Roubini

Every couple of months we publish what Dr. Doom, Nouriel Roubini is saying/predicting about the economic mess we find ourselves in. This week's TIME Magazine has an interview with him where he mentions Ireland. Here is some of it:

Where is the global economy heading from here?
My concern right now is that this U-shaped recession we are in could turn into something much uglier, meaning a Japanese-style L-shaped recession: near stagnation or stag-deflation. We're in the worst global synchronized recession in the last 60 years. Unless we take the right policy actions we'll end up in a near-depression. I did not want to use that term six months ago. At that time I said the chances of a near-depression were only 10%. But today those chances are 33% or so.

How can this be avoided?
You have to have a set of concerted, coherent policies done not just by the U.S., but Europe, Japan, China and everyone else. The credit crunch is just massive. One thing that's needed is much more aggressive monetary easing. The second dimension is that you need much more fiscal stimulus — in the countries that can afford it — that is front-loaded. The U.S. [stimulus package] is $800 billion but only $200 billion is front-loaded. Of that $200 billion [in stimulus] this year, half of it is tax cuts. That's going to be a waste of money because people are not going to spend it.

Why hasn't the banking mess been cleaned up?
You have to do triage between banks that are illiquid and undercapitalized but solvent, and those that are insolvent. The insolvent ones you have to shut down. You need more aggressive credit creation by the government or you have to force the banks to lend. We're in a war economy. You need command-economy allocation of credit to the real economy. Otherwise the incentive individually for every institution is to pull out, not extend credit. Not enough is being done.

Is there a part of the world you are especially worried about right now?
I'm worried about every part of the world. People thought the rest of the world would decouple from the U.S. That was nonsense. Emerging Europe is on the verge of a fully fledged sovereign debt, banking and currency crisis. I think China is in a near-recession right now. Many emerging markets, even those that are in better shape, are in severe trouble. I don't think there is any economy in the world right now that is safe.

Is a breakup of the European monetary union possible?
I don't see that as being likely but the probability of that eventually happening is rising. Right now we are facing a situation in which many countries now have banking systems that are too big to fail and also too big to be saved. Now if Ireland or Greece go bust, then there is already a commitment from the Germans and French to, one way or another, bail them out — because they know that otherwise the monetary union is going to collapse. But if you have to rescue on top of them Austria and Italy, Portugal and Spain and Belgium and the Netherlands, then that is not going to be possible. I am still of the view that we can avoid a collapse of the monetary union, but this is really the very first true test of its stability.

Many people are pinning their hopes on the Chinese government to stimulate demand. Is that justified?
I have to give credit to the Chinese. Their fiscal stimulus will contain the degree of economic contraction. But China is radically dependent on U.S. growth. Forcing state-owned enterprises and banks to spend more when you have overcapacity, or to lend more when there are already large [amounts of bad debt], is going to postpone a problem, maybe by a few months. But it will lead to a harder fall down the line. A hard landing is unavoidable given what has happened to the rest of the world.

Deflation Q&A

The London Times is running regular briefings to coincide with 'Target Two Point Zero', the Bank of England contest for English sixth-formers run in conjunction with the newspaper. The competition challenges students to play the role of the Bank's Monetary Policy Committee (MPC) and recommend the best level for interest rates. This week's topic is one we have already written a lot about - deflation. Unfortunately, we cannot enter the competition but the article is a good one and deals with an issue I mentioned in class to the Fourth and Fifth years last week.

What is deflation?
The dreaded “D” word, one of the most feared economic blights, refers to sustained falls in prices in the economy for goods and services.

Don't we already have falling prices for some products?
Yes. For goods such as many types of clothing, Britain has got used to steadily cheaper prices as a result of intense high street competition and cheap imports from Asia. But deflation is different, meaning falls in prices more or less across the board.

But that sounds good. What's the problem?
The trend can sound like a money-saving bonanza. A short-lived burst of deflation for only a few months might end up like that and need not be a disaster. Problems start when consumers collectively curb spending, constantly waiting for ever-cheaper prices. In turn, this sucks the lifeblood of demand from the economy. With spending falling sharply, businesses sell less and less and are forced to cut wages and lay off staff - leading to even less spending, lower demand and sharper falls in prices. A vicious, downward spiral takes hold that can spell deep and prolonged recession. Once deflation sets in, it can be tough to reverse it, as negative effects feed on themselves. For example, if interest rates have been cut sharply to try to rekindle spending, then once they fall to zero it is impossible to cut them further and, after factoring in falling prices, this means that real interest rates are still higher than zero.

Are there any other effects?
Unfortunately, yes. Debt is a headache. Where prices and incomes generally are falling in a bout of deflation, this means that the real value of peoples' debts, relative to falling incomes, is rising. So debts become an ever bigger burden, stretching the time that is needed to pay them off to longer periods. This is known as “debt deflation”. In an economy such as Britain's, where households have the highest burden of debt of any leading economy, it poses a particularly severe danger.

How can economies escape?
With great difficulty. Deflation is like quicksand. Once in it, it is very hard to escape the mire. Solutions to “reflate” the economy are found in flooding the financial system with ultra-cheap money. This can be done by governments printing money to give away in tax cuts, although this risks irreversible damage to a country's finances, or by a central bank buying up assets from banks, effectively handing them extremely cheap cash.

Is deflation likely to take hold now?
There is a significant danger. Headline inflation in the United States could turn negative as soon as this week, after a huge reversal of last year's surge in fuel prices. In Britain, the Bank has said that it expects inflation on some measures to fall into negative territory for at least a few months. This may fall short of full-blown deflation, but will magnify the danger of it.

www.bankofengland.co.uk/education/targettwopointzero www.timesonline.co.uk/targettwopointzero

First we had 'stagflation'... now we have 'stagdeflation'

'Stagflation' is an economic term which came to prominence in the 1970s. It exists when we have stagnation (little or no economic growth and high and rising unemployment) along with rising inflation. Put basically, stagflation occurs when the economy isn't growing but prices are. One way stagflation could occur would be an increase in the price of oil in an oil-importing country, which tends to raise prices at the same time that it slows the economy by making production less profitable - causing firms to lay off workers. This happened to a great extent during the 1970s, when world oil prices rose dramatically during the the world oil crisis.

However, an economist has now coined a new phrase 'stagdeflation' for us to concern ourselves with. It comes from Nouriel Roubini (or 'Dr. Doom', as he has become known), pictured above, a professor of economics at New York University. He believes stagdeflation will, in six months, become the main worry for economic policymakers worldwide. Stagdeflation exists when we have low growth or recession along with falling inflation rates.

Why should we heed what Roubini says? Well, his predictions about the current global crisis have been uncannily correct. For example, he said in August 2006, "A housing hard landing will lead to a sharp and severe recession. It may also lead to a banking and financial crisis that may be more acute – and cause a more severe credit crunch – than the Savings and Loan crisis of the 1980s and early 1990s that led to the 1990-1991 recession". We will examine his forecasts further at a later date. He believes stagdeflation is happening already. The US recession is leading to deflation in areas where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.). The unemployment rate is up sharply and commodity prices are down sharply - about 30% (from their July peak) in the last three months and, he believes, they are likely to fall much more in the next few months as the advanced economies' recession goes global. It will be interesting to see how his predictions pan out in 2009.

New York Times profile of Roubini, 17 August 2008
Roubini on the financial crisis, 15 July 2008, Bloomberg TV