Fear Premium

An exclusive conversation with Nouriel Roubini and Ian Bremmer on the hidden economic risks as geopolitical tensions bubble over in the Middle East and China.

By , a former executive editor at Foreign Policy.

With anti-American tensions simmering across the Middle East and anti-Japanese sentiment flaring across China, the European fiscal crisis all of a sudden seems like yesterday's problem. Not so fast, say Nouriel Roubini and Ian Bremmer, who argue that while the immediate disaster in Europe may have been averted, the fundamental problems haven't even been touched.

With anti-American tensions simmering across the Middle East and anti-Japanese sentiment flaring across China, the European fiscal crisis all of a sudden seems like yesterday’s problem. Not so fast, say Nouriel Roubini and Ian Bremmer, who argue that while the immediate disaster in Europe may have been averted, the fundamental problems haven’t even been touched.

In this wide-ranging interview, Roubini and Bremmer see dark omens on the horizon: a "deteriorating" geopolitical environment, a potentially "dangerous" trade war with China if Mitt Romney were to win the U.S. presidency and label Beijing a currency manipulator, and a "fear premium" spiking international markets over what seems like inevitable conflict among the United States, Israel, and Iran.

Foreign Policy: Are we out of the woods in Europe yet?

Nouriel Roubini: The recession is still deep, and it’s becoming deeper. The vulcanization of banks and of public debt markets is still ongoing, and therefore the economic side of the crisis is still with us. The positive is that now the Europeans realize that for a monetary unit to be viable, you need a banking union, a fiscal union, and an economic union to provide legitimacy for the transfer of power from national governments to the center. And they’ve finally put in play a coordinated bond program to provide support to struggling sovereign states. Those are positives, but the fundamental problems of the eurozone remain. The recession is deepening in the periphery, ascribing to the eurozone extreme difficulty in reaching agreements on these elements of a union. Take banking, or the first element of a banking union; if it is supervisory, there is still marked disagreement on how, when, and so on. So the challenges of restoring competitiveness, restoring external balance, restoring growth, are significant, and therefore I still see a very risky road ahead for the eurozone.

Ian Bremmer: George Soros, you probably saw it, came out and basically told [Angela] Merkel that the Germans basically have to support growth or they have to leave the eurozone. And of course, the reality is that Merkel is going to do neither, and that’s precisely why Nouriel’s downside for continued poor-growth recession, lack of competitiveness across the eurozone, is going to persist, because the desire to fix these long-term structural problems of eurozone governance comes part and parcel with very strong, long-term austerity, which is causing very significant problems across all these peripheral states. As a political scientist, I actually see an interesting problem emerging: I’m quite optimistic, as I have been for some time, that the eurozone stays in place and, ultimately, that governance gets stronger. But what’s interesting is that as that occurs, you are weakening national institutions in Europe. And you’re not just weakening from the top; you’re not just taking sovereignty away from many of these governments in terms of banking regulation and in terms of budgetary authority and fiscal authority; you’re also undermining them from below because as you continue with this crushing austerity, you’re leading to a situation where every incumbent gets voted out and extremist parties start popping up across Europe who are just disgusted with their national authority. So as you work toward fixing the structural economic imbalances in Europe — or should I say the structural governance problems — you may start creating some unsustainable political conflict across the continent.

FP: Where’s the leadership going to come from? There’s no longer Nicolas Sarkozy in France, and Britain’s David Cameron is not interested in playing any sort of a leadership role.

NR: Well, the problem with faith in the eurozone is, of course, that you have 17 countries, 17 governments, 17 coalitions, and sometimes they don’t agree even within a coalition, like in Germany, within CDU, CSU, and Free Democrats. So any process that leads to more EU integration, whether banking, fiscal, economic, political, is going to be very challenging and take a long period of time. At the same time, as you suggested, the top leaders, who believe much more strongly in this European integration, are not there anymore. I mean, Angela Merkel comes from East Germany. We’ll have to see the views of the French Socialists. Some of them are more pro-European; some of them, like the current foreign minister, Laurent Fabius, who was against the referendum in 2005 in France — he voted no — is a little more skeptical. And so, in other parts of the world — and I spoke recently with [José María] Aznar, former prime minister of Spain, he believes that there shouldn’t be a greater union, that Europe should remain a union of separate sovereign states, certainly not the federal system. So there are marked disagreements, and certainly there is no leadership.

IB: And that lack of leadership plays out internationally as well. Historically, the Brits were very interested in having an outsized international diplomacy role. Increasingly, you look at Cameron, you look at [Foreign Secretary William] Hague — these are folks who really are focused on the economic side of Britain and trying to be part of the global growth story, but not trying to play a significant geopolitical leadership role. Under Sarkozy, France was much more interested in that. That’s not true under [French President François] Hollande. Germany is overwhelmingly focused — yes, they certainly are taking on a great deal of leadership in terms of the way we think about European institutions, but beyond that, if you want to talk from an extra-European position, outside of Europe, as Kissinger said, there’s still no address.

FP: What about China? How worried should we be about the economic slowdown there?

NR: In China, there is an economic slowdown in capital spending, infrastructure spending, and in real estate. And the problem of China is to rebalance its growth away from net exports, away from high savings, away from fixed investments (which is now 50 percent of GDP) and facilitate reform that will increase consumption. My concern is that the new leadership is going to come out of China and is going to be a collective leadership with seven or nine members of the founding committee of the Politburo. Some of them are pro-market-oriented folks; some of them are more in favor of civil enterprises; some of them want to accelerate political reforms; but any progress they’re going to make in the election of balance in the growth rate of China is going to be slow. It might end up being too late compared to what is desirable enough. And by the mid to late part of next year, a hard landing in China — meaning growth at 5 percent or below — becomes a more likely scenario.

FP: Do the Chinese just not realize that keeping Xi Jinping in a box for two weeks is an unsettling thing?

IB: No, they don’t, and I think that they are piqued that they have to say anything. They do not feel accountable, certainly not to the New York Times or to the international journalistic community.

FP: And high officials have blown off Hillary Clinton as well.

IB: That’s right. And you saw there were sources close to the leadership that said he had a minor back problem and that he’d be back. I accept that at face value — or close to face value — in the sense that if it had been something more serious, we would have seen folks close to Xi Jinping leaving the country and showing up at American consulates, things like that. I don’t think there was a significant instability issue.

But the point is that the Chinese leadership has absolutely no desire or intention to provide any level of direct accountability or transparency to the people that they govern. Their perspective is, "Look, we’re responsible for improving the social safety net; we showed you our five-year plan. However we do that is really not your issue. This is not a democracy." And the way they handled Xi Jinping shows that. But while it’s not a democracy, it is increasingly an informationally empowered society. It’s very hard to run a 21st-century economy with a population of 1.3 billion people with a 20th-century government, and the ability of the Chinese to do this is going to come under much greater pressure. And certainly I believe that the breadth of anti-Japanese demonstrations that you’ve seen across that country over the last couple weeks — and the Chinese government clearly coordinated and stimulated a lot of them — it’s not coincidence that that comes right after Xi Jinping shows up. We’re not going to talk about the "where was the president" issue; we’ll talk about our level of distaste for what the Japanese are doing.

FP: It’s the old bogeyman game that’s worked so well.

IB: And it’s interesting that it’s focused on Japan. It could have been focused on a lot of things. Japan’s an easy one for the Chinese, and the level of Japanese exposure to China is something that should really worry Tokyo at this point.

FP: Nouriel, how concerned are you about the anti-Japanese sentiment in China?

NR: Well, that depends on whether the shutdown of Japanese firms in China is going to be a matter of days or persist over time. The paradox of Japan is that by doing a large amount of foreign-backed investments in China, it is hostage to the fact that political tensions on the issue of the contested islands or whatever can cause a lot of economic damage to Japan. The leverage of Japan is significantly limited.

FP: Ian, in the wake of the recent protests across the Muslim world, are you concerned about the political risk to the United States?

IB: Well, the political risk to the U.S. isn’t actually that high. I don’t think that anything happening in the Middle East is going to have that dramatic an impact on U.S. elections, nor do I believe that the U.S. is planning to play nearly as significant of a role in the Middle East as it has historically. It’s very interesting in terms of Israel. On the one hand, that means the ability of Israel to get the U.S. to set down red lines to stop the Iranians on the nuclear front is very, very constrained. And the Israelis are going to be upset about that, and they’re going to bluster about it, and they’re going to try and raise the perceived geopolitical risk so that people take it seriously.

On the other side, it’s not all bad news for Israel. The willingness of the U.S. to press the Israelis on settlements in the West Bank is also going to decline, so you can play it both ways. But the real point here is what we’ve seen over the past weeks — these massive anti-Western demonstrations across the region, the attack on the consulate in Benghazi. If you thought it was going to be hard to stop the Syrian war and remove Bashar al-Assad from power, it just got a lot harder. The U.S. is much less prepared now to countenance support for a relatively unknown Syrian opposition that includes many of the same sorts of Islamic militants that we see as sort of armed paramilitaries in Libya.

The willingness of the Russians or the Chinese to countenance more pressure on Syria has gone down significantly given what’s happened over the past weeks. Bashar al-Assad, 18 months in and 20,000 deaths into the war that he’s been prosecuting against his own people, actually looks a little more insulated from Western and international pressure than he did a week ago. And that’s not just a problem for Syria; that’s a problem in terms of the potential expansion of that war into proxy conflict between Sunni-Shiite powers in the region, the refugee crisis expanding into Turkey and Jordan and elsewhere, and the destabilization of Lebanon. This has significant implications, but perhaps fewer for the U.S. than anywhere else, and that’s a particular problem given that it’s the U.S. that has historically done most of the heavy lifting in this part of the world.

FP: Nouriel, how concerned are you by rising tensions over Iran’s nuclear program?

NR: I’m not a geopolitical expert, and I don’t know whether the likelihood of a military attack by Israel and/or the U.S. is high or not. Most likely, it’s not going to happen before the election. But I would say that the only thing is by next year, sanctions are not going to credibly deter Iran from continuing its project to develop a bomb, and therefore, even short of a military confrontation, tensions are going to rise. Because Israel is going to eventually take action, and just the threat that there is going to eventually be war — and that Israel, the U.S., and Iran are all going to be involved in it — could lead to an increase in oil prices. It’s already been happening in the last few weeks and months.

Given the slowdown in global economic growth, oil prices today should be 10 percent lower than they are right now. Why are they so high and rising? Because there is a fear premium, and in my view, next year that fear premium is going to be higher. If there is war, oil could go to $200 a barrel for awhile, and that can cause a global depression, but even if there is no war, and oil goes to $130 a barrel because there is a fear premium, that’s going to be a negative for all oil-importing countries — the U.S., Europe, Japan, China, India, and other advanced economies and emerging markets that are major oil importers. So it’s a negative even short of an outside military confrontation in the Middle East to cause some damage to the oil market in negative ways for global growth.

FP: Do you buy Mitt Romney’s statement that Russia really is our "No. 1 geopolitical foe"?

IB: That’s very funny; you know, [Vladimir] Putin just kicked USAID [out of] Russia, so at the very least, it’s going to cost U.S. taxpayers a little less. Maybe Romney will like him more now. I think that it was a little farcical that Romney called Russia the No. 1 geopolitical foe." It implies that he was looking back at the 1980s or the 1970s. But then again, when Obama was asked, he said that al Qaeda was our No. 1 geopolitical foe, and that means he’s looking back 10 years.

The reality is that China is the country that we’re most concerned about, but you don’t want to mention China. It’s like Voldemort, you know, on the international stage — because they can hurt you, and the U.S. is very interdependent with China. So, they’ve been trying to manage the relationship, but if you look at U.S. foreign policy and you look at the Obama strategy, which has been this pivot toward Asia which includes engaging much more closely and directly with American allies across the region — whether it’s Vietnam or Indonesia, Japan or even Myanmar — that’s a strategy that has paid off quite well, for Hillary Clinton in particular. There’s also been a focus on economic statecraft in this administration, which clearly is oriented over concern at the rise of Chinese state capitalism. But if you look at Romney, he’s made a lot of statements about Russia, and he’s picked on Obama for playing "nice-nice" with [Dmitry] Medvedev, but the reality is that Romney has said that on day one, if he comes into office, he’s going to declare China a currency manipulator. Now, I don’t believe he would actually do that. But if you take him at face value, I assure you that on day two of a Romney administration, Russia’s not going to look like the No. 1 geopolitical foe of the United States.

FP: Nouriel, what would happen if Romney declared China a currency manipulator? Can you play that out, just a little bit?

NR: Well, there are two scenarios. One is that it starts the process that leads to negotiations between China and the United States regarding the trade imbalance; that the two sides, constructively — in spite of the tension — sit down and discuss it. But I don’t think it would be a positive, and I wish that if Romney gets into power, he won’t decide to brand China a manipulator. If he does, perhaps China wouldn’t respond that aggressively. But there is a scenario in which both sides eventually escalate the tension, and Congress starts to think about taking preemptive action against China, given that they’ve been branded as manipulators, and then China could retaliate by imposing tariffs on a number of U.S. goods, and that could escalate, not into a full-scale trade war, but certainly into a trade war that becomes kind of dangerous. So that’s the risk.

FP: Should we be worried about increasing protectionism?

IB: I think we should be worried about more fragmentation of the global marketplace — and certainly that we’re not going to be doing global trade agreements anymore. We’ll do regional trade agreements, we’ll do bilaterals, and that’s less efficient for the global marketplace. I don’t see a lot more protectionism coming from the United States, and the reason for that is because the legislative process in the U.S., Democrat and Republican, remains dominated by private-sector interest. I mean, back in 1974, 3 percent of congressmen that retired went into private-sector lobbies. Today, that’s over 50 percent for the Senate, and it’s over 40 percent for the House of Representatives. And that’s true whether you’re a Democrat or a Republican. And that overwhelmingly is a break on greater protectionism because that has to go through the same legislation. So people can talk a lot of red meat, but that’s very different from actually putting it into practice.

FP: Nouriel, in the Mother Jones-leaked video of Romney, he claimed that global markets would welcome his victory. Do you buy this?

NR: Well, I would say that certainly a meaningful part of the business and financial community has been disappointed with Obama and would prefer a Romney victory, believing that — rightly or wrongly — Obama has not been as pro-business. So, yes, a Romney election might lead to a certain rally in the stock market. But the reality is that the problems of the United States require a bipartisanship response, because there is gridlock. And therefore, the fundamental problem of fixing the fiscal solvency of the U.S. cannot be addressed by one party alone. I’ll give you an example. Say Romney is elected, and he says I want to cut $3 trillion [of] spending on Medicare and Social Security as a form of entitlement. Great, he’s not going to have 60 votes in the Senate, and therefore Democrats are going to say, either you have to include $1 to $1.5 trillion worth of tax increases, especially for the rich or corporate environment, or we’re going to block this. So in some sense, it doesn’t really matter whether Romney is elected or President Obama is reelected. You need some modicum or some degree of bipartisanship in the United States to resolve the fundamental economic, fiscal, and financial issues that the U.S. is facing. So, even if there was a short-term stock market rally, unless he can essentially induce bipartisanship, that’s going to fizzle out.

FP: Do you think the U.S. economy is really on the upswing?

IB: I mean, I’m generally an optimist on most things: I believe in American progress; I believe in humanity’s progress. When you look at life expectancy, when you look at global health care, when you look at people coming out of poverty, all those sorts of things are good. And the U.S. drives more innovation and entrepreneurship and creates more new things that really matter, game-changers, than any other country in the world. And that’s clearly long term very good for the market. I was looking at Apple’s capitalization today — it’s higher than the capitalization of all corporations listed in Portugal, Ireland, Greece, and Spain combined, which says a lot. It really says something. But increasingly, that’s being done leaving behind very large numbers of Americans. So you can tell me that even if the U.S. gets a deficit that looks more sustainable, even if the U.S. starts putting policies in place that are going to be very promising for foreign direct investment, if larger numbers of Americans are not participating in it long term, that will create more polarization in the system and will undermine the ultimate competiveness of the United States. So I do have a mixed view as a consequence of that.

FP: Nouriel, what are the unforeseen, destructive events that have not been priced into the markets right now?

NR: Well, I think that the risks to the global economy are several. One is that the eurozone crisis gets worse and becomes a train wreck. The second one is that the fiscal cliff becomes severe in the United States and you have a contraction. The third one is that you might have a hard landing in China, and the fourth one is the risk of conflict in the Middle East. I think that each one of them alone could trigger a global economic downturn because they’re all systemically important, let alone if several of them were to occur at the same time in a virulent way. So, that’s the risk we’re facing. Of course, with each one of them, appropriate policy reactions may stem those risks — for every problem, there is a solution — but we’ll see whether the policy response is going to be adequate, within countries and across countries, because a lot of them imply policy coordination, as in the case of the eurozone. Even without a global perfect storm of crises the next year could be quite bumpy for the global economy and for financial markets.

IB: I think the geopolitical environment is deteriorating. I think America is stable and will continue to look stable; Europe is going to be very disappointing from a growth perspective, but it’s not going to fall apart. But the geopolitical environment is deteriorating. We see this particularly across the Middle East, and it’s not going to improve. We’ll see much more sectarian conflict and — although I don’t think anyone’s going to attack Iran or stop them on the nuclear side — the likelihood of growing interstate, not just intrastate, conflict within the Middle East is growing dramatically. And furthermore, the ability of countries to effectively balance between competing U.S. and Japanese opportunities in Asia is becoming more of a problem. It’ll be true under Obama; it’ll be true under Romney. We see that with China and Japan. Despite all the attention we’ve had on the Middle East over the course of the last weeks, the implications of dramatically deteriorating China-Japan relations — the world’s second- and third-largest economies — are vastly greater for the global economy. We’re going to see a lot more of that over the last year.

Ben Pauker is a former executive editor at Foreign Policy.

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