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Monday, May 9, 2011

Transcript: 438 Nouriel Roubini on how to defuse the debt bomb

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NOURIEL ROUBINI: Well, when you have a high debt problem, there are only four solutions for it. The best solution, of course, is growth. Because if your growth is high, then you can solve any problem, especially a debt problem, because the denominator upward GDP income is rising more than the numerator. Unfortunately, because of the balance sheet crisis, we are not going to have high growth in the Eurozone, in the US, in Europe. So we cannot grow ourselves out of the high debt problem.

The second solution is savings. If you spend less, consume less in the private/public sector, you save more and you reduce your debt. But then you have the paradox of thrift of Keynes. If everybody suddenly stops consuming, there is a recession, output falls, and you fall in the same trap. Or if you are doing fiscal consolidation and too much public savings front-loaded, again that’s recessionary. Output falls, your debt and deficit rise. So you cannot save yourself out of a debt problem.

The third solution is, of course, inflating yourself out of a debt problem. I don’t think central banks are going to take that path, even if you could make an argument that it might be a good idea. Reduce debt deflation, wipe out the real value of private and public debt through high inflation. That’s going to be dangerous in the long run, if we do that. Unlikely it is going to happen.

So, if you cannot grow yourself or save yourself or inflate yourself out of a debt problem, you have to do debt restructuring. That’s what’s going to happen. Debt restructuring of government: Ireland, Spain, Portugal. Debt restructuring of the household sector in countries where they had too much debt and a housing bubble that went bust. Debt restructuring of the banks, like in Ireland. You cannot essentially grow or save or inflate yourself out of a debt problem, eventually you have to have orderly debt reduction and restructuring. We have kicked the can down the road. We have not done it. We started with private debt. We pretended it was a liquidity problem.

We socialized those things. It became a public debt problem. In countries that have lost market access, now you have supernationals bailing out the nationals: Ireland, Portugal, Greece. Nobody is going to be coming from the moon or Mars to bail out the IMF or the ECB or the EFSF. So you cannot go from private to public to supernational debt. Eventually you have to restructure these debts. That’s a tough choice…
Nouriel Roubini. Author of Crisis Economics and one of the people who should be listened to because he was right.

One of the key insights of John Maynard Keynes and other demand siders, Hyman Minsky, Michal Kalecki, Steve Keen, and others, is that capitalism is basically unstable. It is prone to boom and bust. Intrinsically prone. This key insight has been rejected by the current policy framers, who have placed hopes and prayers for stability in the quintessential capitalist institution, the banks. This cannot end well.

And indeed, it is not ending well. The stabilization and bailout of the banks has not resurrected the economy decimated by a bank-led housing bubble. The myriad back-door bailouts, from cheap money and too-big-to-fail insurance to accounting changes and rejection of debt restructuring for households have not led to anything. Monetary policy has been a failure except in creating bubbles in emerging economies and bidding up the prices of liquid financial assets.

Which reminds us, the commodity bubble may have burst. It is fairly easy to tell a bubble after the fact, because there is no plateauing of the price at a level indicated by new supply/demand functions. No, no, no. All the supply and demand stuff is quickly forgotten in grateful praise of mercifully lower oil prices. But did the unrest in the Middle East suddenly subside? Is peak oil now less of a problem? Maybe demand from emerging markets is plummeting?

But it won’t drop fast enough for the cacophony of dunces we’ve captured for today’s Idiot of the Week. Led by head dunce Ken Pruitt of Bloomberg who has seen ten times the inflation that has actually existed and predicted a hundred times that amount.

We’ll hear more from Roubini as well. But first here is James Ferguson, head of strategy at Arbuthnot Securities.

The relationship we’ve seen between QE and inflation expectations, and the way that’s fed into commodities and particularly into stock prices does look very powerful. It’s quite clear that QE didn’t have the effects that Ben Bernanke was expecting, that is the effect on housing and on long bond yields. It has instead has this effect on inflation expectations and stocks.

So we have to expect that if QE II is going to end in June on schedule as now has been indicated that things may change a bit, that is, post-June. We may actually see a change in inflation, commodity-driving sort of market outlook.

So far as we can see in markets the relationship between the timing and the magnitude of QE has been very, very close to the timing and magnitude of changes in the stock market. So one would have to read from that that these things are happening in real time, not really being anticipated. I mean, after all, we’ve never really seen anything like this before, so people are guessing a lot in terms of how these things work themselves through the system.

Over the last sort of 12 to 18 months worldwide in markets, what we’ve seen is the beneficial impact of a quite unbelievably unprecedented amount of public sector balance sheet expansion, an amazing amounts of stimulus in terms of fiscal and monetary policy, which I don’t think people really appreciate how out of the ordinary that is. If you start taking this away… In the UK we have the austerity measures kicking in from this month onwards. In the US, of course, you’ve got your new political fiscal period starting in October, you’ve got the end of QE II in June. All other things being equal, I think, if you take this much stimulus out of the market, it is likely to lead or translate into some sort of a slowdown.

So I think we won’t be seeing more of the same because we’re not going to see the same levels of stimulus. We’re in a position where the authorities can manage the economic data sufficiently so we’re unlikely to have a double dip. Technically speaking to have a double dip we have to have two consecutive quarters of negative GDP growth. And I think if we had one, the authorities would step in pretty fast with QE III, with fiscal stimulation, et cetera. So I think what we’re going to get is we’re going to get a very managed decline, where the authorities basically hold back as much as they can on the stimulus. Which to some extent is getting to dangerous levels now in terms of debt to GDP.

But they’ll also be fine-tuning that with the results as they come in. So I think what we’ve seen is the sweet spot, where we had the stimulus without too much, um, negative attachment to that. Now I think what we’re going to have to be prepared for probably slower levels of growth than most people are used to

Maybe more like one percent growth over time, rather than, say, three or four percent.
James Ferguson

What you hear here is deep concern on the part of this trader that the end of QE II will spell the end of the demand pull on financial assets. What you don’t hear here is the connection between overheating economies and inflation in the developed world.

Let’s step back. As a lead-in to today’s idiot of the week, let’s consider the question: Why inflation?

Answer # 1: The Fed is printing money which is increasing the M in the Monetarists MV = PQ.


No. The Fed is pushing chips into the financial casino, which is bidding up the prices of financial assets which now include commodities plays. That is what has driven cost-push inflation. The V in MV has collapsed, so the M is meaningless.

Answer #2: Commodities are being bid up by the robust growth of emerging economies.


No. Bubbles in emerging economies are coming out of QE II and cheap Fed money fleeing to the latest rising price, but these economies are still small compared to the developed world. Some demand pull, yes, robust growth, no. At least not healthy growth.

Answer #3: The federal government is spending too much.


Answer #4: Inflation is always and everywhere a monetary phenomenon.


I guess that was a gratuitous buzzer in memory of Milton Friedman. See answer #1. Inflation is a general rise in prices. I saw a blogger try to say recently it is a general and continuous rise, but I think that’s a little bit of a stretch.

Answer #5: Inflation is something that can be dealt with by raising interest rates.

What, no buzzer?

ONLY because raising interest rates CAN cool an economy that is overheated by raising financing costs. And in the classic demand-pull inflation where prices are bid up by excess consumer demand, that might be effective. Do we have that now?


Okay. Enough of that noise. Overheated economy? Excess consumer demand over supply? Industrial output straining capacity. No. We don’t have that. We have a very stagnant economy, very slack consumer demand, and we have rising – or HAD rising – commodity prices. If you look just a little further than the end of your nose, you see that commodity prices – oil prices – are themselves a drag on demand and should in themselves crimp consumer demand for other products.

So. When you see inflation hawks talking about raising interest rates to combat inflation, you are seeing them throwing a millstone to a swimmer barely able to support commodity prices. Let me rephrase that. Increasing interest rates increases costs. In normal times, this would mean increasing prices. But financing at two percent vs. zero is not really the issue. The issue is lack of demand. No long-term large investment is being made in this environment, at least domestically, so no long-term large investments are going to be crimped.

What happens with higher food and energy? Households have to cut back. What does headline inflation measure? The aggregate of all prices. What does core inflation measure? All prices less energy and food. Let’s call food a surrogate for all commodities. Core inflation measures wages. Core inflation is stagnant because wages are stagnant.



CARL LANTZ: If you go back to last October, November, even during the summer of last year, we saw consumer spending was sort of flat-lining, industrial production momentum was slowing, and most importantly inflation expectations had fallen quite low – well below 2 percent in, say, ten-year TIPS. And I think the QE program more than anything stabilized those inflation expectations. So you’ve seen quite a dramatic rise to north of two-and-a-half percent. By taking, sort of, deflation off the table, you had risky assets do quite well.


And one of the other impacts of the QE program that I think is often underestimated is that by committing to this somewhat controversial program, the Fed made it very clear that they were a very long way from raising rates. So it was really less about driving long-term rates down as it was about stabilizing expectations around the timing of Fed hikes and the probability of deflation.

KEN PRUITT: Well, yeah, and well you say, last year it was the possibility of deflation, not enough inflation in the system. Now, and I’ve pointed this out before, you know, Carl, somebody listing to this, driving home from the supermarket with a stop at the gas station, doesn’t believe it when Mr. Bernanke says its only a temporary problem.


LANTZ: Well, I can sympathize. I just filled up the tank, and I didn’t realize this, but the credit card machine shut off at $100 in a twenty-six gallon tank.



… It was over four dollars, so I didn’t even fill up. Um. Yeah. That’s what we refer to as repeat purchases. We tend to buy gas quite frequently and food quite frequently, so that’s what influences our inflation expectations.

PRUITT: Well, I usually don’t pay that much attention. But I did notice yesterday I was spending twenty-two cents a gallon than I was a week ago.



LANTZ: Yeah. You can’t not notice it. You know, that’s part of the reason that QE II is going to end on schedule is, you know, the public for the most part has ignored the Fed over the years, and doesn’t really understand monetary policy. But I think this is a unique time in American history where the Fed is in the center of the sort of whole political debate about debt and deficits and inflation.

And, uh, I think that more than usual the public is perceiving inflation problems and it is being attributed to the Fed, with the help of some, you know, U-Tube cartoons and editorials. The Fed is in this difficult position of not wanting to raise rates, but having to talk tough when it comes to inflation expectations. So we’ve seen a lot of hawkish comments from the usual suspects. Even the doves, I think, are what I would say are conditionally hawkish. They say, “If this is more than transitory, we’ll do something.” But that begs the question, What is transitory?

LAKSCHMAN ACHUTHAN (ECRI): Right. The doves, one of them, I think the New York Fed president kind of got in an interesting discussion about this, that food and energy prices are rising, and I think he was trying to make the point that the broad basket of inflation hasn’t really risen very much.

But that is lost on the public because you’re buying food and energy. And they’re still maintaining…. Some key Fed officials are still maintaining a relatively dovish view. And when you look at the tea leaves on the FOMC, you know, and all the, you know, the doves and the hawks. Is there a shift going on, or are they all staying in their camps?

LANTZ: I think it’s more complicated than just the two camps. It seems to me that around this issue of energy and commodity prices there is a robust discussion about to what extent the Fed is contributing to it. And the party line from the core is that they are not. But I would refer people back to the March FOMC statement where they mention rising commodity prices only in the context of inflation. And they said they expected it to be transitory – in parenthesis, you know, they hope it’s transitory – but they didn’t emphasize it as a drag on growth, which some of the doves might have historically preferred to characterize it in those terms. So I think the hawks are making some headway with the argument that the Fed can’t just assume that it’s all external to monetary policy.


Let’s cleanse the palate with some more observations from Nouriel Roubini, here speaking to the potential virtue of inflation, but with a caution. And you haven’t heard that caution from Demand Side, who has seen inflation as a way of helping reduce the real value of the debt burden. Roubini makes some telling points here. But remember, the successful recoveries from previous post-war recessions have entailed some inflation. Also remember from Kalecki and Minsky that inflation or reflation is inevitable with any meaningful increase in investment, because the new workers in the investment goods sector will be competing with the consumption goods workers for the output of the consumptions goods sector. This will be true whether the investments are in new factories for private goods or – much better – in infrastructure, energy, education and climate change mitigation – the public goods we need.

But here, responding to the question, Yes, we shifted the debt from the private to the public sector and are now shifting it to the IMF and supernational institutions. Couldn’t we then go to inflation?
TOM KEEN: Can’t we go from private to public to supernational to inflation?

ROUBINI: We could do that. That’s an option. I would say on two counts, on a normative one it is not desirable for three reasons, and on a positive one it is not likely. It is not desirable for three reasons. One , if the inflation genie gets out of the bottle, then you’re going to need a nasty Volcker-style recession to break the inflation expectation and bring back the genie into the bottle. Or as Premier Yen, Wen said the other week, “Once the inflation tiger is out of the cage, bringing it back in is going to be very difficult.” That’s the first problem.

Secondly, inflation can reduce the real value of nominal debt at fixed rates. But most of the liabilities in the system today are short term at variable rates. Liabilities of the banking system, of the household sector, of government. As soon as you rise expected inflation through inflationary policy, all that stuff gets repriced. And unless you have hyper-inflation, then debt reduction doesn’t occur through inflation.

Three, and more importantly, the last time we used the inflation tax to wipe out our private and public debt, in the 70’s twice, we were a net creditor country, and we were a net lender country. We were running a current account surplus. Today we are the biggest net debtor in the world, to the tune of $3 trillion, and we are the biggest net borrower in the world. Our current account deficit is still half a trillion a year. So we have to borrow from the rest of the world.

And our creditors who are still financing us are not going to bend over and accept a massive capital levy on the holding of dollar assets if we are going to wipe out the real value of these dollar assets through inflation and debasement of the currency. There will be a run against the dollar, a collapse of the dollar, a spike of long rates.

Those are telling points. What they mean to me is that inflation as a strategy is not in the cards. How would it be done when the money supply is not available as a useful tool? I don’t know. They might try more of the QE stuff, shoving cheap chips to the financial players. But the inflation incident to new investment may be palatable, since it would be more contained and would be accompanied by growth.


  1. What I've taken away from this discussion is that a deliberate policy of creating inflation is far too risky. And that also, just letting it happen may also be equally risky since it will be automatically countered by a deflationary rise in interest rates.

    The idea of restructuring debt seems to suggest that creditors must take a haircut. My perspective is one in which the wealthy have wound up the spring on the securitisation-machine and so must let it unwind. The idea of restructuring to me also suggests that the wealth of the wealthy is overvalued because of speculation using securities in a selfish and reckless way.

    My interest, however, is in the fate of ordinary people. I see the securitisation of pensions, savings, and insurance as something that ordinary people have no power to resist. If peoples' pensions etc also have to take a haircut they will be hurt.

    In addition restructuring also seems to 'share' the problems that private banking has created by winding up the spring of the machine in the first place. Restructuring will then have an element of socialization of the bankers problems - and like austerity, this will be outside of democratic control as we have experienced recently across the developed world. As a result, ordinary people will again get hurt. Is there anything that can be done to stop this or make it less painful?

  2. Ordinary people are getting killed by the current scheme of transferring the debt to the sovereigns and letting them pay for it in taxes. The rich ought to get in on this party by having their tax rates go up.

    Securitization is dead as a form of large-scale investment, as far as I am aware. The question of whether the wealth of the wealthy is overvalued. Only insofar as the rest of us make good on it by bailing them out. I think that is the point. The wealth of the wealthy in nominal terms is tied up in these financial assets that -- when they go bust -- taxpayers make good on because the alternative is unthinkable.

    I think it was L. Randal Wray, or one of his buddies at Kansas City who said, "Debts that cannot be repaid, will not be repaid." Roubini is absolutely right here, we don't have a choice. There will be restructuring. Will it be orderly or disorderly? Orderly would involve closing the casino and getting the real economy back in the game. Disorderly means huge political, social and economic problems.

    Pension funds can wait out the storm better than anybody else, except perhaps government. The rest of us are mortal and need the money when we need it. The hysterical matrons of the bond market will never want to take a hit. But, as Roubini says, if you can't grow (BECAUSE of the debt), and you can't save (paradox of thrift), and you can't inflate (because debts are now designed to inflate too), then the only option left is to restructure. From household mortgages to sovereign bonds.