A Global Perfect Storm

Nouriel Roubini

15 June 2012
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NEW YORKDark, lowering financial and economic clouds are, it seems, rolling in from every direction: the eurozone, the United States, China, and elsewhere. Indeed, the global economy in 2013 could be a very difficult environment in which to find shelter.


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For starters, the eurozone crisis is worsening, as the euro remains too strong, front-loaded fiscal austerity deepens recession in many member countries, and a credit crunch in the periphery and high oil prices undermine prospects of recovery. The eurozone banking system is becoming balkanized, as cross-border and interbank credit lines are cut off, and capital flight could turn into a full run on periphery banks if, as is likely, Greece stages a disorderly euro exit in the next few months.


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Moreover, fiscal and sovereign-debt strains are becoming worse as interest-rate spreads for Spain and Italy have returned to their unsustainable peak levels. Indeed, the eurozone may require not just an international bailout of banks (as recently in Spain), but also a full sovereign bailout at a time when eurozone and international firewalls are insufficient to the task of backstopping both Spain and Italy. As a result, disorderly breakup of the eurozone remains possible.


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Farther to the west, US economic performance is weakening, with first-quarter growth a miserly 1.9%well below potential. And job creation faltered in April and May, so the US may reach stall speed by year end. Worse, the risk of a double-dip recession next year is rising: even if what looks like a looming US fiscal cliff turns out to be only a smaller source of drag, the likely increase in some taxes and reduction of some transfer payments will reduce growth in disposable income and consumption.



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Moreover, political gridlock over fiscal adjustment is likely to persist, regardless of whether Barack Obama or Mitt Romney wins November’s presidential election. Thus, new fights on the debt ceiling, risks of a government shutdown, and rating downgrades could further depress consumer and business confidence, reducing spending and accelerating a flight to safety that would exacerbate the fall in stock markets.


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In the east, China, its growth model unsustainable, could be underwater by 2013, as its investment bust continues and reforms intended to boost consumption are too little too late. A new Chinese leadership must accelerate structural reforms to reduce national savings and increase consumption’s share of GDP; but divisions within the leadership about the pace of reform, together with the likelihood of a bumpy political transition, suggest that reform will occur at a pace that simply is not fast enough.



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The economic slowdown in the US, the eurozone, and China already implies a massive drag on growth in other emerging markets, owing to their trade and financial links with the US and the European Union (that is, nodecoupling” has occurred). At the same time, the lack of structural reforms in emerging markets, together with their move towards greater state capitalism, is hampering growth and will reduce their resiliency.


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Finally, long-simmering tensions in the Middle East between Israel and the US on one side and Iran on the other on the issue of nuclear proliferation could reach a boil by 2013. The current negotiations are likely to fail, and even tightened sanctions may not stop Iran from trying to build nuclear weapons. With the US and Israel unwilling to accept containment of a nuclear Iran by deterrence, a military confrontation in 2013 would lead to a massive oil price spike and global recession.



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These risks are already exacerbating the economic slowdown: equity markets are falling everywhere, leading to negative wealth effects on consumption and capital spending. Borrowing costs are rising for highly indebted sovereigns, credit rationing is undermining small and medium-size companies, and falling commodity prices are reducing exporting countries’ income. Increasing risk aversion is leading economic agents to adopt a wait-and-see stance that makes the slowdown partly self-fulfilling.


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Compared to 2008-2009, when policymakers had ample space to act, monetary and fiscal authorities are running out of policy bullets (or, more cynically, policy rabbits to pull out of their hats). Monetary policy is constrained by the proximity to zero interest rates and repeated rounds of quantitative easing.


.Indeed, economies and markets no longer face liquidity problems, but rather credit and insolvency crises. Meanwhile, unsustainable budget deficits and public debt in most advanced economies have severely limited the scope for further fiscal stimulus.


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Using exchange rates to boost net exports is a zero-sum game at a time when private and public deleveraging is suppressing domestic demand in countries that are running current-account deficits and structural issues are having the same effect in surplus countries. After all, a weaker currency and better trade balance in some countries necessarily implies a stronger currency and a weaker trade balance in others.



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Meanwhile, the ability to backstop, ring-fence, and bail out banks and other financial institutions is constrained by politics and near-insolvent sovereigns’ inability to absorb additional losses from their banking systems. As a result, sovereign risk is now becoming banking risk. Indeed, sovereigns are dumping a larger fraction of their public debt onto banks’ balance sheet, especially in the eurozone.



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To prevent a disorderly outcome in the eurozone, today’s fiscal austerity should be much more gradual, a growth compact should complement the EU’s new fiscal compact, and a fiscal union with debt mutualization (Eurobonds) should be implemented. In addition, a full banking union, starting with eurozone-wide deposit insurance, should be initiated, and moves toward greater political integration must be considered, even as Greece leaves the eurozone.



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Unfortunately, Germany resists all of these key policy measures, as it is fixated on the credit risk to which its taxpayers would be exposed with greater economic, fiscal, and banking integration. As a result, the probability of a eurozone disaster is rising.


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And, while the cloud over the eurozone may be the largest to burst, it is not the only one threatening the global economy. Batten down the hatches.







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Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was one of the few economists to predict the recent global financial crisis. One of the world’s most sought-after voices on its causes and consequences, he previously served in the Clinton administration as Senior Economist for the President’s Council of Economic Advisers, and has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.



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Copyright Project Syndicate - www.project-syndicate.org


June 17, 2012 8:04 pm
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What happens if Angela Merkel does get her way
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Wolfgang Münchau




The Bundesbank said there should be no banking union until there is a fiscal union. Angela Merkel said that there should be no fiscal union until there is political union. And François Hollande said that there should be no political union until there is a banking union. They have 10 days to disentangle that knot.



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The interesting thing is that all statements are correct in a certain way, but only the French president offered a practical solution; without crisis resolution, there can be no political union. Mr Hollande made a concrete proposal to allow the European Stability Mechanism to inject unlimited equity into banks; allow it to refinance itself through the European Central Bank; and to let the ECB supervise the 25 largest financial institutions. The German chancellor responded, respectively, with Nein, Nein and Ja.


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Unfortunately, the 25 largest banks have no bearing on this problem. It is the other banks that matter. Ms Merkel has accepted the weakest and least relevant bit of Mr Hollande’s proposal.



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With so many ideas on the table, it is critically important to understand what is required right now. Spain needs an equity injection into its banking system from the eurozone, not through a loan to the Spanish recapitalisation fund. Only when that happens, can Mariano Rajoy, the Spanish prime minister, claim to have nailed the problem and set off to watch the football – an activity at which he excels. And to address Italy’s problem, the EU needs to find a way to lower its interest rates. This can only occur through one of the following three measures: a eurobond; direct bond purchases through the ECB, or the ESM. But Italy is too big to fit under the umbrella, the ECB does not want to monetise debt and Germany is opposed to a eurobond.



.The obvious solution to a sequencing problem is to have it all: a banking union, a fiscal union and a political union. That may well happen. But I somehow did not have the impression that Ms Merkel was kidding when she rejected any proposal that could solve the crisis. So 10 days before the next European summit, my optimism is restrained.


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What if there is no deal or another fudge? In that case, I would expect Italy and Spain to leave the eurozone. If a banking union is a necessary prequisite for a monetary union, and you are told that a banking union is politically unacceptable, then one must sadly conclude that the monetary union is unfeasible. I do not say this lightly. A break-up would be catastrophic.



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In the absence of a deal next week, I would expect to see an acceleration of a slow-motion bank run. Why should citizens leave their money in their local banks, when foreign investors are pulling out and when even the EU is making preparations to impose capital controls? Market interest rates will rise further and it will only be a matter of time before both Italy and Spain are cut off from market funding.


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In the case of Greece, the best moment to default would not be now, but next year. The country still runs a primary deficitbefore the payment of interest. A default would make more sense for Spain, but not quite yet. It would be easiest for Italy. It has a large pile of debt, but a low deficit. With an interest rate of more than 6 per cent and a loss of competitiveness, Italy cannot simultaneously remain solvent and inside the eurozone.

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Clearly, Mario Monti is not going to pull the trigger. He was installed in the job of Italian prime minister to avoid such an outcome. But the political mood in Italy is changing. The arrival of Beppe Grillo and his populist Five Star movement as a force in Italian politics tells us that we should not expect Brussels-compliant technocrats to run the country for ever. “The EU is out of control and the euro is a box of dynamite with a fuse that is getting ever shorter. And we are sitting on top of it,” Mr Grillo wrote in his blog.



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If Italy and Spain were to leave the eurozone, they would probably also default on their foreign debt. Such an act would probably cause the European financial system to collapsesomething that would ultimately reverberate in Italy and Spain, too. But the irony is that an Italian or Spanish exit would probably end up hurting France and Germany more than it would hurt Italy or Spain.



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Ms Merkel said there was now a race going on between the eurozone and the financial markets. That comment tells us that she clearly understands what is going on. But that does not mean that she is willing, or in a position, to do what needs to be done. I get the sense that her talk about political union is only a ruse to deflect from a catastrophic failure to resolve the crisis.



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Copyright The Financial Times Limited 2012.


There is only so much central banks can do

Mohamed El-Erian

June 15, 2012




Judging from the growing number of official remarks, central banks – in a standalone capacity and jointly – have been discussing what to do in the event of major disruptions to the European payments and settlement system. The immediate focus is, of course, Sunday’s highly uncertain election in Greece. But the contributing factors go well beyond this as they are entwined in Europe’s increasingly messy debt and banking circumstances.



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In welcoming such signs of responsible contingency planning, it is important to distinguish between what central banks can deliver and what they are incapable of doing. In the context of today’s complex crisis in Europe, these critical institutions have essentially been reduced to the role of fire brigades.



They can try to reduce the risk of a fire and, should one occur, stand ready to fight it and contain damage. But, acting on their own, they are unable to alter materially the behaviour of those who place whole neighbourhoods at risk.



Through both emergency liquidity operations and the willingness to stand as a solid counterparty in dysfunctional markets, central banks can offset (but not eradicate) disruptions to the payments and settlement system. Most critically, they can reduce the devastating impact of marketsudden stops,” which are the equivalent of economic and financial heart attacks for capitalism.



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Recent statements from a host of officials – including Mario Draghi, European Central Bank president, Mervyn King, Bank of England governor, and Timothy Geithner, US Treasury secretary – suggest this is indeed on the to-do list of major central banks. And the output, should it be necessary, would come in the form of both individual measures and globally co-ordinated ones.



But central banks are not the reason why Europe faces the tail risk of catastrophic disruptions. If anything, they have been working hard to prevent Europe from getting into the mess it finds itself in today. This, in turn, speaks to the critical policy distinction between willingness, ability and effectiveness.



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While certainly willing and partially able, central banks have not been effective in severing the majorfeedback loops” that erode on a daily basis the integrity of the eurozone, discourage private capital inflows and undermine the wellbeing of the global economy. Specifically, acting on their own, they do not have enough instruments to stop the bad interactions between weak banks and deteriorating sovereign creditworthiness. They have even fewer tools to stop individual country problems from contaminating what is an increasingly synchronised global slowdown. And they are powerless when it comes to breaking the adverse feedback loop between bad economics and bad politics.



Simply put, if they are not joined by more effective responses on the part of politicians and other government agencies, the best central banks can do is to slow marginally the steadily eroding impact of the west’s triple threat – of too little growth, too much debt and excessive political polarisation. And in pivoting from crisis prevention to crisis management, they can (and are) on alert to clean up the mess, but cannot counter all of the damage.



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This reality is yet another indication of the extent to which the west has become hostage to a never-ending series of emergency tactical responses when what is critically needed is also a set of coherent strategic decisions. This leaves central banks in the role of a consistently scrambling fire brigade. And the longer they are in this role, the greater the erosion in their effectiveness to deal with an ever increasing number of fire threats.



Greece’s Catharsis?

Yannos Papantoniou

15 June 2012
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ATHENSSunday’s election in Greece will decide whether confrontation or negotiation will be used to change the terms of Greece’s refinancing agreement with the eurozone. Rather than helping Greece to overcome its crisis, the austerity policies pursued since May 2010 have plunged it into a deep recession that perpetuates fiscal deficits and aggravates financial uncertainty.




It is becoming increasingly clear that if Greece proceeds to unilateral action – whether by repealing unpopular austerity laws or renouncing the loan agreement itself – the eurozone will suspend disbursement of the loan. The government will find it impossible to fulfill basic obligations, such as paying salaries and pensions, and the country will formally default. International banks will cease to finance Greek enterprises, including imports, creating shortages of fuel, food, and medicines. As confidence that Greece will remain in the eurozone plummets, a run on deposits will cause the banking system – and, eventually, the real economy – to collapse.



The next step will be forced exit from the euro and reintroduction of the drachma, implying a dramatic drop in living standards, owing in part to immediate devaluation of the new currency and high inflation. Meanwhile, the benefits in terms of competitiveness will be very limited, owing to the country’s narrow export base, and will evaporate in a vicious circle of devaluations and rising interest rates.



Long-term stagnation and high unemployment are the likely result of confrontation with the eurozone, which leaves only the path of renegotiation. The new political balance emerging in Europe after the Socialists’ victory in France’s presidential election creates scope for changes in the terms of the loan agreement that would help to boost economic growth.




Opting for renegotiation assumes the victory of pro-euro political forces in Sunday’s elections. New Democracy, Pasok, and Democratic Left belong to this group, as opposed to Syriza and some smaller parties on the extreme right and left, which support a confrontational stance vis-à-vis the eurozone, eventually leading to the euro exit. If a pro-euro majority emerges on June 17, the new government’s main challenge will be to propose a new policy agenda, and then to negotiate a revised deal with the eurozone.



The key to growth is increased competitiveness through higher productivity and lower production costs. In the 1990’s, in the run-up to joining the eurozone, Greece achieved substantial gains on this front. With inflation falling sharply, real incomes increased. Fiscal deficits were reduced. Important structural reforms were implemented, particularly privatization. Investment accelerated, and major infrastructure projects were realized. High growth rates were achieved in conditions of stability.



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Unfortunately, that effort ceased over the last decade. Selfish interests prevailed. Business groups attempted to capture specific markets. Public-sector trade unions fought for preserving privileges. Tax discipline was further weakened. The welfare state was transformed into a system of endemic waste. A gap emerged between the economy’s productive base, which remained stagnant, and Greeks’ expectations (and demands), which were rising fast.



The agreement with the eurozone attempted to close the gap in a clumsy and misguided way. Instead of focusing on structural reforms to liberate the economy’s productive forces, it relied on income cuts and tax increases. The incompetence of the governments that implemented the agreement exacerbates that defect by sidelining structural reforms and enacting only the terms concerning austerity.



The renegotiation should aim at changing the policy mix in the following directions:
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  • Extending the timetable of fiscal-deficit reduction in order to limit the depth of the recession.

  • Avoiding any new cut in incomes or new taxes, with reduction in indirect taxation to start immediately.

  • Social-protection measures, particularly for the unemployed.

  • A European Marshall Plan, through grants from the European Union’s structural funds and loans from the European Investment Bank, in order to sustain economic activity and create new jobs.


Achieving these targets presupposes that Greece’s new government implements all of the structural changes agreed with the eurozone. Privatization, opening up closed markets and professions, promoting entrepreneurship, and eliminating public-sector waste should proceed at a fast pace over the next few months.



The European Marshall Plan would offer a unique opportunity to reorient growth policies. Greece should move beyond its traditional focus on sectors such as tourism, shipping, and construction, and search for new areas of comparative advantage in renewable energy, high-value-added services, and selected lines of manufacturing that benefit from the country’s research potential.



If Greece succeeds in fulfilling the requirements of a revised financing agreement with the eurozone, it may win the confidence bet by convincing financial markets that it is determined to achieve the targets.



Confidence will unlock the door to economic recovery. The fear of a return to the drachma will recede. Consumption levels will begin to recover. Deposit outflows will cease. The banking system will be reinforced. Investors will reevaluate opportunities for undertaking new initiatives. A virtuous circle may be set in motion, leading the country, eventually, to escape the crisis zone.




The outcome of Sunday’s election will determine which way Greece goes – and, also, of course, how the unfolding Greek drama affects the eurozone’s future.


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Yannos Papantoniou was Economy and Finance Minister of Greece from 1994 to 2001 and is currently President of the Center for Progressive Policy Research, an independent think tank



The Gospel of Growth
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Julia Gillard , Lee Myung-bak
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17 June 2012
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CANBERRA/SEOUL Almost four years after the start of the global financial crisis, the world economy remains fragile and unemployment is unacceptably high. There are roughly 200 million unemployed people worldwide, including nearly 75 million young people. Growth is weakening in many countries, risks are mounting, and uncertainty has intensified, owing especially to events in Europe. Only swift and sustained recovery can stem the rise in the human cost of economic stagnation.



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When the G-20 meets in Los Cabos, Mexico, on June 18-19, its challenge will be to shift public perceptions from pessimism and concern about the future to an optimistic mindset of growth and stability. We need resolute action to address the uncertainty confronting the global economy and to chart a path toward self-sustaining recovery and job creation.


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We see two components to such a strategy. First, we need a clear message from Europe – the immediate source of global economic concern – that it is taking decisive steps to stabilize and strengthen its banks, and that it is focused on restoring growth while credibly committing itself to fiscal consolidation. A crucial element of restoring confidence in Europe is agreement on a “roadmap” for the eurozone to underpin its monetary union with a fiscal union and a banking union, including pan-European supervision and deposit insurance.


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It is essential that Europe move quickly to ensure that its banks are adequately capitalized and backstopped. In this regard, we welcome the recent decision by Spain to seek financial assistance from the European Union to recapitalize its banks as required. Decisive steps to safeguard the banking sector’s health are necessary not only to reduce some of the risks that are preoccupying markets, but also because healthy financial institutions are vital for economic growth.


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Europe must have credible fiscal-consolidation plans to restore debt sustainability, but it is also essential that it has a growth strategy that includes policies aimed at boosting investment, freeing up product and labor markets, deregulating business, promoting competition, and building skills. These reforms, including deeper institutional integration, will be politically difficult and their benefits will take time to become fully apparent; but setting a clear pathway will underpin public confidence in Europe’s long-term growth and cooperation.



We do not underestimate the magnitude of the reforms that Europe has achieved in recent years. Since the G-20’s meeting at Cannes last November, for example, Europe has increased its financial firewalls by €200 billion ($252 billion), restructured Greek debt, taken steps towards strengthening its banks and banking regulations, established rules for fiscal discipline, and implemented a range of labor- and product-market reforms.



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But the magnitude of the challenges confronting Europe implies an urgent need for far more decisive reforms. We are confident that Europe will act together to meet these challenges, and we will continue to support such efforts, because European stability and growth matter for us all.


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Second, we need a clear message from the G-20 that all of its members are delivering policies for strong, sustainable, and balanced growth. To be meaningful, the message must be backed up with action: G-20 members must demonstrate that their policies are clearly directed toward restoring economic growth and creating jobs, and that they will be accountable for meeting their commitments in full. And world leaders must be unambiguous about resisting protectionism and opening trade and investment.


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In particular, we believe that an international agreement on trade facilitation is the right step, as it would reduce export and import costs and restore momentum to global trade liberalization. The G-20 must demonstrate in Los Cabos that reform of the International Monetary Fund is continuing. That means that countries must deliver on their commitment to increase IMF resources by more than $430 billion, and that the Fund’s quota and governance structure must reflect the ongoing global shifts in economic influence.


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Economic growth and new jobs are crucial to improving people’s livelihoods now and to ensuring the prosperity of future generations. The reforms needed to secure these objectives are not easy, and change will not happen overnight. But the world expects the G-20 to deliver.


Copyright Project Syndicate - www.project-syndicate.org