Roubini: The Clear And Present Risk

Comments from Dr.Nouriel Roubini highlighted on theglobeandmail, Desperately seeking an exit strategy

• ...... So the key issue for policy-makers is to decide when to mop up the excess liquidity and normalize policy rates – and when to raise taxes and cut government spending, and in which combination.
  
  The biggest policy risk is that the exit strategy from monetary and fiscal easing is somehow botched, because policy-makers are damned if they do and damned if they don't. If they have built up large, monetized fiscal deficits, they should raise taxes, reduce spending and mop up excess liquidity sooner rather than later.
  
  The problem is that most economies are now barely bottoming out, so reversing the fiscal and monetary stimulus too soon – before private demand has recovered more robustly – could tip these economies back into deflation and recession. Japan made that mistake between 1998 and 2000, just as the United States did between 1937 and 1939.
  
  But if governments maintain large budget deficits and continue to monetize them as they have been doing, at some point – after the current deflationary forces become more subdued – bond markets will revolt. When that happens, inflationary expectations will mount, long-term government bond yields will rise, mortgage rates and private market rates will increase, and one would end up with stagflation (inflation and recession).

• Getting the exit strategy right is crucial: Serious policy mistakes would significantly heighten the threat of a double-dip recession. Moreover, the risk of such a mistake is high, because the political economy of countries such as the United States may lead officials to postpone tough choices about unsustainable fiscal deficits.
  
  In particular, the temptation for governments to use inflation to reduce the real value of public and private debts may become overwhelming. In countries where asking a legislature for tax increases and spending cuts is politically difficult, monetization of deficits and eventual inflation may become the path of least resistance.
  
  
  
  

Dr. Doom Calls Himself Dr.Realist!

I enjoyed the following newsweek interview on Dr.Doom, Nouriel Roubini.

• Weymouth: What do you believe is happening to the economy today?
  Roubini: The rate of economic contraction you have seen in the last two quarters—6 percent annualized—is going to slow down. The optimists are already talking about the "green shoots" of spring, about economic activity becoming positive. [They say] we will have positive growth in the third quarter, and in the fourth quarter we will grow 2 percent over the previous quarter. They expect that next year, growth will go back to above 2 percent.
  
  Compared with this optimistic consensus, I believe that the rate of economic contraction is going to slow from minus 6 percent in the last two quarters to minus 2 percent by the fourth quarter. Next year, I believe that the growth rate is going to be 0.5 percent for the U.S. average. Even if we are technically out of a recession, we are going to feel like we are in a recession. The bottom of the economy is not going to be in three months, but rather toward the beginning or middle of next year.
  
  So you are still Dr. Doom?
  No, I am not Dr. Doom. I am Dr. Realist. I don't believe we are going to end up in a near depression. Six months ago I was more worried about an L-shaped near depression. Today, after the very aggressive policy actions taken by the U.S. and other countries, the risk of that near-depression L has been reduced from 30 percent to 15 or 20 percent. We are instead in the middle of a U.
  
  You think the Obama administration is on the right track?
  I have to give credit to the administration. Within 30 days of coming to power, they did an $800 billion stimulus package, a new program to deal with mortgages and foreclosures, and also a bank plan that when Treasury Secretary Tim Geithner came with details, made the markets rally sharply. Each one of these three programs has some flaws. The fiscal stimulus could have been more front-loaded. For the mortgages, eventually you are going to need a reduction of the face-value principal of the mortgages. And on the banks, I believe after the stress tests it is going to be obvious that even some of the largest banks are so fundamentally in trouble that you cannot buy their toxic assets. You need to take over these banks on a temporary basis, clean them up and then sell them back to the private sector.
  
  You have to nationalize these banks?
  Yes. If you do not like the dirty N word, you can call it a "temporary takeover."
  
  How about the deficit the banks are building up?
  In the short term I am supportive of it, because if we didn't have these fiscal deficits, the recession would become a depression. On the other side, I do agree that this is not a free lunch. We are going to add trillions of dollars to our public debt, which is going to go from 40 to 80 percent of the GDP. There are only a few ways in which you can finance that extra public debt. If you rule out default and a capital levy on wealth, you either have the "inflation tax" or you have to painfully cut spending or raise taxes, and either one is not going to be politically palatable.
  
  What is going to fuel the next growth cycle?
  That is a difficult question. The periods of high growth in the United States in the last 25 years have been characterized by an asset and credit bubble. Whatever the future growth is going to be, this time around it needs to be sustainable and not bubble-prone because we are running out of bubbles to create. We had the real-estate [bubble], tech bubble, housing bubble, hedge-fund bubble, private-equity bubble, commodities bubble, even the art bubble—and they are all bursting.
  
  What makes you different from the other economists?
  We think usually that crowds—on average—can be wiser than individuals. In this case, most people got it wrong because whenever we are in an irrational, exuberant bubble, people fail to think correctly.
  
  Do you believe this is a bear-market rally or do you think it is the market anticipating an economic recovery?
  As we reach newer lows, we may be closer to a level of the market that is fundamentally right. A year ago we were not as close to a true bottom. Today we are closer to it. As we become closer to the bottom of the economy, the stock market looks ahead and sees the light at the end of the tunnel and rallies. In spite of these caveats, I would argue that even the latest market rally is a bear-market rally.
  
  Do you worry about China getting tired of holding our bonds?
  In the short run, China has no option but to accumulate more reserves and dollar reserves. Why? Because if they stop doing that, their currency would appreciate sharply while their exports are plunging. So in the short run, they are going to keep on accumulating. But I have seen a huge number of new initiatives in the last month that suggest [the Chinese] are pushing for the yuan to become an international currency and a reserve currency. They are doing bilateral deals with countries like Argentina and half a dozen others in yuan, not in dollars.
  
  They are moving away from the dollar?
  Yes, slowly they will. First they have to establish their own currency as an international currency. That will take years, but already in a month they have done more than in the last 10 years.

Source: http://www.newsweek.com/id/195053

Dr Doom: Recession Could Last Much Longer!

More Warnings from Dr. Doom

US Recession Could Last Up to 36 Months: Roubini

• "We could end up ... with a 36-month recession, that could be "L-shaped stagnation, or near depression," Roubini said. He puts the chance of a severe U-shaped recession at 66.7 percent, and a more severe L-shaped recession at 33.3 percent.
  
  Roubini listed a litany of negative omens: Capex spending down 20-30 percent for investment grade companies, self-perpetuating deflation, all making a bad situation worse.
  
  "If you expect prices to be lower tomorrow, why would you buy today?", asked Roubini. He says it's easier to break out of am inflationary cycle than a deflationary one, and while a year of deflation "is okay," longer would be "a disaster."
  

More Bearish Comments From Dr. Doom & Black Swan

Posted on CNBC. http://www.cnbc.com/id/29103328

From Professor Roubini

• “If you don’t do everything right, and I think there’s a large probability that’s going to happen, then we may end up in a multi-year stagnation or near depression like the one that Japan had,” he added.
  
  Roubini said there is still a 20 percent downside risk to U.S. global equities, and he advises investors to stay in cash until there is a real bottom.
  
  “Officially the write-downs have been about $1 trillion; I see another $2.6 (trillion) coming up,” he said. “…Losses are mounting and this severe recession is going to get only bigger.”

From Nassim Taleb

• “If I follow my logic to the end, what I thought would happen was anything fragile…would break, namely the banks and people who have a lot of debt and private equity," he said. "This is just happening. It’s not finished yet; it hasn’t probably started."
  

Banking System Is Effectively Insolvent

Posted on Bloomberg news.

• Jan. 20 (Bloomberg) -- U.S. financial losses from the credit crisis may reach $3.6 trillion, suggesting the banking system is “effectively insolvent,” said New York University Professor Nouriel Roubini, who predicted last year’s economic crisis.
  
  “I’ve found that credit losses could peak at a level of $3.6 trillion for U.S. institutions, half of them by banks and broker dealers,” Roubini said at a conference in Dubai today. “If that’s true, it means the U.S. banking system is effectively insolvent because it starts with a capital of $1.4 trillion. This is a systemic banking crisis.”
  
  Losses and writedowns at financial companies worldwide have risen to more than $1 trillion since the U.S. subprime mortgage market collapsed in 2007, according to data compiled by Bloomberg.
  
  President Barack Obama will have to use as much as $1 trillion of public funds to shore up the capitalization of the banking sector, following the $350 billion injection by the Bush administration, Roubini told Bloomberg News. Congress last year approved a $700 billion rescue fund, of which half remains to be disbursed.
  
  Bank of America Corp., the largest U.S. bank by assets, posted a quarterly loss of $1.79 billion last week, its first since 1991, and received $138 billion in emergency government funds. Citigroup Inc. posted an $8.29 billion fourth-quarter loss, completing its worst year, and plans to split in two under Chief Executive Officer Vikram Pandit’s plan to rebuild a capital base eroded by the credit crisis.
  
  “The problems of Citi, Bank of America and others suggest the system is bankrupt,” Roubini said. “In Europe, it’s the same thing.”

Source: http://bloomberg.com/apps/news?pid=20601087&sid=a746r_1q9OOY&refer=home