- Nouriel Roubini - Article summarizing the US and global economic outlook
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Article summarizing the US and global economic outlook
Nouriel Roubini | Mar 22, 2009
Here is below an English translation of an article in the Italian financial newspaper Il Sole 24 Ore that summarized a presentation about the US and global economy and financial markets that I recently made in Italy:
Whoever dares to ask Dr. Doom- Nouriel Roubini - if the crisis has reached its bottom, if the worst is behind us, must also have the courage to hear his answer that can be summed up in two letters, an predictably "no". According to the professor of economics at New York University, which now enjoys an undisputed reputation worldwide for having predicted well in advance and with an accurate analysis the crisis that has brought the world to its knees, the markets have yet to discount other bad news: he is of the view - in truth he is not the only - that the rise in stock markets in the last few days are a temporary "bear market rally” with more contraction ahead. However, in an intense presentation held yesterday in Milan at a meeting organized behind closed doors by Calyon Crédit Agricole, Dr. Doom gave a glimmer of hope: "there is possibly light at the end of the tunnel," he said, although with close teeth. That bottoming out however requires a number of conditions: it requires governments and central banks of the countries most affected by the worst recession since the Great Depression of 1929 – the United States, European Union, China and Japan in the first place - "to adopt anti-crisis measures that very aggressive and front loaded". What has been implemented so far, in terms of fiscal stimulus and monetary policies, including unconventional policies, is not enough. The severity of the crisis is such – “the world economy in danger of falling into the abyss of a near depression" to put it as Roubini says it - that resolving this crisis requires major policy efforts and timely and bold decisions by the governments. Here is a summary of the Doom-thinking on the major open questions that are most relevant to the markets as of 20 March 2009.
Banks The "good news" for Dr. Doom is that after the failure of Lehman Brothers the systemic risk associated with further disorderly bankruptcies of major financial institutions has been reduced: the countries of the G7 and the European Union have admitted that letting Lehman in a disorderly way was a mistake "and promised that they will do everything possible to prevent an event of this scale happening again”. According to Roubini guarantees for deposits and for new borrowing of banks and the recapitalization of banks with public capital are positive developments. However, according to Roubini, much more remains to be done: many American and British banks are still unstable, near insolvent and many institutions will have to temporarily "nationalized"; this will be the proper way to "clean up their balance sheets." Roubini recommends that the State takes the task of cleaning up the balance sheets of insolvent banks, by taking them over and then separating good and bad assets. You can also expect more bad financial news from banks, insurance companies, hedge funds and even by countries that have committed similar policy mistakes as in Iceland: highly leveraged and troubled institutions will be forced to sell illiquid assets into illiquid markets, thus triggering new lows in global stock markets.
Speaking of toxic securities, Roubini said, because its estimates on the losses of the banking system worldwide (3,600 billion dollars) are worse than those of the IMF (2,200 billion) because the IMF estimated the losses based on current delinquencies and charge off rates while Roubini forecasts are based on projections of what losses will be at the peak in a year from now in a reasonable macro scenario. Dr. Doom prefers the Swedish model of cleaning up banks because the Japanese model, "keeping alive zombie banks," turned out a failure that prolong the depression. Finally, among the short-term initiatives that can help to resolve the crisis Roubini discussed appropriate forms of a suspension of mark-to-market accounting and the temporary easing of capital requirements of banks.
Recession: V or U or L Dr. Doom had already foreseen a long and protracted U-shaped recession for the world economy when the prevailing view was of a short and shallow V-shaped recession for the US. Roubini yesterday made it clear that his estimate for the length of the recession in the U.S. is moving from 24 to 36 months, with an unemployment rate in the U.S. that is heading towards 10%. Its "U" in the meantime is worsening day by day. "If the Obama Administration and the rest of the world will not intervene in drastic manner, with anti-crisis fiscal and other policies even stronger than those announced, the" U "is likely to turn into a" L ", i.e into a near-depression." The forecasts by Roubini about the global economy are bleak. "Do you remember the saying that when the U.S. sneezes, the world catches a cold. Well now the United States have a severe chronic case of pneumonia." Why does Roubini sees a gloom on a global scale and does not believe in "decoupling" (according to which Europe and other economies can grow without following the U.S. in its recession)? Yesterday, he argued that excesses of leverage also existed in many countries outside the US: the "too much" leverage (excessive borrowing of households to purchase homes and/or auto loans, student loans, and broader consumer credit) was prevalent also in the UK, Spain, Ireland, Iceland, some Baltic states, Emerging, Europe, Dubai, etc. According to Roubini, if the growth in China slows from 10% to 5% as likely this year that is a "hard landing" for China.
Another source of vulnerability for the world – according to Roubini - is the risk of financial and currency crisis that is affecting a number of emerging countries in Europe: Latvia, Estonia and Lithuania, Pakistan, Korea, Indonesia, Venezuela and Ecuador were all been mentioned yesterday. For all these reasons the forecasts of Dr. Doom on the likely contraction of the global economy in 2009 have deteriorated from -0.5 to -1.2 percent. "In other times the world growth below the threshold of +2.5% was bad news as that is the signal of a global recession."
Break the vicious circle There may be light at the end of the tunnel according to Roubini if the right policies are undertaken. Governments and central banks should commit to "break the vicious circle", the lack of confidence that is hindering real investment spending by companies that are solvent and that is leading sound households not to spend. What must be avoided is a situation where small, medium and large-sized solvent firms fail because of the lack of credit, i.e. the liquidity and credit crunch that hurts even sound enterprises unable to roll over their debts. Firms are reacting to the falling demand by investing less and reducing production and unemployment as their goal is to survive the crisis by saving cash. But the loss of jobs or the risk of becoming unemployed restrains the consumption of households. In this scenario, Roubini points out that banks that are under-capitalized, as many are, are being forced to reduce their risks and thus provide even less credit. And it is in this area, the NYU professor, that governments and central banks can play a crucial role with interventions to assist small and medium sized enterprises and households at risk of going bankrupt because of the lack of credit; therefore, government guarantees of lending and recapitalizations of banks can help. In short, governments and central bank are the only agents who take actions to prevent a worse recession. “Partially socializing the losses of banks, firms and households, transferring to the public sector the losses of the private sector will be very expensive public debt-wise; but it is the policy medicine that can help an L-shaped near depression" in the words of Roubini.
Deflation and inflation Roubini argues that one should not be concerned about future high inflation. As he explains. "If a patient comes into the emergency room and is in a coma fighting to survive, I simply don’t believe that doctors in such a situation should be concerned about the diet of the patient and tell him to first exercise, go on a diet and lose weight if he is overweight, or first to convince him to stop smoking: first of all you need to do something immediate to prevent the patient from dying." Well, a recession that threatens to turn into a depression that is like a near death experience for the global economy: and that is why Dr. Doom (who during the conference yesterday he spoke of a small but rising risk of collapse of the global economy and the risk of a global depressionary catastrophe) urges governments and central banks to focus on the risk of deflation. Prices will fall because firms have an over-supply of unsold good that they will try to dispose of by reducing prices. Roubini also argues that commodities prices, despite recent decreases (even by 60% for oil), may drop further, fueling the deflationary pressures. He sees "more downside risk" for oil and gold prices. As demand and consumption falls below production, prices fall and firms cut back production and employment leading to another round of falling demand; this is the vicious circle that governments need to prevent.
The role of central banks Having mentioned the specter of a "liquidity trap," Roubini argued yesterday that policy rates dow to zero and quantitative easing (creating base money through the purchase of securities in the market) is necessary but not sufficient. According to Dr. Doom central banks must do more. So far they have done too little too late. Their goal should be to reduce market credit spreads that right now are so high that they are pricing the risk of a depression. The fact high yield spreads of corporate bonds are 2,000 basis points above Treasuries is likely excessive. According to Roubini, given the likely rate of defaults and recovery rates in case of bankruptcy short of a depression outcome, a 2,000 basis points spread implies that high yield corporate bonds are cheap. But the high yield bond market is frozen. That is why central banks consider buying some private assets with greater credit risk; "while this would increase the risks on the central banks balance sheet this is necessary to reduce the excessively high market spreads." As for the ECB, Roubini is critical of this central bank as it has done too little too late to reduce its policy rate (that is still a long way from the zero bound in the Eurozone) and is still behind the curve in considering and implementing quantitative easing. The objective should be to ease the credit crunch with unconventional monetary policy actions and new tools. The risk of inflation from such aggressive easing is so far minimal: in spite of aggressive base money increases the money and credit multiplier has sharply fallen and the quantitative easing has not – so far – increased credit significantly.
The dollar and Treasury bondsRoubini yesterday expressed aloud what everyone thinks: that the United States would like a weak dollar, the Eurozone a weak euro, Japan a weak yen, China a weak yuan, and Switzerland a weak Swiss franc, each as a way to boost their sagging exports and growth. But this is not possible as all currencies cannot be weak relative to each other. So, what is the prediction of Dr. Doom for exchange rates? Without going into much detail, the argument was this: the only true "AAA" assets in the real world at the moment are US Treasurie. Many previous "AAA" securities issued by banks, industrial companies, as well as those in securitized products, and even those of sovereign states that are shaky like some in the Eurozone, are not true AAA or have been massively downgraded. And if risk-averse investors are still looking for really safe investments, with the highest rating "AAA" they have little choice but that of U.S. Treasuries. Also, even if the Administration Obama fiscal deficits floods the market for government bonds denominated in U.S. dollars, a large proportion of this issuance will be purchased by the Federal Reserve thus keeping rates low. All this means that the U.S. dollar is – in relative terms – still a safer choice for risk averse investors. In the medium term, the dollar will need to depreciate - according to Roubini – but it will not experience an outright collapse because "this weakness is not a trend."
Global Current Account Imbalances The ideal scenario for the future of the global economy is – according to Roubini - is a more balanced global economy where the US consumes less and exports more reducing its trade deficit, while the Chinese, Japanese and German economies reduce their trade surpluses and rely more on domestic demand as a source of growth. Also, although it will take time governments that have increased their fiscal deficit to GDP ratio and their debt to GDP ratio with draconian anti-crisis stimulus packages will have to restore fiscal discipline to ensure medium terms fiscal sustainability. Roubini argued that saving the world and preventing a depression will have a high fiscal cost:"there is no free lunch”. The cost of the rescue will be steep and fiscal deficit bill will come eventually due when governments will have to increase taxes and/or reduce government spending to service their higher stock of public debt. But, according to Dr. Doom, there is no alternative: "in the long run we may all be dead – to paraphrase Keynes – but in the short run it is more important to avoid by any means an early near-death of the global economy."
http://www.rgemonitor.com/roubini-monitor/256108/article_summarizing_the_us_and_global_economic_outlook
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.”
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