Tuesday, June 9, 2009

Roubini to Green Shoots Crowd: "Get Out Your Weed Eaters!"

Nouriel Roubini tries to sober up all those observers drunken with green shoots tonic:
Those tentative green shoots that we hear so much about these days may well be overrun by yellow weeds even in the medium term, heralding a weak global recovery over the next two years.

First, employment is still falling sharply in the US and other economies...This will be bad news for consumption and the size of bank losses.

Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not really started, because private losses and debts of households, financial institutions, and even corporations are not being reduced, but rather socialized and put on government balance sheets. Lack of deleveraging will limit the ability of banks to lend, households to spend, and firms to invest.

Third, in countries running current-account deficits, consumers need to cut spending and save much more for many years. Shopped out, savings-less, and debt-burdened consumers have been hit by a wealth shock (falling home prices and stock markets), rising debt-service ratios, and falling incomes and employment.

Fourth, the financial system – despite the policy backstop – is severely damaged. Most of the shadow banking system has disappeared, and traditional commercial banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalized. So the credit crunch will not ease quickly.

Fifth, weak profitability, owing to high debts and default risk, low economic – and thus revenue – growth, and persistent deflationary pressure on companies’ margins, will continue to constrain firms’ willingness to produce, hire workers, and invest.

Sixth, rising government debt ratios will eventually lead to increases in real interest rates that may crowd out private spending and even lead to sovereign refinancing risk.

Seventh, monetization of fiscal deficits is not inflationary in the short run, whereas slack product and labor markets imply massive deflationary forces. But if central banks don’t find a clear exit strategy from policies that double or triple the monetary base, eventually either goods-price inflation or another dangerous asset and credit bubble (or both) will ensue...

Eighth, some emerging-market economies with weaker economic fundamentals may not be able to avoid a severe financial crisis, despite massive IMF support.

Finally, the reduction of global imbalances implies that the current-account deficits of profligate economies (the US and other Anglo-Saxon countries) will narrow the current-account surpluses of over-saving countries (China and other emerging markets, Germany, and Japan). But if domestic demand does not grow fast enough in surplus countries, the resulting lack of global demand relative to supply...will lead to a weaker recovery in global growth, with most economies growing far more slowly than their potential.

So, green shoots of stabilization may be replaced by yellow weeds of stagnation if several medium-term factors constrain the global economy’s ability to return to sustained growth...

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