ROUBINI'S LAST WORDS ON THE RECOVERY

IN LATE AUGUST 2009-- ROUBINI SPEAKS!

Slow recovery and double dip recession are likely, so says Prof. Nouriel Roubini, of the NYU Stern School of Business says (Aug 23, 2009) in the Financial Times of London (See: http://www.ft.com/cms/s/0/90227fdc-900d-11de-bc59-00144feabdc0.html, downloaded 8-24-09)

Roubini sees a close correlation with the “way the advanced economies of the world were contracting” in the last quarter of ‘08 and first quarter of ‘09 with that of the Great Depression of ‘29. But in 2008 world leaders “finally” responded with the powerful economic tools in their arsenal. Their efforts worked and the free-fall subsided according to Roubini.

But when will the global economy bottom out? Roubini says it has done so already in most emerging markets such as China, Brazil, India Latin America and parts of Asia. But for the advanced economies (USA and parts of Europe) the recession will not end before the end of the year.

On the question of the shape of the recovery…will it be rapid (“v” shaped curve) or slow (“u” shaped curve)—Roubini thinks the latter is to be expected. He describes it as “anemic and below trend for at least a couple of years”. He also points to a risk of a “w” shaped double dip curve.

But why will recovery be anemic?

First: Job opportunities are still falling sharply in the US and elsewhere. Prof. Roubini estimates unemployment to reach over 10% by 2010. Alone, that factor would crimp demand and exacerbate bank mortgage losses…and add to the problem of the loss of skills from key sectors of the economy, thus slowing recovery and worker productivity.

Second: There is a widespread crisis of solvency, states Roubini…not just liquidity. Banks, companies, households and individuals were so deeply leveraged-up that they continue to remain close to insolvency even though the losses of the financial institutions have been “put on the government balance sheets” this does not change the basics. Insolvency “limits the ability of banks to lend, households to spend and companies to invest.”

Third: In countries like the US—consumers need to cut spending and save more but as noted above, these very consumers are debt-burdened and as well are faced with a “wealth shock” from falling home prices, shrinking incomes, and loss of employment.

Fourth: The financial system—despite the bailout money—is still damaged. Banks are saddled with “trillions of dollars in expected losses on loans and securities while still being seriously undercapitalized”.

Fifth: Due to high debt, default risks, low growth and weak profit margins, companies are hesitant and/or constrained to increase production, hire workers and invest in new equipment.

Sixth: Government releveraging by building up large fiscal deficits risks crowding out private sector spending. Since the effects of the stimulus package will fizzle out by early next year.. private investment must materialize on time to make up the short-fall. Will investment confidence materialize? Roubini suggests that private investors may not be so sanguine.

Seventh: Global imbalances can lead to a weaker global recovery. With the US economy (one of the world’s “profligate”nations according to Roubini) slowed, countries which save—such as China, Germany and Japan—will have to make up the difference (for their lowered exports) with domestic spending, but this may be a big bill to fill and if domestic demand does not grow fast enough, a weaker global recovery will result.

Finally, there is a tendency for wary government policy makers (sometimes prodded by the political opposition) to take large fiscal (bailout) deficits seriously. As a response, they may act to raise taxes, and cut spending as a way to mop up excess liquidity (to avoid inflation). But if they do so, they risk tipping the economy back into recession and deflation. On the other hand, if they maintain large deficits-- inflationary expectations become their worry, since this will generate higher bond-yield demands and hurt the economy due to higher borrowing rates…and possible stagflation.

Then there is the energy problem. At present, Roubini thinks that oil prices are rising faster than economic fundamentals warrant. But these prices could be driven even higher by excessive liquidity (pumped into a weak economy) chasing scarce assets—and by speculation.

Last year when oil reached $145 a barrel it created havoc with the economies of oil importing countries. Gasoline costs at the pump skyrocketed to nearly four dollars a gallon putting a crimp in the economies of homeowners who travel to distant job sites, to companies which deliver goods by truck, etc. etc. Those higher costs certainly tipped some mortgagees into default.

In summary, Roubini sees an “anaemic and below trend” recovery for the advanced economies and a big risk for double dip inflation.