Just How Bad Is Bad?
Nouriel Roubini and Ian Bremmer debate the double-dip recession and whether China could end up like Europe's PIIGS.
With global markets in a tailspin and the Dow Jones industrial average down more than 9 percent in the past month, jittery investors are wondering whether this is a second coming of the Great Recession and whether an increasingly insolvent United States and Europe’s weak periphery will be able to weather the storm. Are we seeing the first slide into a double-dip recession? Is the euro doomed? And can China stay above the fray? Foreign Policy asked two of the world’s most prescient market watchers, Nouriel Roubini and Ian Bremmer, for their views about what they see in the months and years ahead.
Perhaps it’s not surprising that Roubini, better known as Dr. Doom, sees the outlook as being "more scary" than it was two or three years ago — but it’s less systemic failures that concern him than the total inability of buffoonish politicians and weak governments to do anything about it. They’re "out of policy bullets," says Roubini.
Bremmer is a bit more sanguine. "I don’t believe that we’re heading for a second recession," he says. "But I think that it’s going to feel like a recession for an awful lot of people." What really worries him is China: While Europe and the United States try to muddle through the mess, "the Chinese are kicking a bigger can farther down the road than anyone else." In short, the global economy might get a whole lot worse before it gets better.
Foreign Policy: It’s obvious now, if it wasn’t before, that the economic outlook is not good. But how bad are the systemic market factors and what’s the near- to medium-term future of the strength of the global economy?
Nouriel Roubini: At this point there is serious risk of a double-dip recession in the U.S. and most other advanced economies. If you look at the latest numbers from the United States, from GDP growth in the first quarter, to consumption, to housing, to even the labor market figures today, they are very weak. [The unemployment figures] were better than expected because expectations were low and the unemployment rate fell only because 200,000 people got so discouraged that they left the labor force. Otherwise it would have gone up.
So everything is suggesting that we are already at slow speed and now with a 10 percent market correction, the wealth effects, and the widening of credit spreads can make that worsening of business, consumer, and investor sentiment even worse. And that’s in United States.
In the eurozone periphery, five countries are already in a recession: Greece, Ireland, Portugal, Italy, and Spain. Three of them have lost market access, and at this point, the chances that Italy and Spain are going to lose market access are very high. And Italy and Spain are "too big to fail," or too big to be bailed out. The United Kingdom has had flat economic activity for three quarters. Japan had a double dip and is going to recover just because of the [post-Fukushima] reconstruction for a few quarters.
And now the kind of forward-looking indicators like global PMI [private mortgage insurance] suggest there is also a massive slowdown in the growth of the countries that were growing very fast: China, India, emerging markets, and those countries like Australia that were growing because of their resource orientation. The outlook to me looks very bleak.
I think the most important difference compared to the past is that we are running out of policy bullets. The U.S., the U.K., and the eurozone are doing fiscal contraction. There’s going to be a fiscal drag on the idea of backstopping the banks that are running out of those options — because now governments are distressed.
Another problem is governments cannot bail out their banks, but actually sovereign risk is becoming banking risk because of the exposure of the banks to government debt. We may see a little more quantitative easing, but the European Central Bank is not going to do it, the Bank of England is not going to do it because inflation is above targets, and the Fed is going to do a little — but too little too late, and it’s not going to make much of a difference at this point. Last year, $600 billion of QE2 [quantitative easing 2] and a trillion dollars of additional tax cuts and transfer payments give us a growth of 3 percent for one quarter. But growth [in the other three quarters of last year] was averaging below 1 percent.
So how are we going to get out? We are running out of policy bullets. The policymakers don’t have monetary bullets; they don’t have fiscal bullets; they cannot even backstop their own financial system. That’s why it’s more scary than a year ago, two years ago, or three years ago — when we had all these policy bullets. Now we are running out of them.
FP: Ian, is this then a political problem as well? Has this new "age of austerity" put enormous pressures on governments? Do you feel as bleakly about the future as Nouriel does?
Ian Bremmer: The one place that I am probably less bleak is that I don’t believe that we’re heading for a second recession. Again if we’re defining it as a couple quarters of negative growth, but I think that it’s going to feel like a recession for an awful lot of people. But the level of both uncertainty and volatility in the markets is absolutely going to be sustained through this electoral cycle. Obviously that hurts President Obama, and it hurts Congress even more. The political figures right now for the general views on Congress are the worst they’ve been since the New York Times started taking records in 1977. That’s extraordinary. And it’s because there’s a view among a solid majority of Americans that the United States’ economy is actually entering into structural doldrums and no one is prepared to do anything about it.
Where I agree with Nouriel is that I think that the ability to engage in massive policy redress is not there. You’ll see some version of a QE3 in the United States — I think that’s right, and no one expected we’d be talking about that six months ago. But you’re still talking fundamentally about muddling through. That’s true in the United States, it’s true in Japan, and it’s certainly true in Europe. And the big change that we’ve seen politically in the last few months is that there really was a belief in the markets that, yes, the debt limit deal was going to prove obstreperous, but ultimately the Democrats and Republicans knew that they had to work for something that would be the outlines of a deal — and then, after the [2012 presidential] elections, the U.S. was going to start treating the deficit seriously.
Well, what we are seeing is two things. First of all, there’s now a lack of belief that that’s going to happen in the United States. So the willingness of people to believe that when pushed against a wall Congress will be able to act effectively, that confidence is gone. And whether or not there are coming downgrades from the ratings agencies, you’re going to see downgrades in the way big money — not just smart money — thinks about America. That’s clearly driving the direction we’ve seen over the last couple days.
This is not just a short-term covering of bets. This is more structural. And then there’s the issue of a confluence of economic crises. If this were just about the United States right now I’d feel much more confident that the U.S. can handle a couple more quarters, even a year, of anemic growth. But heading into an election season when the major European economies are seeing their spreads widen and are seeing investor sentiment turn against them very quickly, the ability to create contagion into the U.S. markets is significant. That’s where we need to worry. Structurally, I think the world is in a much more problematic place right now than in many ways it has been in the past couple years.
FP: Where do we need to act first?
NR: First of all, an anemic, subpar, below-trend growth — a "U-shaped" recovery — is the best we can hope for because this was a recession caused by financial crisis caused by too much debt and leverage, first in the private sector and now in the public sector. And my own work, on America and others, suggests that whenever you have a balance sheet recession, you’re going to have anemic growth at best for many years as there is a painful process of deleveraging. You have to spend less in the private and public sectors to save more, or destabilize to reduce debt and leverage. And that takes many years. We have barely started the deleveraging of government and the debt levels of many financial institutions are very high.
The best we can do is to avoid a double-dip recession, but now we have had a whole bunch of additional tail risks: rising commodity prices, the Middle East petroleum pricing that led to more geostrategic risk and higher oil prices, the Japanese earthquake that slowed down growth globally, renewed worries about the periphery of the eurozone, and now worries about the unsustainability of the U.S. fiscal deficit and the ugly fight we had that led almost to government shutdown and then to almost a technical default on Treasuries.
So these are lingering additional shocks. One day the trouble comes from Greece or the next day it comes from worries about the United States, or the next day it comes from worries about Italy and Spain losing market access, or the next day it’s Portugal and Ireland again, or it’s the United Kingdom or Japan. Private and public debt problems — whether it’s the housing sector or the financial system or central and local governments — are going to be repeated sources of systemic shock, of risk aversion, or market worries.
But these are not problems that are going to resolve anytime soon because these debt and leverage issues have to be reduced gradually for many years. So every other month, or every other week, or every other quarter, we’re going to have another sector or another country or another government being in trouble. And that’s going to have a negative effect on markets — and the last thing you need right now is a market correction that’s going to potentially lead to a double-dip recession.
We could get back into a negative feedback loop between the real economy, asset prices on the downside, and sovereign and private debt — all of which risk leading to more market corrections, more widening, more negative wealth effects feeding back to the real economy.
We may be back to that vicious circle of falling asset prices, widening credit spreads, and weakening economic activity that we had in 2007-2009.
FP: Ian, do you also see the economy slipping back into the bad old days?
IB: Where I’m concerned is that the global political environment is much less conducive to resolving shocks as they were in 2008 when the United States and Lehman Brothers was in crisis. Well, the G-20 and everyone was suddenly panicked, but everyone was focused on one thing — which was what can we do so that this doesn’t lead to a meltdown in the global financial system. Gillian Tett in the Financial Times wrote a little bit breathlessly that today reminds her of 2008, that it’s very similar. I think it’s very different.
I don’t think the severity or the shock is anywhere near as great. We’re not talking about the sudden implosion of the world’s financial markets. But I think the financial ability to respond isn’t there; we don’t have the same commonality of purpose. All of this is occurring against the process of global rebalancing where the countries that are growing extremely strongly are also countries that are important creditors to the United States and Europe, most notably China. And I think that in 2008 these guys were suddenly faced with an "Oh my god, what happens if the U.S. suddenly goes under?" You know, "We need to do everything possible to shore up this system."
But the Chinese are taking a much longer-term view right now — which is, we need to hedge away from the U.S., we need to try to decouple ourselves. The long-term structural implications of the U.S. and the Europeans not getting their house in order quickly are much more dangerous this time around than they were in 2008, even if 2008 represents a much greater short-term shock and potential catastrophe than today presently does.
Keep in mind that in 2008 we had the worst recession that the country had experienced since the Great Depression and we could have had a depression. We’re at least an order of magnitude away from that right now, maybe two orders. But structurally, we actually have much greater danger as a consequence of the relative autonomy, clear-sightedness, and the willingness of a lot of the players out there to act strategically.
I agree with what Nouriel said so strongly — that we don’t have a lot of policy bullets right now. One or more of the players in the developed world that are facing real structural troubles need to come up with a credible solution to make the markets feel more confident that, over the long term, we are going to see some real sustainable growth. The United States government shows no ability to do that; none of the European peripherals show any ability to do that. Only the Germans do, but they’re not what’s causing the crisis right now. And the Japanese show no capacity of doing that, so it’s a much broader and more systemic problem this time around, even if the level of shock doesn’t rise to the same level.
FP: So where are the economic wise men in all this? The last time we faced a crisis of this sort there were Larry Summers, Ben Bernanke, and Tim Geithner. We had at least a sense that there were some economic mandarins trying to guide the global response. But who’s there now?
IB: From my perspective, I look at someone like [European Commissioner for Economic and Monetary Affairs] Olli Rehn as incredibly impressive, even inspirational, in the sense that he is doing the best he can possibly do. And yet what he is saying is, "The best the Europeans can do is muddle through." I don’t know what Nouriel thinks from the American perspective, but that strikes me as sort of an ominous leitmotif for where we are right now politically.
NR: Well you know, there may be individuals that might have leadership … but I think the fundamental problem is not the individuals. It’s that in most advanced economies, they have weak governments. In the U.S., we have divided government. Two parties: one doing taxing; the other doing spending cuts. In the peripheral eurozone, minority governments from Portugal to Spain lead to eventual loss of market access. In Italy, there’s a buffoon like Berlusconi. In the U.K. we have fragile cohesion that might also fall apart. In Japan, we might have soon enough six prime ministers in the last five years — it’s worse in Italy in terms of political instability in the 1960s and ’70s! Even in Germany, which is growing robustly, Angela Merkel is not particularly popular within her own party, let alone with the opposition.
I think the fundamental problem is that tough choices need to be made — gradual fiscal austerity, structural reform — [which] imply [the necessity of] governments that can look beyond electoral cycle. And we don’t have a situation in which this is possible, when growth is anemic, unemployment is high, and deleveraging is painful. Governments don’t have the leadership to do the right thing, not nationally, and not in terms of international cooperation. So, smart individuals might be here and there, but fundamentally, there is a political economy problem in most advanced economies that remains unresolved.
FP: To what extent is China an issue here? You said that growth will probably slow a little bit there, but is currency imbalance a fundamental cause of this?
IB: Look at what the Chinese have been doing with their currency over the last couple years: They have been addressing it, but addressing it at their own pace, with inflation in mind and with very different constituencies that have different interests in terms of growth and unemployment.
I think that China is an issue because it understands better than anyone else that the short-term electoral cycles in the West are going to create inability to make the kind of policy moves that are required to create long-term sustainable economic growth and trajectory. So as a consequence, if you’re China right now, you don’t believe long-term sustainability of the dollar as the world’s reserve currency. Even if you were concerned in 2008-2009 about what Americans would be able to consume to continue to allow China to have a more managed transition to its own internal rebalancing, you don’t believe that anymore. You believe that you’re going to be forced to rebalance domestically much more quickly.
I think that China’s economic decision-making is going to be forced into a faster pattern towards not only getting up the value chain, but towards building their own consumption. And that’s going to put a lot of strain on the Chinese domestically, and it will create greater risks within the Chinese economy. I don’t think that’s something to fear, however, and I’m probably more bullish than Nouriel is as we look out over the next two years.
But I think that the point is that the decision-making going on in China, which previously had really basically embraced a win-win of interconnectedness and mutually assured economic structure between the U.S. and China, is rapidly getting eroded. One final point I’d like to make is that there’s nobody out there that’s more interested long term in a sustainable euro than the Chinese, as an effective hedge against the dollar. If you watch what the Swiss franc has been doing recently, you know that there aren’t many places for these guys to move to if the euro isn’t strong — and if the euro does really fall apart, I think we should watch very carefully the relationship between China and Germany.
FP: Nouriel, what do you think of the future of the eurozone? Is it doomed?
NR: Well before I get to that, I think China is part of the problem: They’re still allowing very slow appreciation of the RMB [renminbi], aggressively intervening. And since the RMB is shadowing U.S. dollar, every other emerging market from Asia to Latin America is shadowing the RMB; and therefore the appreciation of undervalued currencies — in countries that have large current account surpluses, countries that have commodity currencies — is not occurring fast enough. The countries that have large deficits are going to have weak domestic demand because of the leveraging of the public sectors, so they need to grow to get net export growth, which implies a weakening of the dollar in other currencies of countries.
So the surplus countries that were oversaving have to save less and consume more and let their currency appreciate. But, if anything, China has responded to its slowing net exports not by boosting consumption — which is now up to 33 percent of GDP — but rather by pushing fixed investments from 40 to 50 percent of GDP. By 2013, China is going to have a hard landing — because no country is going to be so productive that you invest every year half of your GDP into new capital stock. You’re not going to have at the end of the day a massive NPL [non-performing loan] problem, a massive public debt problem (the Chinese public debt is now 80 percent of GDP), and a massive amount of overcapacity that’s going to lead this investment boom into investment bust.
As for the eurozone, I would say, for sure, that they’ll be restructuring public debt and banking debt. In Greece first, in Portugal and Ireland next, and if Italy and Spain were to lose market access (something I think is likely), there is not going to be official money enough — with the deficit then tripled — to backstop both Italy and Spain. Secondly, even if you can deal with banking debt and public debt to orderly restricting of this debt, you’re not going to have economic growth unless you restore competitiveness. And unless the euro goes back to parity to the dollar, something unlikely, or unless you go through a painful deflation, it is unlikely to occur and is going to create even more recession. Then, if you cannot grow yourself out of a competitiveness problem, if you cannot devalue yourself out of the problem, then the only option is to exit the monetary union. I think in the horizon of the next three to five years, the chances that the weaker members of the eurozone, starting with Greece and Portugal, are going to decide of the costs of staying in the union are greater than the benefits.
The point is that the current approach to the eurozone problem is not a stable equilibrium; it is an unstable disequilibrium. Kicking the can down the road, going from private to public debt to supernational debt, throwing more good money after bad money, is not going to work. Either the EU is going to move in the direction of a greater political, economic, and fiscal union, toward integration; but I don’t think this is likely because the German conditions for accepting a fiscal union is that the periphery gives up all fiscal autonomy. So if that’s not going to happen, then the other outcome of this unstable disequilibrium is first, orderly and disorderly restructuring, and eventually, a breakup of the eurozone. I think it’s a likely scenario.
FP: Ian, do you see this devolution happening in Europe?
IB: First of all, on Europe, I’m generally much more bullish, but I’m much more bullish because I come from a different perspective. Economically, everything that we’re talking about here makes an awful lot of sense, but politically, there’s strength among the actors across the eurozone — both the European leaders themselves and corporate leaders, who have very strongly petitioned across the continent recently the importance of protecting a single currency, as well as the strength of European institutions.
Let’s face it, the European institutions, and I’m talking about the ECB [European Central Bank], the European Commission, the European Parliament, are much stronger than they were five years ago, 10 years ago, 20 years ago. They absolutely want a stronger Europe over time. It is true that it’s going to be much more onerous on these peripheral states to accept the loss of sovereignty that’s implied by coordinating fiscal policy, much more so than the loss of sovereignty implied by common currency policy, which was required when they first put the eurozone together.
But even if the present equilibrium is not sustainable, I do think that the muddling through will lead to increasing restrictions — first soft restrictions, then hard restrictions — that will indeed ultimately lead to a stronger fiscal union and will take away a significant amount of sovereignty for these countries. You’re already seeing that with the existing Greek, Portuguese, Spanish austerity, some of which is very significant, absolutely reflecting a giving-away of fiscal sovereignty. It may not be legally required, but effectively required by the markets. It’s certainly required for the Germans, the French, and the European institutions to buy into any bailout.
I think that process is already under way. It’s very, very messy; it’s very ugly. From a political perspective, I can see it continuing much more likely than a breakup. The real point is that this has been the year of kicking the can down the road. The Europeans are doing it; Japanese are doing it; the Americans are showing that they’re doing it. And the biggest danger is (though, I personally don’t think it’s 2013-2014; it’s later) is the Chinese are kicking a bigger can farther down the road than anyone else.
They have the greatest job to do. They have the economic structures required, the biggest changes in their governments, both economically and politically, much greater than the challenges presently faced in Greece or Spain, Portugal or Italy, and they are in some way, they are the least set up to accomplish it. And the steps that they’re taking presently are pushing off the day of reckoning, while, at the same time, the global economy is requiring it of the Chinese even faster. And so, even though China looks like a great story right now for the next year, two years, long term, that’s the one that’s going to come back and bite us, the one that we’re going to need to pay the most attention to.