Sep 15th 2018

The Makings of a 2020 Recession and Financial Crisis 

by Nouriel Roubini and Brunello Rosa

 

Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University and co-founder of Rosa & Roubini Associates. Brunello Rosa is co-founder and CEO of Rosa & Roubini Associates and a research associate at the Systemic Risk Center at the London School of Economics. 

 

NEW YORK – As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is what actually will trigger the next global recession and crisis, and when.

The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession.

There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.

Second, because the stimulus was poorly timed, the US economy is now overheating, and inflation is rising above target. The US Federal Reserve will thus continue to raise the federal funds rate from its current 2% to at least 3.5% by 2020, and that will likely push up short- and long-term interest rates as well as the US dollar.

Meanwhile, inflation is also increasing in other key economies, and rising oil prices are contributing additional inflationary pressures. That means the other major central banks will follow the Fed toward monetary-policy normalization, which will reduce global liquidity and put upward pressure on interest rates.

Third, the Trump administration’s trade disputes with China, Europe, Mexico, Canada, and others will almost certainly escalate, leading to slower growth and higher inflation.

Fourth, other US policies will continue to add stagflationary pressure, prompting the Fed to raise interest rates higher still. The administration is restricting inward/outward investment and technology transfers, which will disrupt supply chains. It is restricting the immigrants who are needed to maintain growth as the US population ages. It is discouraging investments in the green economy. And it has no infrastructure policy to address supply-side bottlenecks.

Fifth, growth in the rest of the world will likely slow down – more so as other countries will see fit to retaliate against US protectionism. China must slow its growth to deal with overcapacity and excessive leverage; otherwise a hard landing will be triggered. And already-fragile emerging markets will continue to feel the pinch from protectionism and tightening monetary conditions in the US.

Sixth, Europe, too, will experience slower growth, owing to monetary-policy tightening and trade frictions. Moreover, populist policies in countries such as Italy may lead to an unsustainable debt dynamic within the eurozone. The still-unresolved “doom loop” between governments and banks holding public debt will amplify the existential problems of an incomplete monetary union with inadequate risk-sharing. Under these conditions, another global downturn could prompt Italy and other countries to exit the eurozone altogether.

Seventh, US and global equity markets are frothy. Price-to-earnings ratios in the US are 50% above the historic average, private-equity valuations have become excessive, and government bonds are too expensive, given their low yields and negative term premia. And high-yield credit is also becoming increasingly expensive now that the US corporate-leverage rate has reached historic highs.

Moreover, the leverage in many emerging markets and some advanced economies is clearly excessive. Commercial and residential real estate is far too expensive in many parts of the world. The emerging-market correction in equities, commodities, and fixed-income holdings will continue as global storm clouds gather. And as forward-looking investors start anticipating a growth slowdown in 2020, markets will reprice risky assets by 2019.

Eighth, once a correction occurs, the risk of illiquidity and fire sales/undershooting will become more severe. There are reduced market-making and warehousing activities by broker-dealers. Excessive high-frequency/algorithmic trading will raise the likelihood of “flash crashes.” And fixed-income instruments have become more concentrated in open-ended exchange-traded and dedicated credit funds.

In the case of a risk-off, emerging markets and advanced-economy financial sectors with massive dollar-denominated liabilities will no longer have access to the Fed as a lender of last resort. With inflation rising and policy normalization underway, the backstop that central banks provided during the post-crisis years can no longer be counted on.

Ninth, Trump was already attacking the Fed when the growth rate was recently 4%. Just think about how he will behave in the 2020 election year, when growth likely will have fallen below 1% and job losses emerge. The temptation for Trump to “wag the dog” by manufacturing a foreign-policy crisis will be high, especially if the Democrats retake the House of Representatives this year.

Since Trump has already started a trade war with China and wouldn’t dare attack nuclear-armed North Korea, his last best target would be Iran. By provoking a military confrontation with that country, he would trigger a stagflationary geopolitical shock not unlike the oil-price spikes of 1973, 1979, and 1990. Needless to say, that would make the oncoming global recession even more severe.

Finally, once the perfect storm outlined above occurs, the policy tools for addressing it will be sorely lacking. The space for fiscal stimulus is already limited by massive public debt. The possibility for more unconventional monetary policies will be limited by bloated balance sheets and the lack of headroom to cut policy rates. And financial-sector bailouts will be intolerable in countries with resurgent populist movements and near-insolvent governments.

In the US specifically, lawmakers have constrained the ability of the Fed to provide liquidity to non-bank and foreign financial institutions with dollar-denominated liabilities. And in Europe, the rise of populist parties is making it harder to pursue EU-level reforms and create the institutions necessary to combat the next financial crisis and downturn.

Unlike in 2008, when governments had the policy tools needed to prevent a free fall, the policymakers who must confront the next downturn will have their hands tied while overall debt levels are higher than during the previous crisis. When it comes, the next crisis and recession could be even more severe and prolonged than the last.


Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University and co-founder of Rosa & Roubini Associates. Brunello Rosa is co-founder and CEO of Rosa & Roubini Associates and a research associate at the Systemic Risk Center at the London School of Economics. 

Copyright: Project Syndicate, 2018.
www.project-syndicate.org

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Oct 14th 2018
Now the Trump administration is eroding the dollar’s global role. Having unilaterally reimposed sanctions on Iran, it is threatening to penalize companies doing business with the Islamic Republic by denying them access to US banks. The threat is serious because US banks are the main source of dollars used in cross-border transactions. According to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), dollars are used in nearly half of all cross-border payments, a share far greater than the weight of the US in the world economy. In response to the Trump administration’s stance, Germany, France, and Britain, together with Russia and China, have announced plans to circumvent the dollar, US banks, and US government scrutiny. “Plans” may be a bit strong, given that few details have been provided. But the three countries have described in general terms the creation of a stand-alone financial entity, owned and organized by the governments in question, to facilitate transactions between Iran and foreign companies.
Oct 5th 2018
There are a lot of oddballs in US President Donald Trump’s entourage, but few are as odd – or as sinister – as 33-year-old Stephen Miller, Trump’s senior policy adviser. Miller resembles a type on the far right that is more common in Europe than the US: young, slick, sharp-suited, even a trifle dandyish. He is a skilled rabble-rouser, whose inflammatory rhetoric against immigrants and refugees – “We’re going to build that wall high and we’re going to build it tall !”– drives the crowds at Trump rallies into a frenzy. One of his crowd-pleasing notions is that migrants will infect Americans with terrible diseases.
Oct 3rd 2018
.....here we are in 2018, 40 years after Camp David. The Palestinian dream of an independent state is not only unrealized but is most likely unrealizable. With many Palestinians now favoring a one state solution......the once "Arab minority"  is now a majority.....
Sep 25th 2018
The US stock market, as measured by the monthly real (inflation-adjusted) S&P Composite Index, or S&P 500, has increased 3.3-fold since its bottom in March 2009. This makes the US stock market the most expensive in the world, according to the cyclically adjusted price-to-earnings (CAPE) ratio that I have long advocated. Is the price increase justified, or are we witnessing a bubble?
Sep 23rd 2018
Global debt recently hit a new record high of 225% of world GDP, amounting to US$164 trillion. The world is now 12 points deeper in debt than the previous peak in 2009, with advanced economies’ ratios at levels not seen since World War II.
Sep 18th 2018
To understand them, it is worth looking at three reputable leaders who died this summer: former United Nations Secretary-General Kofi Annan, former British Foreign Secretary and NATO Secretary-General Peter Carrington, and US Senator John McCain. Having worked with Annan and for Carrington, I can vouch for their grace, honor, and commitment to truth. McCain plainly had the same qualities, not to mention a level of personal bravery far beyond what is expected of most of us (though it should be noted that Carrington was also a war hero). These leaders’ combination of honor and commitment to truth – two attributes that are intrinsically connected – is nowhere to be seen in Trump or Johnson.
Sep 18th 2018
From controlling the media to stoking nationalism, Russian President Vladimir Putin has always known how to keep his approval ratings high. But Russians’ lives are not getting any better, especially after the latest round of Western economic sanctions – and Putin’s declining approval rating shows it.
Sep 15th 2018
As we mark the decennial of the collapse of Lehman Brothers, there are still ongoing debates about the causes and consequences of the financial crisis, and whether the lessons needed to prepare for the next one have been absorbed. But looking ahead, the more relevant question is what actually will trigger the next global recession and crisis, and when. The current global expansion will likely continue into next year, given that the US is running large fiscal deficits, China is pursuing loose fiscal and credit policies, and Europe remains on a recovery path. But by 2020, the conditions will be ripe for a financial crisis, followed by a global recession. There are 10 reasons for this. First, the fiscal-stimulus policies that are currently pushing the annual US growth rate above its 2% potential are unsustainable. By 2020, the stimulus will run out, and a modest fiscal drag will pull growth from 3% to slightly below 2%.
Sep 12th 2018
Next month, a judge in Oregon will begin hearing a case brought against the United States government on behalf of 21 young people, supported by the non-profit organization Our Children’s Trust, who allege that the authorities’ active contributions to the climate crisis violate their constitutional rights. The government defendants have repeatedly tried – so far without success – to have the case thrown out or delayed, and the trial is currently scheduled to start on October 29.
Sep 5th 2018
Wars are expensive, as the Russian people are now learning. The Kremlin is pursuing military adventures in Eastern Ukraine and Syria, and though these conflicts are limited in scope, one wonders if the country can really afford them.
Sep 1st 2018
This week, the California state legislature voted to mandate that all the state’s electricity come from non-carbon sources (chiefly wind, solar and hydro) by 2045. Since California if it were a country would have the world’s fifth largest economy, and since so many other states are economically integrated with it, this plan, if signed by governor Jerry Brown, could help transform the entire country. The goal is less difficult than it seems on the surface. California had already committed to getting one third of its electricity from renewables by 2020, and reached that goal in 2017. It committed to getting 50% of its electricity from renewables by 2030, and in fact will likely reach that goal 10 years early, in 2020.
Aug 29th 2018
Quote: "This may ultimately result in creation of a new accounting standard - the Enterprise Value of Data – which could become an integral part of financial statements, capturing the value of the largest and most ignored corporate asset: data."
Aug 29th 2018
What comes through clearly in polling on US public opinion is that there is a deep partisan divide on the Israeli/Palestinian issue, with key demographic groups increasingly more supportive of Palestinian rights and antagonistic to hardline Israeli policies. In some ways, the Netanyahu/Trump "marriage" has also helped to fuel the partisan divide. A Pew poll from earlier this year found that support for Palestinians far surpasses support for Israel among self-described "progressive" and "liberal" voters. And a recent Gallup poll shows that only 17% of Democrats now have a favorable view of the Israeli leader. 
Aug 27th 2018
History suggests that current-account imbalances ultimately matter a great deal. A still-unbalanced global economy may be forced to relearn that painful lesson in the coming years.
Aug 27th 2018
The United States economy is doing well. But the next recession – and there is always another recession – could be very bad. The US Bureau of Economic Analysis estimates that GDP growth in the second quarter of 2018 reached 4.1% – the highest since the 4.9% seen under President Barack Obama in 2014. Another year of growth will match the record ten-year expansion of the 1990s. Add to that low unemployment, and things are looking good. But this cannot continue forever.
Aug 24th 2018
If Britain leaves the European Union with no deal in place to govern trade with its biggest partner, it will fall back on World Trade Organisation rules. The same set of rules would apply to EU countries and non-EU trade partners. This is why the UK government has published a series of “technical notices” detailing preparations for a no-deal Brexit. Here are seven reasons that sum up why a no-deal Brexit and defaulting to WTO rules would be bad for British businesses and the wider economy.
Aug 23rd 2018
Unlike today’s aspiring strongmen, a truly tough leader would stand up for international cooperation, and seek to persuade voters why it matters. One hopes that French President Emmanuel Macron, German Chancellor Angela Merkel, and Japanese Prime Minister Shinzo Abe will do precisely that in the coming months. In the meantime, we must pray that wannabe tough guys like Trump and Erdoğan do not do too much damage to their respective countries, and to the rest of us. It is time to make cooperation great again.
Aug 23rd 2018
Historians will mark August 21, 2018, as a turning point in American history. President Donald Trump’s personal lawyer pleaded guilty to 8 counts of criminal wrongdoing that could carry a sentence of up to 65 years. Most significantly, he pleaded guilty to having attempted illegally to interfere in an election “in coordination with and at the direction of a federal candidate for office.”
Aug 22nd 2018
As the usual political inferno between parties and private firms rages on, the phantom threat of mafia involvement in Italian construction has resurfaced. The region of Liguria sadly scores quite high in the assessments of mafia infiltration. In the area, Calabrian mafia clans of the ‘ndrangheta – Italy’s most powerful mafia today – have heavily invested in the construction sector, in public tenders and in the exploitation of the port of Genoa and the roads to France and to the rest of the Italian north, for the purposes of illegal trafficking.
Aug 15th 2018
Why do conspiracy theories and general charlatanism so often receive their strongest support from the world’s dictators? Sure, dictators are almost always oddballs themselves, but that cannot be all there is to it. In fact, it is worth asking whether quackery is a necessary feature of authoritarian rule.