Roubini: «Monetary policy has to prevent an economic collapse»
Nouriel Roubini, economist and famously known as «Dr. Doom», regards only the central banks as a backstop to prevent a global depression, as he explains in an interview with «Finanz und Wirtschaft».
If his nickname «Dr. Doom» is suitable, Nouriel Roubini has often been asked. He then answers: «I’m Dr. Realist». As if to prove a point, during the turbulence in financial markets at the beginning of the year, the famous US-economist explained to every one’s surprise, that there was not another financial crisis like in 2008 imminent, and neither a worldwide recession. «There are plenty of downside risks, but there is also some upside», Roubini said at the FuW Fund Experts Forum in Rueschlikon/Zurich last week. «Required is a sensible and realistic assessment.»
Mr. Roubini, will the unconventional monetary policy be escalated? - Most probably yes. When push comes to shove, policy rates can go as negative as necessary. At some point, the banks might want to switch from excess reserves into cash. Then, either by law or by regulation, it can be determined that the banks don’t get more cash than they need for their transactions with their depositors. The rest of the money has to be kept as excess reserves, with a negative rate, a tax. Eventually even cash can be taxed. We may end up in such a world.
Negative policy rates hurt the banks and therefore bank lending and the economy. - Not only negative rates hurt banks, but also quantitative easing QE. It pushes down long term interest rates and reduces the interest rate margin of banks.
Isn’t this counterproductive? - Central bank policy might hurt the banks, but if these measures avoid deflation and a recession, banks are better off than in a downturn where their borrowers go bankrupt and their losses and the risk in the market increase. I would say that the banks benefit from unconventional policy.
Will central banks also expand their asset purchase programs? - The amount of money can be increased by buying not only government and corporate bonds but also foreign assets. There is no limit, even if that could lead to a currency war. If the Euro and the Yen become too strong, the ECB and the Bank of Japan might have no other choice. Even now, Japan is buying foreign assets through the backdoor, for example via the state owned pension fund GPIF.
Which measures should central banks take? - Once central banks reach the zero bound, they have limited options. Either they increase the quantity of money by buying public, private or foreign assets – with quantitative easing QE, credit easing or interventions in the foreign exchange market. Otherwise, central banks have to lower policy rates below zero. They can do a little bit of one and a little bit of the other, at the end of the day these measures are all variants of the same thing.
Is at least the US-economy robust enough for an interest rate increase by the Fed? - In mid-February, US high yield spreads were 900 basis points. High grade spreads were also going sharply higher. Three months of such high spreads, and the US economy would be in a recession. The Fed knows that perfectly well. Such high credit spreads would kill any economic recovery, even more so than a falling stock market or a strong dollar.
Have central banks not gone too far already? - If you say «Nein» to the European Central Bank and also «Nein» to fiscal stimulus in Germany and in the Periphery, as the German finance minister Wolfgang Schäuble does, the Eurozone goes into a double dip recession, deflation and depression. If you want to criticise central banks, arguing that they do too much, then you need to do massive fiscal stimulus. Otherwise aggregate demand is below supply and there will be a depression. However, most of the people who are critical of central banks are also critical of fiscal policy. This is contradictory.
Aren’t structural reforms more important? - People say that there are structural problems in Europe. There might be. But output is below potential, big time. Underemployment is serious; there is huge slack in labour markets, and also in goods markets. Underutilisation has to be filled with aggregate demand, through monetary or fiscal policy, or both. Otherwise you get a depression. No one want’s that after the experience of the great depression in the thirties.
Governments don’t do enough? - We are in a world where politicians still don’t want to use the fiscal tool, even those who do have fiscal space, and where structural reform occurs only slowly. The positive impact of reforms on growth takes time, and in the short term they can have a negative impact on the economy. Therefore, the only game in town remains monetary policy.
So the ECB hasn’t gone too far? - People forget that the alternative is worse. Jens Weidmann, President of the German Bundesbank, is certainly not dovish. Even he said recently, that he might not agree on the full scale of what has been done, but that he affirms the main direction: We need monetary accommodation and a combination of QE, credit easing and a negative policy rate. So even hawks are saying that the ECB has to use unconventional monetary policy.
Is the ECB in the current low interest environment not too much fixated on its inflation target of 2%? - The reason is not just that it is failing its price stability mandate, but monetary policy has to prevent an economic collapse. Weidmann said: People are not just savers, they are also debtors who can go bankrupt and workers who could lose their job. So even Weidmann gets it, that negative policy rates in the net are actually positive.
How will the world economy develop? - There was an economic slowdown as soon as we got the risk-off episode in January and February. The US was slowing down, also China, Emerging Markets, commodity exporters like Canada and Australia. The only ones in expansion were paradoxically Europe and Japan. But since then they have gone to a slowdown. The US is improving, but barely. China is not slowing but stabilising, and I’m not convinced that this is the beginning of a new expansion.
So the state of the world economy doesn’t look very good. - It is not so bad. People call it the new mediocre, the new normal, the secular stagnation, we call it the new abnormal. At least it’s not a recession or a depression. It may be the best that you can expect from the world in the next few years.
A danger for the world economy is a slump in China. - For a number of years, when many people were very optimistic and expected a soft landing of the Chinese economy, I said no way. Then people became too pessimistic and expected a hard landing and zero growth. That is not likely. China has done overinvestment and has overcapacity and too much debt. Economic growth is sharply slowing down, and it is not 6,7% as officially reported but rather between 5,5 and 6%. Potential growth in China for the next five years is going to be 5%. The bad news is that there is a bumpy slowdown, the good news is that there won’t be a hard landing.
How bad is Chinas debt situation? - It’s bad. However, China has the ability to socialise many of the losses, therefore a run on the banking system is unlikely. There could be a slowdown of credit and a bumpy landing of the economy. From time to time, shocks will occur and the markets will panic again. But China will not have a real collapse of the economy and of the currency. They have enough policy tools to sort of manage it – in a bumpy and messy way.
What is the risk of a global recession triggered by China? - A global recession or a financial crisis could be triggered by a meltdown of growth in China that leads to a collapse of the currency and of the stock market. The probability for this I would say is 20%. This is not my baseline scenario, it is a tail risk that you have to worry about. However, the government tries to maintain growth at 6,5%, which is above potential. The only way to do this is more bad investment, more overcapacity, more bad debt. This will create problems down the line.
Which risks for the world economy lie in the Eurozone? - At this point, nobody wants Greece to exit the Eurozone, even though they haven’t done all the things that they need to do. But with the refugee crisis, a failed state on the border of Europe would be a disaster. There will be a compromise and they will continue to kick the can down the road. Greece is insolvent, but if you push maturities 30 or 40 years in the future and cut interest rates low enough, that is in essence the same thing as a debt reduction. Greece has been a 200 Bio. € public debt problem, there was enough money from the EU, the ECB and the IMF for a backstop. Italy is a 2 Trillion € public debt problem.
Is Italy a risk for the Eurozone? - If Italy loses market access, it will not be possible to do a 2 Trillion € bailout. There is a positive scenario where Matteo Renzi stays in power, the economy keeps up through reforms and slowly the debt to GDP ratio stabilises and starts gradually to decrease. In another scenario, Renzi loses power, and with the new electoral law the party Cinque Stelle could take over. They are against the Euro and Italy will exit the Eurozone. So either Renzi politically and economically is successful, and Europe and Germany are patient with him. Or Italy could lose access to capital markets and leave the Eurozone.
What would that mean for the currency union? - It would survive if small Greece left. But if Italy eventually exits, that’s the end of the Eurozone. What happens in Italy in the next six months is key to whether the Eurozone will survive or is doomed.
Switzerland is next door. Can the Swiss National Bank pursue an independent monetary policy? - If other central banks ease, the SNB has to ease more. If Brexit occurs, not only the pound will fall but I’m sure that there will be safe haven inflows into the franc. For the SNB to do more is a combination of more intervention on the foreign exchange market, even lower negative interest rates, which is possible, and a reduction of the exemptions for banks. When push comes to shove, the SNB might have to restrict the ability of banks to convert excess reserves into cash.
Would lower negative interest rates mean negative interest on savings deposits? - You don’t have to tax depositors, the interest rate can be zero. It’s about preventing the banks from converting their excess reserves into cash.
What else could Switzerland do? - Switzerland has massive amounts of fiscal space. Not much is done, among other things because of the debt rules. But suppose the SNB reaches the limit of what they can do, with a risk of massive overvaluation and economic recession, maybe then Switzerland has to change its attitude towards fiscal policy.
Between an even more expansive monetary policy and risks for the world economy – what should investors do? - After seven years of asset reflation, there is no obvious asset class that is cheap. Public equities are expensive, more so in the US than in Europe and Japan, although I don’t call it a bubble. I would keep more cash than usually, because of the risk of market corrections. I wouldn’t go into gold because the upside is limited, unless there is global inflation or a global financial crisis. In a world like this, then year US Treasuries are a good tool, they are pretty good value and actually yields could fall and the price could go higher – if only because there is an impact of more easing by the central banks of Japan and the Eurozone.
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