Published: December 26 2008 20:16 | Last updated: December 26 2008 20:16
In the buzzy, scruffy warren of offices in New York from which Nouriel Roubini runs his economics aggregration and commentary website, one of the young cyber-serfs has taped a New York Post story about the boss to the chalky wall. “NYU Playboy Warns: Econ Party’s Over”, the sub-heading declares, next to a photograph of a smiling, open-shirted Mr Roubini, sandwiched between two attractive young women.
Not so long ago, the phrase “playboy economist” would have been a joky oxymoron, likely to feature in satirical lists alongside “selfless hedge fund manager” and (at least before the US surge in Iraq) “military intelligence”. But, in a sign that practitioners of the dismal science are among the few beneficiaries of the global economic meltdown, this crisis has transformed the 50-year-old New York University professor from a respected academic economist into a minor celebrity.
Mr Roubini, who offered one of the first and most nuanced predictions of the financial and economic crash, is ambivalent about the personal scrutiny his fame has attracted. After Nick Denton, founder of the Gawker website, first pointed to the contrast between the economist’s “Dr Doom” public persona and his party-going private life, Mr Roubini sent Mr Denton a Facebook message in which he declared: “I work very, very hard and I also enjoy life . . . To paraphrase Seinfeld: anything wrong with that?”
But sitting at his modest desk in the corner of an open-plan office, Mr Roubini tells me the “playboy” tag was “a gross mischaracterisation”. He said he was sometimes recognised on the street, but mostly by “geeks and wonks”. “There are not paparazzi yet,” Mr Roubini, wearing jeans, a black jacket and a deep tan that belies the miserable New York weather, says with a self-deprecating chuckle. “No one has said, ‘You have a brilliant mind’, and asked me out.”
He is keener still to debunk the view that he is a “perma-bear” whose prescient forecasts are simply a matter, as one critic has said, of even a stopped clock telling the right time twice a day. Well before his 15 minutes, Mr Roubini had amassed an armoury of intellectual credentials, earning his PhD from Harvard, working in the economics department at Yale and spending two years as a policymaker in Washington, including serving as senior adviser to Tim Geithner, then an undersecretary at the Treasury, and now President-elect Barack Obama’s choice as Treasury chief.
Moreover, Mr Roubini says it was economic analysis, rather than a gloomy cast of mind – he describes himself as a cheerful pragmatist – that inspired his bleak predictions. “This crisis was not a Black Swan event,” he argues, citing Nassim Nicholas Taleb’s book on the importance of the extreme and the unknowable. “It was more of a generalised asset and credit bubble throughout the economy . . . But whenever you are in the middle of a bubble people find ways to justify the asset prices.”
Mr Roubini’s fans – particularly in the business world, where he is now in high demand – agree. “He’s been the most right of all the economists around,” fund manager and philanthropist George Soros says. Lawrence Summers, the incoming head of Mr Obama’s National Economic Council, who was Mr Roubini’s ultimate boss at the Treasury and who has been an adviser to his website, said this autumn: “Nouriel’s great virtue is that he was right. A lot of stuff that he laid out that people thought was nuts has happened, so I give him credit.”
Mohamed El-Erian, chief executive of asset-manager Pimco, describes Mr Roubini as “brilliant” and a favourite intellectual combatant because “he is not shy to engage in discussions”. Mr El-Erian says Mr Roubini first started to develop a following in the investing community at the beginning of this decade when his website, RGE Monitor, became more widely known: “He started to look at these negative feedback loops in the economy earlier and more than anyone else I know.” Pimco rated him highly enough that in 2004 the California-based company invited him to a special meeting of its investment committee.
One of his strengths, according to Mr El-Erian, is his willingness “to think outside the box”. That iconoclasm may stem in part from Mr Roubini’s peripatetic biography. Born in Istanbul to Iranian-Jewish parents, as a preschooler he moved with his family to Tehran and Tel Aviv, before they settled in Milan when he was five. He grew up speaking Farsi at home with his parents, Italian at school, Hebrew on frequent visits to his relatives in Israel, where his parents still maintain a home, and English as his education progressed. He is now a US citizen and a resident of New York’s trendy Tribeca area. He has never married.
He describes his upbringing as that of “a true international economist”. As a self-described “global nomad”, he simultaneously feels at ease almost everywhere but never fully assimilated anywhere.
That perspective, and his youthful experience of societies in transition, helped him to see a continuity between the emerging market crises he analysed in Bailouts or Bail-ins, the 2004 book he wrote with economist Brad Setser, and looming problems in the US.
“It was almost like a natural continuation of my interest in emerging markets,” he says. “I saw that the US had very large twin deficits, a housing boom, I saw the private sector excesses . . . There were things in the US that could delay the crisis but not prevent it.”
It is a parallel that may seem obvious today. But back in the days of Francis Fukuyama’s The End of History theory, US exceptionalism and free-market triumphalism, Mr Roubini’s was definitely a minority view.
Although his former bosses from the Clinton Treasury are going back to Washington next month, he says the role of outside oracle suits him best. Like his carpet-importing father, Mr Roubini is an avid entrepreneur, as enthusiastic about the prospects for his website – he boasts about his 40 employees and offices in Hong Kong and New York – as he is about economics.
As for the future, he warns that 2009 will probably be the worst year: “I expect a global recession and a very severe one.” But he promises not to be an eternal pessimist: “In the medium term, the integration of India and China is a boon for the global economy and I think the US can fix its market, too. Maybe one day Dr Doom can become Dr Boom.”
While most of the upside in government bonds has likely already been made, we maintain our long duration call.
Aggressive monetary easing by each of the major central banks has helped fuel the rally at the long-end of the curve. While the recent drop in yields leaves most government bond markets well into overvalued territory, we are in no rush to take profits on our long duration call. Government bond prices may not have much more upside but value is not a timing tool and the growth and inflation backdrop is likely to keep yields suppressed for an extended period. However, we do advise clients to shift their long bond allocations to high quality nongovernment spread product, as we expect a significant narrowing in early 2009. We will await evidence that the global economy is beginning to stabilize, which will most likely take until the second half of 2009, before shifting further down in quality. The time-frame would move up if the Fed signaled that it would begin buying corporates in the interim. While legislation prevents the central bank from directly buying these issues, the Fed could purchase corporate bonds off balance sheet by setting up an SIV.
The FOMC clearly crossed over the line into quantitative-easing territory by cutting the fed funds target rate virtually to zero, promising to hold it low for a long period, and committing to large purchases of mortgage-related assets and possibly long-term Treasurys.
In the statement that followed, the FOMC shifted emphasis away from the target rate as the Fed's primary means of implementing monetary easing in favor of aggressively expanding its balance sheet to drive private sector borrowing rates lower. Early clues to its latest thinking were provided late last month upon the launch of its agency and MBS purchase programs and Term Asset-Backed Liquidity Facility (TALF). At that time, it promised to increase the size, the scope and the term of its liquidity facilities as necessary to get credit markets moving again. These comments were echoed in the FOMC statement, which confirms the Fed is prepared do whatever it takes to restore order to the financial system and head off a potentially damaging bout of deflation. The Fed will drive agency and agency-backed MBS yields lower, and will keep Treasurys well bid. If investment-grade corporate bond yields do not fall in the coming months, the Fed could add new facilities to support this market as well.
For Dr. Doom, a Crash Worthy of His Warnings Daniel McGinn NEWSWEEK From the magazine issue dated Jan 5, 2009
With the economy in a tailspin and the layoff tally climbing, this is a tough time to be a second-year M.B.A. student who's about to hit the job market. It may be especially tough for the students who gathered in a second-floor classroom at New York University in early December to listen to a lecture on the global economy by their professor, Nouriel Roubini. To start the class, Roubini clicked an overhead screen to show the day's economic news. "The numbers are awful," he said, referring to the latest unemployment estimates. He clicked to another piece
of data. "That's as bad as you can get," he said grimly. For the next 90 minutes, Roubini—clad in a black suit, with tousled dark hair, fingering his reading glasses as he paced the front of the classroom—discussed his 15-point plan for rebuilding the global financial system. The M.B.A.s followed closely and challenged some of his points. Nothing he said should have made them optimistic, but that's hardly a surprise: there's a reason Roubini's nickname is Dr. Doom.
Roubini, who began making dire predictions about a U.S. economic collapse back when Americans were still busy flipping condos and doing cash-out refis, has become the oracle of the financial crisis. As early as mid-2006, on his well-read blog and in speeches, he explained why the bursting housing bubble would drive an unusually severe recession. He predicted mortgage defaults would cause financial institutions to fail, and that soaring oil prices, combined with falling home prices, would cause debt-ridden consumers to dramatically cut spending. At the time, most economists were predicting a "soft landing," and even those forecasting a housing downturn didn't foresee its deep impact on the financial system. Today Roubini scoffs at their optimism. "[My view] was so obvious, I don't know how anyone could argue otherwise," he says.
Roubini was born in Turkey to Iranian parents, but spent most of his early years in Italy. He came to America in 1983 to earn his Ph.D. at Harvard and never left. During the 1990s he taught economics at Yale and NYU, but he also dabbled in policy, spending summers at the International Monetary Fund, the Federal Reserve and the World Bank; for two years he worked alongside Larry Summers and Tim Geithner in the Clinton White House and Treasury Department. During that time he began closely studying the financial collapses in Mexico, Argentina and other developing economies, eventually coauthoring a seminal book on the topic. By the late 1990s, he'd begun posting his views on a blog that became a must-read for economy watchers.
Unlike economists who rely on complex math models to do their forecasting, Roubini operates more like a meteorologist, sifting through data, watching patterns and looking for similarities to past events. By 2004, Roubini was becoming alarmed by America's "twin deficits" as both the federal budget shortfall and trade imbalance grew wider. Despite its size, he wrote, the U.S. economy was starting to resemble an emerging market on the verge of collapse. In 2006, his pessimism shifted to the overinflated housing market as the catalyst for a U.S. downturn. During this time, he recalls taking a day off from a Las Vegas conference and driving out to the desert, passing mile after mile of newly built, unoccupied homes. "They were ghost towns," he says. "If this isn't a housing bubble that's going to pop, what is?" At the time, many mainstream economists disagreed with his calls. During a debate at the IMF in 2006, Anirvan Banerji of the Economic Cycle Research Institute derided his "subjective forecasting by selective analogy to past episodes that favor his bearish views." Even now, with much of the scenario Roubini spun out proving true, other observers point to inconsistencies. "He deserves a lot of credit for warning people early on about the possibility of a severe financial collapse," says Brookings Institution economist Martin Baily. "[But] I do not think the way the crisis has happened exactly fits what he says."
Roubini says he takes no pleasure from the current economic hardship. Still, he's not saying he'd prefer to have been wrong. "You're glad in the sense that, if you're intellectually honest, you're found out to be right, [even if] you don't go around and gloat," he says. Despite his prescience, he's suffered just like the rest of us: he's remained fully invested in stock index funds through the market downturn, causing his portfolio to plummet. And he has no expectation of a quick turnaround. He thinks the recession will last until the end of 2009, with the economy contracting a severe 4 or 5 percent, and unemployment peaking at above 9 percent in 2010. Stocks have further to fall, he says, suggesting the Dow could bottom out around 7,000. He's encouraged by the incoming Obama administration's talk of a big stimulus package, though, and expresses confidence that Summers and Geithner will prove aggressive recession fighters. And though critics may dismiss Roubini as permanently dour, he says that's not necessarily so. "Eventually, when we get out of this crisis, I'll be the first one to call the recovery," he says. "Then maybe I'll be called Dr. Boom." In his view, alas, that name change could be a long time coming.
HELICOPTER BEN GOES ZIRP, QE, AND MORE... WHILE THE GLOBAL ECONOMY ENTERS STAG-DEFLATION
By Nouriel Roubini
REG Monitor
December 17, 2008
Original source: RGEM Monitor
The Fed decision yesterday to cut the Fed Funds range to 0-0.25% formalized the fact that, over the last month, the Fed had already moved to a ZIRP (zero-interest-rate-policy) -- as the effective Fed Funds rate was already close to zero -- and started a policy of QE (quantitative easing) as its balance sheet has surged over the last few months from $800 billion to over $2 trillion. And -- as discussed below -- the Fed is now undertaking even more unorthodox policy actions.
These Fed policy actions are occurring while the U.S. and the global economy is now risking a protracted bout of stag-deflation, a disease that I first discussed as early as January 2008 when I warned about the risk of a global deflation and stag-deflation. While it is now fashionable to talk about such deflationary risks –- and the latest U.S. CPI figures confirm that we are entering into deflation -– some of us were worrying about the coming deflation well before the mainstream –- concerned with short-run and unsustainable increases in commodity prices –- discovered the deflationary risks in the global economy.
It was clear to those of us that saw early on the risks of a severe U.S. and global recession that, once that recession would emerge, deflationary rather than inflationary pressures would emerge as slack in goods markets, slack in labor markets, and slack in commodity markets would emerge. So now we need to worry about stag-deflation, deflation, liquidity traps, and debt deflation. Welcome to the world of stag-deflation or, as Krugman would put it, to the world of “depression economics.”
So what is the outlook for the U.S. and the global economy in 2009? And what is the likely policy response to the risks of a global stag-deflation? Let us discuss next these two questions…
The outlook for the U.S. and the global economy is now very bleak and getting worse as the global economy is experiencing its worst recession in decades. In the U.S., recession started last December, and will last at least 24 months until next December -- the longest and deepest U.S. recession since World War II, with the cumulative fall in GDP possibly exceeding 5 percent. In comparison, the last two recessions in 1990-91 and 2001 lasted only 8 months each and in 2001 (1990-91) the cumulative fall in GDP was only 0.4% (1.3%). There is also a risk that this deep and protracted U-shaped recession (the mainstream consensus view of a V-shaped short and shallow recession is now out of the window) may morph into a more severe Japanese style L-shaped recession unless aggressive fiscal policy and recapitalization of the financial system is enacted.
The recession in other advanced economies (the euro zone, the U.K., other European economies, Canada, Japan, Australia, and New Zealand) started in the second quarter of this year, before the financial turmoil in September and October further aggravated the global credit crunch. This contraction has become even more severe since then. I don’t expect growth in the advanced economies to recover before the end of 2009.
There is now also the beginning of a hard landing in emerging markets as the recession in advanced economies, falling commodity prices, and capital flight take their toll on growth. Indeed, the world should expect a recession (growth in the -1 to -2% range) in Russia and a near recession (growth close to zero) in Brazil next year, owing to low commodity prices. There will also be a very sharp slowdown in China and India that will be the equivalent of a hard landing (growth well below potential) for these countries. In China the latest figures for electricity use, export[s,] and imports suggest that the economy is already close to the hard landing scenario of a growth rate of 5%. The deceleration of growth in China is much more rapid than expected.
Other emerging markets in Asia, Africa, Latin America, and Europe will not fare better, and some may experience full-fledged financial crises. More than a dozen emerging-market economies now face severe financial pressures: Belarus, Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania, Turkey, and Ukraine in Europe; Indonesia, South Korea, and Pakistan in Asia; and Argentina, Venezuela, and Ecuador (a country that has just defaulted on its sovereign debt) in Latin America.
How is the policy response in the U.S. and other countries to this risk of a global stag-deflation?
The Fed decision yesterday to cut the target for the Fed Funds rate to a 0% to 0.25% range is just underwriting what was already obvious and happening in reality: while the target Fed Funds was -- until yesterday -- still 1% in the last few weeks -- following the massive increase in liquidity by the Fed -- the actual Fed Funds was already trading at a level literally close to 0%.
So the Fed just formalized what was already happening for weeks now, i.e. that the Fed Funds rate was already zero and that the Fed had already moved to quantitative and qualitative easing (QE) in the form of massive increase in the monetary base and aggressive use of monetary policy -- via a range of new facilities and tools -- to reduce short term and long term market rates that are stubbornly high in a sign that the credit crunch is severe and worsening.
I predicted early in 2008 that the Fed Funds rate "would be closer to 0% than to 1%" in the midst of a severe recession. Now 12 months into this severe recession (that officially started in December 2007) -- a recession that will last at least another 12 months (if not, as possible, much longer) -- the Fed Funds rate is already down to 0% (the beginning of the zero-interest-rate-policy or ZIRP for the U.S.) and the Fed has moved into uncharted unorthodox monetary policy as a severe stag-deflation is taking place.
And, as predicted here over a month ago, the Fed is now committed to keep the Fed Funds rate close to zero for a long time (as a way to push lower long term Treasury yields), is purchasing agency debt and agency MBS in massive amount; and is even considering purchasing long-term Treasuries as a way to push lower long term government bond yields that are already falling sharply.
More aggressive policy actions may be undertaken by the Fed as a severe credit crunch shows no signs of relenting. In his 2002 speech on deflation the Bernanke spoke even of helicopter drops of money, monetizing fiscal deficits, and even buying equities. The latter actions have already been partially undertaken: the Fed is effectively already monetizing the U.S. fiscal deficits as the purchase of markets assets (agency debt and MBS and other facilities) is financed with the Fed printing presses rather than the TARP program; and now with the Fed considering the purchase of long-term Treasuries, such monetization of deficits will be made more formal. Also, since the TARP has been turned into a program to recapitalize financial institutions (and thus boost their capital and market value), the U.S. has already effectively intervened indirectly in the equity market (by partially nationalizing a good part of the U.S. financial system); once the Fed starts to buy the U.S. long-term Treasuries financing the TARP program, this indirect Fed purchase of U.S. equities will be even more clear.
While Fed actions to reduce mortgage rates -- via purchases of agency debt and agency MBS -- are partially successful, as long-term mortgage rates are falling, most of Fed purchases of private assets have been so far limited to very high-grade securities. Thus, the gap between the yield on high-grade commercial paper purchased by the Fed and the one that the Fed is not purchasing is sharply rising; ditto for the gap between agency MBS and private label MBS; also, while long-term Treasury yields are sharply falling, the spread of corporate bonds -- both high-yield and high-grade -- relative to Treasuries remains huge, as a sign of a severe credit crunch. Thus as a next step the Fed may be soon forced to walk down the credit curve and start buying private short-term and long-term securities with lower credit rating. That would mean that the Fed will take on even more credit risk than is already taking on today while purchasing illiquid private assets. But desperate times lead to desperate actions by desperate policymakers.
In the rest of the world, monetary and fiscal easing is also occurring as global policymakers are trying to prevent a global stag-deflation; but the policy response in most countries is more limited and constrained than the aggressive one of the U.S. monetary and fiscal authorities.
In the Eurozone the policy response has been extremely slow. First, the ECB is behind the curve and cutting rates too little and too late. Second, the ECB has been much less creative and aggressive than the Fed in creating new facilities to unclog the liquidity and credit crunch that is becoming as severe in Europe as in the U.S. Third, the fiscal policy stimulus in the E.U. is weak: those countries that need a stimulus the most (Italy, Portugal, Greece, Spain, U.K.) are the ones that can afford it the least given their large fiscal deficits and debts; and those who can afford it the most -- Germany -- are least willing to have it. Fourth, the recapitalization of financial institutions in Europe is occurring more slowly than in the U.S. and some of the financial firms rescue plans have been partly botched. Also, cross-border financial activities and the lack of cross-border burden sharing in the E.U. limit the ability of the E.U. to rescue large financial firms with cross-border activities. Add to this the fact that many banks in Europe are too big to fail but also too big to be rescued (large relative to the fiscal resources of their country’s government). Fifth, the structural rigidities of Eurozone (labor markets in particular) may cause the Eurozone contraction to be as severe as the U.S. one even if the initial economic and financial imbalances were less severe in this region.
While the U.S. and Japan are already into a ZIRP policy, other advanced economies’ central banks will in 2009 get very close to it, starting with those in Switzerland and the U.K. And more unorthodox monetary policies, such as QE and the other ones adopted by the Fed, may become more popular in a number of advanced economies.
In the many emerging-market economies at the risk of a financial crisis, aggressive monetary easing and fiscal easing are not likely. Indeed, many of these countries start with large fiscal deficits and debt, thus requiring fiscal discipline rather than easing. Moreover, many of these countries have large stocks of foreign currency liabilities whose real value would sharply increase if easy monetary policy leads to a sharp depreciation of their currency. Thus, there is less room for monetary easing. Also, many of these countries don’t have the fiscal resources to provide liquidity and capital to their financial institutions that are now facing a sudden stop of capital inflows. The international community -- IMF programs, World Bank [and] other IFIs' financial support, and the Fed/ECB with their swap lines -- can help countries under distress as long as they implement appropriate policy changes, but the risks of outright financial crises remain in some of the weakest economies.
In China -- which is now at risk of a severe hard landing -- it is not clear whether the aggressive fiscal and monetary/credit easing will be able to prevent a hard landing. Can aggressive monetary/credit and fiscal policy easing prevent this hard landing? Not necessarily. First, note that China has already reduced interest rates three times in the last few months and eas[ed] some credit controls. But monetary and credit policy easing may be ineffective: if capex spending by the corporate sector starts to fall sharply as the fall in next exports leads to a sharp fall in the expected return on new capital spending on exportables, a reduction of interest rates and/or an easing of credit controls will make little difference to such capex spending: easing money and credit will be like pushing on a string as the overinvestment of the last few years has led to a glut of capital goods. There is indeed already evidence [for] that, but corporate loan demands have diminished sharply while commercial banks have hesitated to lend while choosing to firewall risks. The government can ease money and credit, but it cannot force corporat[ions] to spend and banks to lend if loan demand is falling because of low expected returns on investment.
Could fiscal policy rescue the day and prevent a Chinese hard landing? The optimists argue yes by pointing out that fiscal deficits and public debt are low in China and that China has the resources to engineer a rapid fiscal stimulus in a short period of time. But the ability of China to implement a rapid and massive fiscal stimulus is limited, for a variety of reasons. First, the combined effects of natural disasters, social strife in the West, and the Olympics have created a large hole in the central government budget this fiscal year. The Ministry of Finance may have dipped into various stabilization funds to avoid the appearance of running a large deficit. For regional and municipal governments, the decline in turnover in local property markets has reduced the flow of fees and taxes, causing them to delay ambitious industrial development plans, in some cases. Second, a hard landing in the economy and in investment would lead to a sharp increase in non-performing loans of the -- still mostly public -- state banks; the implicit liabilities from a serious banking problem would then add to the implicit and explicit budget deficits and public debt. Note that the poor quality of the underwriting by Chinese banks -- which financed a huge overinvestment in the economy -- has been hidden for the last few years by the high growth of the economy. Once net exports go bust and real investment sharply falls, we will see a massive surge in non-performing loans that financed low return and marginal investment projects. The ensuing fiscal costs of cleaning up the banking system could be really high. Third, as pointed out by Michael Pettis -- a leading expert of the Chinese economy -- a surge in tax revenues in last four years has been more than matched by the surge in spending, so that if revenue growth diminishes/reverses, it might not be easy to slow spending growth proportionately. Contingent liabilities from non-performing loans could also reduce resources available for a fiscal stimulus.
In summary, with traditional monetary policy becoming less effective, non-traditional policy tools aimed at generating greater liquidity and credit (via quantitative easing and direct central bank purchases of private illiquid assets) will become necessary in many advanced economies. And while traditional fiscal policy (government spending and tax cuts) will be pursued aggressively, non-traditional fiscal policy (expenditures to bail out financial institutions, lenders, and borrowers) will also become increasingly important in these advanced economies.
In the process, the role of states and governments in economic activity will be vastly expanded. Traditionally, central banks have been the lenders of last resort, but now they are becoming the lenders of first and only resort. As banks curtail lending to each other, to other financial institutions and to the corporate sector, central banks are becoming the only lenders around.
Likewise, with household consumption and business investment collapsing, governments will soon become the spenders of first and only resort, stimulating demand and rescuing banks, firms, and households.
The long-term consequences of the resulting surge in fiscal deficits are serious. If the deficits are monetized by central banks, inflation will follow the short-term deflationary pressures; if they are financed by debt, the long-term solvency of some governments may be at stake unless medium-term fiscal discipline is restored.
Nevertheless, in the short run, very aggressive monetary and fiscal policy actions -- both traditional and non-traditional -- must be undertaken to ensure that the inevitable stag-deflation of next year does not persist into 2010 and beyond.
Published: December 2 2008 19:53 | Last updated: December 2 2008 19:53
The US and the global economy are at risk of a severe stag-deflation, a deadly combination of economic stagnation/recession and deflation.
A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labour costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation.
Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high – despite policy rates close to zero – leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors’ problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions.
As traditional monetary policy becomes ineffective, other unorthodox policies have been used: massive provision of liquidity to financial institutions to unclog the liquidity crunch and reduce the spread between short-term market rates and policy rates; quasi-fiscal policies to bail out investors, lenders and borrowers. And even more unorthodox “crazy” policy actions become necessary to reduce the rising spread between long-term interest rates on government bonds and policy rates and the high spread of short-term and long-term market rates (mortgage rates, commercial paper, consumer credit) relative to short-term and long-term government bonds.
To reduce the former spread the central bank needs to commit to maintain policy rates close to zero for a long time and/or start outright purchases of government bonds; to reduce the latter it needs to spread massive liquidity, such as by direct purchases of commercial paper, mortgages, mortgage-backed securities (MBS) and other asset-backed securities. The Fed has already crossed that bridge with facilities that are aimed at reducing short-term market rates, such as Libor spreads; it has now moved to influence long-term mortgage rates by buying MBSs.
Traditionally, central banks are the lenders of last resort but they are becoming the lenders of first and only resort, as banks are not lending. Central banks are becoming the only lenders in the land. With consumption by households and capital spending by corporations collapsing, governments will soon become the spenders of first and only resort as fiscal deficits surge.
The financial crisis has already become global as financial links transmitted US shocks globally. The overall credit losses are likely to be close to a staggering $2,000bn. Thus, unless financial institutions are rapidly recapitalised by governments the credit crunch will become even more severe as losses mount faster than recapitalisation.
But with governments and central banks bringing private sector losses on to their balance sheets, fiscal deficits will top $1,000bn for the US in the next two years. The Fed and the Treasury are taking a massive amount of credit risk, endangering the long-term solvency of the US government.
In the next few months, the flow of macroeconomic and earnings news will be much worse than expected. The credit crunch will get worse, with deleveraging continuing as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, leading to further cascading falls in prices, other insolvent financial institutions going bust and a few emerging market economies entering a full-blown financial crisis.
The worst is not behind us: 2009 will be a painful year of a global recession, deflation and bankruptcies. Only very aggressive and co-ordinated policy actions will ensure the global economy recovers in 2010 rather than facing protracted stagnation and deflation.
The writer is professor of economics at the Stern School of Business, New York University, and chairman of RGE Monitor, an economic consultancy
Central banks around the world have undertaken a number of measures to forestall deflation and lift the global economy out of economic slump and credit crisis. Aside from traditional monetary policy tools such as official interest rate cuts and relaxations in reserve requirements, central banks have resorted to alternative unconventional tools. Quantitative easing has begun in the epicenters of the credit crisis, U.S. and Europe, who may be joined by other central banks as they too head towards zero interest rates in leaps and bounds (Sweden moved the most in the developed world by 175bp in one shot). With monetary policy transmission broken by the unwillingness of the private sector to lend or borrow, central banks have had to scurry for alternatives to rate cutting in order to restore markets. They set up an alphabet soup of liquidity facilities that lend funds or purchase assets, offered guarantees on deposits and loans, and established currency swap lines, in addition to a host of fiscal stimulus packages announced by governments. Check out “Policy Responses to the Global Credit Crisis”
The founder of bond giant Pimco warned of a subprime contagion back in July 2007.
While 2008 will probably be best known as the year that global stock markets had their values cut in half, it was really much, much more. It was a year in which every major asset class - stocks, real estate, commodities, even high-yield bonds - suffered significant double-digit percentage losses, resulting in the destruction of over $30 trillion of paper wealth. To blame this on subprime mortgages alone would be to dismiss an era of leveraging that encompassed derivative structures of all types, embodying a belief that economic growth was always and everywhere a certainty and that asset prices never go down. As 2008 nears its conclusion, we as an investor nation have been forced to face a new reality. Wall Street and Main Street are fearful that a recession may be replaced by a near depression.
The outcome essentially depends on the ability of the Obama administration to rejuvenate capitalism's "animal spirits" by substituting the benevolent fist of government for the now invisible hand of Adam Smith. Federal spending and guarantees in the trillions of dollars will be required to fill the gap created by the deleveraging of private balance sheets. In turn, lenders and investors alike must begin to assume risk as opposed to stuffing money in modern-day investment mattresses. The process will take time. Twelve months of the Obama Nation will not be sufficient to heal the damage of a half-century's excessive leverage. The downsizing of private risk positions - replaced by government credit - will also result in reduced profit margins and a slower rate of earnings growth after the bottom is reached.
Investors need to recognize these titanic shifts in market and public policies and be content with single-digit returns in future years. Perhaps the most lucrative pockets of value are in high-quality corporate bonds and preferred stocks of banks and financial institutions that have partnered with the government in programs such as the Troubled Assets Relief Program (TARP). While their profitability may be restricted, their ability to pay interest and preferred dividends should be unhampered. Above all, stick to high-quality companies and asset classes. The road to recovery will be treacherous.
Dow 4,000. Food shortages. A bubble in Treasury notes. Fortune spoke to eight of the market's sharpest thinkers and what they had to say about the future is frightening.
1 of 8
Nouriel Roubini
Known as Dr. Doom, the NYU economics professor saw the mortgage-related meltdown coming.
We are in the middle of a very severe recession that's going to continue through all of 2009 - the worst U.S. recession in the past 50 years. It's the bursting of a huge leveraged-up credit bubble. There's no going back, and there is no bottom to it. It was excessive in everything from subprime to prime, from credit cards to student loans, from corporate bonds to muni bonds. You name it. And it's all reversing right now in a very, very massive way. At this point it's not just a U.S. recession. All of the advanced economies are at the beginning of a hard landing. And emerging markets, beginning with China, are in a severe slowdown. So we're having a global recession and it's becoming worse.
Things are going to be awful for everyday people. U.S. GDP growth is going to be negative through the end of 2009. And the recovery in 2010 and 2011, if there is one, is going to be so weak - with a growth rate of 1% to 1.5% - that it's going to feel like a recession. I see the unemployment rate peaking at around 9% by 2010. The value of homes has already fallen 25%. In my view, home prices are going to fall by another 15% before bottoming out in 2010.
For the next 12 months I would stay away from risky assets. I would stay away from the stock market. I would stay away from commodities. I would stay away from credit, both high-yield and high-grade. I would stay in cash or cashlike instruments such as short-term or longer-term government bonds. It's better to stay in things with low returns rather than to lose 50% of your wealth. You should preserve capital. It'll be hard and challenging enough. I wish I could be more cheerful, but I was right a year ago, and I think I'll be right this year too.
Tech Ticker (Dec 4, 2008): 2009 Recession Will Be Severe: 'There Is a Global Deflationary Risk,' Roubini Says (click for video)
From Tech Ticker: 2009 Recession Will Be Severe: 'There Is a Global Deflationary Risk,' Roubini Says
Central bankers around the world are pulling out all the stops in order to combat a severe economic downturn that threatens to get even worse."There is a global deflationary risk," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor. "That's what central bankers are worried about."In Europe today, the ECB and Bank of England slashed rates by greater than expected levels. Meanwhile, the Fed and Bank of Japan are taking "unorthodox actions" to pump liquidity into their economies. Both central banks are engaged in "quantitative easing," meaning rates are effectively zero regardless of what the official policy is."The Fed is trying to preemptively avoid a deflation trap [which] is very dangerous," Roubini says. "Whether they'll be successful or not, I don't know."The problem, he says, is there's going to be a "severe recession" both in the U.S. and globally in 2009. That means falling demand for goods and increased slack in the labor markets. That will put further downward pressure on prices and raise the risk of outright deflation, which is defined as: A persistent decline in general price levels, typically accompanied by a severe contraction in employment and economic output."It's hard to undo the structural factor" of falling demand meeting a supply glut of goods and services, he says, recommending the following policy actions to try and stem the deflationary tide:
A "huge" fiscal stimulus package: $500-$700B.
Recapitalize the banks faster, i.e., get TARP money distributed sooner.
Rather than focusing on mortgage rates, reduce the face value of debt owed by "insolvent homeowners" in order for them to be able to spend again and avoid a "tsunami of foreclosures."
Tech Ticker (Dec 5, 2008): Dr. Doom Foresees Much More Pain: So Why Is Roubini's 401(k) All in Stocks? (click for video)
Dr. Doom Foresees Much More Pain: So Why Is Roubini's 401(k) All in Stocks?
Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor, has earned the nickname "Dr. Doom" for his dire predictions about the economy over the last couple of years (most of which have come true).So it was a shocker when word got out on Wall Street that Roubini was the most bullish guy in the room at a recent dinner he hosted in NYC. There were even rumors Roubini's retirement account was 100% in stocks (since confirmed).Has Dr. Doom become a raging bull?Not quite. But with the financial meltdown in full, protracted swing, it seems as if the rest of the world has caught up with him."The mainstream is getting closer to my views about a very severe U.S. and global recession," he says. "On the other side, I'm not in the Armageddon camp," forecasting a severe recession through 2009, but not a repeat of the Great Depression.So why is Roubini's 401(k) 100% in equities? He's not an active investor, and "over 10 to 20 years equities outperform any other asset class," he says in the accompanying video.Unlike so many others, Roubini's not calling a bottom, for sure: He sees another 20%-30% downside risk for stocks, and advises that investors avoid all "risky assets," including commodities for the foreseeable future. Instead, he recommends Treasuries and, over the medium term, corporate debt.In case you need further proof that Dr. Doom hasn't lost his edge, Roubini predicts that macroeconomic news and earnings will be much worse than expected in the coming months, as the dollar weakens even further. "The surprise is how bad the the economy [will get]."At least there's some things you can still count on in an uncertain world.
Tech Ticker (Dec 5, 2008):'Massive Destruction of Capital': Roubini Sees $3T in Bank Losses, More Bailouts (click for video)
From Tech Ticker: 'Massive Destruction of Capital': Roubini Sees $3T in Bank Losses, More Bailouts
It's gotten to the point where you can't tell the bailout programs without a scorecard, so here goes (with a nod to Fox's Brian Sullivan):
TARP: Troubled Asset Relief Program. This is the Treasury's big $700 billion ($850B including pork) program that has been used to prop up financial institutions.
TAF: Term Auction Facility (or TAFfy). Program by which the Fed auctions funds to financial institutions — allowing them to use their toxic assets for collateral.
TALF: Term Asset-Backed Lending Facility (or "son of Taffy"). Recently announced Fed program designed to help the market for student, auto and other consumer loans.
CPFF: Commercial Paper Funding Facility. Buys commercial paper directly from corporations.
AMLF: Asset-Backed Money Fund Lending Facility. Fed program designed to buy short-term paper (including commercial paper) to prevent money market funds from "breaking the buck."
TSLF: Term Securities Lending Facility. Fed program that lets banks swap bad mortgage and other debt from their books in exchange for Treasuries.
SLF: Special Lending Facilities. Originally designed to loan money to fund JPMorgan's purchase of Bear Stearns in March. Also used to back AIG's balance sheet to avoid total collapse.
PDCF: Primary Dealer Credit Facility. This is the Fed program that allowed broker/dealers and other non-banks to tap the Fed's discount window (back when there were independent broker/dealers).
"Desperate times call for desperate policy actions," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor.
Roubini, who predicted the government would need to do many of the programs above long before they were announced, says there are "much more" bailouts and related programs ahead. "We are facing the risk of global deflation," he says (as discussed in more detail here). "The risk is if [policymakers] do too little you end up in a serious depression."
Although concerned there is "some government giveaway" happening, Roubini's big worry is the TARP funds are not being dispersed quickly enough to recapitalize the banks, which he forecasts will ultimately suffer credit losses approaching $3 trillion. This is a "massive destruction of capital," says the famously bearish economist. "If you don't recapitalize the banks, the credit crunch will be much, much worse."
Tech Ticker (Dec 4, 2008): Roubini: Bail Out the Automakers, But Only on These Conditions...(click for video)
From Tech Ticker: Roubini: Bail Out the Automakers, But Only on These Conditions...
Congress should approve a bailout of the U.S. auto industry because the "collateral damage" of their failure would be "very severe," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor."We're spending $2 trillion to bail out financial institutions," the economist notes. "What's the fairness of not giving say $50 billion of low interest loans to automakers to help them restructure?But Roubini is no ally of the auto industry CEOs currently making their case in Congress. He says any government aid must be "highly conditional" and only occur after a prepackaged bankruptcy that includes:
Replacement of current management
Concessions from both the UAW and automakers
A wipeout of existing equity and debt-holders
Temporary nationalization of the auto industry
The appointment of a "car czar" is clearly a touch subject but Roubini says those worried about moral hazard and issues like free enterprise are fighting the last war.
"There's already massive amounts of government intervention in the economy, we've [crossed] that bridge," he says. "The question now is, what are we doing to do right? If it takes an auto czar to really structure these firms, so be it."
The Fed will now target lower private sector borrowing rates, which is a critical step in mitigating the economic downturn and the credit crunch.
The Fed announced earlier this week the creation of the Term Asset-Backed Securities Loan Facility (TALF), which will lend up to $200 billion to holders of AAA-rated ABS backed by newly and recently originated consumer and small business loans. The Fed also will purchase up to $100 billion in GSE debt, and up to $500 billion in GSE-backed MBS, steps similar to those we indicated were imminent in BCA's fixed-income bulletins. There is little hope of an economic recovery when the cost of borrowing to the private sector is prohibitively high, so these Fed measures are crucial. In particular, the authorities must target lower mortgage rates to support the housing market. The Fed's purchase program may need to grow, but is an important step. No doubt, banks will remain under pressure to deleverage for some time and lending standards will remain tight. However, risk aversion should moderate and the severe credit crunch should ease if investors see lower private sector borrowing rates and some improvement in final demand via fiscal stimulus. Bottom line: Investors should be positioned for a tightening in high-quality spreads, especially U.S. agencies and MBS.
A deflation scare will grip the developed world over the next 12-24 months.
Our research on past real estate bear markets and subsequent banking sector stress (throughout Europe, the U.S. and Japan) highlights that these episodes always lead to a recession, followed by a multi-year period of sub-par growth (i.e. negative output gap). In turn, excess supply helps dramatically drive down core CPI inflation in the years that follow. Granted, it could be argued that the previous episodes occurred during a period of strong structural disinflationary trends, thereby amplifying the magnitude and duration of the decline in price pressures. Nonetheless, core CPI inflation is likely to drop sharply throughout the G7 over the next 12-24 months, to lows at least comparable to the 2003 deflation scare. In turn, it is likely that the U.S. prints very low positive or even mildly negative headline CPI numbers, given the drag resulting from the recent plunge in food and energy prices. Headline inflation is less likely to turn negative in Europe given the rigidity of the price structure but a deflation scare similar to the U.S. earlier this decade is likely. The implication is that policymakers will continue to ease aggressively and then stay on hold for an extended period, benefiting our long duration call. While the longer-term consequences of such actions may be inflationary, government bond yields will adjust lower in the near term.
Merrill Lynch: We introduce a proprietary indicator to monitor this cycle as it unfolds. In contrast to the developed world, BRICycle shows that this is still a mid-cycle slowdown, not a recession. The BRIC walls are about to be hit by the effects of the credit crunch. The outlook for exports is terrible and for credit growth is cloudy. Yet emerging markets have some tricks up their sleeves and can help stabilize the global economy. BRIC consumption alone contributed 110bp to global growth this year, against 20bp from US consumption. There is a lot more to come, in our view. Wage growth remains high, consumers underlevered and policies supportive. The global economy is intensifying its process of rebalancing. 78% of global growth is now coming from emerging markets, rising to 88% next year. Regionally, Brazil and India are currently the most resilient BRICs, with China and Russia showing signs of a slowdown
Morgan Stanley: We have composed annual increases in official reserves into trade balance, FDI flows and everything else. Everything else’ could include portfolio flows,remittances, loans and any other type of capital flows.The presumption here is that the more a country is reliant on this last category of flows, the more vulnerable the currency is, in an environment of abating capital inflows. Looking at the BoP positions of the BRIC economies, a prospective decline in capital flows into EM might be most damaging for the INR and least so for the CNY. RUB looks somewhat better positioned than BRL. Thus, CNY > RUB > BRL > INR
BRIC economies should see solid growth in 2008 although performance will not be as good as in 2007 – 2Q08 growth remained strong but some slowdown is expected among other challenges
DB: If anything, most if not all BRIC countries currently seem to be at risk of overheating. While all are growing strongly, unless Brazil and Russia experience a productivity revolution, their economic growth rates will remain way below China’s and India’s.
Goldman Sachs: Solid but not spectacular growth among BRICs will still be extremely helpful as we estimate the BRICs will contribute close to 50% of total global growth in both 2008 and 2009, as opposed to only 30% back in 2006
Performance of BRICs exports varies: Brazil and Russia continue to see some significant gains y/y but mostly on the back of sharp price increases in commodities, while volume slowed in Russia and is actually negative in Brazil. China export growth remains high but is starting to slow while Indian exports are growing slower.
Domestic demand remains quite strong in all of the BRIC economies although some signs of moderation can already be seen. As a consequence, imports will continue to play a crucial role, supplying local production. Overall, import growth will remain high especially driven by the sharp increase in commodity prices
Inflation is a global threat and it is not different for the BRIC countries. The inflation outlook and the response to the worsening inflation is nonetheless different among those countries – Russia has the highest inflation figures and the least enforcing response, while Brazil has the lowest inflation figures with the most austere monetary policy response.
Russia headline CPI at 15.1% is the top among many EME, followed by India (+8.2%), China (+7.7%) and Brazil (+5.6%).
Russia: Inflation is the highest since 2002 with food prices way above earlier readings. High capacity utilization and low unemployment as well as negative real interest rates (-5.0%) might postpone any fast conversion of inflation readings
China: Inflation figures already fell back slightly but more monetary tightening – including revaluation of the CNY would be needed to control inflation.
India: Central bank cut the repo rate, more easing is expected.
Brazil: Highest real interest rate among the BRICs and the most protracted tightening, it is expected to be the least vulnerable to the inflationary pressures.
On long-term trends:
The rapid rise of the BRIC economies bears similarity to the post-war high-growth period of Japan and Korea. Comparing with these countries, China seems to be at an advanced stage of development. India, though a few steps behind China, is poised to follow a similar growth path. With a much higher income per capita than India and China, Russia and Brazil are ahead in the development stage (Goldman Sachs)
We have used the penetration rate of refrigerators and TV sets to gauge how the standard of living has changed and, most importantly, what section of the population benefited from the rapid growth witnessed in the past decade:
1) It seems that the gap in living standard between the urban and rural populations has decreased since the mid-1990s, indicating that high growth did penetrate in the rural areas
2) Comparing the BRIC economies, it is not surprising that Brazil and Russia's refrigerator penetration rates are higher than that of India and China. However, it seems that China has caught up with Brazil in the past decade. India is strikingly behind the rest of the BRICs again suggesting that it is probably the BRIC that is most behind in its stage of development
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