The world, as Roubini sees it

Business Times - 25 Jun 2011

The world, as Roubini sees it

It's not a pretty picture - 2011 has so far been a 'good' year for any prophet of doom. The renowned economist discusses what else could go wrong

By VIKRAM KHANNA
ASSOCIATE EDITOR

NOURIEL Roubini, who predicted - in astounding detail - the 2008 global financial crisis, is the new 'Dr Doom' among economists. He also probably represents the closest an economist can come to being a rock star.

Although he still has the demeanour of a slightly dishevelled academic (he is professor of economics at New York University's Stern School of Business, currently on sabbatical), he is a celebrity, chased by the media and sought for speaking engagements.

He spends most of his time roaming the globe, consulting with clients, which include governments, corporations and hedge funds. He is booked for breakfasts, lunches, dinners and even teas. He writes his columns (which appear on his website, RGEMonitor.com and are also syndicated to newspapers) on long-distance flights. He has people to handle his schedule of appointments.

At a recent roundtable discussion over tea with some 20 financial industry people at the Bloomberg offices in Singapore, Professor Roubini was in his element. He spoke for some 90 minutes, non-stop, without notes and with the fluency of an actor delivering his lines. He covered a vast amount of territory, alerting his audience to current crises and potential crises across the world.

Flood of negative news

2011 has so far been a 'good' year for any prophet of doom, given the flood of negative news: the turmoil in the Middle East; the earthquake and tsunami in Japan; the debt woes of Greece, Ireland and Portugal; concerns of a renewed economic slowdown in the United States; rising inflation in Asia; and unrest in China. Any or all of these problems could get worse.

But Prof Roubini prefers to begin on a positive note. Some good things have happened post-crisis, he points out. Output in the major economies has recovered to pre-crisis levels. The tail risks of a double- dip recession in the United States and a disorderly collapse of the eurozone are lower than a year ago. High-grade companies have strong balance sheets, and are sitting on some US$2 trillion in cash. If they get more confident, they will spend more on capex, hiring and acquisitions, and may even become engines of a growth revival.

The world is witnessing the secular rise of emerging economies - not just China and India, but also countries in Latin America, Eastern Europe and Africa, as well as the oil-rich Middle East.

An illustration of how much less skittish and panicky the markets, at least, have become: last year, the problems in Greece, which accounts for barely 2 per cent of eurozone GDP, triggered an equity market correction of almost 20 per cent. This year, potentially much greater risks, such as rising commodity prices, the mayhem in North Africa and the Middle East and the disaster in Japan - on top of continuing problems in Greece - have led to a much smaller correction.

However, during the last month, things have taken a turn for the worse. The downside risks to the global economy have been magnified, according to the don.

Take the world's largest economy. Optimists suggest it has hit a soft patch, but Prof Roubini insists that it's worse than that. After a weak first half, the US economy looks set to remain weak for the rest of the year and into 2012. The US public sector (including state and local governments) is deleveraging through spending cuts, which is hurting the private sector; the labour market is in a funk, with unemployment stuck at 9 per cent plus; the housing market has fallen every month since last August, and is nowhere near turning. A year from now, he suggests that about half of US mortgages will be underwater. The result: more foreclosures, more housing supply, and still lower prices.

On Wednesday, the US Federal Reserve confirmed that the economy is indeed doing worse than expected. It projected growth in 2011 to come in at 2.7-2.9 per cent - about the same as in 2010.

Fed chairman Ben Bernanke appeared nonplussed. 'We don't have a precise read on why this slower pace of growth is persisting,' he said.

If the future for the US economy is bleak, the prospects for the eurozone are even worse, according to Dr Doom.

The sovereign debt problems of the countries of the so-called periphery of the eurozone - Greece, Ireland and Portugal - are chronic. In the immediate aftermath of the global financial crisis, banking risk became sovereign risk because the bad debts of banks were taken over by governments. Now, sovereign risks are becoming banking risks because the large debts of distressed governments are sitting mostly on the balance sheets of banks. The eurozone's banks need to be cleaned up - but it's not happening. This is all the more urgent for the fact that banks play a much bigger role in financing the real economy in Europe than in the US, where the capital markets are more active.

The peripheral countries face issues of insolvency, not illiquidity, said Prof Roubini. Even if Greece endures every austerity prescribed by the International Monetary Fund (IMF), its public debt will be 160 per cent of GDP; remember, he adds, that Argentina defaulted in 2002 when its public debt was about 50 per cent of GDP. So the question for Greece is not whether debt restructuring will occur, but when. The sooner the better, or else the risk of a disorderly restructuring will rise.

Portugal and Ireland will be like Greece, he said. One to two years out, they too will lose access to capital markets and their debts will need to be restructured.

But the elephant in the room is Spain. It's too big to fail, but maybe also too big to save, under existing arrangements for emergency funding in the eurozone. Prof Roubini sees 'a meaningful chance' of Spain also losing market access in the next 18 months - which is not yet priced in.

More shocks in eurozone

After the bursting of a humongous property bubble, Spanish home prices have fallen only 11 per cent from their peak. They will probably fall 30-40 per cent, said the professor. And like elsewhere, the losses will end up on the books of the government - which could lead to the eurozone's biggest sovereign debt crisis yet.

You would expect that the European Central Bank (ECB) would be trying to help the eurozone's struggling periphery. But in many ways, it's making the situation worse, according to Prof Roubini. 'The ECB is on an inflation jihad; inflation is its single mandate. It doesn't care about growth, unemployment, banking problems or competitiveness.'

And so, the ECB goes on raising interest rates. It will probably hike by a total of 75 basis points in 2011, and then some more in 2012. It views the problems of the periphery as being structural and fiscal - in other words, not its business. 'But the reality,' said Prof Roubini, 'is that the more the ECB raises rates, the stronger the euro becomes, the greater the loss of competitiveness. Growth won't recover, and fiscal, banking and debt problems will get worse.'

Japan in a jam

Okay, so the US and Europe look bad. What about Japan?

Prof Roubini noted that normally, earthquakes and tsunamis do not have enduring economic consequences. But this time it may be different in the case of Japan, for four reasons.

First, we still don't know the full extent of the nuclear contamination resulting from the damage to the Fukushima nuclear facility. Second, one consequence of the disaster has been a reconsideration of nuclear power around the world, especially in Europe. This will put upward pressure on oil prices, which is bad for the global economy. Third, the Japanese disaster has disrupted the global supply chain for key components such as semiconductors and auto parts, hurting production. Finally, there are questions about how Japan - which is already running a fiscal deficit of 10 per cent of GDP - will finance reconstruction.

If it does so through tax increases, this would deepen Japan's recession. If it increases public debt, this would lead to higher rates on Japanese government bonds, which would crowd out investment and weaken growth. If it tries to repatriate savings from overseas, the yen would soar - and the last thing Japan needs right now is a stronger yen. The only pro-growth way of financing reconstruction is through monetisation, but the Bank of Japan (BOJ) is opposed to this option.

You might think emerging economies such as those in Asia are the saving grace of the global economy. But their strengths are, in many ways, also weaknesses, according to Dr Doom.

Most Asian economies are growing at faster than their potential (long-term) growth rates, leading to overheating, high inflation and frothy real estate markets - as is evident in parts of China, India, Hong Kong and Singapore.

Some of these countries - those which use interest rates as a policy instrument - are 'behind the curve on monetary policy', Prof Roubini said. One of the key problems is that they are reluctant to let their currencies strengthen unless China takes the lead - which is not really happening. Right now, the risk of a hard landing for Asian economies is small, he said. But the longer they take to rein in their monetary policies and frothy asset markets, the more that risk will increase.

Of particular concern, according to the professor, is that China's economy will have a hard landing sometime around 2013-14.

Recall that during the global crisis in 2008/09, China's exports collapsed from 11 per cent of GDP to 5 per cent of GDP. Yet China was still able to get 8 per cent growth in 2009 when most other economies in the region tanked. How did it achieve this miracle? Essentially by ramping up investment, which rose from 42 per cent of GDP to almost 50 per cent in two years. (China's consumption remained at 35 per cent of GDP.)

China basically went on a massive investment binge, building commercial and residential real estate, infrastructure, railroads, highways, airports, ghost towns - you name it.

State-owned banks gave cheap loans to state-owned enterprises who were directed to produce more capacity, when there was already a glut.

According to Prof Roubini, if history is any guide, China's economy is headed for trouble. 'Every episode of overinvestment historically has ended up in a hard landing,' he pointed out. 'The Soviet Union in the 1960s and 1970s, Latin America in the '70s, East Asia in the '90s. There is not a single case in the last 50 years where it hasn't happened.'

What's more, China's overinvestment has been bigger than these past cases. 'In East Asia, investment was 40 per cent of GDP at bust time,' he noted. 'In China, it's already 50 per cent of GDP.'

Overinvestment typically leads to two problems, he added. One: a massive nonperforming loan problem in the banking system. That's on the cards for China, where about one-third of infrastructure projects have zero cash return. And two, the emergence of massive overcapacity, which implies an investment bust will occur.

'Three-quarters of global capacity for cement, steel and aluminium comes from China,' he pointed out. 'So when they run out of building highways, airports and railroads, where will this capacity go? It will be dumped on global markets. It will be a source of global deflation. It will also lead to protectionism. Nobody will accept China dumping its steel on global markets. It's going to be a problem not only for China but for the global economy.'

But that's a story for 2013-14, he said. For now, there are other sources of gloom to worry about.

Source/转贴/Extract/: www.businesstimes.com.sg
Publish date:25/06/11