Market intelligence: Risks to the global economy abound, but no collapse likely, says 'Dr Doom'

04 April 2014 09:33 Source:ICIS Chemical Business

Nouriel Roubini, the economist known as ‘Dr Doom’, highlights five major new risks to the global economy, including the shift in China. Yet the outlook is less than catastrophic

In such precarious times, let’s check in with the economist known as Dr Doom, a moniker earned from his exceptionally dire predictions.

Economists so heavily caveat their forecasts to the effect of declaring “on the one hand… but on the other…” that they long ago prompted then US president Harry Truman to famously demand: “Give me a one-handed economist!”

Still today, many economists give their views based on several scenarios. While a worthy exercise, the main point often gets muddled, leaving the audience no wiser and perhaps more grateful in their own choice of profession. Where most economists weigh positives and negatives, risks and opportunities, what does “Dr Doom” see? Old risks and new risks – naturally.

This shouldn’t be surprising for those familiar with Nouriel Roubini. The NYU economics professor and chairman of Roubini Global Economics earned his nickname from his dire forecasts preceding and during the global financial crisis of 2008-2009.

Speaking at an event organised by the Latin Jewish Center of New York on 26 March, Roubini outlined the six old risks – the break-up of the eurozone; the US falling off the fiscal cliff/defaulting on its debt; deflation in Japan; low inflation/deflation in the US and Europe; war between Israel and Iran; and the Arab Spring. “Each of these six risks are not gone – they could come back, but this is a lower probability,” said Roubini.


Roubini outlines the new risks for the global economy

Copyright: Joseph Chang/ICIS

Rather, there are five new risks for the global economy. Risk #1 is the US Federal Reserve (Fed) tapering its quantitative easing (QE), or debt buying programme.

“The Fed tapering is already being priced in with higher long-term yields. But what is not being priced in is when rates will rise above zero – this would impact the short end of the yield curve. This risk is that the Fed could tighten too fast, too soon,” noted Roubini.

The Fed could raise interest rates as soon as mid-2015, he said. “This could be a shock.”

While new US Fed chair Janet Yellen is dovish, favouring looser monetary policy, Roubini points out that the Fed is no longer a “monarchy” as it was with previous chairman Ben Bernanke at the helm. Rather, with many high-profile members on the Fed board along with Yellen, “the chairman is not the king – at best, a prime minister. Ben is gone and the hawks are in.”

A more hawkish Fed could weigh on the global chemical sector, as higher interest rates could put a big damper on industrial activity, especially related to housing and construction, as well as automotive – the drivers of the US economic recovery.

Risk #2 is the mirror image of #1 – that the Fed normalises rates too slowly – keeping rates so low for so long that a massive new bubble in financial markets emerges. “It’s damned if you do, damned if you don’t. If you delay the end of QE to 2015 or 2016, the bubble could be worse,” Roubini warned.

Risk #3 is China. While some predict a hard landing and others soft, the reality is probably in between. But right now, “the optimists are too optimistic,” he said.

China is transiting its economy from fixed investment to consumption. But this rebalance will occur slowly and not without resistance, noted the economist.

The groups with political power – the provincial governments, property developers and state-owned enterprises (SOEs), all “like fixed investment”. But on the consumption side, the people have zero political power.

“To rebalance, China needs GDP growth below 7% – less fixed investment and more labour-intensive sector growth. Yet, if we see below 7%, the government may panic,” he said. He said 7.5% growth “won’t allow rebalancing. But if growth slows and the government doubles down with credit-fuelled fixed investment, you’ll have more non-performing loans – bad debts from misallocation of capital – that will postpone the rebalance and increase the risk of a harder landing.”

So what markets are not yet pricing in is 6% or lower GDP growth in China. “A negative surprise in China is the biggest risk now,” the economist said. Many players in Asia’s chemical sector are hoping for China to launch a new round of stimulus to kick-start economic growth once again. Chemicals demand in Asia has not recovered anywhere near expectations after the Lunar New Year holidays.

Risk #4 is secular stagnation – simply a period of lower growth than usual for developed economies. Roubini did not dwell on this much.

The last risk, #5, is an emerging market growth slowdown. “The US Fed is tapering, China growth is slowing and the commodity supercycle has ended. This is bad news for emerging markets. Latin America was growing well despite poor policies, but this is now over,” Roubini stressed. It has been a “lost decade” for emerging markets, with the lack of structural reforms to improve education and competitiveness, he said.

China and Russia moved towards a growth model based on state capital with SOEs and state-owned banks. Others such as Brazil, India, South Africa, Argentina and Venezuela focused on trade protectionism.

Latin America can no longer count on double-digit GDP growth from China, a commodity supercycle and a zero interest-rate policy from the US, he noted.

“Lack of structural reform will lead to 1-2% lower annual GDP growth for emerging markets versus the last decade,” said Roubini. “There must be more investment in infrastructure and education to improve competitiveness and produce growth. Unless there is a higher level of investment versus GDP, they cannot grow.”

Aside from the five new risks, the main two geopolitical risks are a new Cold War with Russia emerging from the Ukraine standoff, and whether China’s rise on the world stage will be peaceful or “less peaceful”, the economist said.

So what can we take away, other than that we live in a world fraught with risk? One surprising element was that Roubini was not quite as negative as one might have thought – the Dr Doom attribution raises the bar on expectations for pessimism. Roubini is not predicting a collapse in China, or a recession in the US or the eurozone. For now, expect slower economic growth – both from China, amid a drawn-out rebalancing, and other emerging markets such as Latin America.

Be vigilant when it comes to excesses, or imbalances, building up in the system. One could argue that the US Fed’s QE programme has already created a massive imbalance. But, given that Roubini highlighted risk #2 as being the Fed creating another bubble in the financial markets by continuing zero interest rates for too long, we just might not be there yet.

By Joseph Chang