Wednesday, December 10, 2008

My Man Nouriel (Roubini)

Nouriel Roubini, with whom I have lately fallen in hot (intellectual) love, has some first-rate economic/financial analysis to share with us:

Central banks around the world have undertaken a number of measures to forestall deflation and lift the global economy out of economic slump and credit crisis. Aside from traditional monetary policy tools such as official interest rate cuts and relaxations in reserve requirements, central banks have resorted to alternative unconventional tools. Quantitative easing has begun in the epicenters of the credit crisis, U.S. and Europe, who may be joined by other central banks as they too head towards zero interest rates in leaps and bounds (Sweden moved the most in the developed world by 175bp in one shot). With monetary policy transmission broken by the unwillingness of the private sector to lend or borrow, central banks have had to scurry for alternatives to rate cutting in order to restore markets. They set up an alphabet soup of liquidity facilities that lend funds or purchase assets, offered guarantees on deposits and loans, and established currency swap lines, in addition to a host of fiscal stimulus packages announced by governments.
He then asks the question: are "the pieces now in place to prevent global stag-deflation?" (which, by the way, is a most relevant concern), and answers it by saying:
It is too soon to tell. So far, money market and commercial paper markets have shown tentative signs of easing. But elsewhere in the private sector credit market, tensions remain as asset prices move shambolically and de-leveraging drags on among households, banks and businesses. Though money supply has grown, the velocity of money has slowed despite the flood of liquidity from central banks and official interest rates effectively at or near zero. In other words, we have fallen into a liquidity trap. Such a blow to consumer demand makes deflation in 2009 a real possibility.
You may be bored or just too financially overwhelmed to appreciate the rest of his lucid thinking on what lies ahead, but it's really important to your future financial success (unless you've already got your bonus from one of the bailed-out entities), and since I like you a lot, here's some of my favorite Roubini goodness:
Leading the global effort against the credit crisis/recession/deflation are the Federal Reserve and the ECB. Since the start of the crisis, the Fed and ECB have cut a cumulative 425bp and 175bp, respectively. Other central banks in both the developing and developed world have been more aggressive in cutting rates but they started from a higher base or began easing late. In addition to rate cuts, the Fed and ECB have used more targeted measures, setting up new liquidity facilities, asset purchasing programs and currency swap lines, as well as bailing out systemically critical firms and broadening the range of collateral and extending the term of funds lent out at special facilities. . . . The Fed began paying interest on reserves deposited at the Fed to allow for essentially limitless balance sheet growth. At the same time, the ECB began offering unlimited cash at its weekly auctions. As a result, the Fed and ECB's balance sheets have exploded. Despite liquidity raining down on the financial system from the Fed and ECB, the financial fires have yet to be extinguished. Yes, money market rates are off their peaks and the commercial paper market contraction has bottomed. But a lack of confidence among lenders in potential borrowers (and a lack of confidence among potential borrowers given the profit or income outlook) and falling asset valuations has stymied significant easing in market interest rates, such as for mortgages and car loans. Rate cuts and quantitative easing notwithstanding, it seems the threat of a liquidity trap is looming on the U.S. (and the EMU). Central banks still have ammo left to shoot their way out of the trap and forestall deflation. One option is debt monetization: inflating away the public debt from sharp fiscal expansion to stimulate the economy. Bernanke recently brought up the option of Federal Reserve purchases of longer-term Treasuries and agency debt. In the U.S., private demand continues to fall sharply as does the string of awful economic and financial news. The latest employment report surprised on the negative side (with the largest payroll decline since 1974) and job losses are bound to keep mounting. U.S. GDP is expected to shrink 4% or more in Q4 2008 and the contraction is expected to continue throughout 2009. Orthodox and unorthodox monetary policy measures are certainly needed but they have to be accompanied by a significant stimulus on the fiscal side to support aggregate demand. The great retrenchment of the private sector balance is already under way and the new U.S. administration is getting ready to make the largest investment in infrastructure of the last 50 years. The details of the size and content of the stimulus package are not available yet. However, there seems to be a general consensus that a package of $300-$400bn dollars is a lower bound to keep the economy moving. Let’s make some back of the envelope computations. The depreciation of the U.S. stock of housing goods brings serious negative wealth effects. According to our computations a 30% fall in home prices peak to trough (and U.S. home prices might very well fall more than that) could result in a negative wealth effect that could subtract up to $400-$500bn from private consumption over time. In the same fashion, a painful rebalancing process that would bring to U.S. saving rates back to the levels of a decade ago (around 6%) would be compatible with a decline in consumption of almost $1 trillion. It is welcome news that the stimulus package will most likely be in the $500-700bn range and that it will target productive investment in infrastructure, public services and green technology. However, a fiscal stimulus will not prevent a severe recession at this point – the U.S. economy is officially already in recession since Q4 2007 – but will make the recession shorter and less severe than it would otherwise have been. The EU Commission’s ‘recovery plan’ to be adopted during the EU summit on December 11-12 envisages a fiscal stimulus of around 1.5% of EU GDP or €200bn (approx $260bn). Most of the money will be drawn from national budgets, with EU countries asked to contribute €170bn (approx $221bn) or 1.2% of the EU's GDP. The rest – around €30bn (approx $39bn) or 0.3% of GDP – would come from the EU's own budget and the European Investment Bank (EIB). While some large member states such as the UK and France would like to see a larger common effort to maximize the economic impact and reduce cross-border leaks, Germany looks back at 10 years of hard structural adjustment and highlights the need for each country to keep its own house in order. The same dynamic is also blocking a Common European Bond, which was recently rejected by ECB president Trichet.
Read more here. Suzan ______________________


BadTux said...

The two important words in his article:

liquidity trap.

When you have a liquidity trap, what is happening is that you're pushing on a string. You're pushing money into the system, but it's just sitting there. It's not moving. It's not doing anything. It's not increasing economic activity or anything. It's just getting stuffed under mattresses -- or into U.S. Treasury Bonds, whatever -- because nobody knows whether they'll have a job next week thus they're saving rather than spending, and nobody knows what companies are going to still be in business next week so they're dumping their dough into treasuries, rather than into the next hot startup company.

We have reached the end of Milton Friedman style monetary policy. It has failed as surely as Herbert Hoovert style monetary policy, albeit for different reason (Herbert Hoover believed that deflation was *good*, while Milton Freidman believed that you could solve liquidity traps via helicopter drops of hundred dollar bills). Only massive spending programs to create jobs will get something pulling on the other end of that string, will get the demand ramping back up, will stabilize the financial markets once companies are selling stuff again. And the neat part about it is that the Feds can just print the money, at least to start with, because the solution to deflation is to print money. Except instead of airdropping $100 bills like ole' Milty suggested, we're gonna build some roads and rails and shit with it that can, like, actually *do* something for the nation...

- Badtux the Keynesian Penguin

Suzan said...

Thanks for the comment, Tuxy!

I thought the idea that we will be suffering stagflation along with deflation merited some consideration also.

Good times ahead, huh? Courtesy of the Dick and Bush (very slowly exiting) chaingang.


Serving Patriot said...


You can bet this:

decline in [U.S.] consumption of almost $1 trillion

is scaring the living daylights out of those export based economies in Asia - especially China!

As bad as it is here now, imagine how bad, and dangerous, it is becoming over there where last month, something on the order of 2-3 MILLION workers lost their jobs.

Beijing may quickly find itself on the leading edge of navigating the tricky waters of widespread worker discontent and foiled expectations. Both lead to revolutions.

As the whole global economy skids to a rocky bottom, it will be even worse in places already at the bottom of the heap - like Pakistan. Normally, no one cares about these people - except that the Pakistani's have nukes and there are still some very wealthy countries (for now) that wouldn't mind a fire sale to shop at!


Suzan said...

Oh yes, SP,

I saw a little bit of that concern on the evening news on the face of a Chinese manufacturer. He just couldn't believe the plunging order numbers (from overseas).

I don't want to minimize this situation, but they had no idea how quickly the "paper tiger" syndrome may come back to bite them, did they? I know I'm overstating this a little bit, but the ones in the saddle seem to be changing yet again.

You think anyone will be talking about trying "socialism" as a fairer system soon?

Naaaaa. Me neither.


BadTux said...

Uhm, you *do* know that China is no longer socialist, right? Oh, they give some lip service to socialism, but any society where a) medical care is not guaranteed, b) retirement is not guaranteed, and c) there is no unemployment insurance, can realistically be called socialist.

You want socialist, you need to head over to the Scandinavian countries. They're not purely socialist, but they're close enough for our purposes. And seem to be healthy, happy, smart, and reasonably affluent compared to most folks on the planet. Hmm...

- Badtux the Socialism Penguin

BadTux said...

Oh, what China *is*, is a Confucian dictatorship. Pretty common in the history of nations in that area, e.g., Singapore. Just with some Commie lip gloss on it. Mao's Little Red Book is just Confucianism with the serial numbers filed off in the end, it seems...

-Badtux the History Penguin

Suzan said...

Thanks for the comments, Tuxy!

This is very cool to be sharing this information with the world here.

My undergrad majors were Poli Sci and Int'l Studies where my senior year was spent writing my thesis on the "new" China (early 70's). So, yes, I know that. Before senior year my concentration was in the Far East (India, China and Japan) with two courses in the Mideast. I was particularly appalled at how the Confucianism was thunderstruck by the predator Commies who were more than happy to become predatory Cappies at the drop of the US dollar.

What is great about your response is that lots of other folks may not be acquainted with these facts, and have just had the pleasure of hearing it for the first time.

And yes, oh to live in France or one of the Scandinavian countries (for their sophisticated approach to healthcare as a prerequisite for a well-governed civilized society).

Thanks again!


P.S. Yes, the "socialism" comment was about US.