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Triple Shocks: Japan, Oil, European Debt

March 23, 2011

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Nouriel Roubini

In my view, the fundamental problems of the peripherals are not going to be resolved by a lower interest rate on the official loan. Greece has a public debt that is going to be soon 150 percent of GDP. The Irish banks are in big trouble, and putting their liabilities on the balance sheet of the government makes the government insolvent. So you need something much more fundamental.

In Greece you need an orderly restructuring of the public debt. In Ireland, you need to convert that debt and secured claims of the banks into equity as a way of recapitalizing the banks. So you need debt restructuring in both the public and the private sector. That is much more radical than reducing the interest rate on the loans of the IMF or the EU.

They are going to move in the right direction, but whatever they are going to do in my view is going to be too little, too late.

You have to extend the official resources. You have to redo hard restore competitiveness and growth. You have to restructure private and public debt. So in my view, there is not going to be a comprehensive plan that resolves the problems of the periphery of the Eurozone, especially the excessive amounts of private and public debt. So you’re going to kick the can down the road, and then the Market is going to react negatively and they’ll have to do more somewhere down the line. So this is a chronic problem that is going to take many years to resolve.

The view that they are going to resolve them in March with an agreement is far-fetched.

Certainly, in the periphery of the Eurozone, fiscal austerity, structural reform, lack of competitiveness implies either continued recession or very, very anemic economic growth. Could be longer term near depression of the sort we saw in Japan in the 1990s.

On Japan:

In the short run whenever you have shocks like this — there was the earthquake in Kobe in Japan in 1995 — you have a weakening of economic activity, because suddenly capital stock is destroyed, people die or cannot work or go to work, there is damage to supply and the productive capacity. So you have a slowdown in output. But then over time, if there is a massive of fiscal stimulus to rebuild infrastructure, you name it, there could be an economic recovery over the medium term. But certainly it is a negative for the stock market. Given the destruction of wealth and also the kind of effects on confidence are going to be significant. And let’s not forget there will be fiscal stimulus to reconstruct, but Japan already has a budget deficit close to ten percent of GDP, a debt close to 180 percent of GDP, an aging of population, so this is certainly the worst thing that can happen to Japan at the worst time.

There we have Nouriel Roubini speaking to Bloomberg on the prospects for Europe and Japan. The third flavor of crisis is, of course, the Middle East and North Africa and oil. Today we look at it all.

First, we need to look again at the manifest inadequacy of GDP as a measure of economic well-being. In the current case, with Japan, a whole lot of economic activity will occur in the coming year to reconstruct the energy infrastructure away from Nuclear and to adapt to and mitigate quake damage. So the GDP impacts in the short term will be offset more than completely in the medium and longer terms.

Notice that the well-being of the citizenry will not be captured by this GDP metric, which is concerned only with the buzzing around the hive, not with the output of the hive or its physical condition, nor even the condition of the buzzers.

Take some contrast – in the current situation in Lybia, for example, undergoing a civil war or a war of liberation. Since its GDP consists of its export of oil, there is zero influence of its people in actual economic measures.

Contrast again to the environmental damage being inflicted on the planet every year by greenhouse gas emissions. Arguably as a global economy each year we absorb several times the damage to the long-term viability of our resource base and ability to produce, from the way we go about our business every day. The Fukushima nuclear plant is still not stabilized, and radiation is continuing to be emitted, but it is only ironic that many times that damage is being denied or else accepted under the dictum that we cannot do anything for fear of overtaxing our economy.

Regarding GDP. Alternative measurements of economic activity were explored by the Sarkozy Commission chaired by Amartya Sen and Joseph Stiglitz, but they may have gotten lost in the weeds. If GDP simply included an accounting for net depletion or damage to our economy’s physical, natural and human resources, we’d be doing things a lot differently than we are. Supporting the price of liquid financial assets and stimulated credit creation would not be the first order of business for the Fed, for example. Economic growth would come to mean more than buzzing around the hive. The REAL condition of our economies would appear on the screen of public understanding. The effect of not having a coherent measure is the effect of mapping a path over a cliff.


As a forecaster who predicted a downturn in 2011 based on a weak economy and risks to the financial sector from European debt and American commercial real estate, a downturn triggered by oil prices and restrictions on credit, the Japanese catastrophe was eerily reminiscent of 2001 and 9-11

The 2001 recession was dated from April 2001, and Alan Greenspan was in Europe hat in hand pleading for lower interest rates from the ECB on 9-11. He couldn’t get back into the country for three days. But 9-11 occurred and bailed out Greenspan, W and the host of incumbent forecasters on the economy, who had predicted the New Economy quote unquote and the end of the business cycle.

Same like now. The commodity bubble is clearly in play, the downturn clearly continues unabated, but because this huge, dramatic and tragic event occurred, the forecasts in place which predicted what eventually happens have become immediately obsolete. Now we can throw it like sand in the eyes of the public. Another black swan.



PRUITT:  Even Callaway Golf considers Japan, I mean they get 17 percent of their revenue out of the country.

POWERS: Yes, yes. Despite the decline of Japan’s economy, the Japanese remain avid golfers. Their golf courses are among the finest in the world, and they insist on the best golf clubs. Now the feeling is that as Japan is digging out of the rubble, a Japanese salaried man is not going to feel like splurging and going off and buying a new set of sticks from Callaway, so that’s another impact on the U.S. economy.

PRUITT: And they’re so ubiquitous on television, Aflac, the insurance company with the duck. Well, who knew until this that Aflac gets 75 percent of its business from Japan?

POWERS: Yes. In a very shrewd move, they started thirty years ago recognizing a gap in the medical insurance business in Japan. They exploited that gap and they’re very, very established in Japan. Now they say they’ll be okay, but time will tell.

Cutting into this coverage by Bloomberg’s Ken Pruitt and Chris Power, we have to note that the effect of the catastrophe on individual Japanese is not coming up on the radar too well. Here you see that we are more worried about the company that provides can’t work coverage, i.e., unemployment insurance, than we are about the tens of thousands who may have lost their livelihoods.

In discussing the tendency of the Japanese to hoard against old age and want, we at Demand Side have characterized the social safety net in that country as very poor. It is, overall , however, not that much poorer than the United States’, ranking on a par in some measurements with Mexico. Although lifetime employment in Japanese companies is something of a thing of the past, there are substantial private pension benefits for former workers in big companies, although these have come under attack during the past few years.


LEGGETT: So I think we have problems with nuclear and we have problems with oil. As the Daily Telegraph said, Nuclear and Oil both look as if they could be in meltdown. We have an array of problems. And I think the most important thing that governments have to do now is to accelerate their clean energy programs, particularly energy efficiency. We lead with energy efficiency, but we’ve also got to mobilize the full family of renewable energy technologies, and do it as quickly as we can. That’s the main message coming out of this.

COHEN: Dr. Takin. Let me put it to you. Are you being too sanguine about oil?

TAKIM: The first part is that there is plenty of oil that is available. Supply is … Saudi Arabia has the spare capacity. And in the pipeline there are oil fields, giant discoveries have been made, in the tens of billions of barrels around the world, and they can come on stream. So I don’t think we will have a crunch in oil supply, at least for another twenty years. That I don’t think would happen. But to go and encourage other uses of energy, I definitely agree. Especially to encourage conservation, to increase efficiency in our energy use, all sorts of energy, and go to renewables. But we have to accept in reality in the world, it takes time.

LEGGETT: Yeah, well, there are two very different risk narratives. You know, there are profound disagreements.

There we have Jeremy Legget and Manasheen Takim from the BBC’s Business Daily with Leslie Cohen.

On this subject Roubini in a Project Syndicate column, raises the spectre that political turmoil in the Middle East increases the risk of stagflation, a lethal combination of slowing growth and sharply rising inflation. While Demand Side reserves the term “inflation” for a general phenomenon, Roubini’s point is well taken. Here quoting:

The latest increases in oil prices – and the related increases in other commodity prices, especially food – imply several unfortunate consequences (even leaving aside the risk of severe civil unrest).

First, inflationary pressure will grow in already-overheating emerging market economies, where oil and food prices represent up to two-thirds of the consumption basket.

The second risk posed by higher oil prices – a terms-of-trade and disposable income shock to all energy and commodity importers – will hit advanced economies especially hard, as they have barely emerged from recession and are still experiencing an anemic recovery.

The third risk is that rising oil prices reduce investor confidence and increase risk aversion, leading to stock-market corrections that have negative wealth effects on consumption and capital spending. Business and consumer confidence are also likely to take a hit, further undermining demand.

If oil prices rise much further – towards the peaks of 2008 – the advanced economies will slow sharply; many might even slip back into recession. And, even if prices remain at current levels for most of the year, global growth will slow …

The ammunition bag is empty, according to Stephen Roach: quoting

Alas, there is an added complication that makes today’s shocks all the more vexing: governments and central banks have exhausted the traditional ammunition upon which they have long relied during times of economic duress. That is true of both monetary and fiscal policy … Policy interest rates are close to zero in the major economies in the developed world, and outsize budget deficits are the norm. As a resulth more vexing: governments and central banks have exhausted the traditional ammunition upon which they have long relied during times of economic duress. That is true of both monetary and fiscal policy … Policy interest rates are close to zero in the major economies in the developed world, and outsize budget deficits are the norm. As a result, unconventional – and untested – policies, such as so-called “quantitative easing,” have become the rage among central bankers.

All along, such unconventional policies were viewed as a temporary fix. The hope was that policy settings soon would return to pre-crisis norms. But, with one shock following another, the “exit strategy” keeps being deferred.

Just as it is next to impossible to take a critically ill patient off life-support treatment, it is equally difficult to wean post-bubble economies from their now steady dose of liquidity injections and deficit spending. In an era of extraordinarily high unemployment, political pressures only compound the problem.
This raises perhaps the most troublesome concern of all: with a post-crisis world getting hit by one shock after another, and with central banks having no latitude to cut interest rates, it is not hard to envision a scenario of open-ended monetary expansion that ends in tears. The dreaded inflationary endgame suddenly looms as a very real possibility.

Inflationary, here, is connected specifically with central banks shoving money into the financial sector. Deficits as Minsky has pointed out, end up as corporate revenues. We continue to call for abandoning trickle down and employing people directly doing things that need to be done. This is perhaps more directly inflationary, but is also more stable. The wealth effect in a poor society is not to be trusted.

Meanwhile, the surest sign of a downturn emerged last week from the Fed’s Open Market Committee, which pronounced, The Economic recovery is on a firmer footing, although the target range for the federal funds rate remains at 0 to 1/4 percent , the policy of reinvestment of principal payments remains, there is no change to the plan to purchase an additional $600 billion of longer-term Treasury securities by the end of June 2011, and the key sentence “likely to warrant exceptionally low levels for the federal funds rate for an extended period” remains.

So firmer is a relative term.

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