19 June 2012
Nouriel Roubini
Dark, lowering financial and economic clouds are, it seems, rolling in from every direction: The euro zone, the United States, China and elsewhere.
Indeed, the global economy next year could be a very difficult environment in which to find shelter.
For starters, the euro zone crisis is worsening, as the euro remains too strong, front-loaded fiscal austerity deepens recession in many member countries, and a credit crunch in the periphery and high oil prices undermine prospects of recovery.
The euro zone banking system is becoming balkanised, as cross-border and inter-bank credit lines are cut off, and capital flight could turn into a full run on periphery banks if, as is likely, Greece stages a disorderly euro exit in the next few months.
Moreover, fiscal and sovereign-debt strains are becoming worse as interest-rate spreads for Spain and Italy have returned to their unsustainable peak levels.
Indeed, the euro zone may require not just an international bailout of banks (as recently in Spain), but also a full sovereign bailout at a time when euro zone and international firewalls are insufficient to the task of backstopping both Spain and Italy.
As a result, disorderly breakup of the euro zone remains possible.
US REACHING STALL SPEED
Farther to the west, US economic performance is weakening, with first-quarter growth a miserly 1.9 per cent - well below potential.
And job creation faltered in the past two months, so the US may reach stall speed by year end.
Worse, the risk of a double-dip recession next year is rising: Even if what looks like a looming US fiscal cliff turns out to be only a smaller source of drag, the likely increase in some taxes and reduction of some transfer payments will reduce growth in disposable income and consumption.
Moreover, political gridlock over fiscal adjustment is likely to persist, regardless of whether Mr Barack Obama or Mr Mitt Romney wins November's presidential election.
Thus, new fights on the debt ceiling, risks of a government shutdown, and rating downgrades could further depress consumer and business confidence, reducing spending and accelerating a flight to safety that would exacerbate the fall in stock markets.
CHINA UNDERWATER BY 2013
In the east, China, with its growth model unsustainable, could be underwater by next year, as its investment bust continues and reforms intended to boost consumption are too little too late.
A new Chinese leadership must accelerate structural reforms to reduce national savings and increase consumption's share of GDP; but divisions within the leadership about the pace of reform, together with the likelihood of a bumpy political transition, suggest that reform will occur at a pace that simply is not fast enough.
The economic slowdown in the US, the euro zone, and China already implies a massive drag on growth in other emerging markets, owing to their trade and financial links with the US and the European Union.
At the same time, the lack of structural reforms in emerging markets, together with their move towards greater state capitalism, is hampering growth and will reduce their resiliency.
SELF-FULFILLING SLOWDOWN
Finally, long-simmering tensions in the Middle East - between Israel and the US on one side, and Iran on the other - on the issue of nuclear proliferation could reach a boil by next year.
The current negotiations are likely to fail and even tightened sanctions may not stop Iran from trying to build nuclear weapons.
With the US and Israel unwilling to accept containment of a nuclear Iran by deterrence, a military confrontation next year would lead to a massive oil price spike and global recession.
These risks are already exacerbating the economic slowdown: Equity markets are falling everywhere, leading to negative wealth effects on consumption and capital spending.
Borrowing costs are rising for highly indebted sovereigns, credit rationing is undermining small and medium-size companies, and falling commodity prices are reducing exporting countries' income.
Increasing risk aversion is leading economic agents to adopt a wait-and-see stance that makes the slowdown partly self-fulfilling.
RUNNING OUT OF RABBITS
Compared with 2008-09, when policymakers had ample space to act, monetary and fiscal authorities are running out of policy bullets - or, more cynically, policy rabbits to pull out of their hats. Monetary policy is constrained by the proximity to zero interest rates and repeated rounds of quantitative easing.
Indeed, economies and markets no longer face liquidity problems, but rather credit and insolvency crises.
Meanwhile, unsustainable budget deficits and public debt in most advanced economies have severely limited the scope for further fiscal stimulus.
Using exchange rates to boost net exports is a zero-sum game at a time when private and public deleveraging is suppressing domestic demand in countries that are running current-account deficits and structural issues are having the same effect in surplus countries - a weaker currency and better trade balance in some countries necessarily implies a stronger currency and a weaker trade balance in others.
Meanwhile, the ability to backstop, ring-fence and bail out banks as well as other financial institutions is constrained by politics and near-insolvent sovereigns' inability to absorb additional losses from their banking systems.
As a result, sovereign risk is now becoming banking risk. Indeed, sovereigns are dumping a larger fraction of their public debt onto banks' balance sheet.
GERMANY'S RESISTANCE
To prevent a disorderly outcome in the euro zone, today's fiscal austerity should be much more gradual, a growth compact should complement the EU's new fiscal compact, and a fiscal union with debt mutualisation (Eurobonds) should be implemented.
In addition, a full banking union, starting with euro zone-wide deposit insurance, should be initiated, and moves towards greater political integration must be considered.
Unfortunately, Germany resists all of these key policy measures, as it is fixated on the credit risk to which its taxpayers would be exposed with greater economic, fiscal and banking integration. As a result, the probability of a euro zone disaster is rising.
And, while the cloud over the euro zone may be the largest to burst, it is not the only one threatening the global economy. Batten down the hatches. PROJECT SYNDICATE
NOURIEL ROUBINI is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics.
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