The surging price of the world’s best-known cryptocurrency has made some investors rich and prompted skeptics to point to the excesses of the current bull market. Central bank digital currencies (CBDCs) may offer a surer route to greater financial inclusion, but are policymakers and the public prepared for this potentially radical innovation?
In this Big Picture, Harvard University’s Kenneth Rogoff thinks that the COVID-19 pandemic could accelerate the emergence of CBDCs, and outlines two ways in which monetary policymakers could introduce them. The case for a digital dollar, however, is far from clear-cut, says Barry Eichengreen of the University of California, Berkeley, not least because fear that a digital renminbi will challenge the greenback’s global dominance is overblown. But New York University’s Nouriel Roubini makes the case that CBDCs could replace both an inherently crisis-prone banking system and worthless private cryptocurrencies such as Bitcoin.
Chatham House’s Jim O’Neill is similarly unimpressed by the Bitcoin hype, and explains why cryptocurrencies like it will never be anything more than speculative vehicles. For that reason, says Willem H. Buiter of Columbia University, only those with a robust appetite for risk and the wherewithal to absorb heavy losses should consider investing in them. By contrast, Brian Armstrong of cryptocurrency exchange Coinbase argues that cryptocurrencies with strong consumer-privacy protections should be a key feature of the post-pandemic recovery.
Either way, conclude Katharina Pistor of Columbia Law School and Co-Pierre Georg of the University of Cape Town, central banks may soon need to expand their remit and develop a new regulatory infrastructure to manage both public and private digital currencies.
The COVID-19 pandemic is accelerating the long-term shift away from cash, and monetary authorities risk falling behind. A recent report from the G30 argues that if central banks want to shape the outcome, they need to start thinking fast.
CAMBRIDGE – As the COVID-19 crisis accelerates the long-term shift away from cash (at least in tax-compliant, legal transactions), official discussions about digital currencies are heating up. Between the impending launch of Facebook’s Libra and China’s proposed central-bank digital currency, events today could reshape global finance for a generation. A recent report from the G30 argues that if central banks want to shape the outcome, they need to start moving fast.
Much is at stake, including global financial stability and control of information. Financial innovation, if not carefully managed, is often at the root of a crisis, and the dollar gives the United States significant monitoring and sanctions capabilities. Dollar dominance is not just about what currency is used, but also about the systems that clear transactions, and, from China to Europe, there is a growing desire to challenge this. This is where a lot of the innovation is taking place.
Central banks can take three distinct approaches. One is to make significant improvements to the existing system: reduce fees for credit and debit cards, ensure universal financial inclusion, and upgrade systems so that digital payments can clear in an instant, not a day.
The US lags badly in all these areas, mainly because the banking and financial lobby is so powerful. To be fair, policymakers also need to worry about keeping the payments system secure: the next virus to hit the global economy could well be digital. Rapid reform could create unexpected risks.
At the same time, any effort to maintain the status quo should provide room for new entrants, whether “stable coins” pegged to a major currency, like Facebook’s Libra, or redeemable platform tokens that large retail tech companies such as Amazon and Alibaba might issue, backed by the ability to spend on goods the platform sells.
The most radical approach would be a dominant retail central-bank currency which allows consumers to hold accounts directly at the central bank. This could have some great advantages, such as guaranteeing financial inclusion and snuffing out bank runs.
But radical change also carries many risks. One is that the central bank is poorly positioned to provide quality service on small retail accounts. Perhaps this could be addressed over time, by using artificial intelligence or by expanding financial services offered by post office branches.
In fact, when it comes to retail central-bank digital currencies, economists worry about an even bigger problem: Who will make loans to consumers and small businesses if banks lose most of their retail depositors, who comprise their best and cheapest source of borrowing?
In principle, the central bank could re-lend to the banking sector the funds it gets from digital currency deposits. This would, however, give the government an inordinate amount of power over the flow of credit, and ultimately the development of the economy. Some may see this as a benefit, but most central bankers probably have deep reservations about assuming this role.
Security is another issue. The current system, in which private banks play a central role in payments and lending, has been in place around the world for more than a century. Sure, there have been problems; but for all the challenges banking crises have created, systemic breakdowns in security have not been the major issue.
Technology experts warn that for all the promise of new cryptographic systems (on which many new ideas are based), a new system can take 5-10 years to “harden.” What country would want to be a financial guinea pig?
China’s new digital currency offers a third, intermediate vision. As the G30 report describes in greater detail than previously available, China’s approach involves eventually replacing most paper currency, but not replacing banks. In other words, consumers would still hold accounts at banks, which in turn would hold accounts with the central bank.
When consumers want cash, however, instead of getting paper currency (which is rapidly becoming passé in Chinese cities anyway), they would receive tokens in their digital wallet at the central bank. Like cash, the central-bank digital currency would pay zero interest, giving interest-bearing bank accounts a competitive edge.
Of course, the government can change its mind later and start offering interest; banks may also lose their edge if the general level of interest rates collapses. This framework does take away the anonymity of paper currency, but many monetary authorities, including the European Central Bank, have discussed ideas for introducing anonymous low-value payments.
Last, but not least, a shift to digital currencies would make it easier to implement deeply negative interest rates, which, as I have argued for many years, would go a long way toward restoring the potency of monetary policy in crises. One way or another, the post-pandemic world will move very fast in payments technologies. Central banks cannot afford to play catch-up.
Who Needs a Digital Dollar?
Recently, the idea of a digital greenback elicited support from US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. Ultimately, the advantages of a digital dollar will need to be weighed against the potentially high costs and significant risks to the financial system that come with it.
BERKELEY – The idea of a digital dollar has been in the air for some time now. Recently, it descended from the ether to the lips of US Treasury Secretary Janet Yellen and Federal Reserve Chair Jay Powell. At an event in February, Yellen flagged the idea as “absolutely worth looking at,” adding that the Federal Reserve Bank of Boston, in conjunction with academics at MIT, was already doing so. In Congressional testimony the following day, Powell called a digital dollar “a high priority project for us.”
Some see this as another front in the technological cold war between the United States and China. The People’s Bank of China (PBOC) will almost certainly be the first major central bank to roll out a digital currency, in 2022 at the latest. If the US doesn’t move quickly, it will fall behind. America’s financial system will remain stuck in the twentieth century, damaging US competitiveness. The dollar’s position as the dominant international currency will be eroded by the ease of using China’s digital unit in cross-border transactions, and the US will squander a singular source of monetary and financial leverage.
In fact, such concerns are either overblown or flat-out wrong. The PBOC’s main motivation for issuing a digital renminbi is to create a government-controlled alternative to two very large and loosely regulated digital payment platforms, Alipay and WeChat Pay.
The ubiquity of Alipay and WeChat Pay raises the specter of the Chinese authorities losing control of payment flows through the economy. And because they use information on payments to inform their lending activities, their pervasiveness points to the possibility of the authorities losing control of financial flows and credit allocation more generally. Thus, the PBOC’s determination to issue a digital currency is part and parcel of the Chinese government’s decision last November to quash the initial public offering of Ant Group, Alipay’s corporate parent.
The American government has no analogous worries. In the US, scores of different platforms, such as PayPal, Stripe, and Square carry out digital payments, which are ultimately settled by banks, and hence through Fedwire, the Federal Reserve’s in-house system for clearing interbank transactions. Visa, Mastercard, Discover, and American Express process the lion’s share of card-based payments, but their actual cards are issued by banks, which are regulated, limiting risks to the payments and financial system. Here, too, settlement occurs through Fedwire.
Similarly, it is important to bear in mind how far the renminbi lags behind the greenback as an international currency. Currently, China’s currency accounts for a mere 2% of global cross-border payments, a negligible share compared to the dollar’s 38%.
To be sure, the convenience of a digital renminbi would hasten its uptake in cross-border transactions. But that digital currency might also have a hidden backdoor, enabling Chinese authorities to track transactions and identify those undertaking them, discouraging use by third parties. Given this, it’s hard to see China’s digital currency as a game changer internationally.
So, the decision to create a digital dollar would have to be justified on other grounds. The soundest justification is financial inclusion. Americans without credit cards and bank accounts, who rely entirely on cash, are denied not just financial services but other services as well. Rideshare companies ask you to link your app to your credit or debit card; no card, no pick-up. And no bank account, no card.
In this context, recall the difficulty the US Treasury had in getting pandemic relief checks to the unbanked. If everyone had a Federal Reserve-issued electronic wallet into which digital dollars could be deposited, this problem would be solved.
Digital dollars could also address the exorbitant cost of cross-border money transfers. But foreign governments might be reluctant to permit their nationals to install the Fed’s digital wallet, because that would leave them and their central banks unable to enforce their capital controls, which they value as macroprudential tools.
Alternatively, the Fed’s digital wallet could be made interoperable with foreign digital wallets. But interoperability would require close cooperation between central banks on the details of technology and security. While there are efforts in this direction, making it work would be a daunting task, to say the least.
Ultimately, such advantages should be weighed against the costs and risks of digitizing the dollar. If people shift their savings from banks to digital wallets, banks’ ability to lend will be hamstrung. Some banks will close, and small businesses that rely on banks for credit will have to look elsewhere.
Moreover, a Fed-run network of retail payments would be a rich target for hackers and digital terrorists. Security and financial stability are of the essence, and it is not obvious that they can be guaranteed. All this is to say that while the case for a digital dollar may be worthy of examination by Yellen and Powell, it is hardly a slam-dunk.
Why Central Bank Digital Currencies Will Destroy Cryptocurrencies
Leading economic policymakers are now considering whether central banks should issue their own digital currencies, to be made available to everyone, rather than just to licensed commercial banks. The idea deserves serious consideration, as it would replace an inherently crisis-prone banking system and close the door on crypto-scammers.
NEW YORK – The world’s central bankers have begun to discuss the idea of central bank digital currencies (CBDCs), and now even the International Monetary Fund and its managing director, Christine Lagarde, are talking openly about the pros and cons of the idea.
This conversation is past due. Cash is being used less and less, and has nearly disappeared in countries such as Sweden and China. At the same time, digital payment systems – PayPal, Venmo, and others in the West; Alipay and WeChat in China; M-Pesa in Kenya; Paytm in India – offer attractive alternatives to services once provided by traditional commercial banks.
Most of these fintech innovations are still connected to traditional banks, and none of them rely on cryptocurrencies or blockchain. Likewise, if CBDCs are ever issued, they will have nothing to do with these over-hyped blockchain technologies.
Nonetheless, starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.
As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system.
By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services. Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.
If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.
Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.
The main problem with CBDCs is that they would disrupt the current fractional-reserve system through which commercial banks create money by lending out more than they hold in liquid deposits. Banks need deposits in order to make loans and investment decisions. If all private bank deposits were to be moved into CBDCs, then traditional banks would need to become “loanable funds intermediaries,” borrowing long-term funds to finance long-term loans such as mortgages.
In other words, the fractional-reserve banking system would be replaced by a narrow-banking system administered mostly by the central bank. That would amount to a financial revolution – and one that would yield many benefits. Central banks would be in a much better position to control credit bubbles, stop bank runs, prevent maturity mismatches, and regulate risky credit/lending decisions by private banks.
So far, no country has decided to go this route, perhaps because it would entail a radical disintermediation of the private banking sector. One alternative would be for central banks to lend back to private banks the deposits that moved into CBDCs. But if the government was effectively banks’ only depositor and provider of funds, the risk of state interference in their lending decisions would be obvious.
Lagarde, for her part, has advocated a third solution: private-public partnerships between central banks and private banks. “Individuals could hold regular deposits with financial firms, but transactions would ultimately get settled in digital currency between firms,” she explained recently at the Singapore Fintech Festival. “Similar to what happens today, but in a split second.” The advantage of this arrangement is that payments “would be immediate, safe, cheap, and potentially semi-anonymous.” Moreover, “central banks would retain a sure footing in payments.”
This is a clever compromise, but some purists will argue that it would not solve the problems of the current fractional-reserve banking system. There would still be a risk of bank runs, maturity mismatches, and credit bubbles fueled by private-bank-created money. And there would still be a need for deposit insurance and lender-of-last-resort support, which itself creates a moral hazard. Such issues would need to be managed through regulation and bank supervision, and that wouldn’t necessarily be enough to prevent future banking crises.
In due time, CBDC-based narrow banking and loanable-funds intermediaries could ensure a better and more stable financial system. If the alternatives are a crisis-prone fractional-reserve system and a crypto-dystopia, then we should remain open to the idea.
The Bitcoin Lottery
The sudden rise of “special purpose acquisitions companies” and cryptocurrencies speaks less to the virtues of these vehicles than to the excesses of the current bull market. In the long term, these assets will mostly fall into the same category as speculative “growth stocks” today.
LONDON – I was recently approached about setting up my own “special purpose acquisition company” (SPAC), which would allow me to secure financial commitments from investors on the expectation that I will eventually acquire some promising business that would prefer to avoid an initial public offering. In picturing myself in this new role, I mused that I could be doubly fashionable by also jumping into the burgeoning field of cryptocurrencies. There have been plenty of headlines about striking it big, quickly, so why not get in on the action?
Being a wizened participant in financial markets, I declined the invitation. The rising popularity of SPACs and cryptocurrencies seems to reflect not their own strengths but rather the excesses of the current moment, with its raging bull market in equities, ultra-low interest rates, and policy-driven rallies after a year of COVID-19 lockdowns.
To be sure, in some cases, pursuing the SPAC route to a healthy return probably makes a lot of sense. But the fact that so many of these entities are being created should raise concerns about looming risks in the surrounding markets.
As for the cryptocurrency phenomenon, I have tried to remain open-minded, but the economist in me struggles to make sense of it. I certainly understand the conventional complaints about the major fiat currencies. Throughout my career as a foreign-exchange analyst, I often found that it was much easier to dislike a given currency than it was to find one with obvious appeal.
I can still remember my thinking during the run-up to the introduction of the euro. Aggregating individual European economies under a shared currency would eliminate a key source of monetary-policy restraint – the much-feared German Bundesbank – and would introduce a new set of risks to the global currency market. This worry led me (briefly) to bet on gold. But by the time the euro was introduced in 1999, I had persuaded myself of its attractions and changed my view (which turned out to be a mistake for the first couple of years, but not in the long term).
Similarly, I have lost count of all the papers I have written and read on the supposed unsustainability of the US balance of payments and the impending decline of the dollar. True, these warnings (and similar portents about Japan’s long-running experiment in monetary-policy largesse) have yet to be borne out. But, given all this inductive evidence, I can see why there is so much excitement behind Bitcoin, the modern version of gold, and its many competitors. Particularly in developing and “emerging” economies, where one often cannot trust the central bank or invest in foreign currencies, the opportunity to stow one’s savings in a digital currency is obviously an inviting one.
By the same token, there has long been a case to be made for creating a new world currency – or upgrading the International Monetary Fund’s reserve asset, special drawing rights – to mitigate some of the excesses associated with the dollar, euro, yen, pound, or any other national currency. For its part, China has already introduced a central bank digital currency, in the hopes of laying the foundation for a new, more stable global monetary system.
But these innovations are fundamentally different from a cryptocurrency like Bitcoin. The standard economic textbook view is that for a currency to be credible, it must serve as a means of exchange, a store of value, and a unit of account. It is hard to see how a cryptocurrency could meet all three of these conditions all of the time. True, some cryptocurrencies have demonstrated an ability to perform some of these functions some of the time. But the price of Bitcoin, the canonical cryptocurrency, is so volatile that it is almost impossible to imagine it becoming a reliable store of value or means of exchange.
Moreover, underlying these three functions is the rather important role of monetary policy. Currency management is a key macroeconomic policymaking tool. Why should we surrender this function to some anonymous or amorphous force such as a decentralized ledger, especially one that caps the overall supply of currency, thus guaranteeing perpetual volatility?
At any rate, it will be interesting to see what happens to cryptocurrencies when central banks finally start raising interest rates after years of maintaining ultra-loose monetary policies. We have already seen that the price of Bitcoin tends to fall sharply during “risk-off” episodes, when markets suddenly move into safe assets. In this respect, it exhibits the same behavior as many “growth stocks” and other highly speculative bets.
In the interest of transparency, I did consider buying some Bitcoin a few years ago, when its price had collapsed from $18,000 to below $8,000 in the space of around two months. Friends of mine predicted that it would climb above $50,000 within two years – and so it has.
Ultimately, I decided against it, because I had already taken a lot of risk investing in early-stage companies that at least served some obvious purpose. But even if I had bet on Bitcoin, I would have understood that it was just a speculative punt, not a bet on the future of the monetary system.
Speculative bets do of course sometimes pay off, and I congratulate those who loaded up on Bitcoin early on. But I would offer them the same advice I would offer to a lottery winner: Don’t let your windfall go to your head.
Notwithstanding the recent spectacular surge in its price, Bitcoin will remain an asset without intrinsic value whose market value can be anything or nothing. Only those with healthy risk appetites and a robust capacity to absorb losses should consider investing in it.
NEW YORK – On February 8, Elon Musk’s electric-car firm Tesla announced that it had invested $1.5 billion of its cash reserves in Bitcoin back in January. The news helped to boost the cryptocurrency’s already skyrocketing price by a further 10%, to a record high of more than $44,000. But, especially in Bitcoin’s case, what goes up can just as easily come crashing down.
Bitcoin was invented in 2008 and began trading in 2009. In 2010, the value of a single Bitcoin rose from around eight-hundredths of a cent to eight cents. In April 2011, it traded at 67 cents, before subsequently climbing to $327 by November 2015. As recently as March 20 last year, Bitcoin traded at about $6,200, but its price has since increased more than sevenfold.
Today, Bitcoin is a perfect, 12-year-old bubble. I once described gold as “shiny Bitcoin,” and characterized the metal’s price as a 6,000-year-old bubble. That was a bit unfair to gold, which used to have intrinsic value as an industrial commodity (now largely redundant), and still does as a consumer durable widely used in jewelry.
Bitcoin, by contrast, has no intrinsic value; it never did and never will. It is a purely speculative asset – a private fiat currency – whose value is whatever the markets say it is.
But Bitcoin is also a socially wasteful speculative asset, because it is expensive to produce. The cost of “mining” an additional Bitcoin – solving computational puzzles using energy-intensive digital equipment – increases at such a rate that the total stock of the cryptocurrency is capped at 21 million units.
Of course, even if Bitcoin’s protocol is not changed to allow for a larger supply, the whole exercise can be repeated through the issuance of Bitcoin 2, Bitcoin 3, and so on. The real costs of mining will thus be replicated, too. Moreover, there are already well-established cryptocurrencies – for example, Ether – operating in parallel with Bitcoin.
But as the success of government-issued fiat currencies shows, the universe of speculative bubbles is by no means restricted to cryptocurrencies like Bitcoin. After all, in a world with flexible prices, there is always an equilibrium where everyone believes the official fiat currency has no value – in which case it consequently has no value. And there are infinitely many “non-fundamental” equilibria where the general price level – the reciprocal of the fiat currency’s price – either explodes and goes to infinity or implodes and falls to zero, even when the money stock remains fairly steady or does not change at all.
Finally, there is the unique “fundamental” equilibrium at which the price level (and the value of the currency) is positive and neither explodes nor implodes. Most government-issued fiat currencies appear to have stumbled into this fundamental equilibrium and stayed there. Keynesians ignore these multiple equilibria, viewing the price level (and thus the price of money) as uniquely determined by history and updated gradually through a mechanism like the Phillips curve, which posits a stable and inverse relationship between (unexpected) inflation and unemployment.
Regardless of which perspective one adopts, real-world hyperinflations – think of Weimar Germany or the recent cases of Venezuela and Zimbabwe – that effectively reduce the value of money to zero are examples not of non-fundamental equilibria, but rather of fundamental equilibria gone bad. In these cases, money stocks exploded, and the price level responded accordingly.
Private cryptocurrencies and public fiat currencies have the same infinite range of possible equilibria. The zero-price equilibrium is always a possibility, as is the unique, well-behaved fundamental equilibrium.
Bitcoin clearly is exhibiting neither of these equilibria at the moment. What we have instead appears to be a variant of a non-fundamental explosive price equilibrium. It is a variant because it must allow for Bitcoin to make a possible, if unexpected, jump from its current explosive price trajectory to either the nice fundamental equilibrium or the not-so-nice zero-price scenario. This multiple-equilibrium perspective doubtless makes it appear risky to invest in intrinsically valueless assets like Bitcoin and other private cryptocurrencies.
The real world is of course not constrained by the range of possible equilibria supported by the mainstream economic theory outlined here. But that makes Bitcoin even riskier as an investment.
Tesla’s recent Bitcoin buy-in shows that a large additional buyer entering the market can boost the cryptocurrency’s price significantly, both directly (when markets are illiquid) and indirectly through demonstration and emulation effects. But an exit by a single important player would likely have a similar impact in the opposite direction. Positive or negative opinions voiced by market makers will have significant effects on Bitcoin’s price.
The cryptocurrency’s spectacular price volatility is not surprising. Deeply irrational market gyrations like the one that drove GameStop’s share price to unprecedented highs in January (followed by a significant correction) should serve as a reminder that, lacking any obvious fundamental value anchor, Bitcoin is likely to remain a textbook example of excess volatility.
This will not change with time. Bitcoin will continue to be an asset without intrinsic value whose market value can be anything or nothing. Only those with healthy risk appetites and a robust capacity to absorb losses should consider investing in it.
Cryptocurrencies’ Time to Shine?
Now that the COVID-19 pandemic has accelerated the trend toward e-commerce, policymakers and the general public should apprise themselves of the latest developments in cryptocurrencies. And just as e-commerce requires encryption to protect personal privacy, so do digital coins.
SAN FRANCISCO – Even as all of humanity mobilizes against COVID-19, thoughts are turning to how the world will be different after the crisis. As businesses rush to adapt to the new world of social distancing, the pandemic has accelerated an already inexorable trend toward digital commerce. This broader shift should also include the widespread adoption of digital currencies, which provide stronger consumer financial and privacy protections.
For most of the twentieth century, encryption was reserved for national-security needs. Cryptography helped the Allies win World War II, and then protected secret communications during the Cold War. Until as recently as 1992, the United States, as a matter of national security, did not allow cryptographic technology to be exported. Encrypted communication was not widely available, and anyone using it was assumed to have something to hide.
But starting in the 1990s, early Internet entrepreneurs began calling for encryption to be used in e-commerce, arguing that it was needed in order to protect customer credit card numbers, passwords, and other information entered online. It turned out that the same encryption technology that had been created in academic labs – where trust and collaboration reigned – could be useful to everyone.
US policymakers and law enforcement initially balked at this push toward widespread encryption. In their view, privacy for everyone meant privacy for terrorists, drug dealers, and money launderers. As FBI Director Louis J. Freeh told Congress in 1994, preserving the US government’s ability to intercept Internet communications was “the No. 1 law enforcement, public safety, and national security issue facing us today.”
The debate about end-to-end encryption is still raging. But, crucially, consumer expectations have changed since the 1990s. The overwhelming majority of Internet traffic is now encrypted, and most of us have been trained to look for the closed-lock icon in our browser before entering sensitive information. Popular apps like WhatsApp, Telegram, iMessage, and Signal have led the way in normalizing private messaging that can’t be tracked by third parties.
But there is one area of our lives where privacy is not yet the norm: our personal financial information. By law, financial firms are required to collect reams of personal information about their customers. This information ultimately ends up on online databases, where it presents a tempting target for hackers. In 2017, the credit-rating firm Equifax revealed that a data breach had exposed sensitive information about more than 147 million consumers, or just under half the US population. That followed a similar breach in 2013, when hackers famously obtained the names, credit card numbers, and other information about tens of millions of Target customers.
Fortunately, a solution is on the horizon. Cryptocurrencies hold the promise of creating a more open financial system, with worldwide access, instantaneous fund transfers, lower costs, and vastly improved consumer-privacy protections. When Bitcoin first gained popularity, many people incorrectly assumed that it was anonymous money. In fact, as a blockchain technology, it uses a public ledger that records a digital trail of every transaction. Blockchain analytics firms are thus now helping law enforcement track down criminals who thought their trail was covered. And cryptocurrency exchanges like Coinbase have instituted robust anti-money-laundering and know-your-customer programs that rival those of any financial institution.
Several more recent developments in cryptocurrency technologies promise to take consumer privacy to even higher levels, and they are sure to be controversial. First, “privacy coins” such as Zcash and Monero offer new cryptocurrency protocols that make every transaction untraceable. Other cryptocurrencies aspire to replicate these features, and even JP Morgan has explored private transactions through its Quorum cryptocurrency. This shift is a bit like when websites moved from HTTP to HTTPS as the global standard: it lets consumers know that their information is protected by default.
Second, so-called non-custodial cryptocurrency wallets now enable customers to store their own private keys (which allow one to move funds) instead of relying on a third party. By not actually storing customer funds, the providers of non-custodial wallets are aiming to position themselves as software companies rather than financial institutions subject to regulation. In the past, non-custodial wallets required a certain degree of technical sophistication to operate, limiting their use. But, like encrypted messaging apps, they are becoming increasingly accessible to a mass market.
Unsurprisingly, these innovations have alarmed banks, regulators, and law-enforcement agencies. But just as the early Internet needed encryption to enable digital commerce, cryptocurrencies need privacy protections to unlock their full power and potential. Whether one needs to guard against authoritarian regimes, data harvesters, or criminals, the best way to ensure that sensitive financial data isn’t hacked is to avoid having to collect it in the first place.
Enhancing consumer financial protections does not mean giving free rein to criminals. Law-enforcement agencies still have a wide range of tools at their disposal, from subpoenaing cryptocurrency exchanges to examining conversions into and out of fiat currencies (which are likely to remain the choke points for law enforcement). And these exchanges will continue to be regulated as financial services, regardless of whether consumers are using privacy coins or non-custodial wallets.
Having watched the US benefit enormously from the creation of the world’s leading Internet companies, many countries are now working to attract the next generation of cryptocurrency firms. For countries thinking about cryptocurrency policy, the best approach, as always, will be to strike a balance between law enforcement, cybersecurity, privacy, innovation, and economic competitiveness.
Consumers in a free society will always demand and expect reasonable levels of privacy. Our financial lives are no exception. Fortunately, cryptocurrencies can fix some of the most vexing issues in financial services. As we plan to rebuild economically after the COVID-19 crisis, we must allow these technologies to grow.
The Right Response to the Libra Threat
Facebook’s plans for a digital currency and payments system have understandably been met with skepticism, bordering on outrage. Clearly, if a serial violator of the public trust can unilaterally insinuate itself into the global monetary system, something must be done to manage the rise of digital private monies.
NEW YORK – Facebook’s plan to launch a new digital currency, Libra, within a year has won few friends. Regulators, policymakers, and academics reacted to the news swiftly, and for the most part skeptically. US congressional committees quickly arranged hearings, and the issue featured prominently at the G7 meeting in France last month.
Facebook’s disrepute as a guardian of user privacy helps to explain some of the blowback. The real bombshell, however, was the sudden realization of the threat posed by digital currencies to the existing monetary system – not at some later date, but right now. Cryptocurrencies have been around for over a decade, but none has been adopted widely enough to challenge the existing order. With the potential to mobilize more than two billion monthly active users, Facebook could change that.
Now that the company has thrown down the gauntlet, governments should use the opportunity to advance a form of digital currency that serves the public good. Even the staunchest defenders of the current monetary system will admit that it does not work equally well for everyone. Moreover, the system is being rapidly outpaced by technological change, much of which is insufficiently regulated and could expose consumers to unforeseen risks.
It doesn’t have to be this way. Technology could enable the development of a far better system. One of the original motivations behind Bitcoin and other cryptocurrencies was to establish an alternative, censorship-resistant payment system. Sweden and Singapore are on track to create central-bank-backed digital currencies (CBDCs) of their own. In China, a handful of companies, including Alibaba and Tencent, have launched closely regulated and supervised digital currencies for transactions that are settled in renminbi. In Kenya, Mali, and elsewhere, phone companies offer digital-payment services to everyone, even those without a bank account.
These experiments offer plenty of models to choose from. But first, we must consider a fundamental question: Should the state allow the creation of private money, or should it tightly limit efforts like Bitcoin and Libra, even at the risk of curtailing innovation?
Money is conventionally defined by the functions it performs: it is a means of exchange, a store of value, and a unit of account. The dollar, pound, yen, and euro each perform all three functions, but not without some help from the private sector. Banks play a critical role in payment systems (the exchange function of money), by issuing private monies in the form of book money and the like. They also offer deposits, which can be viewed as stores of value (assuming they are insured). Only the unit-of-account function – which guarantees a currency’s nominal value as legal tender for paying taxes – is in the hands of the state alone.
Given that some of the defining functions of money can be farmed out to private actors, the question is whether, and to what extent, they should be. Shouldn’t we favor CBDCs over all the different forms of privately issued digital monies? After all, there are powerful normative arguments to be made for CBDCs. As public goods, payment systems should be available on equal terms to everyone. And with modern technologies, we can finally cut out the middlemen (banks) who have been skimming the cream off the top for centuries.
On the other hand, there is also a case to be made against the monopolization of the payment system. Under ideal circumstances, CBDCs could usher in a fully integrated, highly efficient system that works for everyone. But in the real world, even a slight technical glitch or other governance failure could have systemic effects. Generally speaking, monolithic systems lack the resilience of diversified systems, not to mention the incentives for further innovation.
Still, a multiplicity of payment systems comes with problems of its own. The transaction costs of converting diverse currencies, either into one another or into fiat currency, could be enormous. And the history of free banking tells us that unregulated monetary systems are prone to collapse.
This conundrum could be solved by creating a single framework for all digital currencies, which would keep the door open for innovation. Alternatively, it could be addressed through common protocols to govern interoperability among separate systems, similar to how the Internet has evolved.
Either way, we need a new infrastructure for managing both public and private monies. They should be treated as a public good, and thus accessible on a non-profit basis. They should be open to anyone looking to develop specific new products or services, subject to a simple registration requirement. Depending on the service, all offerings should be regulated to ensure the safety and stability of the monetary system. To reduce compliance costs for smaller start-ups, supervisory authorities could provide free consultation about the appropriate regulatory channels for new products. And, where necessary, regulation should be streamlined to avoid unnecessary overlap and other sources of inefficiency.
Digital monies present us with a massive challenge. Traditionally, the guardians of the money system, central banks, have focused narrowly on monetary policy and financial stability. Guiding financial innovation is far outside their existing mandates. But given the pace of change, they may have no choice but to expand their remit sooner rather than later.
After the 2007-09 financial crisis, the imbalances and risks pervading the global economy were exacerbated by policy mistakes. So, rather than address the structural problems that the financial collapse and ensuing recession revealed, governments mostly kicked the can down the road, creating major downside risks that made another crisis inevitable. And now that it has arrived, the risks are growing even more acute. Unfortunately, even if the Greater Recession leads to a lacklustre U-shaped recovery this year, an L-shaped “Greater Depression” will follow later in this decade, owing to 10 ominous and risky trends.
The first trend concerns deficits and their corollary risks: debts and defaults. The policy response to the Covid-19 crisis entails a massive increase in fiscal deficits – on the order of 10% of GDP or more – at a time when public debt levels in many countries were already high, if not unsustainable.
Worse, the loss of income for many households and firms means that private-sector debt levels will become unsustainable, too, potentially leading to mass defaults and bankruptcies. Together with soaring levels of public debt, this all but ensures a more anaemic recovery than the one that followed the Great Recession a decade ago.
A second factor is the demographic timebomb in advanced economies. The Covid-19 crisis shows that much more public spending must be allocated to health systems, and that universal healthcare and other relevant public goods are necessities, not luxuries. Yet, because most developed countries have ageing societies, funding such outlays in the future will make the implicit debts from today’s unfunded healthcare and social security systems even larger.
A third issue is the growing risk of deflation. In addition to causing a deep recession, the crisis is also creating a massive slack in goods (unused machines and capacity) and labour markets (mass unemployment), as well as driving a price collapse in commodities such as oil and industrial metals. That makes debt deflation likely, increasing the risk of insolvency.
A fourth (related) factor will be currency debasement. As central banks try to fight deflation and head off the risk of surging interest rates (following from the massive debt build-up), monetary policies will become even more unconventional and far-reaching. In the short run, governments will need to run monetised fiscal deficits to avoid depression and deflation. Yet, over time, the permanent negative supply shocks from accelerated de-globalisation and renewed protectionism will make stagflation all but inevitable.
A fifth issue is the broader digital disruption of the economy. With millions of people losing their jobs or working and earning less, the income and wealth gaps of the 21st-century economy will widen further. To guard against future supply-chain shocks, companies in advanced economies will re-shore production from low-cost regions to higher-cost domestic markets. But rather than helping workers at home, this trend will accelerate the pace of automation, putting downward pressure on wages and further fanning the flames of populism, nationalism, and xenophobia.
This points to the sixth major factor: deglobalisation. The pandemic is accelerating trends toward balkanisation and fragmentation that were already well underway. The US and China will decouple faster, and most countries will respond by adopting still more protectionist policies to shield domestic firms and workers from global disruptions. The post-pandemic world will be marked by tighter restrictions on the movement of goods, services, capital, labour, technology, data, and information. This is already happening in the pharmaceutical, medical-equipment, and food sectors, where governments are imposing export restrictions and other protectionist measures in response to the crisis.
The backlash against democracy will reinforce this trend. Populist leaders often benefit from economic weakness, mass unemployment, and rising inequality. Under conditions of heightened economic insecurity, there will be a strong impulse to scapegoat foreigners for the crisis. Blue-collar workers and broad cohorts of the middle class will become more susceptible to populist rhetoric, particularly proposals to restrict migration and trade.
This points to an eighth factor: the geostrategic standoff between the US and China. With the Trump administration making every effort to blame China for the pandemic, Chinese President Xi Jinping’s regime will double down on its claim that the US is conspiring to prevent China’s peaceful rise. The Sino-American decoupling in trade, technology, investment, data, and monetary arrangements will intensify.
Worse, this diplomatic breakup will set the stage for a new cold war between the US and its rivals – not just China, but also Russia, Iran, and North Korea. With a US presidential election approaching, there is every reason to expect an upsurge in clandestine cyber warfare, potentially leading even to conventional military clashes. And because technology is the key weapon in the fight for control of the industries of the future and in combating pandemics, the US private tech sector will become increasingly integrated into the national-security-industrial complex.
A final risk that cannot be ignored is environmental disruption, which, as the Covid-19 crisis has shown, can wreak far more economic havoc than a financial crisis. Recurring epidemics (HIV since the 1980s, Sars in 2003, H1N1 in 2009, Mers in 2011, Ebola in 2014-16) are, like climate change, essentially manmade disasters, born of poor health and sanitary standards, the abuse of natural systems, and the growing interconnectivity of a globalised world. Pandemics and the many morbid symptoms of climate change will become more frequent, severe, and costly in the years ahead.
These 10 risks, already looming large before Covid-19 struck, now threaten to fuel a perfect storm that sweeps the entire global economy into a decade of despair. By the 2030s, technology and more competent political leadership may be able to reduce, resolve, or minimise many of these problems, giving rise to a more inclusive, cooperative, and stable international order. But any happy ending assumes that we find a way to survive the coming Greater Depression.
• Nouriel Roubini is professor of economics at New York University’s Stern School of Business. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.
In September 2006, Nouriel Roubini told the International Monetary Fund what it didn’t want to hear. Standing before an audience of economists at the organization’s headquarters, the New York University professor warned that the U.S. housing market would soon collapse — and, quite possibly, bring the global financial system down with it. Real-estate values had been propped up by unsustainably shady lending practices, Roubini explained. Once those prices came back to earth, millions of underwater homeowners would default on their mortgages, trillions of dollars worth of mortgage-backed securities would unravel, and hedge funds, investment banks, and lenders like Fannie Mae and Freddie Mac could sink into insolvency.
At the time, the global economy had just recorded its fastest half-decade of growth in 30 years. And Nouriel Roubini was just some obscure academic. Thus, in the IMF’s cozy confines, his remarks roused less alarm over America’s housing bubble than concern for the professor’s psychological well-being.
Of course, the ensuing two years turned Roubini’s prophecy into history, and the little-known scholar of emerging markets into a Wall Street celebrity.
A decade later, “Dr. Doom” is a bear once again. While many investors bet on a “V-shaped recovery,” Roubini is staking his reputation on an L-shaped depression. The economist (and host of a biweekly economic news broadcast) does expect things to get better before they get worse: He foresees a slow, lackluster (i.e., “U-shaped”) economic rebound in the pandemic’s immediate aftermath. But he insists that this recovery will quickly collapse beneath the weight of the global economy’s accumulated debts. Specifically, Roubini argues that the massive private debts accrued during both the 2008 crash and COVID-19 crisis will durably depress consumption and weaken the short-lived recovery. Meanwhile, the aging of populations across the West will further undermine growth while increasing the fiscal burdens of states already saddled with hazardous debt loads. Although deficit spending is necessary in the present crisis, and will appear benign at the onset of recovery, it is laying the kindling for an inflationary conflagration by mid-decade. As the deepening geopolitical rift between the United States and China triggers a wave of deglobalization, negative supply shocks akin those of the 1970s are going to raise the cost of real resources, even as hyperexploited workers suffer perpetual wage and benefit declines. Prices will rise, but growth will peter out, since ordinary people will be forced to pare back their consumption more and more. Stagflation will beget depression. And through it all, humanity will be beset by unnatural disasters, from extreme weather events wrought by man-made climate change to pandemics induced by our disruption of natural ecosystems.
Roubini allows that, after a decade of misery, we may get around to developing a “more inclusive, cooperative, and stable international order.” But, he hastens to add, “any happy ending assumes that we find a way to survive” the hard times to come.
Intelligencer recently spoke with Roubini about our impending doom.
You predict that the coronavirus recession will be followed by a lackluster recovery and global depression. The financial markets ostensibly see a much brighter future. What are they missing and why?
Well, first of all, my prediction is not for 2020. It’s a prediction that these ten major forces will, by the middle of the coming decade, lead us into a “Greater Depression.” Markets, of course, have a shorter horizon. In the short run, I expect a U-shaped recovery while the markets seem to be pricing in a V-shape recovery.
Of course the markets are going higher because there’s a massive monetary stimulus, there’s a massive fiscal stimulus. People expect that the news about the contagion will improve, and that there’s going to be a vaccine at some point down the line. And there is an element “FOMO” [fear of missing out]; there are millions of new online accounts — unemployed people sitting at home doing day-trading — and they’re essentially playing the market based on pure sentiment. My view is that there’s going to be a meaningful correction once people realize this is going to be a U-shaped recovery. If you listen carefully to what Fed officials are saying — or even what JPMorgan and Goldman Sachs are saying — initially they were all in the V camp, but now they’re all saying, well, maybe it’s going to be more of a U. The consensus is moving in a different direction.
Your prediction of a weak recovery seems predicated on there being a persistent shortfall in consumer demand due to income lost during the pandemic. A bullish investor might counter that the Cares Act has left the bulk of laid-off workers with as much — if not more — income than they had been earning at their former jobs. Meanwhile, white-collar workers who’ve remained employed are typically earning as much as they used to, but spending far less. Together, this might augur a surge in post-pandemic spending that powers a V-shaped recovery. What does the bullish story get wrong?
Yes, there are unemployment benefits. And some unemployed people may be making more money than when they were working. But those unemployment benefits are going to run out in July. The consensus says the unemployment rate is headed to 25 percent. Maybe we get lucky. Maybe there’s an early recovery, and it only goes to 16 percent. Either way, tons of people are going to lose unemployment benefits in July. And if they’re rehired, it’s not going to be like before — formal employment, full benefits. You want to come back to work at my restaurant? Tough luck. I can hire you only on an hourly basis with no benefits and a low wage. That’s what every business is going to be offering. Meanwhile, many, many people are going to be without jobs of any kind. It took us ten years — between 2009 and 2019 — to create 22 million jobs. And we’ve lost 30 million jobs in two months.
So when unemployment benefits expire, lots of people aren’t going to have any income. Those who do get jobs are going to work under more miserable conditions than before. And people, even middle-income people, given the shock that has just occurred — which could happen again in the summer, could happen again in the winter — you are going to want more precautionary savings. You are going to cut back on discretionary spending. Your credit score is going to be worse. Are you going to go buy a home? Are you gonna buy a car? Are you going to dine out? In Germany and China, they already reopened all the stores a month ago. You look at any survey, the restaurants are totally empty. Almost nobody’s buying anything. Everybody’s worried and cautious. And this is in Germany, where unemployment is up by only one percent. Forty percent of Americans have less than $400 in liquid cash saved for an emergency. You think they are going to spend?
You’re going to start having food riots soon enough. Look at the luxury stores in New York. They’ve either boarded them up or emptied their shelves, because they’re worried people are going to steal the Chanel bags. The few stores that are open, like my Whole Foods, have security guards both inside and outside. We are one step away from food riots. There are lines three miles long at food banks. That’s what’s happening in America. You’re telling me everything’s going to become normal in three months? That’s lunacy.
Your projection of a “Greater Depression” is premised on deglobalization sparking negative supply shocks. And that prediction of deglobalization is itself rooted in the notion that the U.S. and China are locked in a so-called Thucydides trap, in which the geopolitical tensions between a dominant and rising power will overwhelm mutual financial self-interest. But given the deep interconnections between the American and Chinese economies — and warm relations between much of the U.S. and Chinese financial elite — isn’t it possible that class solidarity will take precedence over Great Power rivalry? In other words, don’t the most powerful people in both countries understand they have a lot to lose financially and economically from decoupling? And if so, why shouldn’t we see the uptick in jingoistic rhetoric on both sides as mere posturing for a domestic audience?
First of all, my argument for why inflation will eventually come back is not just based on U.S.-China relations. I actually have 14 separate arguments for why this will happen. That said, everybody agrees that there is the beginning of a Cold War between the U.S. and China. I was in Beijing in November of 2015, with a delegation that met with Xi Jinping in the Great Hall of the People. And he spent the first 15 minutes of his remarks speaking, unprompted, about why the U.S. and China will not get caught in a Thucydides trap, and why there will actually be a peaceful rise of China.
Since then, Trump got elected. Now, we have a full-scale
- trade war,
- technology war,
- financial war,
- monetary war,
- pretty much anything across the board. Look at tech — there is complete decoupling. They just decided Huawei isn’t going to have any access to U.S. semiconductors and technology. We’re imposing total restrictions on the transfer of technology from the U.S. to China and China to the U.S. And if the United States argues that 5G or Huawei is a backdoor to the Chinese government, the tech war will become a trade war. Because tomorrow, every piece of consumer electronics, even your lowly coffee machine or microwave or toaster, is going to have a 5G chip. That’s what the internet of things is about. If the Chinese can listen to you through your smartphone, they can listen to you through your toaster. Once we declare that 5G is going to allow China to listen to our communication, we will also have to ban all household electronics made in China. So, the decoupling is happening. We’re going to have a “splinternet.” It’s only a matter of how much and how fast.
And there is going to be a cold war between the U.S. and China. Even the foreign policy Establishment — Democrats and Republicans — that had been in favor of better relations with China has become skeptical in the last few years. They say, “You know, we thought that China was going to become more open if we let them into the WTO. We thought they’d become less authoritarian.” Instead, under Xi Jinping, China has become more state capitalist, more authoritarian, and instead of biding its time and hiding its strength, like Deng Xiaoping wanted it to do, it’s flexing its geopolitical muscle. And the U.S., rightly or wrongly, feels threatened. I’m not making a normative statement. I’m just saying, as a matter of fact, we are in a Thucydides trap. The only debate is about whether there will be a cold war or a hot one. Historically, these things have led to a hot war in 12 out of 16 episodes in 2,000 years of history. So we’ll be lucky if we just get a cold war.
Some Trumpian nationalists and labor-aligned progressives might see an upside in your prediction that America is going to bring manufacturing back “onshore.” But you insist that ordinary Americans will suffer from the downsides of reshoring (higher consumer prices) without enjoying the ostensible benefits (more job opportunities and higher wages). In your telling, onshoring won’t actually bring back jobs, only accelerate automation. And then, again with automation, you insist that Americans will suffer from the downside (unemployment, lower wages from competition with robots) but enjoy none of the upside from the productivity gains that robotization will ostensibly produce. So, what do you say to someone who looks at your forecast and decides that you are indeed “Dr. Doom” — not a realist, as you claim to be, but a pessimist, who ignores the bright side of every subject?
When you reshore, you are moving production from regions of the world like China, and other parts of Asia, that have low labor costs, to parts of the world like the U.S. and Europe that have higher labor costs. That is a fact. How is the corporate sector going respond to that? It’s going to respond by replacing labor with robots, automation, and AI.
I was recently in South Korea. I met the head of Hyundai, the third-largest automaker in the world. He told me that tomorrow, they could convert their factories to run with all robots and no workers.Why don’t they do it? Because they have unions that are powerful. In Korea, you cannot fire these workers, they have lifetime employment.
But suppose you take production from a labor-intensive factory in China — in any industry — and move it into a brand-new factory in the United States. You don’t have any legacy workers, any entrenched union. You are going to design that factory to use as few workers as you can. Any new factory in the U.S. is going to be capital-intensive and labor-saving. It’s been happening for the last ten years and it’s going to happen more when we reshore. So reshoring means increasing production in the United States but not increasing employment. Yes, there will be productivity increases. And the profits of those firms that relocate production may be slightly higher than they were in China (though that isn’t certain since automation requires a lot of expensive capital investment).
But you’re not going to get many jobs. The factory of the future is going to be one person manning 1,000 robots and a second person cleaning the floor. And eventually the guy cleaning the floor is going to be replaced by a Roomba because a Roomba doesn’t ask for benefits or bathroom breaks or get sick and can work 24-7.
The fundamental problem today is that people think there is a correlation between what’s good for Wall Street and what’s good for Main Street. That wasn’t even true during the global financial crisis when we were saying, “We’ve got to bail out Wall Street because if we don’t, Main Street is going to collapse.” How did Wall Street react to the crisis? They fired workers. And when they rehired them, they were all gig workers, contractors, freelancers, and so on. That’s what happened last time. This time is going to be more of the same. Thirty-five to 40 million people have already been fired. When they start slowly rehiring some of them (not all of them), those workers are going to get part-time jobs, without benefits, without high wages. That’s the only way for the corporates to survive. Because they’re so highly leveraged today, they’re going to need to cut costs, and the first cost you cut is labor. But of course, your labor cost is my consumption. So in an equilibrium where everyone’s slashing labor costs, households are going to have less income. And they’re going to save more to protect themselves from another coronavirus crisis. And so consumption is going to be weak. That’s why you get the U-shaped recovery.
There’s a conflict between workers and capital. For a decade, workers have been screwed. Now, they’re going to be screwed more. There’s a conflict between small business and large business.
Millions of these small businesses are going to go bankrupt. Half of the restaurants in New York are never going to reopen. How can they survive? They have such tiny margins. Who’s going to survive? The big chains. Retailers. Fast food. The small businesses are going to disappear in the post-coronavirus economy. So there is a fundamental conflict between Wall Street (big banks and big firms) and Main Street (workers and small businesses). And Wall Street is going to win.
Clearly, you’re bearish on the potential of existing governments intervening in that conflict on Main Street’s behalf. But if we made you dictator of the United States tomorrow, what policies would you enact to strengthen labor, and avert (or at least mitigate) the Greater Depression?
The market, as currently ordered, is going to make capital stronger and labor weaker. So, to change this, you need to invest in your workers. Give them education, a social safety net — so if they lose their jobs to an economic or technological shock, they get job training, unemployment benefits, social welfare, health care for free. Otherwise, the trends of the market are going to imply more income and wealth inequality. There’s a lot we can do to rebalance it. But I don’t think it’s going to happen anytime soon. If Bernie Sanders had become president, maybe we could’ve had policies of that sort. Of course, Bernie Sanders is to the right of the CDU party in Germany. I mean, Angela Merkel is to the left of Bernie Sanders. Boris Johnson is to the left of Bernie Sanders, in terms of social democratic politics. Only by U.S. standards does Bernie Sanders look like a Bolshevik.
In Germany, the unemployment rate has gone up by one percent. In the U.S., the unemployment rate has gone from 4 percent to 20 percent (correctly measured) in two months. We lost 30 million jobs. Germany lost 200,000. Why is that the case? You have different economic institutions. Workers sit on the boards of German companies. So you share the costs of the shock between the workers, the firms, and the government.
In 2009, you argued that if deficit spending to combat high unemployment continued indefinitely, “it will fuel persistent, large budget deficits and lead to inflation.” You were right on the first count obviously. And yet, a decade of fiscal expansion not only failed to produce high inflation, but was insufficient to reach the Fed’s 2 percent inflation goal. Is it fair to say that you underestimated America’s fiscal capacity back then? And if you overestimated the harms of America’s large public debts in the past, what makes you confident you aren’t doing so in the present?
First of all, in 2009, I was in favor of a bigger stimulus than the one that we got. I was not in favor of fiscal consolidation. There’s a huge difference between the global financial crisis and the coronavirus crisis because the former was a crisis of aggregate demand, given the housing bust. And so monetary policy alone was insufficient and you needed fiscal stimulus. And the fiscal stimulus that Obama passed was smaller than justified. So stimulus was the right response, at least for a while. And then you do consolidation.
What I have argued this time around is that in the short run, this is both a supply shock and a demand shock. And, of course, in the short run, if you want to avoid a depression, you need to do monetary and fiscal stimulus. What I’m saying is that once you run a budget deficit of not 3, not 5, not 8, but 15 or 20 percent of GDP — and you’re going to fully monetize it (because that’s what the Fed has been doing) — you still won’t have inflation in the short run, not this year or next year, because you have slack in goods markets, slack in labor markets, slack in commodities markets, etc. But there will be inflation in the post-coronavirus world. This is because we’re going to see two big negative supply shocks. For the last decade, prices have been constrained by two positive supply shocks — globalization and technology. Well, globalization is going to become deglobalization thanks to decoupling, protectionism, fragmentation, and so on. So that’s going to be a negative supply shock. And technology is not going to be the same as before. The 5G of Erickson and Nokia costs 30 percent more than the one of Huawei, and is 20 percent less productive. So to install non-Chinese 5G networks, we’re going to pay 50 percent more. So technology is going to gradually become a negative supply shock. So you have two major forces that had been exerting downward pressure on prices moving in the opposite direction, and you have a massive monetization of fiscal deficits. Remember the 1970s? You had two negative supply shocks — ’73 and ’79, the Yom Kippur War and the Iranian Revolution. What did you get? Stagflation.
Now, I’m not talking about hyperinflation — not Zimbabwe or Argentina. I’m not even talking about 10 percent inflation. It’s enough for inflation to go from one to 4 percent. Then, ten-year Treasury bonds — which today have interest rates close to zero percent — will need to have an inflation premium. So, think about a ten-year Treasury, five years from now, going from one percent to 5 percent, while inflation goes from near zero to 4 percent. And ask yourself, what’s going to happen to the real economy? Well, in the fourth quarter of 2018, when the Federal Reserve tried to raise rates above 2 percent, the market couldn’t take it. So we don’t need hyperinflation to have a disaster.
In other words, you’re saying that because of structural weaknesses in the economy, even modest inflation would be crisis-inducing because key economic actors are dependent on near-zero interest rates?
For the last decade, debt-to-GDP ratios in the U.S. and globally have been rising. And debts were rising for corporations and households as well. But we survived this, because, while debt ratios were high, debt-servicing ratios were low, since we had zero percent policy rates and long rates close to zero — or, in Europe and Japan, negative. But the second the Fed started to hike rates, there was panic.
In December 2018, Jay Powell said, “You know what. I’m at 2.5 percent. I’m going to go to 3.25. And I’m going to continue running down my balance sheet.” And the market totally crashed. And then, literally on January 2, 2019, Powell comes back and says, “Sorry, I was kidding. I’m not going to do quantitative tightening. I’m not going to raise rates.” So the economy couldn’t take a Fed funds rate of 2.5 percent. In the strongest economy in the world. There is so much debt, if long-term rates go from zero to 3 percent, the economy is going to crash.
You’ve written a lot about negative supply shocks from deglobalization. Another potential source of such shocks is climate change. Many scientists believe that rising temperatures threaten the supply of our most precious commodities — food and water. How does climate figure into your analysis?
I am not an expert on global climate change. But one of the ten forces that I believe will bring a Greater Depression is man-made disasters. And global climate change, which is producing more extreme weather phenomena — on one side, hurricanes, typhoons, and floods; on the other side, fires, desertification, and agricultural collapse — is not a natural disaster. The science says these extreme events are becoming more frequent, are coming farther inland, and are doing more damage. And they are doing this now, not 30 years from now.
So there is climate change. And its economic costs are becoming quite extreme. In Indonesia, they’ve decided to move the capital out of Jakarta to somewhere inland because they know that their capital is going to be fully flooded. In New York, there are plans to build a wall all around Manhattan at the cost of $120 billion. And then they said, “Oh no, that wall is going to be so ugly, it’s going to feel like we’re in a prison.” So they want to do something near the Verrazzano Bridge that’s going to cost another $120 billion. And it’s not even going to work.
The Paris Accord said 1.5 degrees. Then they say two. Now, every scientist says, “Look, this is a voluntary agreement, we’ll be lucky if we get three — and more likely, it will be four — degree Celsius increases by the end of the century.” How are we going to live in a world where temperatures are four degrees higher? And we’re not doing anything about it. The Paris Accord is just a joke. And it’s not just the U.S. and Trump. China’s not doing anything. The Europeans aren’t doing anything. It’s only talk.
And then there’s the pandemics. These are also man-made disasters. You’re destroying the ecosystems of animals. You are putting them into cages — the bats and pangolins and all the other wildlife — and they interact and create viruses and then spread to humans.
- First, we had HIV. Then we had
- SARS. Then
- MERS, then
- swine flu, then
- Zika, then
- Ebola, now
- this one.
And there’s a connection between global climate change and pandemics. Suppose the permafrost in Siberia melts. There are probably viruses that have been in there since the Stone Age. We don’t know what kind of nasty stuff is going to get out. We don’t even know what’s coming.
Former senior economist for International Affairs on the White House Council, Nouriel Roubini discusses why he believes the ‘crypto-bubble’ has burst for good.
Famed for predicting the 2007 Global Financial Crisis and Credit Crunch, Nouriel Roubini has predicted two of the biggest bubbles in the 21st century. He is now turning his attention to the cryptocurrency markets and has been highly critical of not only the currencies but the technology behind them, blockchain.
Roubini is a well-respected Professor of Economics at New York University’s Stern School of Business and the Chairman of Roubini Macro Associates, a global macroeconomic consultancy firm in New York. From serving as the Senior Economist for International Affairs on the White House Council of Economic Advisors, to advising the International Monetary Fund and The World Bank, Roubini is thought of as a highly esteemed economist.
Cryptocurrencies have been in steady decline since their peak in January 2018. Do you think this market is capable of ever reaching its original glory or has the bubble well and truly burst?
I have called crypto-currencies the mother and father of all bubbles now gone bust. The crypto bubble has burst for good and will not recover as these were assets with no intrinsic value. Since their peak in early 2018 Bitcoin has lost more than 80% of its value; the other top 10 crypto-currencies – such as ETH, XRP, etc – have lost over 90% of their value while 1000s of other “shitcoins” (a technical term of jargon for this garbage of pseudo-currencies) have lost between 95% and 99% of their value. This is no surprise as a study suggests that 81% of all Initial Coin Offerings (non-compliant securities illegally skirting all securities laws) were a scam in the first place, 11% are dead or failing and the remaining 8% traded on some crypto exchanges have lost over 90% of their value.
Crypto was the biggest bubble in human history as, compared to other historical bubbles – such as Tulipmania, the South Sea Bubble and the Mississipi Bubble, the parabolic price increase in the three years before the peak was much worse – at 60X price increase – than other bubbles (that increase at 10 to 30X rates) while its bust since the 2018 peak has been as fast and furious as any previous bubble (see the chart below). The Nasdaq bubble in the late 1990s was miniscule compared to the Bitcoin bubble as it increased 4X in the three years before the peak, not 60X. And this internet bubble included many real companies with real business plans, revenues and profits, not the scammy “white papers” of cryptocurrencies.
Comparing crypto-currencies to the early days of the internet is nonsense. A decade since the launch of the WWW in 1991 there were over 1 billion users of the internet, not the approximate 70 million wallets of crypto most of them dormant. A decade after the launch of the internet there were dozens of killer apps – such as email, web sites, etc – and exponentially increasing transactions in the billions of units; while in crypto there is not a single killer app – apart from useless “krypto-kitties”, Ponzi Pyramids and Casino Games with miniscule transactions – while total transaction volume has collapsed since 2018 by over 85%. And in successful real technologies like the internet or stock trading transaction costs collapse over time. Instead in crypto, transaction costs – measured as miners’ revenues divided by number of transactions – have skyrocketed since 2018. So any comparison of crypto to the early days of the internet is nonsense.
You publicly debated and criticised Ethereum with Vitalik Buterin, its founder. What do you think is the most flawed aspect of these cryptocurrencies in comparison to fiat currencies?
The most flawed aspect of so called “crypto-currencies” is that that they aren’t really currencies or moneys. For an asset to be considered a money or currency it must satisfy three criteria:
- it has to be the unit of account for all transactions and the single numeraire for pricing all goods, services and assets/liabilities.
- It must be a widely used and cheap means of payments. And
- it has to be a stable store of value and have stable purchasing power over goods and services.
Bitcoin alone – let alone thousands of other “shitcoins” fails miserably on all criteria. It is not a unit of account and given the proliferation of thousands of “crypto-currencies” there is no single numeraire for all transactions. It is a lousy means of payments as the “proof of work” authentication method doesn’t allow more than five transactions per second; instead, for example, the Visa network allows for 25K transactions per second and growing. And the transaction costs/fees – as measured by miners’ revenues – are high and growing over time. And it is a very poor store of value as its price can fluctuate by 5% to 20% per days. So, any merchant accepting Bitcoin could lose all its profit margin in a day given the price fluctuations. Also, the supply of most cryptocurrencies – with the exception of Bitcoin – is increased and debased at will by its issuers; so price inflation and currency debasement in the crypto world is several orders of magnitude worse than fiat currency in stable low inflation economies like all advanced economies and most emerging markets.
These fundamental flaws of cryptocurrencies cannot be resolved over time given the famous Buterin “Inconsistent Trinity” principle: ie no cryptocurrency can be at the same time
- scalable (in terms of number of transactions),
- decentralized and
Fiat currencies and traditional banking system are scalable and secure but are centralized with reputable institutions that have decades long histories of trust, credibility and reputation (central banks, private banks, other financial institutions). Cryptocurrencies are not scalable and future solutions that may lead to scalability – such as proof of stake – would not be decentralized and would thus not be secure. Decentralization in crypto is a myth as miners are now a centralized oligopoly in shady jurisdictions with poor rule of law such as China, Russia, Belarus, etc.; trading is centralized as 99% of trading occurs in highly insecure and hackable centralized exchanges rather than decentralized exchanges that are all failing given no volume or liquidity. Wealth is centralized as the index of inequality for Bitcoin is worse than North Korea where Kim Jung Un and his lackeys control most of income and wealth. And developers are centralized too as Vitalik Buterin is “benevolent dictator for life” while developers are effectively police, prosecutors and judges as the myth of “the code is law” is over-turned when things go wrong – an hack – and a fork of a crypto-currency takes places on totally arbitrary terms.‘Cryptocurrencies: Irrational Exuberance or Brave New World?’ Watch Nouriel Roubini speaking:
It is clear that central banks are in talks about challenging current cryptocurrencies with central bank digital currencies. Do you think that central bank digital currencies could compete with our current cryptocurrencies and in what timescale?
A number of central banks are considering issuing central bank digital currencies – or CBDC – but such CBDCs would have nothing to do with crypto-currencies or blockchain while completely dominating such inferior assets. Starry-eyed crypto-fanatics have seized on policymakers’ consideration of CBDCs as proof that even central banks need blockchain or crypto to enter the digital-currency game. This is nonsense. If anything, CBDCs would likely replace all private digital payment systems, regardless of whether they are connected to traditional bank accounts or cryptocurrencies.
As matters currently stand, only commercial banks have access to central banks’ balance sheets; and central banks’ reserves are already held as digital currencies. That is why central banks are so efficient and cost-effective at mediating interbank payments and lending transactions. Because individuals, corporations, and non-bank financial institutions do not enjoy the same access, they must rely on licensed commercial banks to process their transactions. Bank deposits, then, are a form of private money that is used for transactions among non-bank private agents. As a result, not even fully digital systems such as Alipay or Venmo can operate apart from the banking system. By allowing any individual to make transactions through the central bank, CBDCs would upend this arrangement, alleviating the need for cash, traditional bank accounts, and even digital payment services.
Better yet, CBDCs would not have to rely on public “permission-less,” “trustless” distributed ledgers like those underpinning cryptocurrencies. After all, central banks already have a centralized permissioned private non-distributed ledger that allows for payments and transactions to be facilitated safely and seamlessly. No central banker in his or her right mind would ever swap out that sound system for one based on blockchain.
If a CBDC were to be issued, it would immediately displace cryptocurrencies, which are not scalable, cheap, secure, or actually decentralized. Enthusiasts will argue that cryptocurrencies would remain attractive to those who wish to remain anonymous. But, like private bank deposits today, CBDC transactions could also be made anonymous, with access to account-holder information available, when necessary, only to law-enforcement authorities or regulators, as already happens with private banks. Besides, cryptocurrencies like Bitcoin are not actually anonymous, given that individuals and organizations using crypto-wallets still leave a digital footprint. And authorities that legitimately want to track criminals and terrorists will soon crack down on attempts to create crypto-currencies with complete privacy.
Insofar as CBDCs would crowd out worthless cryptocurrencies, they should be welcomed. Moreover, by transferring payments from private to central banks, a CBDC-based system would be a boon for financial inclusion. Millions of unbanked people would have access to a near-free, efficient payment system through their cell phones.‘Crypto Brawl, Alex Mashinsky vs Nouriel Roubini. BlockShow Americas’ Watch Nouriel Roubini speaking:
What advice would you give to a business that are thinking of offering the possibility of transacting with their customers and clients in cryptocurrency?
First of all, almost no business accepts the use of crypto-currencies in transactions or as a means of payments. Not even crypto or blockchain conferences accept Bitcoin to register, they require hard dollars or euros. Second, any merchant using a cryptocurrency in transactions would be subject to massive market risk as the price of the cryptocurrency can change so fast that the entire profit margin of the business can be wiped out in minutes or hours by such price volatility.
Third and most important point, the business model behind firms requiring the use of cryptocurrencies to do purchases of goods or services is simply to rip off their customers. Indeed, in normal business transactions, customers can buy goods and service with conventional fiat currencies. But in an ICO, customers must convert that currency by buying into a limited pool of tokens in order to make a purchase. No legitimate business that is trying to maximize profits would require its customers to jump through such hoops. In fact, the only reason to restrict a purchase to token-holders is to create an illegal cartel of service providers who are safe from price competition and in a position to gouge their customers. Consider Dentacoin, a ridiculous cryptocurrency that can be spent only on dental services (and which almost no dentist actually accepts). It would be hard to come up with a better illustration of why business cartels are illegal in all civilized countries.
Of course, the crypto-cartels would counter that customers who incur the cost of buying a token will benefit if that token appreciates in value. But this makes no sense. If the price of the token rises above the market value of the good or service being provided, then no one would buy the token. The only plausible reason for forcing the use of a token, then, is to hike prices or bilk investors.
Beyond facilitating illegal activity, crypto-tokens obfuscate the price-discovery benefits that come when a single currency operates as a unit of account or numeraire. In a crypto-utopia, every single good and service would have its own distinct token, and average consumers would have no way to judge the relative prices of different – or even similar – goods and services. Nor would they have any real certainty about a token’s purchasing power, given the volatility of crypto-token prices.
Imagine living in a country where instead of simply using the national currency, you had to rely on 200 other world currencies to purchase different goods and services. There would be widespread price confusion, and you would have to eat the cost of converting one volatile currency into another every time you wanted to buy anything.
The fact that everyone within a given country or jurisdiction uses the same currency is precisely what gives money its value. Money is a public good that allows individuals to enter into free exchange without having to resort to the kind of imprecise, inefficient bartering on which traditional societies depended.
That is precisely where the ICO charlatans would effectively take us – not to the futuristic world of “The Jetsons,” but to the modern Stone Age world of “The Flintstones” where all transactions occur through the barter of different tokens or goods. Even the Flintstones had a more sophisticated financial system than the barter of crypto: they used shells as coins for payments and as a numeraire. Crypto instead takes us back to pure inefficient barter. It is time to recognize their utopian rhetoric for what it is: self-serving nonsense meant to separate credulous investors from their hard-earned savings.
Can we expect Blockchain to disrupt the finance industry over the next 10 years?
Blockchain will not disrupt the finance industry over the next decade. There is indeed a revolution in financial services, but it has nothing to do with crypto or blockchain. This revolution is called “FinTech” and is based on three related elements:
- Artificial Intelligence/Machine Learning (AI),
- Big Data (BD) and the
- Internet of Things (IoT).
It will revolutionize digital payment systems, credit allocation, insurance, asset management, capital market activities, risk management, etc. In the payments sphere you already have digital payment systems used by billions of individuals in billions of transactions a day that have nothing to do with blockchain or crypto: they are Alipay and WeChat Pay in China; UPI- based systems in India, M-Pesa in Kenya and all over Africa; PayPal, Venmo, Square and many other ones in the US and Europe. So, there is a revolution in the provision of financial services that will disrupt many traditional banks and providers of financial services, but it has nothing to do with a decentralized blockchain.
Blockchain is also failing to deliver solutions for both financial services firms and for corporations, non-profit organizations and governments in spite of the myth that blockchain will revolutionize all sorts of financial and corporate transactions. Indeed, faced with the public spectacle of a market bloodbath in cryptocurrencies, boosters have fled to the last refuge of the crypto scoundrel: a defense of “blockchain,” the distributed-ledger software underpinning all cryptocurrencies. Blockchain has been heralded as a potential panacea for everything from poverty and famine to cancer. In fact, it is the most overhyped – and least useful – technology in human history. In practice, blockchain is nothing more than a glorified spreadsheet.
But it has also become the byword for a libertarian ideology that treats all governments, central banks, traditional financial institutions, and real-world currencies as evil concentrations of power that must be destroyed. Blockchain fundamentalists’ ideal world is one in which all economic activity and human interactions are subject to anarchist or libertarian decentralization. They would like the entirety of social and political life to end up on public ledgers that are supposedly “permissionless” (accessible to everyone) and “trustless” (not reliant on a credible intermediary such as a bank). Yet far from ushering in a utopia, blockchain has given rise to a familiar form of economic hell. A few self-serving white men (there are hardly any women or minorities in the blockchain universe) pretending to be messiahs for the world’s impoverished, marginalized, and unbanked masses claim to have created billions of dollars of wealth out of nothing. But one need only consider the massive centralization of power among cryptocurrency “miners,” exchanges, developers, and wealth holders to see that blockchain is not about decentralization and democracy; it is about greed.
As for blockchain itself, there is no institution under the sun – bank, corporation, non-governmental organization, or government agency – that would put its balance sheet or register of transactions, trades, and interactions with clients and suppliers on public decentralized peer-to-peer permission-less ledgers. There is no good reason why such proprietary and highly valuable information should be recorded publicly.
Moreover, in cases where distributed-ledger technologies – so-called enterprise DLT – are actually being used, they have nothing to do with blockchain. They are private, centralized, and recorded on just a few controlled ledgers. They require permission for access, which is granted to qualified individuals. And, perhaps most important, they are based on trusted authorities that have established their credibility over time. All of which is to say, these are “blockchains” in name only. It is telling that all “decentralized” blockchains end up being centralized, permissioned databases when they are put into use. As such, blockchain has not even improved upon the standard electronic spreadsheet, which was invented in 1979.
No serious institution would ever allow its transactions to be verified by an anonymous cartel operating from the shadows of the world’s authoritarian kleptocracies. It is no surprise that whenever “blockchain” has been piloted in a traditional setting, it has either been thrown in the trash bin or turned into a private permissioned database that is nothing more than an Excel spreadsheet or a database with a misleading name. Indeed, a recent study of 43 experiments trying to use blockchain for development and non-profit purposes (remittances, refugees identities and services, banking the poor and unbanked, and other lofty philanthropic causes) has shown that zero out of 43 experiments have had any success; so blockchain experiments have had a 100% failure rate.
Do you believe that once the flaws and shortcomings surrounding security, scalability and of cryptocurrencies have been addressed, it would make more sense to transact using it?
I do not believe that the problems of security and scalability of cryptocurrencies can ever be resolved. At the conceptual level security and scalability are incompatible with the decentralization that crypto and blockchain claim to want to achieve. And if you have a system that gets you scalability and security with centralization you are back to traditional financial systems and/or their modern evolution that is non-blockchain based FinTech. The problems of security in cryptocurrencies are extremely severe and cannot be resolved. If you take traditional financial systems based on central banks, fiat currencies and commercial banks you have significant amounts of security. You have deposit insurance for your deposit; you have lender of last resort support by central banks in case of destructive runs; you have support of systemically important financial institutions; you have supervision and regulation with liquidity and capital requirements. And when something goes wrong – like fraud on your credit card balances or bank account – it takes one phone call to block or reverse such fraud and being issued a new credit card or bank accounts. Of course, the provision of such public goods of financial security comes at a modest price of some reasonable fees for the safety of your financial assets, accounts and transactions.
In crypto-land you have instead a total Wild West of financial insecurity; no deposit insurance, no lender of last resort, no support of systemically important institutions, no proper regulation and enforcement of security laws. If an exchange is hacked your money is gone for good as scores of episodes of centralized exchanges being hacked show. If you are subject to a crypto-robbery as someone hacked your computer, or tablet or smart-phone your financial wealth is gone in the black-hole of crypto. If there is a “51% attack” – a form of crypto-robbery that is very common among smaller crypto-currencies your wealth is gone for good. If you lose your private key or someone steals it from you your crypto assets are gone for good. The only safe solution is “cold storage”, the equivalent of hiding your crypto wealth in a cave and hiding on a piece of paper your private key for good and not being able to transact your crypto-assets. It is a return to stone-age financial technology.
There is a reason why all societies rely on trusted institutions with a history of reputation, credibility and redress of fraud to ensure the safety and legality of financial and other transactions. The utopia of having decentralized, permission-less, trust-less algorythms that replace trusted and reputable institutions is a delusion that technology can provide a solution to fundamental problems of trust that only human institutions that have developed for millennia can resolve. There is no decentralized trust-less security or scalability in crypto and there will never be one.
Famed economist Dr. Nouriel Roubini sits down with Real Vision’s Ash Bennington to discuss the outlook for markets and the global economy in 2020 — including his prescient insight on the risks of war with Iran and the potential for a worldwide energy shock caused by conflict in the Middle East. Roubini also explores global growth, US equities & fixed income, The Fed and global central banks, and the tail risks of China trade, politics, and AI. Filmed on December 10, 2019 in New York.
ASH BENNINGTON: Full disclosure.
I used to run your macro economics blog, EconoMonitor.
We’ve known each other for many years.
It’s a great pleasure to be here with Dr. Nouriel Roubini.
NOURIEL ROUBINI: A pleasure being here with you today.
ASH BENNINGTON: Most of our viewers will already know you from your incredible call in 2006
at the conference in September predicting the great financial crisis effectively.
And not just predicting the crisis, but predicting the specific mechanisms that were going to
trigger that crisis.
You talked about mortgage defaults, the problems with the securities that were built around
But you’ve actually been very constructive for many years since the crisis on US equities.
Could you tell us a little bit about how you thought about the recovery, and how you’ve
gotten to kind of where we are right now?
NOURIEL ROUBINI: Well, yeah, the recovery after the global financial crisis was bumpy.
Of course, it was a u-shaped recovery.
It was not your typical v-shaped recovery, because this was not a regular recession.
It was a recession caused by financial crises, and a financial crisis was caused initially
by too much debt in the private sector and then a build up of public debt.
And as we know, whenever you have a financial crises, you have a painful process of deleveraging.
And for a while, you have to spend less and save more in order to reduce that over time.
And that great deleveraging implied that the recovery was anemic and was bumpy in many
But there’s been a recovery that in the US has lasted over 10 years now, the longest
US economic recovery.
And in the rest of the world, the recovery was stronger in emerging markets.
Then there were shocks in the emerging markets.
Europe was more fragile.
It was a double dip recession in some parts of Europe, even a triple dip recession.
But I would say for financial markets, what has happened has been that for the last decade,
there have been a number of the risk off episodes.
And these risk off episodes were triggered by a variety of factors, concerns about the
eurozone, concerns about the hard landing in China, concerns about what the Fed, concerned
about oil prices, and you name it.
But in each one of these episodes, that correction say correction of 10% plus in US and global
equity has been followed by a recovery and then go into higher highs.
My explanation of it is that, one, those concerns that the world economy is going to end up
into another recession turned out to be wrong.
And secondly, in each one of these risk off episodes, the policy reaction of Central Bank
has been to ease more in a conventional and or unconventional way.
And therefore, where there was the Fed, the ECB, the POJ, the BOE, the PBOC.
Central Bank have come to the rescue of economies and markets.
So some of those tail risks turned out to be less severe than thought, and the Central
Bank came to helping economies and markets.
And therefore, we have had this sustained recovery of asset prices that has lasted for
ASH BENNINGTON: Right, and that brings us to US equity markets.
And US equity markets, obviously, we’re sitting here in December of 2019 have had a very good
Could you talk a little bit about how you view that in the context of the broader macroeconomic
NOURIEL ROUBINI: Yes, I mean, I would say that to think ahead about what’s going to
happen to you and even in global equities.
One is the first to start with what’s going to be the economic outlook for next year and
And as you know, we’re in the middle of what’s called the synchronized economic slowdown,
a slowdown that implies that growth is still positive.
But it’s slower than before.
You know, global growth two years ago was 3.8%.
Last year was 3.4%.
This year, the estimate is going to be only 3%.
In spite of that slowdown in growth, this year, US equities have turned out to do very
In part, because some of the tail risk that people are worried about during the year,
where there was a risk of a full scale trade war between US and China, or a hard Brexit,
or a war between the US and Iran in the Middle East.
Those stories have turned out to be milder than previously expected, first point.
Then secondly, again, the Fed, the ECB, and other central banks, once they were aware
of this, kind of a global headwinds came to the rescue of the markets.
So yeah, it started with a Q4 last year that was very bad.
But then given the change in stance of the Fed around the Central Bank and the attenuation
of these tail risk, the market has done so far very well.
Now the first question you probably have to ask yourself is, what’s going to happen to
the global economy next year?
Because it effects then market and policies.
ASH BENNINGTON: That was my next question.
NOURIEL ROUBINI: Yeah, so in order to speak about US equities probably, you have to start
with the real economy.
I would say there are three scenarios.
Scenario number one is the more optimistic one is the one that is being pushed by a number
of say sell side firms on Wall Street.
That says, well, a slowdown, but now some of these tail risks are disappearing.
Financial conditions have eased because of what the Fed, ECB, and other central banks
So we’re going to go back to a economic expansion.
Not very robust.
Instead of having 3% growth like this year, you’re going to go back to 3.4%.
That is OK, but it’s not as strong as it was in 2017, 3.8, for the global economy.
And slight capping growth in US, and Europe, and Japan, and then other advanced economies,
that’s one scenario.
And that scenario is part of a pickup in growth.
The argument goes that inflation has got to maintain.
Because there are global forces that keep wage inflation and price inflation low.
And therefore, central banks with ease are going to stay on hold.
And that might be an ideal scenario for US and global equities.
You get reflation, trade.
You got a pickup in growth.
Earnings keep on doing well.
Monetary policy remain accommodative, and then US and global equity could have, say,
something close to double digit returns in spite of a valuation being very high.
That’s one scenario.
I’m skeptical of it for a few reasons.
Second scenario– ASH BENNINGTON: What are your skeptical points when you think about
NOURIEL ROUBINI: Well, you know, my view of the world today is that rather than that scenario,
we may have a continuation of this global slowdown.
Where growth next year is going to be, say, slightly above 3%, but not as strong as 3.4%.
And it’s going to remain at current levels in the US, and Europe, and other advanced
Maybe slightly pick up in growth in some emerging markets, like Russia or Brazil, that did thoroughly
poorly in the last couple of years.
But I expect a continuation of that slowdown.
That’s the bad news.
The good news is there are more extreme negative scenario.
That will be my third scenario would be of a global recession.
And it would say, as long as US and China have a trade deal, as long as Brexit is solved,
as long as we don’t have a war in the Middle East between the US and Iran, and as long
as Central Bank remain on hold, and accommodative policies probably currently the risk of a
outright recession is right to be a lot.
So then the question is why not to be more optimistic about the global economy, like
scenario one, and instead, believing in the scenario two of continuation of that global
My view is based on a number of argument.
First of all, these argument that were at the bottom of this slowdown doesn’t to be
borne by the data.
If you look at the data for Europe, for Germany, for China, for many emerging markets, yeah,
things are not becoming worse.
But they’re not improving, and the US, maybe things are bottoming out.
ASH BENNINGTON: What are the key data sets you look at, Nouriel, when you talk about
not seeing those decelerations?
NOURIEL ROUBINI: You know, there are, first of all, coincident indicators of economic
activity, like current of the measures of employment, industrial production, retail
But forward looking data in the various PMIs, ISMs, and so on give you a sense of what’s
And one other characteristic of 2019 was the significant collapse in global capital spending.
Banks were very sharply down.
And of course, the reason for it was that there was a option evaluating given that you
didn’t know whether the trade wars with the US and China and other ones are going to escalate
If you have to make major investments of billions of dollars in your factories, and you don’t
know whether things are going to be improving or worsening.
Then you’re going to wait and see.
And while a trade deal between US and China is likely, I think that’s going to be a truce
in a medium long term trade, currency, technology, and even Cold War between the US and China.
And therefore, the sources of uncertainty that keep Capex down maybe are going to remain
I think that’s an important part of this story, I say.
Second part of this story, my view is, as I pointed out, if you look at the data around
the world, we’re not yet seeing a bottoming out of this economic slowdown.
It may be happening in the United States, but the data from any advanced economy emerging
markets are not consistent with that.
There may be a truce between US and China.
But we have a geopolitical situation that might be having an adverse effect on a trade
deal with the US and China.
We don’t know whether there’ll be a media crackdown in Hong Kong.
We don’t know whether China is going to react in a violent way to say a pro-Independence
candidate winning the Taiwan election and so on.
So there are lots of geopolitical uncertainties are going to be weighing on the market, and
the problems of Europe are not just problems related to Brexit.
It now looks like Brexit are going to be solved.
You’re running out of monetary stimulus option for the ECB, the country where fiscal space,
like the Netherlands, could do more by not doing more.
There are fundamental problems of populism in Europe.
There is plenty of fragility in four of the key economies.
Germany, France, Italy, and Spain for different reasons have political uncertainties.
There is a risk of auto tariffs, and there is a glut of capacity in the auto sector.
And the economic reforms in Europe are occurring much more slowly than desirable and optimal.
And therefore, potential growth also with a aging population remains limited.
So I see a world in which while things are not going to get worse, there are going to
strengthen significantly in 2020.
Now the good news, there’s not going to be a recession.
The bad news, we’re going to stay in a slowdown.
The other good news is that Central Bank, of course, are going to stay on hold.
They’re not going to hike.
They’re not going to ease more, most likely.
And therefore, in that scenario, in a situation in which there is still a lot of debt in the
world, public debt, private debt in US, in Europe, in China, in the case of the US, I’m
very concerned about the build-up of corporate debt, whether it’s leveraged loans, C loans,
fallen angel in the high grade, or the spreads on highyield being so compressed in spite
of a build-up of leverage.
I think there are fragility coming.
We have excessive debt ratios that could also imply something of a surprise, negatively,
that leads to a risk of episode and a correction of US and global equities.
So my best scenario for 2020 for US equity would be that if you have positive returns,
they’re going to be in the low single digits, as opposed to high single digits or double
Valuations, of course, are stretched, if you’re looking at Shiller CAPE, seasonally adjusted
And there’s also a wide range of political uncertainty related to the United States.
We’ll see how this impeachment is going to go.
It’s going to be probably noise.
Markets are discounting it.
But that could be a source of.
Tension we’ll see what happens with their nomination for the Democratic Party.
It’s possible that a progressive candidate might be nominated.
And if that’s the case, and if there is a chance that he or she may win elections, then
most of these progressive candidates are coming with proposals for taxing more wealth, taxing
more income, taxing more capital, or taxing more the rich, and you could see that the
nomination of such a candidate may also be a trigger for a risk-off episode and a correction
in US equities as well.
So I would say the year is going to be an OK year, and a year probably in which after
20%-plus returns for US equity this past year, next year if you get low single digits, you’ll
And there are plenty of triggers of a potential risk-off episode that could lead to a 10%
correction at some point during the year.
ASH BENNINGTON: So now that we have the base case and the way you see the world, I’m curious
if we could go and unpack some of those things that you mentioned, so for example, central
banks being on hold.
Policy has been remarkably accommodative for many, many years now.
If you think about where we are with the federal funds rate, hundreds of basis points below
the historical average.
We have balance sheets all over the world at central banks.
Whether we’re talking about the Fed, the ECB, there’s a lot that they own.
So it’s interesting when you say that they’re on hold.
What does it mean, effectively, to stay accommodative at the level that they’re at, and what influence
can that have on asset prices and also on things like aggregate demand and potential
for mis-pricing of assets?
NOURIEL ROUBINI: Well, accommodative has to do with the fact that there has been a global
slowdown, and there is a risk that things will get even worse.
And I think the easing of financial conditions, that additional accommodation is provided,
helps avoid the tail risk of a global recession.
It’s also the source of some of the asset inflation we’ve seen this year.
I think that central banks, most likely, in my baseline scenario, even of a continued
slowdown– they’re not going to do more.
Some of them actually cannot do much more.
ECB and BOJ and other central banks in the smaller parts of Europe already with negative
policy rates– they’re reaching the limits of how negative they can go.
They are doing various versions of quantitative and credit easing.
They cannot do much more, unless there is a severe recession.
And of course, the Fed, with the economy doing OK, growing around 2%, is going to stay on
Of course, the risk is that while the real economy, with low growth and low inflation,
justifies this accommodative monetary policy, that then you’re going to create frothiness
in financial markets.
And by some standards, US and some other risky assets– for example, real estate is very
expensive in many parts of the world.
Credit, of course, is very expensive, with credit spreads being so low.
Government bond yields are very low, and you could say government debt is also expensive.
So we live in the world in which many risky assets, whether it’s public equities, private
equities, real estate, credit, government bonds, are expensive.
Of course, you need a major macro shock to trigger a significant not just correction,
but something worse than that.
And of course, some risk-off episodes may be occurring in the coming year, tensions
related to the US and China, something to do with wars, about geopolitical tensions
around the world, the Issue of all these excesses of corporate debt and re-leveraging and this
So I don’t say we are in a bubble, but certainly we are in a period in which asset markets
are frothy, valuations are stretched, and therefore, any macro shock can lead to a risk-off
episode, can lead to a correction, and that correction may remain persistent, as opposed
to being reversed.
That’s the risk we’re facing right now.
To have a recession, of course, you need a severe macro shock that is going to be persistent
ASH BENNINGTON: One of the things I’m curious about– do you think, in addition to the potential
risk asset bubble, is it possible that we’re seeing distortions, for example, in the financial
system due to the fact that interest rates have been priced far away from where a Taylor
rule would suggest they should be? we see things like compression of net interest margins
Does that have the potential to have some sort of impact throughout the economy as well?
NOURIEL ROUBINI: Well, the distortion is that, of course, some of these valuations are excessive
because interest rates are so low, both on the short end of the yield curve and on the
longer end of the yield curve.
And you have negative not only policy rates, but up to maturity of 10 years.
You have about, depending on the week, $10, $12, $13 trillion equivalent of government
bonds, and even some corporate debt not in the US but outside the US and Europe and Japan
that have a negative yield.
So I think that we live in this dilemma that on one side, the real economy, we have a low
growth and low inflation that justifies this very easy monetary policy.
But on the other side, instead of goods inflation, we’re having asset inflation.
We might not be in a full-scale bubble, but we’re certainly in a situation which is up
on the doubt for a wide range of asset classes.
Asset prices are too high, valuations are been stretched, and therefore, the risk of
a meaningful correction is there as well.
But the dilemma is that the real economy justifies this accommodative monetary policy, including
But then the side effects and then the consequences of it might be asset inflation that eventually
becomes asset frothiness, and asset, then, eventually, credit bubble.
And we are building up the seeds of the next financial crisis with this build up of excessive
leverage, excessive risk-taking, and excessive debt.
As I pointed out, in the US, it’s really concentrated, one in the corporate sector, in the shadow
The official regulated banks now, because of the global financial crisis, have more
capital, less leverage, less risk-taking, more liquidity.
So they are OK.
There has been some de-leveraging, also of their housing sector.
But I would say the two sore points are corporate debt in the US, and also public debt, of course.
The $1 trillion budget deficit is on a trajectory that eventually, of course, is not sustainable.
ASH BENNINGTON: Let’s talk a little bit about corporate debt, because that’s something that’s
been getting a little bit of press over the last six months.
There have been people who have been speculating and worrying about this build-up in the corporate
sector, especially in triple-C and leveraged loans and CLOs and things like that.
What’s your take on that?
How do you think about it?
NOURIEL ROUBINI: Well, if you look at the measures of corporate debt as a share of GDP–
are now back to all-time highs.
That’s a signal.
Secondly, issuance of lots of types of dangerous debt has been increasing.
And it’s not just, of course, junk bonds or C-loans or leveraged loans, but you have about
half $1 trillion of corporate debt in the high-grade– these fallen angels, essentially.
Those were really high-grade.
They’re now one step away from being downgraded to junk bonds, given that there’s been fragility
It’s true that corporate profits have been quite robust.
Earnings have been growing, still fine.
Profit margins have been high.
And if you take a measure of debt of the corporate sector relative not to GDP but earnings, things
And of course, in a world in which short rates are low and long rates are low, while the
debt ratio may be high for the corporate sector, debt Servicing ratios are also low.
And therefore, it allows even highly indebted firms to keep on borrowing more or to roll
over their debt.
However, even in a world in which, say, treasury yields are below 2%, what can happen is that
if there are concerns about the real economy, solid growth, and so on, then you could have
a spike in credit spreads.
We’ve had at least three major episodes of that happening in the last two or three years.
You had the risk-off episode in August-September of 2015.
There were worries about a hard landing in China.
There was another episode in January-February of 2016, where there were worries both about
Chinese and US hard landing, about the collapse of oil prices, about the Fed tightening too
And there was a third risk-off episode in the fourth quarter of last year, Q4 of 2018.
Now, in each one of those episodes, while bond yields on US treasuries were going lower
and lower because people were moving away from risky assets like equities into safe
bonds, credit spreads were widening sharply.
In the January-February of 2016 episode, high-yield spreads went from 300 basis points over treasury
And if debt stayed at 900 for six months, that could have killed the economy and led
to a recession.
Luckily, the Fed came to the– saving the markets.
The worries about the hard landing of the US and China turned out to be wrong, and those
spreads narrowed again.
Or in Q4 of 2018, again, you had total seizure of the C-loan, leveraged loan market, and
So even if interest rates on safe assets may be low and falling more in a risk-off, credit
spreads for the private sector or for risky solvents, like in some parts of the world,
can blow up.
And therefore, you could have the condition for that crisis.
Of course, you need a macro trigger like a sharp slowdown of growth that then leads to
worries that there is a stall in profitability, and that those corporates and other agents
have high debt, cannot more easily roll over their debts or borrow more.
And then that’s a trigger over the repricing of a risk premium.
But we’ve seen those credit spreads widening sharply and suddenly in a number of these
And I think that whenever there is going to be another global macro shock, we’re going
to see a repeat of the same.
ASH BENNINGTON: So talking about central bank policy action, you are, of course, a keen
watcher of the Fed and other central banks.
What do you see right now when you look forward at what’s been happening over the last several
NOURIEL ROUBINI: Well, 2019 was a year where central banks, given the global headwinds,
they decided to ease more.
The Fed cut cumulatively three times by 75 basis points.
The ECB went slightly more negative and restarted QE. Japan has not formally changed policy,
but they’re already at negative policy rates.
They do QE.
They have a yield curve control.
And other smaller European countries have been either easing or signaling, further easing.
I think the question mark is not for 2020, because in the baseline scenario, which there
is not a global recession, central banks are going to stay on hold, and the Fed most likely
is going to stay on hold through elections, and other central banks cannot ease much more.
The ECB can go from minus 50 to minus 60, but then you reach a reversal rate.
You are already doing QE I don’t think you can buy much more than 20 billion euro per
month of bonds without eventually having a scarcity of bonds.
The BOJ could go slightly more negative, from minus 10 to minus 20.
They’re already doing YCC.
They’re already doing massive QE and so on.
The question is, what happens when you have the next recession, and all the central banks
are doing a review of their strategies, the Fed is doing it, the ECB is doing it, and
Now, the attitude of the Fed so far is to say, if we have another recession, we’re going
to hit the zero bound.
And if we’re going to hit the zero bound, then we have to do other things.
And what they’re going to do– they’re comfortable with going back to forward guidance.
They’re comfortable with going back to quantitative easing and credit easing, save buying, again,
So far, they’re not comfortable about things that are slightly more heterodox, like going
negative with a policy rate or having a control on the yield curve by targeting zero bounds
on their longer end, and so on.
ASH BENNINGTON: We spoke about that a couple of weeks ago.
NOURIEL ROUBINI: Yes, exactly.
But so far, the review doesn’t include those more unconventional tools as being part of
I think that what’s going to be happening when the next recession occurs is that the
room, the headroom, is going to be limited.
The Fed has only, now, 150 basis points of headroom.
ECB and BOJ are already deeply in negative territory.
And therefore doing, what has been done in the past, that is, the usual unconventional
quantitative easing with negative rates is not going to be sufficient.
And that’s why I think that policies are going to become even more unconventional, and some
variants of either modern monetary theory– some people call it MMT, some people call
it enhanced quantitative easing or People’s QE or permanent monetization of debt and deficits–
is what we’re going to be seeing.
First of all– ASH BENNINGTON: This is very much a hot topic now, especially on the political
left, where you see people talking about these mechanisms that are meant to effectively monetize
What are your feelings about that?
What are the implications?
What are the risks?
NOURIEL ROUBINI: Yeah, the ideas came from the left, of course.
But what has been happening is that actually in recent years, even mainstream people–
Ben Bernanke spoke and was potentially positive about– helicopter drop of money is another
way of speaking about the MMT.
Adair Turner was the head of the Financial Stability Authority In the UK.
Or even Stan Fischer and his colleagues at BlackRock a few months ago have come up with
an idea about monetizing– ASH BENNINGTON: Former vice chair of the Fed.
NOURIEL ROUBINI: Former vice chair to the Fed came out with idea on a temporary monetization
of fiscal deficits.
I think people recognize, first of all, that fiscal policy is going to be necessary when
there is the next economic downturn, because we are reaching the limit of what you can
do with monetary policy.
And secondly, if you issue more public debt and you don’t monetize it, then long rates
can go higher, and therefore there’s some crowding out.
And therefore, that monetary fiscal easing has to be accompanied by monetary easing,
whether it’s fully coordinated MMT or whether it’s informally coordinated, essentially,
if you combine on a fiscal stimulus with monetization of those deficits.
And then, effectively, you have some variant of MMT or helicopter drop or people’s QE or
[INAUDIBLE] that Stan Fischer and others are speaking about.
Now, it’s controversial, because on one side, some people have been critical, saying, if
you are doing monetization of fiscal debt, you’re going to end up into massive high inflation
and the basement of their currency and the valuation.
But if there is a slack in the economy during the recession, the slack’s in goods and labor
market, then all that extra money is not going to lead to inflation.
So under those conditions over the price economic activity, of course you can do variants of
MMT, and it boosts economic activity and aggregate demand.
ASH BENNINGTON: Well, it’s interesting, because on the other side of the coin, we heard about
the risks of inflation prior to QE, prior to incredibly low interest rates.
And the velocity of money collapsed, and there was never the inflation that was expected
So you do wonder, will it really come now or not?
NOURIEL ROUBINI: Yeah, as I said, if we’re in a situation in which there is slack, like
a next recession, I think inflation is unlikely to come back.
If anything, you’ll have worries about deflation or lowflation.
Inflation has been low for a number of reasons.
For a while, of course, there was significant slack in goods and labor market.
There was this collapse, of course, of velocity, and therefore all that extra base money created
by central bank was being hoarded in the form of excess reserves, rather than putting being
put back at work, and therefore money did not cause inflation.
But even now, where in the US and some other parts of the world have reached something
closer to full employment, and there’s not much slack in goods market, we’re still seeing
So probably, there are also more structural reasons why inflation is low, whether it’s
trade, migration, globalization.
That could be part of the story.
Whether it is workers are weaker and unions are also weak, in a world in unions have less
power, and there’s been a shift in power from labor to capital for a number of reasons.
Whether it’s the gig economy, whether it is an Amazon– effect that implies that there
is less pricing power of traditional retailers.
So there are a whole bunch of reasons why the Phillips curve, both for wages and for
prices, have become flatter and flatter, not on a temporary basis, but more of a permanent
So we live in a world in which actually, inflation is likely to stay low.
And therefore, when the next recession is going to hit, we’ll have a tough choice on
what to do.
We’ll have to go all even more unconventional.
ASH BENNINGTON: One of the things that’s interesting is, I regularly read your Project Syndicate
column, and you’ve made the distinction between a depression in aggregate demand and a negative
exogenous supply-side shock as a cause of recession, and the different policy mechanisms
that are required to address each of those.
Could you talk a little bit about those distinctions and why they’re so important in understanding
NOURIEL ROUBINI: Well, they are important because the global financial crisis– you
can think of it as being a major global aggregate demand shock, and a collapse of animal spirits.
Therefore, the policy response of easing monetary policies in fiscal policy, bailing out illiquid
but solvent agents, was the right one.
ASH BENNINGTON: Traditional Keynesian economics.
NOURIEL ROUBINI: Yeah, traditional Keynesian economics.
What I have noticed, however, is that some of the tail risks that may hit the global
economy in the next few years may not be aggregate demand shock, but negative aggregate supply
If we’re going to have restriction to trade because of US-China or other protectionist
policies by US or another country, that’s a shock that reduces economic activity while
increases, also, inflation because of protection.
It leads to higher cost of importing a variety of goods and services.
If you’re going to have Brexit or other shocks that reduce potential growth, you have lower
potential growth, and you’re going to have a potentially higher costs, because of the
Of course, if there was another oil shock, because we’d go to war with Iran in the Middle
East, like ’73, like ’79, like ’99, there were global stagflationary shocks, growth
is going to be lower, and inflation is going to be higher.
And of course, in a world in which there is a populist backlash against trade, migration,
and globalization and technology, economic policies are becoming more nationalistic,
more inward, restricting migration or restricting trade or restricting FDI.
And all these frictions are essentially equivalent to negative supply shocks that reduce all
growth and rising inflation.
ASH BENNINGTON: That’s very interesting, because you’ve just talked about the stagflation scenario,
which is something that we haven’t heard about for a very long time.
In fact, our younger viewers probably won’t remember this.
You’ve had a great deal of history thinking about crisis.
You wrote a great book called Crisis Economics with Stephen Mihm, where you looked at crises
going back to the South Sea bubble, the Mississippi Company.
And when people think about these supply-side shocks– you think about things like the Suez
Crisis, the Yom Kippur War in ’73, the 79 Revolution– we haven’t experienced anything
even remotely like that causing stagflation in the US.
Is that really a risk if these scenarios play out?
NOURIEL ROUBINI: Well, if some of these negative supply shocks were to materialize, certainly
it will have a negative impact on growth.
Certainly, the globalization or fragmentation of the global economy or balkanization is
going to imply that, say, a global supply chain in tech, in manufacturing industry,
is going to be creating frictions, going to increase cost.
And therefore, you’ll have a negative supply shock that increases prices and reduces growth.
Now, the short-term response to this risk of central bank and also fiscal policy has
been easing for a number of reasons.
Reason number one is that, compared to the ’70s, inflation and inflation expectations
So the risk of an un-anchoring upward is still relatively low.
Two, some of the shocks might lead to a price-level effect, rather than a sustained increase in
So some central banks can look through it.
And three, while they are aggregate supply shocks, they’re also aggregate demand shocks
at the same time.
The collapse of Capex because of, say, the option value of waiting.
Or if there is going to be protectionists, import prices go higher, and consumers are
going to have a reduction in real disposable income and are going to consume less.
And therefore, in the short run, the right policy response, of course, is to have monetary
and fiscal easing.
What I point out is that if these shocks are not transitory, but they’re permanent, they’re
going to permanently reduce growth and increase potentially, prices, then the right response
is not monetary and fiscal easing.
Because if you do monetary and fiscal easing, like in the ’70s, you may end up, eventually,
with runaway inflation, and with unsustainable fiscal deficit and debt.
Instead, the right policy would be to not accommodate them, but to adjust.
If Brexit occurs, potential growth in the UK is lower.
And with potential growth, you cannot stimulate the economy as much.
If we’re going to have a full-scale trade and tech war with the US and China, global
growth is going to be lower, potentially.
And if you ease monetary policy, you’re not going to be able to resolve a negative permanent
supply shock with monetary and fiscal stimulus.
And if you try to do so eventually, not in the short run, you might have, also, upward
inflationary pressure, in spite of these structural factors that are keeping inflation low in
the short run.
ASH BENNINGTON: I mean, talking about structural factors, we’ve also had a dramatic increase
in domestic energy production here in the US that may offset it.
And as prices rise, it will become more economical to extract here in the US at higher price
Does that have an impact on the ability to weather a shock, effectively an energy shock
NOURIEL ROUBINI: Well, it’s true that compared to the ’70s, our reliance on energy production
and consumption is lower structurally.
And we have, now, shale gas and oil that effectively reduces the impact of a negative supply shock.
But I would make the following caveats.
First of all, many other parts of the world are net oil importers, in Europe, and Turkey,
in India and China and many emerging markets, in Japan.
So a shock that increases all prices above $100 per barrel is going to negatively impact
the rest of the world.
Secondly, even in the United States, we’re a net steel and net energy importer.
We’re not yet a net energy exporter.
So the overall impact of an oil shock is negative.
And there’s a distributional effects.
Oil producers or energy producers are going to be better off.
Their profits are going to go higher.
But they’re not going to do much more production or investment, while the impacts are going
to be very negative on the consumers of oil, starting with households.
If you have oil above $100 a barrel because a geopolitical risk in the Middle East, and
you have gasoline prices at $4 to $6 a gallon, then the impact negatively on real disposable
income and consumption is bigger than any positive impact that comes on oil producers
from that oil shock.
So the distribution.
effect is that there’s still a negative aggregate demand shock for the US economy.
So we cannot be so blase about it and say, because we produce so much oil, it’s not going
to impact us.
The distributional effects could be significant.
Households are going to be worse off, and that could be a tipping point for a slowdown
in consumption, because the only thing that’s been holding the economy going with Capex
being so weak has been private consumption.
So either an oil shock or a protectionits shock may be the tipping point for private
ASH BENNINGTON: And potentially another collapse in demand.
NOURIEL ROUBINI: Yeah, that’s a risk.
ASH BENNINGTON: Shift gears a little bit.
One of the things that caught my attention in September was the dislocations in the repo
Could you talk a little bit about the importance of the repo market, what function it serves,
and what you think might have caused those massive spikes in rates?
NOURIEL ROUBINI: Yeah, I mean, what does that mean?
Of course, the repo market is important, because effectively, more than the Fed funds rate
market right now, financial institutions, not just commercial banks, but those shadow
banks, rely on the repo market for their needs of liquidity and lending, money, and so on.
I think part of what has happened was that the Federal Reserve, when it started its policy
of quantitative tightening, believed that actually, the amount of excess reserves that
were needed in the system were lower than otherwise, and that quantitative tightening,
allowing, essentially, the roll-off of maturing debt, implied there was a shrinkage of excess
And then you have, suddenly, a situation in which there is a demand for reserves.
So when the corporate sector, at the end of a quarter, needs a lot of cash to pay taxes,
or have a situation of that sort.
And the other thing that has happened has been then, of course, a number of shadow banks,
including hedge funds, have been using the repo market as a way of borrowing money, as
a way of then going into a variety of carry trades, borrow short low to make risky investments.
So that demand, the repo market for liquidity, has had spikes that are cyclical and structural
when the supply of essential liquidity was limited.
That’s why the Fed is worrying about a similar shock occurring again towards the end of the
I would say that since the Fed has gone aggressively towards providing liquidity and increasing
its balance sheet, again, most likely, these problems are going to be contained.
ASH BENNINGTON: So we talked a little bit about China earlier, and there’s a lot to
There is potential for a currency war, a trade war, effectively, balkanization of the technology
There’s a lot going on.
You’ve written about China as a potential Thucydides trap.
Could you talk a little bit about what your view is in that context and what that means?
NOURIEL ROUBINI: Yeah my view– the strategic rivalry between US and China is going to stay
with us for a long period of time.
I remember about four years ago, in November of 2015, I was with a delegation in Beijing.
We had the honor of meeting President Xi Jinping in the Great Hall of the People just off Tiananmen
And this was actually a year before Trump was elected.
He spent the first 10 minutes speaking formally, specifically, about the Thucydides trap.
For those who don’t know it, Thucydides was the great historian that essentially wrote
the history of why a rising Athens and new rising power facing an existing power, Sparta,
led to war between Athens and Sparta.
And that term now has become, essentially, a code name for a situation which has a rising
power facing an existing power.
ASH BENNINGTON: Graham Allison– NOURIEL ROUBINI: And Graham Allison, from the Kennedy School
of Government at Harvard two years later, wrote the famous book now, Destined to War:
Will the US and China Avoid the Thucydides Trap?
Now, what Xi Jinping was telling us was that the rise of China will be peaceful, and therefore,
we shouldn’t worry about the Thucydides trap.
But guess what?
We’re now two years later where we’re in the middle of a trade war, a currency war, a technology,
war a rather cold war.
Alison pointed out that in 12 out of 16 cases, when you have a rising power facing an existing
one, there is a hot war.
I don’t think in the case of US and China, we’re going to have a hot war, even if there
are strategists both in Beijing and Washington who are thinking about those tail risks.
But certainly, the risk of a cold war between US and China, I think, is a rising risk.
It’s important, because for the last 40 years or so since 1979, when China opened up to
the world with the reforms, of Deng Xiaoping, or since 1989, when we had the collapse of
the Soviet Union and the fall of the Berlin Wall, we have been in a process of greater
globalization and more trade in goods and services and competent labor in technology
and data and information.
And instead, if a collision course with the US and China will occur, we’ll be at the beginning
of deglobalization, of decoupling, of fragmentation of balkanization.
And just to give you an example, know today, the US is worried about the 5G of Huawei and
having a back door to the Chinese government.
And of course, those 5G networks are going to control our telecom and our cell phones
in the next few years.
But in the next few years, once we have autonomous vehicles, we need a 5G system to make sure
that millions of cars that are autonomous don’t hit each other.
But a few years from now, every piece of consumer electronics, even a coffee machine or a toaster
or even a microwave is going to be 5G cheap.
So if you believe that China is listening to our devices, using microphones and drones
and whatever not, they can do so also with a coffee machine or with a toaster.
And therefore, if you’re going to have a technology war, eventually a technology becomes a trade
And therefore, I think you are going in that direction.
If you look at all the data, we are already in a process of decoupling with the US and
We see it in the trade side.
We see it in then FDI, with Chinese FDI in the world has collapsed, or towards the US
has collapsed by 90% in the last couple of years.
We see it in movements of talent, where now people worry in the US that every Chinese
researcher or every student might be potentially suspicious or a spy, whatever.
We see it in a variety of other technological areas, where clearly, China wants to achieve
strategic dominance in the industries of the future, where there is AI, telecom, quantum
computing, biotech, electric vehicles, autonomous vehicles.
And the US now sees China as being a strategic rival of the United States.
And therefore, this tension between the two powers is always going to dominate the technology
of the future, going to imply restriction of movements of technology.
So we see that across the spectrum.
I mean, to give a couple of recent examples, even restriction of data and information,
there is this dating app for gay people that was purchased recently by a Chinese media
And now the US is asking China or this Chinese firm to divest from it, because of worries
that some people that stay in the closet might be subject to blackmail if you have control
of their data.
Or people now are worried that maybe TikTok might be used as a way of essentially getting
data about what US teenagers are doing.
There are even some ideas about making sure that even TikTok is divested from a Chinese
So it’s not just a restriction in trade and goods and services, in capital, in labor,
but also technology, information, and data.
So across the board, we are in a process of de-globalization and decoupling between US
It’s going to occur slowly over time, and a trade truce is going to postpone some of
it until after the US election.
But I think the medium-term trend is deglobalization and decoupling.
ASH BENNINGTON: I mean, the scope of the problem that you just described is absolutely enormous.
If you think about the size of the bilateral trade relationship, and then you talk about
these technology issues that were things we didn’t even think about as recently as five
years ago, it’s an extraordinary degree of coupling technologically, economically– all
of the diplomatic and Asia-Pacific military issues.
I mean, it is an extraordinary problem.
Are you ultimately optimistic about it, pessimistic about it?
Do you think we just blunder forward for a while?
I mean, it almost feels as though there has to be a resolution, or there has to be conflict.
Or is that too simple of a way to look at it?
NOURIEL ROUBINI: Well I don’t believe in a hot war, but there is certainly risk of a
cold war between US and China.
Some people are more pessimistic.
They think of a sheer cold war and just strategic competition between these two major powers.
Other people are more constructive, say, the former prime minister of Australia Kevin Rudd,
who’s an expert on China, says that we should have managed strategic competition between
US and China, so that we compete in some dimensions, and we cooperate in others.
Other people have a variant.
They use the term “co-petition,” where there is competition in some dimensions and cooperation
in other ones.
I think that one important point is going to be Europe, because of course, the US and
China are going to say, either you are with us or against us.
Either my 5G or their 5G, my AI or their AI.
I think that maybe Europe can have a important role in making sure there is still an international
economic order where you follow some rules, even if there is competition in some strategic
dimension, and we don’t have a destruction of the international economic order that we
created with the WTO, the IMF, the World Bank, and the UN, NATO, after World War II.
So it could escalate into a full-scale cold war, or it could be something where you compete
and you cooperate on some dimensions.
I don’t think that the outcome of it is very clear for now.
ASH BENNINGTON: And that conversation has already begun, for example, in the UK, with
using data infrastructure for 5G.
You were talking about World War II, and I was thinking back to World War I, the notion
the Guns of August scenario, that Europe had become so economically integrated that it
was simply impossible that a hot war could take place.
And I suppose the message is that we should never take for granted that positive outcomes
will occur, and we should never stop to attempt to solve these problems.
NOURIEL ROUBINI: Yeah, people make mistakes.
And if you’re in a mindset where you’re fearing the other side, then you can end up into a
self-fulfilling situation, which things escalate in a fullscale cold war or something worse
Therefore, leadership matters, both in the US and in China and in Europe.
Leaders can make sure that some semblance of the international economic order that gave
us peace and prosperity for the last 70 years stays with us.
If we’re going to go the direction of a full-scale trade and cold war, the economic damage is
going to be huge.
When there was the first Cold War between US and Soviet Union, you got a sense of, we
were doing barely any trade, a little bit of oil, a little bit of wheat, and so on.
But there is such an integration of the US and China and global supply chains from Asia
to Europe and so on that decoupling is going to be much more of a negative supply shock
for the global economy, let alone the geopolitical implications of it.
But finding the right balance within cooperating and competing is going to require leaders
that have the long-term view of how to manage this complicated relation, because of all
the geopolitical issues of our time, how to manage the rise of China and make sure it
doesn’t lead to conflict is going to be the most important geopolitical issues for the
next decades to come.
ASH BENNINGTON: Do you have any confidence that we see leadership in the United States,
either presently or on the horizon, that understands the complexity and scope of these problems?
NOURIEL ROUBINI: One can be only hopeful that there will be changes, politically, in the
US so that we have, actually, leadership.
China is rising.
If China is rising, you need to have a strategy towards Asia.
The first thing that, say, Trump did when he came to power in the first week was to
pull out of TPP.
And at least Obama had a strategy.
China is rising.
There’s a pivot of the US towards Asia.
People cannot be just sending a few Marines to Australia.
There has to be an economic lag, and the economic lag was TPP, to make sure that the Asian countries
and the Asian Pacific countries stay in the economic orbit of the United States.
Well, Trump pulled the plug on that one, and the economic pillar of maintaining that strategic
role in Asia has disappeared.
So unless you have a vision about how you engage your allies in Asia– and you have
to engage with them, and you have to support them, whether it’s Korea, whether it’s Japan,
whether it’s the other Asian camps.
Otherwise, they’re going to end up into the economic and then political and geopolitical
orbit of China.
So you need a strategy.
But that probably implies having leaders in the US that have that vision about how, in
a constructive way, you engage China.
This cannot be containment.
It has to be engaging the allies of the United States and Europe and the rest of the world
in Asia, so make sure that the economic re-balance system remains an economic liberal system.
ASH BENNINGTON: So Kennan’s doctrine from the Cold War will not suffice.
We need more engaged leadership.
NOURIEL ROUBINI: Absolutely so.
The Soviet Union was a declining power, and therefore, containing it eventually led to
a collapse of the Soviet Union.
With all its flaws, China is a rising power.
Even if potential growth has fallen, it’s going to be at least 4% to 5% for the next
And if you try to contain China, as opposed to engage it, the risk is that China is going
to become more aggressive.
So it’s a much bigger challenge to manage the relationship with China than it was with
the Soviet Union.
If you make stupid mistakes, then it could escalate into something, which, some of the
conflicts both, economic, financial, but also military and geopolitical, could become tense.
In Asia, of course, there are tensions in Taiwan, in Hong Kong, the East China Sea,
the South China Sea.
All these things are important, and having leaders in the West who know how to engage
China, to push back on certain things, but engage it in others is going to be so absolutely
ASH BENNINGTON: And very complicated potential military flashpoints in the South China Sea
around the shipping lanes.
NOURIEL ROUBINI: Yeah, absolutely so.
And one should recognize that some of the issues of China are legitimate.
Any power that becomes a major economic trading and financial power, also as to flags, is
also a military and geopolitical power.
China is worried that, since they are importing commodities and materials from all over the
world, they have to have some insurance that the shipping lanes, like the Strait of Malacca,
are going to remain open.
So the fact that China has a blue-water navy right now doesn’t have to be seen as aggressive.
It could be purely defensive.
But that’s where there is a source for miscalculation.
What they think as defensive, we can think of it as being aggressive, and then things
ASH BENNINGTON: Guns of August again.
NOURIEL ROUBINI: Yeah.
ASH BENNINGTON: So obviously, we’re coming into a 2020 election cycle.
One of the things that’s coming up quite a great deal is the rise of populism, issues
of economic inequality.
What’s your view of that?
NOURIEL ROUBINI: Yes, throughout the world, we’re seeing this populist backlash against
trade, against globalization, against migration, against supranational authority, even against
technological innovation and maybe threatening jobs and opportunity.
And this is happening, I would say, not just in advanced economies– the election of Trump
in the US or Brexit in the UK or the rise of the political power of some populist parties
of the extreme right or left in some parts of Europe, but you also see authoritarian
strongmen becoming entrenching powers in many emerging market economies.
You have Putin in Russia.
You have Erdogan in Turkey.
You have Orban in Hungary.
You have Maduro in Venezuela.
You have Bolsonaro in Brazil, Duterte in the Philippines.
And Xi Jinping is also an authoritarian leader.
And even Modi in India has some authority unrestricted.
So there is even a threat to liberal democracy.
Now, what’s happened, I think, is in part concerns that are economic, and then there
are also concerns about identity, social, cultural, religious, ethnic identity.
On the economic side of it, I think that the lesson we’ve learned that was known to our
economy is that while trade and globalization, migration, increases the economic pie, there
are also distributional effects.
Some people benefit out of it.
Some people don’t benefit as much of it.
There are winners and losers.
There are those who are going to go ahead, and those that are left behind.
And unfortunately, whether it’s trade or globalization or migration or technology, there are plenty
of people that are left behind, that are struggling.
And it’s not just trade and migration.
In the future, of course, technological innovation in AI is going to threaten jobs and incomes
and entire firms and industries.
And therefore, these distributional effects have to be addressed.
You have to make sure that globalization and digitalization doesn’t leave people behind
and makes it successful for most people.
Otherwise, the populist backlash is going to become more extreme.
ASH BENNINGTON: You’ve written about this devastating trinity, from AI specifically
and technology more generally, that it’s effectively labor-saving, capital-biased, and skills-biased,
which effectively serves to be a pro-cyclical, I guess, effect for income inequality.
NOURIEL ROUBINI: Yeah, income inequality has been rising.
Initially, it was a story about trade, migration, and globalization.
But technology, innovation, and skill-biased labor saving implies that if you have capital,
you’re going to do well.
If you are in the top 20%-30% distribution of skills, you’re going to do well.
But if you are a low-skilled laborer– not just blue-collar, but increasingly even white
collar jobs are going to be threatened by technology– then your income and your jobs
are going to be threatened by this technological innovation.
I think part of the risk is, we may be fighting the last war.
Trump is worried right now about the application of trade and migration for jobs and income.
But make the following thought experiment.
Suppose we have a big wall all over the US, and nobody can get in.
Suppose we have 100% tariffs and we’re not importing anything from the rest of the world
in the next five to 10 to 15 years.
The job disruption that occur through technology– I don’t know whether it takes 10 or 15 years
until we have semi-autonomous vehicles, but you have millions of Uber drivers or millions
of truck drivers, the Teamsters.
And those jobs are going to be gone.
And those jobs have nothing to do with trade.
They have nothing to do with migration.
So even if you, quote, have a big wall, and you have tariffs, technology is going to disrupt many more jobs and incomes and entire firms and industries, more than trade and globalization.
And we have to think about solutions about those problems.
Otherwise, the rise in inequality is going to come from technology, and these other forces
of globalization are going to lead to an even bigger backlash against globalization.
ASH BENNINGTON: It’s extraordinary.
It’s something that’s been happening in blue-collar jobs for decades.
And now, it seems that people who live in cities and read The New York Times are concerned
about it, because they realize that their jobs are being outsourced.
Or there’s this unusual shift that’s happening, with jobs that were previously outsourced.
They’ve now been parameterized and structured in a way that they can be fed into computers.
For example, law, my job, for example.
We have, increasingly, stories being written about financial and economic data by machines.
And it seems as though the potential opportunities to displace labor with technology are virtually
NOURIEL ROUBINI: They are limitless.
And what has happened that is a different route from the past is that with the first,
second, and third industrial revolutions, we’ve moved labor from farm and agriculture
to manufacturing, then from manufacturing to services.
But now, many of the service jobs are also threatened by technology.
Two, the speed at which these things are occurring is much more rapid than the past.
And therefore, the disruptions are going to be severe.
And as you point out, for every job created, say, by Amazon, there may be 10 other retail
jobs that are disappearing.
And now a whole bunch of services, financial services, through fintech are going to be
subject to large amount of automation, payment system.
Threat allocation, robo-advisors, asset management, insurance.
Transportation– we have autonomous vehicles, going to be disrupted app.
Media is being disrupted.
Legal firms are disrupted.
Audit firms are disrupted.
So even good jobs that are white-collar, middle-, upperincome, can be disrupted by technology.
So it’s really a much more sweeping process that’s going to be highly disruptive in the
ASH BENNINGTON: That leads us right back to economic populism here in the United States,
if we look at some of the field in the Democratic Party talking about things like universal
basic income and wealth taxes and some other things that wouldn’t have been on the table
as recently as four years ago.
What’s your view about those?
Are they things that could potentially be helpful, or are they just destructive, in
that they’re going to create economic dislocation?
NOURIEL ROUBINI: Well, we need to do something to help those who are left behind.
I would say the first best policy will be to provide the skills, the human capital,
the tools, the relocation, to make sure that everybody survives and thrives in a globalized
It’s easier said than done.
Not everybody can become a venture capitalist or entrepreneur.
Some people will, but some people are not going to be able to do so.
So if people are going to be left behind, then I think the other thing is to have a broader social safety net.
If you cannot have the same job for life, and you have to hop from one job to another,
you have to make sure that if it’s bad luck, rather than your own characteristics that
led you to lose a job, you have enough unemployment benefits and reskilling, you have enough health
care, you have enough other things that are going to be pensions and others that are going
to make sure that then you can move from point A to B to C. That’s going to be part of the
solution, to try– like in the Nordic model, to help jobs rather than protecting specific
So you need to have that new type of a social safety net.
Paradoxically, you need a wider a social safety net to make sure people are more flexible,
because if there is not a social safety net, people are going to resist globalization and
If they make sure that, then, if they lose a job they can move to other ones, and there
is a safety net, then they’re going to be more flexible.
And if all of these things are not going to be sufficient, of course, some variants of
universal basic income may be part of the solution.
But all these solutions essentially imply that the economic pie becomes bigger, but
the distribution of it becomes more unequal, because owners of physical and financial capital
do better, those that are skilled workers are doing better, and everybody else is left
So you have the margin to tax the winners and then redistribute stuff to those who are
left behind, you get redistributed as income and subsidy.
You can do it as a provision of public services that are essentially free, like health, education,
and reskilling and so on, or you could do it in different ways.
But we’re going to probably have to move towards a more progressive system of taxation and
try to make sure that those that are left behind are less left behind.
ASH BENNINGTON: I was curious about the Nordic model, because these are very small, homogeneous
And how do you administer something like that on a scale of 330 million Americans living
in diverse regions and different regional economies?
It’s an interesting question.
NOURIEL ROUBINI: Yeah, you’re right.
They are much more homogeneous societies, even less so than the past, given migration.
But the idea that you should protect workers rather than specific jobs, I think, a principle
that can be applied anywhere.
If an industry or a firm, because of technology or trade, is disappearing, propping it up
is not be sufficient.
Keeping the same job– ASH BENNINGTON: Always popular.
NOURIEL ROUBINI: You want to make sure that the workers have enough to be able to survive
and then move to something else.
So the concept can be applied even onto a large economy like the United States.
And we do have the fiscal resources, if the economic pie becomes bigger, to tax those
who are successful, to try to help those who are left behind.
ASH BENNINGTON: Does it involve changing the structure of the tax system, meaning, is it
sufficient to simply increase things like corporate taxes some marginal percentage,
Or is it, in your view, going to take something like taxing wealth, as some have suggested?
NOURIEL ROUBINI: Well, whether you tax wealth or you tax more the income of high-income
individuals, or whether you tax slightly more capital and less labor, there are pros and
cons about doing it for wealth as opposed to income as opposed to capital income versus
But I think the basic principle is, the economic pie becomes bigger.
Some people are winners.
Some people left behind.
Those who are left behind– eventually, it’s going to cause economic and social and political
And then you have to tax those who are winners to provide either public services or income
or subsidies to the other ones to maintain an economic balance.
Even from a point of view of economic growth, leaving aside the political instability, if
there is too much redistribution of income from labor to capital, from wages to profits,
you’re transferring income from those who have a propensity to spend to those who have
a high marginal propensity to save.
So these concerns about secular stagnation might be in part due to the rise of inequality.
Karl Marx had this view that capitalism is going to self-destruct because as profits
become larger and wages become lower, you’re going to have this theory of under-consumption.
And I think some of the weakness we’ve seen in the last few years has been driven by this
For a while, we could paper it over by keeping up with the Joneses, by borrowing against
their housing wealth, and that’s why we got the global financial crisis.
But now we have the same dismal income prospects, and people cannot borrow like the past.
So we have to find much more fundamental solutions to this problem of under-consumption.
Otherwise, you have both economic and political instability.
ASH BENNINGTON: Marx was much better at diagnosis than prescription, wasn’t he?
NOURIEL ROUBINI: He was, but certainly, the diagnosis there are some potential fundamental
problems in capitalism that can’t be addressed, happened.
But even after the first and the second industrial revolution, there was the same squeeze on
wages and on labor income.
And those counter the benevolent, I would say, capitalists, realized that you’re going
to have, eventually, revolutions like in Russia and China in the West.
We created a social welfare system, free education, health care, unemployment benefits, worker’s
rights, and other things that increased, actually, incomes of the workers to maintain social
And that’s why that mixed economy, market economy with welfare system, led to a change
of capitalist societies that maintained them successful and stable.
And we’re having the same challenge right now.
Either we reform capitalism to make it work for everybody, or eventually, you’ll have
either revolutions or civil wars or political instability.
That’s a story of the past.
ASH BENNINGTON: So perhaps it’s in continuity that the Silicon Valley potentates are looking
at things as modern-day Henry Fords, perhaps, things such as universal basic income and
other schemes to democratize education and do other things that would be pro-social,
NOURIEL ROUBINI: Yeah.
Well, they’re resisting, however, being taxed more.
I think that we’ll have a backlash against Big Tech, not only because of its economic
power, but also because of– everybody has to pay a fair share of the tax system.
and That’s not happening, especially in the tech sector, in part because of offshoring
and so on.
So we’ll need to have a different tax system, where those who are winners are paying a fair
share of the taxes as well.
ASH BENNINGTON: And also, the different tax treatment for private equity versus ordinary
NOURIEL ROUBINI: Yeah, absolutely.
ASH BENNINGTON: So Nouriel, here we are in December.
As we head into 2020, what are you going to be looking for specifically?
NOURIEL ROUBINI: As I pointed out, there are a variety of scenarios.
I’m more confident that we are going to continue with this global economic slowdown.
But optimists say we’re going to have a reflation and expansion.
And the pessimists, of course, are going to look at potential for shocks that are going
to lead to a recession.
I think that the key things to look for the next few months are going to be, one, what
happens with the US and China, how much there is a real truce and improved trade and tech
relations, as opposed to a truce that leads them to an escalation of a technology war.
ASH BENNINGTON: Are there any specific indicators you’re looking for in that particular outcome?
NOURIEL ROUBINI: Well, the specific one will be that while there’ll be a truce on trade,
I fear that this technology war between the US and China is going to escalate, and the
US may take various types of legislations or regulatory restrictions that restricts
further, for example, what China can do in the United States.
There is a new proposal that the Commerce Department may have the right to block any
technology that comes from abroad, that is coming from a foreign adversary.
That will create a whole new system of bureaucracy equivalent to [INAUDIBLE].
So the technology space, I think, is a very important one.
Regardless of the results of the UK elections, whether it’s going to be a true process of
negotiation that leads to a soft Brexit, as opposed to a contentious relation between
the UK and Europe, it’s going to be something to monitor.
I think that the tensions in the Middle East still can explode.
I don’t know whether Iran can stay for another year under these very severe sanctions imposed
on them without doing something like escalating some of the friction that leads them to a
military attack by the United State.
And that could escalate, certainly.
And I’m going to also look at what happens to Europe, how much political tensions are
going to continue to occur in Germany, in France, in Italy, and Spain the four important
key eurozone economies.
And whether the Trump policies on trade lead to the escalation just not with China, but
also with other parts of the world.
Are we going to have a trade war on technology and digital taxation with Europe?
Are we going to impose taxes and tariffs on European exports of cars?
And there are lots of other things that can happen on the trade protectionist side as
ASH BENNINGTON: So a landscape fraught with quite a bit of peril.
NOURIEL ROUBINI: Absolutely.
And hopefully, some of those tail risks are not going to be materializing, in which case,
maybe this slowdown occurs without the recession, or maybe growth could pick up slightly stronger
than otherwise in a more positive scenario.
ASH BENNINGTON: I love ending on a positive note.
NOURIEL ROUBINI: Yes.
ASH BENNINGTON: Thank you for joining us, Nouriel.
NOURIEL ROUBINI: Great being with you today.
Unlike the 2008 global financial crisis, which was mostly a large negative aggregate demand shock, the next recession is likely to be caused by permanent negative supply shocks from the Sino-American trade and technology war. And trying to undo the damage through never-ending monetary and fiscal stimulus will not be an option.
NEW YORK – There are three negative supply shocks that could trigger a global recession by 2020. All of them reflect political factors affecting international relations, two involve China, and the United States is at the center of each. Moreover, none of them is amenable to the traditional tools of countercyclical macroeconomic policy.
The first potential shock stems from the Sino-American trade and currency war, which escalated earlier this month when US President Donald Trump’s administration threatened additional tariffs on Chinese exports, and formally labeled China a currency manipulator. The second concerns the slow-brewing cold war between the US and China over technology. In a rivalry that has all the hallmarks of a “Thucydides Trap,” China and America are vying for dominance over the industries of the future: artificial intelligence (AI), robotics, 5G, and so forth. The US has placed the Chinese telecom giant Huawei on an “entity list” reserved for foreign companies deemed to pose a national-security threat. And although Huawei has received temporary exemptions allowing it to continue using US components, the Trump administration this week announced that it was adding an additional 46 Huawei affiliates to the list.
The third major risk concerns oil supplies. Although oil prices have fallen in recent weeks, and a recession triggered by a trade, currency, and tech war would depress energy demand and drive prices lower, America’s confrontation with Iran could have the opposite effect. Should that conflict escalate into a military conflict, global oil prices could spike and bring on a recession, as happened during previous Middle East conflagrations in 1973, 1979, and 1990.
All three of these potential shocks would have a stagflationary effect, increasing the price of imported consumer goods, intermediate inputs, technological components, and energy, while reducing output by disrupting global supply chains. Worse, the Sino-American conflict is already fueling a broader process of deglobalization, because countries and firms can no longer count on the long-term stability of these integrated value chains. As trade in goods, services, capital, labor, information, data, and technology becomes increasingly balkanized, global production costs will rise across all industries.
Moreover, the trade and currency war and the competition over technology will amplify one another. Consider the case of Huawei, which is currently a global leader in 5G equipment. This technology will soon be the standard form of connectivity for most critical civilian and military infrastructure, not to mention basic consumer goods that are connected through the emerging Internet of Things. The presence of a 5G chip implies that anything from a toaster to a coffee maker could become a listening device. This means that if Huawei is widely perceived as a national-security threat, so would thousands of Chinese consumer-goods exports.
It is easy to imagine how today’s situation could lead to a full-scale implosion of the open global trading system. The question, then, is whether monetary and fiscal policymakers are prepared for a sustained – or even permanent – negative supply shock.
Following the stagflationary shocks of the 1970s, monetary policymakers responded by tightening monetary policy. Today, however, major central banks such as the US Federal Reserve are already pursuing monetary-policy easing, because inflation and inflation expectations remain low. Any inflationary pressure from an oil shock will be perceived by central banks as merely a price-level effect, rather than as a persistent increase in inflation.
Over time, negative supply shocks tend also to become temporary negative demand shocks that reduce both growth and inflation, by depressing consumption and capital expenditures. Indeed, under current conditions, US and global corporate capital spending is severely depressed, owing to uncertainties about the likelihood, severity, and persistence of the three potential shocks.
In fact, with firms in the US, Europe, China, and other parts of Asia having reined in capital expenditures, the global tech, manufacturing, and industrial sector is already in a recession. The only reason why that hasn’t yet translated into a global slump is that private consumption has remained strong. Should the price of imported goods rise further as a result of any of these negative supply shocks, real (inflation-adjusted) disposable household income growth would take a hit, as would consumer confidence, likely tipping the global economy into a recession.
Given the potential for a negative aggregate demand shock in the short run, central banks are right to ease policy rates. But fiscal policymakers should also be preparing a similar short-term response. A sharp decline in growth and aggregate demand would call for countercyclical fiscal easing to prevent the recession from becoming too severe.
In the medium term, though, the optimal response would not be to accommodate the negative supply shocks, but rather to adjust to them without further easing. After all, the negative supply shocks from a trade and technology war would be more or less permanent, as would the reduction in potential growth. The same applies to Brexit: leaving the European Union will saddle the United Kingdom with a permanent negative supply shock, and thus permanently lower potential growth.
Such shocks cannot be reversed through monetary or fiscal policymaking. Although they can be managed in the short term, attempts to accommodate them permanently would eventually lead to both inflation and inflation expectations rising well above central banks’ targets. In the 1970s, central banks accommodated two major oil shocks. The result was persistently rising inflation and inflation expectations, unsustainable fiscal deficits, and public-debt accumulation.
Finally, there is an important difference between the 2008 global financial crisis and the negative supply shocks that could hit the global economy today. Because the former was mostly a large negative aggregate demand shock that depressed growth and inflation, it was appropriately met with monetary and fiscal stimulus. But this time, the world would be confronting sustained negative supply shocks that would require a very different kind of policy response over the medium term. Trying to undo the damage through never-ending monetary and fiscal stimulus will not be a sensible option.
Dr. Doom lives up to his moniker
.. Roubini pointed to the ongoing U.S.-China trade conflict as the likeliest trigger of the next crisis. “There is a cold war between the U.S. and China,” he said. “We have a global rivalry . . . about who is going to be controlling the industries of the future: artificial intelligence, automation, and 5G.”
Because the standoff has evolved into a one about national security and geopolitics, Roubini predicted that “there will be a trade and tech war between the U.S. and China that’s going to get worse.”
Roubini dismissed the trade truce declared by U.S. President Trump and Chinese President Xi Jinpeng over the weekend as mere talk, though stock market investors appeared to think otherwise this week. The S&P 500 index SPX, -0.05% closed at a record high Monday, while the Dow Jones Industrial AverageDJIA, -0.09% and Nasdaq Composite index COMP, -0.11% also gained to be within 1% of their record closes.
The uncertainty that the standoff has created is forcing businesses to delay or cancel plans to make additional investments, Roubini added. “There’s already been, in the data, a collapse in [capital expenditures] and once capex is down, industrial production is down, and then you have the beginning of a global recession that starts in
- tech, then spreads to
- manufacturing, then to
- industry and then it goes to
- services,” he said.
The Sino-American trade dispute will have even further consequences than just triggering the next recession, as it will cause “a complete decoupling of the global economy” as private entities and countries will have to choose whether to do business with China or the U.S., and it will lead to a reconstruction of “the entire global tech supply chain,” which will be a drag on economic growth going forward.
He compared the predicted U.S.-China “cold war” with that between the Soviet Union and the U.S. during the last century, arguing that the coming war will be more disruptive. “This divorce is going to get ugly compared to the divorce with the U.S. and the Soviet Union,” because there was little economic integration between America and Russia prior to the conflict.