used to year after year in China of 10% plus, 10%. Such that after, frankly, in the last 15, 20 years, we’ve had approximately 400 million Chinese people elevated from the poverty levels to the lower middle classes because of this ongoing tremendous growth.

Now the country is going through a restructuring. It’s moving from an export-driven economy to a more domestic and consumer-driven economy and in the midst of hundreds and hundreds of reform, some of which have already passed, many of which have yet to come.

This is a bit of upheaval for the world and so it’s very concerning, particularly for those of us who follow emerging markets. So I would suggest that this, at the moment, would be the second-biggest risk.

Peter Westaway: Can I just add something?

Jonathan Lemco: Sure.

Peter Westaway: To me the fact that Chinese growth is going to slow is completely as we’d expect for an emerging market that’s gradually catching up. But I think the risk that you’re highlighting is the possibility that that slowdown may be a more accelerated one. I mean people have talked about a hard landing for some time, and I think that that’s really the essence of it.

Jonathan Lemco: It’s the fear.

Peter Westaway: Isn’t it? Yes.

Rebecca Katz: We actually had a follow-up question saying, “Do we think it will financially implode and do we think it will politically implode?” I mean this could have political implications as well.

Jonathan Lemco: It could. The best guess is no. Best guess is, you know, 5.5% is still adequate. It’s not great, but it’s adequate growth. And politically, frankly, the communist regime remains firmly in charge. On the one hand, you have this grand experiment of a communist regime politically or Marxist regime while still encouraging more and more of a free economic market. It is extraordinary. We’ve never seen an experiment like this, with the possible exception of tiny Singapore.

But that being said, China will, I think, continue to grow at 5, 5.5% pace for the foreseeable future. A hard landing, although not impossible, is possible. It’s something we want to be vigilant about. And it forces emerging market countries worldwide to seek other markets for their commodities too.

Third thing I’d just mention briefly, of course, is, particularly for those of us who follow developed and developing markets, is the activity of the U.S. Federal Reserve. And if they raise rates say once by 25 basis points or twice by 25 basis points this year and signal that they might do that, that would be less of an issue for the world economy. But if they surprise us, again unlikely but possible, if they surprise us with greater than 25 basis points and if they do it say more than twice, this could be very problematic for a number of countries around the world. We can get into this if you like.

Rebecca Katz: Yes, okay.

Jonathan Lemco: But Brexit is— .

Peter Westaway: Yes.

Rebecca Katz: Really briefly before we turn to Brexit, we did ask people what they thought the Fed would do with the federal funds rate, so we have those results in and let me just share those with you really briefly.

So most people have responded that they believe the 2.5 to 4%, the new normal, is to be expected. Only about 30% of our viewers said 1 to 2% secular stagnation. And very few actually said 4 to 5%. So others are also not anticipating a big rise in interest rates. Would you tend to agree?

Peter Westaway: Yes. I mean I think that that’s very much in line with our view. And I think the fact that the risks around that new normal to the downside there’s a possibility that we will get stuck in this low-growth environment. But I think it’s more likely that we’re going to go to this new level of 2.5, 3%. And that’s for the Fed, but I think that new normal applies to a lot of other economies as well because I think around the world because the overall growth rate of the global economy is lower than it has been in the past, for various reasons, that typically maps into lower policy rates that central banks settle down at.

And I think that’s really important for investors to understand that. We’re just not going to go back to a world where in normal times we expect the short-term interest rate to be 4, 5%. It’s a very different world.

Rebecca Katz: At least not any time soon. We’ve gotten so many questions about Brexit. It’s been in all the headlines here in the U.S. Obviously very visible in England.

Peter Westaway: I’ve got to go home to vote then; no, because luckily, I’ve already voted. I’ve done my postal vote last week.

Rebecca Katz: Did you?

Peter Westaway: Yes.

Rebecca Katz: Well, tell us a little bit about, you know, maybe for some viewers who may not be up on Brexit, it’s really the vote to stay or to leave the European Union. But what are the implications of that? I’ve heard things like it could be really devastating for the U.K. GDP. It could have big implications for our markets here in the U.S. Where does the truth lie?

Peter Westaway: Yes. I mean I think, you’re right. First of all, let’s just think about what the impact could be for the U.K. economy. I think most of the kind of expert economic opinion is that on balance it’s probably going to be either mildly or strongly negative. And the main reason for that is around the trade implications. Because at the moment the U.K. is part of the European single market, they get favorable trade relationships with their European partners, which is almost half of their trade. And so I think to lose that favorable access could be quite harmful.

It’s possible, and this is what the exit camp would argue, that they will be then able to stimulate trade with other regions—China, emerging markets, even the U.S. But the case for that it’s quite a nuanced argument there.

The second problem is foreign direct investment. A lot of that comes into the U.K. precisely because we’re part of the single market. And so it’s possible that some of that won’t come in. So all of these are reasons why, I think, in the long run could be lower.

Still very uncertain, but what’s absolutely certain is that if we did leave the U.K., if we did leave the E.U., there’d be a long period of uncertainty. And that’s the thing that markets hate. That uncertain environment is the reason why markets are so nervy. And it’s not just about the U.K. economy because, let’s face it, the U.K. isn’t large enough in the global economy to make that much difference, but it’s some of the knock-on consequences.

In particular, I think many people feel, and I would agree, that if the U.K. were to leave the E.U., it might open the door for some other countries in Europe who are mildly or strongly Eurosceptic. And once that’s started, we could have a rerun of the sort of turmoil we had during the sovereign debt crisis a few years ago. And we know that even though that started in Europe, it then radiated out into developed markets, into the U.S. and so on.

So it will be nice to think this problem will be confined to the U.K., but I think at the moment the markets are seeing it very much as a global risk event. And, you know, it’s not just the markets. The IMF have come out and said this is something that’s worrying them.

Jonathan Lemco: Polls are very mixed though. Today alone, for example, we saw two competing polls—one showing the leave slightly ahead, one showing the stay slightly ahead. The markets I have a perception at the moment that the stay is going to win. However valid that is, that’s the perception.

And so we saw a bit of a rally yesterday, a substantial one actually, and a more modest one today, but it’s making everyone very nervous and it’s overwhelming every other issue that we’re dealing with on the international side.

Peter Westaway: And people are very skeptical about opinion polls at the moment because of the recent experience that we had in the U.K. over the general election, over our Scottish referendums, Scottish independence referendum. In both of those cases, there was a relatively late last-minute swing back to the status quo. So I think a large reason why the remain camp is still in the lead in terms of betting markets and in the market view is this, whether it’s an expectation or a hope, that that’s the way voters will move. But this is completely new territory. We’ve never had a vote like this before.

Rebecca Katz: So we actually had question from William in Lake Pleasant, New York, who said, “What are the chances that Brexit is a nonevent?” So if you choose to stay, does it have any implications for the global markets or everything just goes back to normal?

Peter Westaway: Yes, somebody was saying the other day, “Is this going to be another Y2K that everyone got very excited about it and then when it happened, it just, you know, we forgot about it?”

No, I don’t think there is much chance of it being a nonevent simply because we’ve already seen big market movement. I mean sterling alone has fallen the best part of 10% since the start of the year. And I would see it more as a fork in the road. And if there’s a vote to remain, I think the market will probably rally, and if there’s a vote to leave, I think the market generally will weaken, which for an investor that makes life pretty tricky.

And certainly the advice we’ve been giving investors in the U.K. and more generally is, “Don’t try and be too clever and do things radical with your portfolio to try and get around this risk.” It’s much better to sort of look longer-term because— And it’s a good example of why investing globally, having a globally diversified portfolio is really useful. Those investors in the U.K. who have just got U.K. assets are now really regretting that.

Rebecca Katz: Well, I could see the flip, you know, a similar issue for U.S. investors who may be worried. “Oh, I did diversify and now I have exposure to this.” Would our advice be similar to that we’re giving the U.K. investors; sort of hold the course?

Jonathan Lemco: My advice is exactly the same, I think. There’s always something going to be going on in the world that’s a positive and something else that’s a negative. And there’ll be a war somewhere that may affect what we do. There’ll be some political change. Growth numbers may change radically in a particular country. There’s all kinds of events at any one time can affect a particular country, a particular credit.

So as a result, as Peter said, if you are broadly diversified, if you have a long-term focus, you’re probably in the best position to succeed. I know many of you in the audience have heard this before, but time and time again, this seems to come through.

Friday is likely to be a very volatile day. I have no idea which way it’s going to go. Much will depend, I think, on the result. But that being said, the U.K., as important as it is, comprises one relatively small part of our broader portfolios. And so its impact will, in turn, likely be muted.

Rebecca Katz: I would expect every Vanguard webcast to say the same thing about five times. It wouldn’t be a Vanguard webcast without staying the course.

We do have another question for our audience, and I think it’ll shift gears a little bit back to economic growth. So on your screen you should see our second polling question. And, again, put on your hat and try to figure out what the future may hold. By 2025, this time, which of the following will have the strongest economy: India; China, although we’ve talked about that a little bit and maybe we’re a little more skeptical now; the U.S.; or the European Union? And maybe some of that depends on what happens later this week. So just respond now and we’ll take a look at your results in just a few moments.

And I don’t want to give that away, but we do have questions about global economies not getting the growth rates that we saw in the past. So Jim in Simpsonville, South Carolina, wants to know what’s underlying that? Why is the U.S. not growing as quickly and why are other global economies not growing as quickly? And I can turn it to either of you.

Peter Westaway: I mean I’d say there were three main reasons. One is that for many years, certainly in the earlier part of this century, growth was credit-fueled so that if you think about the sort of underlying rate of growth that an economy can achieve, for a while economies were overachieving because it was all credit-fueled. And I don’t think we’re going to see that going forward. Indeed, we’re seeing the opposite. We’re seeing a so-called deleveraging. People are paying down their debt.

The second reason is that for reasons that not everybody understands, productivity growth looking forward just isn’t as strong as it has been in the past. So it’s a bit of a puzzle because you would think with driverless cars and all of the technology, growth would be as good as it’s ever been. But I mean there’s this famous quote by an economist saying, “Productivity is everywhere except in the statistics.” And it’s kind of true. Maybe we’ll see it coming through later, but whatever it is at the moment, we’re going through this lull in productivity growth. So that’s part of it.

And then the third reason which varies from country to country, demographics are not as favorable to growth. So all of these reasons are why the average growth rate is lower. And then, as we said earlier, that then means that the interest rate, the return settle down is just a bit lower.

Jonathan Lemco: Yes, Peter makes a good point because when talking about average, looking at emerging markets alone, for example, you find reasonable rapid growth. Again, 5, 6% growth in some countries of Asia and the large majority are at least reasonably positive. Eastern and Central Europe 2, 3% in some cases. A little bit negative in a few. But overall, 2% or so. It’s not great, of course, but at least it’s positive.

And, finally, Latin America, which is entirely bifurcated, if you will, or expectations of Brazil, the largest country in the region according to the IMF are negative GDP growth for next year. Argentina also probably negative or zero as best we could tell so far. But, by contrast, very well managed politically and economically polities and economies like Chile and Mexico and Columbia and Peru are doing better. And better means 3, 4 or so. Not what it was before, but still adequate and providing, from an investor point of view, some opportunities as well. So we’ve got to be very careful not to generalize.

Rebecca Katz: Yes, but let me go back to the investor question because hasn’t some of our research shown that you can have strong growth in a country, you could have 10% growth in China or 5% growth in China. It doesn’t necessarily mean the stock market will go up 5% or 10%, correct?

Jonathan Lemco: And that’s absolutely right. And, again, what is the stock market? It’s a reflection of companies in a particular country too. And, again, when we evaluate the relative strength and weakness of a particular country, growth is just one important but not the sole characteristic we look at.

If you’re a fixed income or a bond investor, you’re paying very careful attention to how much debt and deficit that country has. What is its fiscal performance? What is its foreign country reserve capability and so on? Is it politically stable? All of these are characteristics that go into the mix.

And one thing that I would just stress at this time and, again, particularly with regard to emerging markets, is we’re seeing relative to the last 10 years, 20 years, 30 years, and so on, reasonably solid performance with regard to all of those indicators.

Rebecca Katz: I think you actually have shared a chart, or we might have it on hand, about debt.

Jonathan Lemco: I’d like to bring that up. So if we can call up the reserve slide, that’d be really great, the gist of which is this. If you look at the foreign currency reserves held by some of the largest emerging market countries, you see that they’re vast.

Now China alone has somewhere over $3 trillion U.S. or Treasuries or other securities just in their storehouse, if you will, just in their central bank and elsewhere which is used for a rainy day. So if you lend China money in the sense that we are buying their bonds, in turn they have the ability to repay you with interest because they have amazing reserves.

But it’s not just China. It’s also countries like Korea and Mexico and Peru and many others around the world that have a tremendous storehouse of reserves.

Peter Westaway: And that contrasts with the earlier emerging market crisis, the Asian crisis in the ’90s—

Jonathan Lemco: Absolutely.

Peter Westaway: —the Latin American crisis in the ’80s where they didn’t have those reserves. And so this is really critical for the stability of those regions really.

Jonathan Lemco: Exactly right. In fact, policymakers in many of these countries, first in Asia but subsequently in Latin America, learned the lesson of the 1997/’98 financial crisis, which had many aspects to it. But, again, one of it was not building up reserves and they decided never again. We are going to build up our foreign currency reserve capability.

Second thing we’re going to do is we’re going to manage our fiscal, our debt performance better than we have in the past. And if you can call up the debt slides, first one you’re going to see is on developed markets where you’ll see that it’s just adequate how well developed economies manage their debt.

But then contrast this with the next slide on developing economies and you see many of them have relatively low debt-to-GDP ratios. And the credit rating agencies, Moody’s and Standard & Poor’s and Fitch, who look at debt more than anything else and assign a rating to these countries say, “You know what, they’re managing their fiscal performance well, they have decent reserves, their growth is adequate. We see some measure of political stability.” And a lot of these countries which in 1998 were junk, were double B and B rated and they had to offer a very high yield for investors to be interested, well, have now been elevated to investment-grade, which means the risk of their default is modest, very modest. It’s unusual such that when it happens, it really makes news like in Argentina or in Ecuador.

And as a consequence, many of these countries’ bonds have found a way into mutual funds offered by Vanguard, for example, and elsewhere too. And the credit risk associated with them is much less than it was.

Rebecca Katz: And perhaps we have something to learn from that or how do we feel about our own debt-to-GDP ratio?

Jonathan Lemco: That’s a really interesting question. On the one hand, the United States has a debt-to-GDP ratio that’s somewhere in the vicinity of almost 100%. Although to be fair, in the last few years, the U.S. deficit is less than half it was. So we’ve improved there because of growth, but our debt is very, very high.

However, the United States has some tremendous advantages. And possibly the single biggest one beyond the fact that it’s the world’s only remaining superpower is that the United States dollar is the world’s most prominent convertible currency. It’s not an accident that so many of these countries have U.S.-dollar-denominated securities in their central banks. The U.S. is trusted. And that’s a remarkable advantage that the United States has.

Peter Westaway: It’s been referred to as the exorbitant privilege, which is to be the world’s reserve currency but it does mean I think the markets give the dollar of the U.S. more leeway, which is not surprising.

Jonathan Lemco: Benefit of the doubt.

Rebecca Katz: So speaking of the U.S., we have our poll results back. And we asked what economy did we think would be the strongest? And we have some patriotic people watching tonight. So about 57% of our viewers said the United States. Only 2.5% said the European Union. 24% said India and 17% said China. So any surprises there? I mean it is a U.S. audience?

Peter Westaway: Yes, I mean if we’re defining strongest as largest GDP in aggregate, then I would think China is going to be the largest. And then the possible question mark I can’t remember when it’s projected that India might even overtake China. But I think that’s much further down the line.

Jonathan Lemco: It is down the road. It’s like 2050 or something.

Peter Westaway: Yes. But I mean I think even today China’s pretty close to overtaking the U.S. Depends how you convert currency.

Jonathan Lemco: Total GDP.

Peter Westaway: Yes, that’s total. And I think it’s really important to understand the distinction between the total size of an economy and the GDP per head, how well off are individuals because China may well become number one in the world in terms of total size but there’s a lot of people.

Rebecca Katz: Has a lot of people.

Peter Westaway: They have a lot of people there. Whereas in GDP per head, they’re number 75 or something like that. So they’re still a long way down. And that’s one of the reasons why a country like China still got lots of scope to catch up, why their growth rate is still so great. But, yes, you can’t ignore China anymore. It’s a big— It’s still classified as an emerging market and it’s—

Rebecca Katz: Yes, we had a question about that. I mean is that too broad a term? Are these countries no longer emerging markets?

Peter Westaway: Yes. It’s emerged.

Jonathan Lemco: In some ways, well, in some ways it’s emerged and, again, it’s very hard to pin down what we were exactly talking about when talking about emerging or developing economies. Depending on the benchmark you look at or the organization evaluating this, is a Korea or is Israel a developing or developed economy? There’s a lot of controversy, for example, with something of that kind.

What we can say, I think, is, yes, China appears to still be developing or emerging despite the fact that it has, at the moment, the second-largest GDP in the world. In terms of purchasing power parity, its ability to buy goods and services, if you will, still pales in comparison to many of the industrialized countries in this regard.

I share the view of many of those who took this poll in believing that the United States going forward will, for the foreseeable future, remain the strongest economy if for no other reason that it is the most diversified economy by a longshot, by comparison to just about certainly every other large economy going forward.

The sense of innovation in this country is remarkable. And I don’t mean to sound like an almost U.S. patriot here, but objectively you look at what characterizes this country of 300-odd million people and so on and the labor mobility and the industrial mobility, the ability to innovate, you’d be hard-pressed to find this on the same scale anywhere else.

Rebecca Katz: Agree?

Peter Westaway: No, I do. I mean I think the— I’m surprised we got 2% of people saying that the European economy was going to be the strongest.

Rebecca Katz: Sympathy vote.

Peter Westaway: Maybe a bit further down the line I might buy into that because I think one of the things about Europe is that there are still— I mean, yes, of course, they’ve had lots of challenges around the euro area and having a single currency. That’s problematic on its own. I think in the long run that will be beneficial for European economies, but the thing that they still haven’t really got sorted out is made the structure reforms in terms of making their economies more flexible in the way that the U.S. did many, many years ago. I think in the U.K. we did many of these structural reforms in the ’80s and ’90s.

But in Europe, they’re still more kind of a corporatist approach. And so certainly the countries of Southern Europe, even France there’s still a lot of reforms to do. So I’m kind of optimistic in the long run, but at the moment I don’t think that dynamism that Jonathan’s talking about that characterizes the U.S. economy is really there.

Rebecca Katz: Okay. And we’ve gotten quite a collection of follow-on questions about Brexit, so we’re going to come back to that topic as well.

I don’t know if you can answer this. I mean I’m sure there’s a lot of speculation around this. Roger asks, “If Britain exists the E.U., does Scotland leave Britain? And then what about Northern Ireland, is there going to be a domino effect?” I know we talked about concerns about people leaving, other countries leaving the European Union, but what about leaving the U.K.?

Peter Westaway: I think it’s a really good question. I mean we don’t know, but certainly the opinion polls would suggest that certainly the people of Scotland are much more in favor of being members of the E.U. The fact that only a couple of years ago they had their own referendum to leave the U.K. And, yes, okay, it was 55, 45, or something in the end, but it’s not that far to swing back. So that will be a possibility.

Whether Northern Ireland would leave is a different issue, but certainly the free movement of people across the border in Ireland, between Ireland and Northern Ireland, which at the moment really helps the economy of Northern Ireland, that will be really damaging for them. So, yes, I think there are many questions like this that have been thrown out. There are probably more that we haven’t even thought of yet that will only become apparent on Friday morning if this is delayed.

Rebecca Katz: I’ll be getting up early.

Peter Westaway: Yes.

Rebecca Katz: Can I shift gears back to the U.S. for a second? We have a great question in for you, Jonathan. If you had a five-minute private meeting with Janet Yellen, what would you tell her?

Jonathan Lemco: That’s a hard one. But I think, as we mentioned before, the first thing that the markets care about or worry about is uncertainty and being surprised. And so to the extent that she is able to convey, in measured tones, over time, a sense of what expectations are of the Fed, what are the most important signals they’ll be looking for from the broader economy as they make their decisions about interest rates? And I would also strongly suggest that they take action, not rashly. But if they’re going to raise rates, let it just be 25 basis points at a time. Reasonably signaled, obviously, they don’t have to explicitly but implicitly signaled, if you will, so it’s slow and measured over time.

We want the central bank to be an ally both, of course, of the American people and, in addition, of the markets as well. So it’s not part of her mandate to reveal exactly what they’re going to do, of course, but to work closely. So as much transparency as is feasible under difficult circumstances and acting in a gradual way, a measured way. I suppose that’s what I would ask for. And to speak clearly, which, fortunately, she does.

Rebecca Katz: She has to watch every word.

Jonathan Lemco: Well, and you can make the case that I can name a couple of her predecessors who are very, very confusing.

Peter Westaway: So can I jump in—

Jonathan Lemco: Yes.

Rebecca Katz: Yes.

Peter Westaway: —and defend central bankers as a former central banker myself in the Bank of England.

Peter Westaway: I mean I think sometimes central bankers and the Fed recently have come in for a little bit of, I would say, perhaps unfair criticism simply because really for the first time they’ve started reacting to overseas developments because of the turmoil in China; the consequences of that for the markets.

And I think because for so long U.S. policy was set mostly to domestic conditions and domestic markets, it’s been a bit of a sea change for just people understanding that. But I mean I recognize what Jonathan is saying. I think this desire for transparency is quite tricky to get across because I think sometimes markets find it confusing when they’re told, “This is what we’re going to do,” and then they end up doing something different.

The reason they’re doing something different is because the world’s changed. You get new information. But that’s what I think is sometimes hard for the markets to swallow. And so just getting that message across more clearly than they do at the moment. I think sometimes there’s almost the, I don’t know, mystic trust put in central— What central banks are able to do. But they’re looking at the same information as the rest of us.

Jonathan Lemco: And one point I would make in this regard is how very viable it is that the U.S. central bank, and others too, are truly independent central banks. They are not manipulated by political leaders. And by the way, this is probably a minority case when you look around the world in many, many countries where they’re often an arm, where they’re explicitly or implicitly of governments and doing their bidding. The one really strong thing we have is an independent central bank that acts at what they believe to be the national interest.

Peter Westaway: Yes, I mean I think it was Keynes who said many years ago that it will be better if central bankers were treated, rather than being like high priests, they were treated like dentists. In other words, they’re just technical people doing a technical job, which is hard but, you know. And I think that’s part of the problem.

Rebecca Katz: Well, let’s talk a little bit more about what central banks are doing outside of the U.S. There’s quite a few questions from our viewers about negative interest rates. And, quite honestly, before we went on air, you were trying to explain to me how you could have negative interest rates and how someone would buy a bond that has a negative interest rate.

So maybe give us a little bit of background about where and how are interest rates going negative in some of these countries and what the implications of that are because we have Connie in Washington and Eric in Virginia both saying, “How should I think about international bonds in light of negative rates?”

Peter Westaway: Yes. Well, I mean negative interest rates are just one part of the armory that central banks have in order to provide stimulus to the economy. So I mean you start off, an economy goes into a downturn, central banks will cut interest rates. They cut interest rates until they hit the floor, which people used to think was zero.

The next thing they’ve done is they’ve indulged in quantitative easing, which is effectively money printing to provide liquidity into the economy boosting asset prices providing spending power. But when that doesn’t work, they’re then looking around for something additional. And so the next step has been to cut interest rates. Not just to zero but below zero.

Now there’s only a limited extent to which you can do that because at the end of the day, people have always got the option of taking out cash in terms of bank notes. And so if your bank is offering you negative interest rates, why on earth would you put your money into the bank?

Rebecca Katz: But isn’t that the idea?

Peter Westaway: No, not really. In practice what’s supposed to happen is banks start offering lower interest rates on deposits, even negative interest rates on deposits, and that will allow them to bring down their lending rates as well so that people will be able to borrow money more cheaply.

The problem is that in practice very few commercial banks are willing to cut interest rates into negative territory. So what you end up having is the only people that are having to pay you a negative interest rate are the banks themselves when they deposit their funds in the central bank. So it’s starting to eat into their profitability and banks are starting to really suffer.

Rebecca Katz: Profits.

Peter Westaway: So in the euro area, in Japan, they’re sort of squealing, to be honest. And so I think even though there’s a lot of publicity around it and it sort of, as you say, is sort of jaw dropping and how unusual it is, but I don’t really think this is going to be the measure that’s going to really make the difference for these economies.

Rebecca Katz: Well, it’s interesting because you mentioned that this is just one tool in the arsenal. And the U.S. used some of these other tools, quantitative easing and buying back bonds. It seemed to work. We have a question from Bert, who said, “That worked in the U.S. It improved,” and his definition of “worked” is it improved stock market performance. We have not seen the same effect in Europe. So when you talk about these things working, what is the goal, the end goal? Is it stock performance?

Peter Westaway: That’s one of them because I think that’s been one of the ways in—and I agree with that presumption that both in the U.S. and I think in the U.K. by providing a boost to not just stocks but risky assets more generally because you effectively buy one set of assets so people are then going to go away and buy some others and they bid up their prices.

That worked for us in the U.K. It worked here in the U.S. But the European economy works in a rather different way. The banks rather than capital markets, the banks are absolutely central to how things work. And because the banks are still effectively a bit broken since the sovereign crisis, that money isn’t flowing into the system in the way that I think policymakers want.

So, I mean I think we have seen a bit of an effect on the stock market prices in Europe, but probably not quite as strong. And so that’s why really there’s still a big question mark in the euro area about whether or not these measures are going to work.

I mean they’ve brought down yields, and that’s a really important thing. You know, remember, sovereign yields in countries like Italy and Spain were up around 7, 8, 9%. These countries are on the brink of not being able to finance themselves. So certainly the effect that QE has had the effect of pushing down yields. But whether it’s really got demand moving as strongly is much less clear.

Jonathan Lemco: It’s very unclear. And, again, a big motive, as Peter has said, the stock market is very important, but can we get banks to lend and in turn promote economic growth? And the jury is totally out on this. This is, to me, something of an almost desperate measure, but we’ll see. It’s almost unfathomable to think that you lend monies or you give money to the bank and in turn get something less down the road. But it’s a tool that they choose to use right now in an effort to try and spur the economy in different ways. And we’ll see.

Rebecca Katz: Well, as we talked about the stock market a little bit, we have a question just in from Eugenia, who says, “What are the implications of all that we’ve presented so far to international bond funds, such as developed-country bond funds and emerging-market bond funds, which we offer here at Vanguard?” So how should investors in those funds think about things like negative interest rates and slower growth?

Jonathan Lemco: I think in a broad sense, international debt, international bonds, continue to provide attractive yields, the bottom line. Those countries that at Vanguard we tend to invest in are still predominantly investment-grade. So, therefore, default risk will be modest, they’re going to have decent macroeconomic performance we think, and they’re going to offer yields that are reasonably attractive and provide a buffer or alternative to equities.

International debt should be, I would urge, a reasonable part, a part of any broadly diversified portfolio. Time and time again these countries have demonstrated reasonable fiscal prudence, adequate growth, as I said before. They are, for the most part, money good certainly on the fixed income side.

And the Vanguard official view is somewhere about 20 to 40% of your entire portfolio should be international and perhaps 25% of that or so should be emerging markets. Give or take, it has everything to do with what your risk acceptance level is. How much risk you’re willing to take.

But certainly for the last 20, 30-odd years, the large majority of these countries have proven to be very good credit risks and so, therefore, should be part of any balanced portfolio.

Rebecca Katz: And when you think—

Jonathan Lemco: Yes, go.

Peter Westaway: Can I just add a couple of things on that? I think one really important point to make for a U.S. investor is that very often international bonds will be hedged back into dollars. And very often that hedge will mean that the effective return you get as a U.S. investor will make it look a lot more like a U.S. yield so it basically turns it back into a positive yield.

Jonathan Lemco: Quite true.

Peter Westaway: Now, of course, that argument goes completely the other way if you’re in Europe because you then buy a U.S. bond and it turns it into a negative yield. But it’s basically the same argument.

But I mean I think the point that Jonathan makes is important that whether you’re talking about yields that are slightly positive as they are in the U.S. or even negative, the fundamental property of having bonds in your portfolio is that they provide stability relative to equities and that they act as a counterweight to equities so when equities fall, bonds tend to rise.

Now probably two years ago people started saying, “Surely that role for bonds isn’t going to work anymore because interest rates are down at 2%, 1%. Surely they can’t act as a counterweight because interest rates can’t fall any further.” And how wrong we were. You know, they have fallen further. We thought there was a floor at zero.

So I think the danger with negative interest rates, and, again, I think having a diversified portfolio rather than just having one country’s bonds in your portfolio is really important because interest rates don’t all move up and down together at the same time. And that’s the key point.

Rebecca Katz: The question I was going to ask because it was such a surprise to me is that when you think about the global bond market, the U.S. is actually a minority of that portfolio.

Jonathan Lemco: Oh, yes.

Peter Westaway: Yes, yes.

Rebecca Katz: There’s so many more assets in non-U.S. bonds, and it was very surprising for me that you would be ignoring a large chunk of the world if you didn’t have that.

Jonathan Lemco: There are more than 90 countries at present that issue U.S.-dollar-denominated debt in our marketplace, for example, and that doesn’t even include those that issue euro debt or Japanese yen denominators or so on. So the United States, in general, although we still have a predominant amount of dollar debt, still there are many, many other countries that issue debt and provide a broad array to investors to choose from.

Rebecca Katz: Well, let’s see if we have another live question. Ah, this is a little bit of a different take. So Richard is asking, “What is it about demographics that makes for slower growth: an aging population, lower birth rates?” I know that these are some issues, population growth is an issue in many countries including China. So talk about that a little bit. Do demographics have, as we think about GDP and overall strength of economies, what role do they play?

Peter Westaway: Well, I mean the demographics ultimately map one for one into the growth of the labor force and there a number of forces in countries like China; we’ve had the one-child policy, which has meant that the labor force is now starting to grow more slowly. In the developed world, especially in some countries in Europe we’ve seen a—

Jonathan Lemco: Italy.

Peter Westaway: Well, Italy is the one in my mind. We’re seeing a trend to women having babies later. Maybe only have one child rather than two. It’s not an official one-child policy but in practice it’s been happening. So, if you like, it’s the other side of the coin to greater female participation in the labor force which, of course, I really think that’s a good thing, but it has had an impact. Maybe a temporary effect but it takes a while for these demographic forces to wash through the population.

So all of these things just means that the growth rate isn’t as strong as it would have been. I mean Japan, if you adjust Japan for its population, its growth rate isn’t quite as bad as it first looks. Japan’s growth rate is awful in headline terms, but in per-head terms, it’s not that much worse than some other western economies.

Jonathan Lemco: That’s right, but Japan and Italy, although extremes, we’re seeing this in other countries too where population growth rates are relatively modest. And that, in turn, means that unless there’s some dramatic change over time the ratio of workers to retirees is going to continue to diminish. Fewer and fewer workers supporting more and more retirees. And that is going to put enormous pressure on national budgets in those countries.

The United States is very fortunate, frankly, in that regard. It’s got relative to other developed economies one of the fastest growing populations in the world today. It’s not quite at the level it had been, but, again, compared to other countries, the U.S. is better off. But this is very worrisome going forward. It’s why there’s pressures in some of these countries for increased levels of immigration into these countries in an effort to try and address this where possible.

Peter Westaway: It’s ironic that the topic that is so controversial both here in the U.S. and in Europe around—

Rebecca Katz: Exodus. ______

Peter Westaway: ­—the migration crisis and the Brexit issue. The Brexit debate is very much around immigration. But in some respects, that is a way of squaring the circle for some of these economies.

Rebecca Katz: So one economy we haven’t talked much about, and David in Maple Valley, Washington, actually says, “We don’t hear much about Greece anymore. Did the political and economic issues get fixed?” So we haven’t talked about Greece tonight. Is all well in Greece?

Peter Westaway: No.

Jonathan Lemco: No.

Peter Westaway: No, they haven’t been fixed, but I mean I think relative to the epicenter of the sovereign debt crisis when there was a strong possibility that Greece would spiral out of the euro and other countries would follow, I think it’s now pretty clear that European policymakers weren’t going to let that happen. And that’s now been accepted. But the policies that Greece need to put in place to make themselves sovereign are still very much a work in progress.

The question of whether or not Greece’s debt will be rescheduled, i.e., forgiven, is still a very live issue where, on the one hand, the European policymakers, mostly Germany, are very much against that, whereas the IMF who in any other context would always say, “You have to reschedule your debt before we give you any more money,” they want to do that. And so that’s the kind of impasse we’re at at the moment.

Jonathan Lemco: I think that’s right, but meanwhile in Greece, quality of life still remains problematic. The economy has stabilized, but it’s still negative growth. They’re still heavily, heavily dependent on Europe to support them. That hasn’t improved.

The immediate crisis has gone away. It’s not as if Greece is going to be leaving the euro zone anytime soon, but it still remains a real problem that for the foreseeable future is still going to depend on Europe for support. It’s a country that’s still dependent on tourism and shipbuilding and a small limit of other industries. And it’s still losing some of its best and brightest to other countries. So it’s by no means out of the woods yet. It’s just the immediate crisis has gone away.

Peter Westaway: And it’s interesting that when Greece does periodically flare up in the headlines, it no longer causes trauma on financial markets. I think markets get that this is not a systemic issue the way it was two, three years ago.

Jonathan Lemco: I think that’s right.

Rebecca Katz: That’s very reassuring, actually.

A question from one of our younger investors who is watching. Michael from Madison, Wisconsin, said, “As a young investor, I’m concerned with these trends that suggest that old market wisdom no longer applies.” I mean we just talked about negative interest rates that we never thought could happen. There’s still a major slack in the job market. Is this a new normal? Is there a fundamental change? Or is this just a phase that we’re in?

Jonathan Lemco: Go ahead.

Peter Westaway: I mean I think it’s really important to distinguish between the new normal, which means growth rates that we settle down at when economies get back to some sort of full capacity. That new normal will be characterized by slower growth. But a lot of the other things we’ve been talking about—negative interest rates, spare capacity, unemployment—that’s more to do with getting ourselves back onto our trend path. That’s what central banks are trying to do. They’re trying to get economies back to their full capacity.

So I think there is a new normal, but I think it’s too strong to say, “Everything is up in the air and it’s all different.” Because for a young investor, the fundamental things still apply, which is risk equities offer you a premium over bonds. And for long-term investing, that’s the way you should think about it. So I think in that respect that’s still the right solution.

Jonathan Lemco: I think that’s right. One thing I would certainly add is that we anecdotally that many corporations, predominantly in the United States but elsewhere too, see a lot of these issues, negative rates being one of them, and so they’re sitting on piles of cash.

And so if you really want to spur economic growth in countries around the world, ultimately, we’re going to have to promote more and more investment, be that domestic but, in addition, also foreign investment too. That’s the ultimate answer to what incentives can we provide to bring in more investment, which in turn will promote more GDP growth? And that’s what we should be working towards.

The central bank is a portion of that. And that’s fine, a public sector institution, but we also need the private sector actively involved in promoting investment, promoting education, etc., etc. That’s how we will work our way through many of these issues.

Rebecca Katz: I was going to say this sounds optimistic. We have a question. Lori said, “Your webcast title says, ‘Is the party over?'” It sounds like you’re saying, “With the right triggers, it’s not.”

Peter Westaway: Well, I think, yes, I mean certainly the party that we went through in the years running up to the financial crisis is over. We’re no longer in a debt-fueled growth world. The world that we’ve moved into will eventually be one where growth is more subdued and belts will be tighter than they were in the past. But high unemployment and low interest rates are not here forever. But it’s just going to take a while to get back to that new normal.

Jonathan Lemco: And we have to manage expectations carefully.

Peter Westaway: Yes.

Jonathan Lemco: That’s key.

Rebecca Katz: Right, I think, you know, Terry, in Des Moines, Iowa, says, “Based on the thoughts of where we’re heading, what is your investment advice for Vanguard clients?” We talked about it a little bit with bonds. You’ve said for young investors, diversify stocks and bonds. Overall, what would we say to investors who this is quite unsettling everything we’re going through? Especially later this week the markets are quite volatile.

Jonathan Lemco: Diversification is the obvious one, and we talked about that. But keeping, and particularly for younger investors, a long-term perspective and, as best you can, detach yourself from the day-to-day changes in the markets. It’s humanly impossible in some ways, but try and not be emotionally involved in whether the market is up or down in a given day. Go on and live your life. And with the knowledge that if you’re broadly diversified and you have reason to be confident where your investments are and on a regular basis you continue to invest, the likelihood is that you’ll do well.

Will there be problems along the road? Of course, but, again, that’s the point of diversification. But keeping that long-term perspective over time and sort of trying to move on without thinking about this all the time could make a big difference.

Peter Westaway: And the other really important point, before you even think about how you’re going to invest your money, is make sure you save. Because what’s critical about this new low-interest-rate environment is in order to generate the same income in retirement as you might have done in the past, you’re going to have to save more because the compound interest just isn’t going to get you the same amount.

And that’s before you even take into account the fact you might be living longer, so you’re going to have to save even more on top of that. So it’s a slightly tough message for people. And one of the things that we hear all the time, and I’m sure it’s true here in the U.S., but our clients in Europe say this all the time is there’s this temptation because of low interest rates to start moving along the risk spectrum to start trying to grasp for higher yields, higher, riskier assets and so on because that’s the only way to generate this income.

And it might work, but it’s a risky strategy by definition. And that’s the danger, I think, that people have unrealistic expec— They don’t modify their expectations and so they think that they can just get what they would have done before.

Rebecca Katz: Are we seeing people reach for yield? Are we seeing cash flow go to a higher yield?

Peter Westaway: Yes.

Jonathan Lemco: Oh, yes, for sure.

Peter Westaway: Oh for sure, yes.

Rebecca Katz: Yes.

Jonathan Lemco: Oh, for sure. But Peter’s point on saving is really key. And there was a time not so long ago when many people working in big companies had company pensions and they built them over time and just a portion of their paycheck was taken out every week or every month or whatever it was on a regular basis. Many of these pensions, probably most, have gone away, frankly.

And you can’t be totally reliant entirely on Social Security. The likelihood is it’ll be there, but it’ll not be enormous, if you will. You’ve got to take the personal initiative. You’ve got to decide to save and to keep at it over and over again on a regular basis. I’m not saying it’s easy because it’s not, but that is the pattern that we would encourage.

Rebecca Katz: Do the things that you can control, and savings is one of them.

I know we have so many questions left it’s unbelievable, and I only have a few minutes. It wouldn’t be an international webcast, we didn’t talk about deflation, so I just want to pose a quick question about deflation from Ming. We’ve talked about that as being a concern again and again. And do a lower-interest-rate environment, negative interest rates, do we think that that increases the chance of deflation either outside of the U.S. or I know we’ve worried about it in the U.S.?

Peter Westaway: I don’t think it increases the chance of deflation, although there’s kind of a school of thought out there that says it could do. I don’t buy into that. But what I think it does is it’s a reflection of the pessimism of central bank’s ability to get inflation back up.

Now I don’t think that’s really a worry here in the U.S. or in my country, the U.K., but certainly in the euro area and in Japan, the ability of the central banks to really inflation up to the targets that they want is really, really limited at the moment.

And Japan had years of fallen prices, deflation. They had this new initiative from the new government, the Abenomics it was called. And for a while inflation picked up, but they’ve started and it’s fallen away again.

Now it’s not been a very helpful environment to get inflation up because oil prices have plummeted from $718 to below $30 for a while and that changes the headline inflation rate. But even if you look through the effect of oil prices, underlying inflation is still very weak. So I think for some of those countries like Japan, there’s a real question mark about what else can they do. Is there something really radical they can do?

Rebecca Katz: And deflation is problematic because it is tough to get out of and people are extending—

Peter Westaway: Exactly, yes. And it’s psychological.

Jonathan Lemco: Yes, exactly.

Peter Westaway: And it’s about expectation. So once people expect prices to fall, then that becomes self—

Jonathan Lemco: They put off buying and they put it off over time, and in return, the economies slip.

Peter Westaway: In the same way that back in the ’70s and ’80s high inflation was so fulfilling. The people expected 10% inflation so they got it. So it’s hard to drag expectations back to where you want it to. And, you know, what these episodes illustrate is how tough it is if you get kicked off the path.

Jonathan Lemco: It is. We live in a very interesting time where inflation is so modest around the world. A little bit of core inflation in a few countries where wages are slightly going up but only slightly. A core of, obviously, petroleum prices, food prices may be edging up a bit in selected countries, but just a little.

Inflation, which we used to worry about more than just about anything else, has mostly gone away. And central banks have been much more effective in many, many countries in managing this problem. Deflation, I’m not suggesting it’ll happen, but that’s something to be vigilant about.

Peter Westaway: And the last policy that we’ve already talked about that is being wheeled out now by many commentators as the way to get away from these deflationary policies is this thing called helicopter money, which is the idea that if you’ve done QE, you’ve done the QE interest rates; the last thing that you can do is effectively do money-financed government spending. So normally when the government spends money, they have to go out and sell bonds in order to allow themselves to spend money. But the alternative is you basically just print money in order to do that.

Now, most people’s first reaction to that is, “Well, isn’t that what they did in Zimbabwe and Weimar, Germany, in the 1920s?

Rebecca Katz: Hope we didn’t do that.

Peter Westaway: Not great. Not great models.

Rebecca Katz: We did it post–World War II here in the U.S.

Peter Westaway: A little bit, yes.

Jonathan Lemco: There’s risk of it in Venezuela right now.

Peter Westaway: Yes. So I think it isn’t complete madness. But I think the only way it could work is if you did it within the context of a well-defined inflation regime, and no one’s tried that before. And we’re not there yet, but I think we might see it in Japan. Watch this space.

Rebecca Katz: Interesting. Well, an hour went by like that, and, obviously, we’ll all be on the edge of our seats for the referendum later this week. Might have to have you back to tell us what the impacts are. I just want to leave it with you for final thoughts. We touched on a lot of things. We probably missed a few things, but, Jonathan, I’ll turn to you for any final thoughts. Anything that we didn’t cover tonight that you think is important?

Jonathan Lemco: The point I want to stress, particularly in regard to emerging markets in general, is how they’ve improved their performance in the last 20, 30 years in a way that is underreported in the press. When it comes to macroeconomic or political issues, the large majority of the countries that are now investing have provided really attractive returns now over time. And although in many cases yields have gone down a bit, they still provide, from a bond perspective especially, a nice alternative to stocks

Don’t ignore the fact that the Koreas and the Malaysias and the Indonesias and the Perus and the Colombias and so on have consistently improved in a way that we just didn’t see coming. But it’s been tremendous. And now many of these countries’ bonds are a part of many of Vanguard’s broader mutual funds.

Only other thing I would say, and it’s something we talk about a lot, is how important it is to think in the long run when you’re investing and to be broadly diversified. I’m sure Peter would address this too. So no matter what happens on Thursday with regard to the Brexit and so on. And it could be important for the markets in the short run. In the medium and longer run, our markets will be affected by all kinds of inputs, all kinds of events of which this is a very important one, but only one.

Rebecca Katz: Right. Peter.

Peter Westaway: Yes, I mean really just building on what Jonathan said, I think the temptation for investors in times like this where it appears that things are going worse than they have done in the past is to look for some other strategy that helps you get out of the problem, whether that’s putting your cash under the bed or going for high-yield bonds or buying gold bars. Or whatever it is, there’s always somebody telling you, “This is the right thing to do now.” You can time it. And, of course, with 20/20, or not 20/20, with perfect foresight, the fact that all these strategies would be great, but we don’t have that.

You know, Jonathan and I spend all day doing this stuff, and it’s really hard to know what’s going to happen next. And so, as investors, it’s really important to keep it simple and keep that long-run focus.

Rebecca Katz: Then I won’t be asking you for your predictions for the U.S.-Argentina game tonight. You don’t have that kind of foresight.

We’ll have to leave it there. It’s been really wonderful having you on. Lots of really interesting issues that I know we’ll be discussing over the coming weeks. So thank you both for the time tonight.

Peter Westaway: Thank you.

Jonathan Lemco: Thanks very much.

Rebecca Katz: And thanks to all of you for joining us this evening. As always, in a few weeks, we’ll send out a transcript of this evening’s broadcast along with video highlights from the broadcast.

And if we could just indulge you for another ten seconds, down on the bottom of our screen you see those widgets again. If you could click on the red icon, that will lead you to our survey and you can tell us what you liked about tonight’s webcast, what you didn’t like, and what you’d like to see more of in the future.

So from all of us here in Valley Forge to all of you, thanks so much for joining us and we’ll see you next time.

Important information Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk, which is the chance that political upheaval, financial troubles, or natural disasters will adversely affect the value of securities issued by companies in foreign countries or regions; and currency risk, which is the chance that the value of a foreign investment, measured in U.S. dollars, will decrease because of unfavorable changes in currency exchange rates. These risks are especially high in emerging markets.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

Investments in bonds are subject to interest rate, credit, and inflation risk.