Nouriel Roubini: Risk in the Age of Bank Failure

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1:24And now to the top analysis of today's markets.

1:33Nero, welcome back to Real Vision. Great being with you today, Ash. It's such a pleasure to have you here with us today. You're one of the most important voices in macroeconomics in the world. We're filming here on March 20, 2023, a great deal to talk about right now, instability in the banking system, about macroeconomic imbalances and risk. Your latest book is all about risk, mega threats, the 10 trends that imperil our future and how to survive them. It's really a crystallization of so much of your thought. Nouriel, big picture, where are we right now and where are we going? Well, we're at a very difficult time because there was already a dilemma in terms of achieving price stability and pushing inflation back to 2 % without causing a recession.

2:25That was the dilemma faced by the Fed, the ECB, and other central banks. But now this dilemma is becoming a trilemma. Because on one side, we want to have price stability and inflation back to 2%. Two, we want to avoid the recession and a hard landing. And three, we want to avoid the financial instability. And as I described in quite detail in my book, we live in a world in which there are both supply and demand forces that are leading to high inflation and stipulation, inflation and recession. And we're also in a world in which there is so much private and public debt that the attempt of central banks to raise interest rates to fight inflation causes not only the risk of a hard landing of the real economy, but it causes the risk of financial instability, debt ratios, private and public, that become excessive and unsustainable.

3:24And then if you're going to have financial instability, that's going to cause a credit crunch. It's going to make the recession more severe. And if the recession becomes more severe, debt ratios that are already high become more unsustainable as incomes and revenues fall. So we are entering a vicious cycle between high inflation, recession, and financial instability feeding on each other. And there's no easy way out of it because we live in a world of high inflation, of negative supply shock, and high debt create financial instability. So either way, we're going to get a hard landing of the real economy and our financial markets at this point.

4:06So I want to share this quote just to give people a little bit of context of how serious you believe this situation is. Quote, spoiler alert, without amazing luck, almost unprecedented economic growth and unlikely global cooperation, this won't end well. We are in way too deep. And then you go on to say, failure to restore sustainable and inclusive growth could plunge us back into the tribal dark ages when competing interests spurred endless national and global conflicts to no one's benefit. It's a very serious picture you paint. You talk about a whole different series of different categories here, just a wide array of challenges facing the globe.

4:45Debt, inflation, demographics, trade, AI, deglobalization, geopolitics, pandemics. It's all in there. Let's start with debt. Talk about where we are. You describe almost an Argentinization of the world right now. How do you see the debt problem in both public and private spaces? Well, as you point out in this book, I discuss not only economic, monetary, and financial risks, but also social, political, geopolitical, environmental, health, and technological. And we're going to get to them, but they're all interrelated to each other. The starting point of the book is two chapters about the model of all debt crisis.

5:28I point out that private and public debt, private being the debt of a household, of businesses, corporates, of banks and other financial institutions, public of course, federal government, state and local, has a share of GDP. This debt ratio globally have gone from 100 % of GDP in the 1970s to 200 % of GDP by 1999 to 350 % of GDP and rising last year. In advanced economies, the average is 420. In China, 330 and rising. Now, until two years ago, debt ratio were high, but debt servicing ratios were low because we had zero policy rates, negative policy rates, quantitative easing, credit easing. So both short and long rates were low.

6:22And while debt ratio were high, that servicing ratio, the interest that you pay on these debts were low. You know, only two years ago, it was an$18 trillion equivalent of public debt between Europe and Japan that had the negative nominal yields. In Denmark, even mortgages were having a negative nominal yield. and therefore while we had a situation potential of that unsustainability, that servicing was so low that even at zombie, zombie households, zombie corporate, zombie businesses, zombie governments, zombie banks, zombie shadow banks could survive even though that servicing rates. Now that party unfortunately is over because for a number of reasons inflation is rising and now central banks are entering an economic downturn, not being able to cut policy rates, but having to rise them in order to fight inflation.

7:17So not only debt ratios are high, but debt servicing ratios are now becoming higher and unsustainable. And people talk about what has happened with Silicon Valley Bank or with Credit Suisse or other financial institutions as if it's just some bad luck. It's not bad luck. I saw it coming and that's what I said in the book. As we have an inflation problem, we'll have to raise interest rates. As we raise interest rates, high-level institutions are going to have debt problems. And this is the beginning of manifestation of those debt problems. They go well beyond the banking system. It includes the corporate sector, it includes parts of the household sector, it includes governments, includes a large number of countries.

8:03So we're starting to see the mother of all these debt crisis. And unfortunately, you know, in the 1970s, we had negative supply shocks like the oil shock of 73 and 79 that led us to inflation and recession, but debt ratios were low, 100 % of GDP in US and Europe. So we did not of a debt crisis. We had a debt crisis in Latin America because when Volcker had to jack up interest rates to 20 percent, Brazil, Argentina, Mexico, and the border like crazy in the 70s, of course they defaulted. But we didn't have massive defaults in the US and Europe. After the global financial crisis, we had a debt problem.

8:48Housing debt, housing debt, mortgages, leveraged banks. So we had a debt crisis, but because this was a demand shock and a credit crunch with low inflation and deflation so we could do massive monetary fiscal and credit easing. Today instead we have the worst of the 70s with a variety of negative supply shocks that are raising inflation reducing growth, stiflation, but we have debt ratio that are much higher than they were even during the global financial crisis by an order of magnitude as we borrowed like crazy in last 15 years. So not only we have inflation, not only we have a recession, not only we have stagflation, but we're on the verge of a stagflationary debt crisis, the worst of the 70s and the worst of the post-GFC period.

9:39So it's a nightmare. Let me ask you about price stability, Neuro. This is interesting because during the most recent cycle we've been through, we've been hearing about the division between the inflationists and the deflationists. There's a case out there right now that says that inflation is past its peak, that we're looking at numbers on the CPI and PCE that are registering from six or 12 months ago. Make the case, Nouriel, for the secular inflation scenario and why you believe that's what we're seeing. It's a secular inflation for a number of reasons. On a cyclical basis, labor markets are super tight in the US but also in Europe.

10:20You have unemployment rates you haven't seen in decades. We have aging of population, where the falling level first participation rate, we have restriction to migration, we have the great resignation, we have beginning of labor strife both in the U.S. and Europe. So wage inflation in U.S. is at a five to six percent range consistent with inflation core being at four, not at two, not this year, not next year and so on. So that remains an issue. Two, in my view, while commodity prices are falling now because people are worried about a recession, in the commodity markets there is tightness. Tightness because China is going to grow faster this year, demand for commodities is going to be higher because the Russia-Ukraine war is going to get worse and therefore shocks to energy prices, fertilizer, foods, industrial metals can occur.

11:16And massively we have under invested into new capacity of energy and industrial metals for a number of reasons. So there is a structural undersupply of new capacity of energy, industrial metals, green metals and so on. So the combination of all these things imply that commodity prices, leaving aside the scare of a recession, are going to remain high. So high wage inflation, high commodity prices, there's no way that core inflation is going to fall to 3 % this year in the U.S. or in the Eurozone and to 2 % next year. Core inflation is going to remain around 4 +, and therefore either central banks raise rates much more, the Fed above 6%, the CB above 4%, or otherwise inflation is going to remain high on a cyclical basis.

12:09On a structural basis, we have a problem because given the amounts of private and public debt, we don't have only fiscal dominance. Fiscal dominance means that in the game of chicken between central banks and fiscal authorities, the central banks have to blink because with too much private, too much public debt and deficits, If you don't blink, you have a debt crisis. But we have a bigger debt trap. There is not only too much public debt, there's also too much private debt. And if central banks raise interest enough to fight inflation, they cause not only a sovereign debt crisis, but also private debt crisis.

12:48And what has happened with the U.S. and European banks is the beginning of a manifestation of debt, debt trap. Final point, therefore, central banks will have to blink. They'll have to win out and monetize the deficits because otherwise we get into a private and public debt crisis. Final point, why inflation is going to be structurally higher. We live in a world in which governments will have to spend more, because they have to fight at least five wars. One is a security war. Everybody's going to have to spend more on the fence. Europeans against the Russian bear. Americans against the Russian bear.

13:27and China, the Chinese will spend more, Australia will spend more, Japan is going to spend more, India is going to spend more. Everybody has to spend more on defense to fight either cold wars or hot wars. War number one. War number two is going to cost us a fortune to fight climate change. Trillions of dollars of public spending to either mitigate or adapt to it. Number three, either we spend a fortune to prevent the next global pandemic or like in COVID, if we don't do it in advance, expose the fiscal cost of picking up the mess are going to be the trillions of dollars. Four, a combination of still globalization, however reduced, and of automation and robotics, what people call globotics, we're going to imply massive disruption of jobs.

14:16They're going to be wiped out because of this technological and globalization revolution. Therefore, we have to have a wider social safety net to fight against these consequences of robotic automation. And five, there is so much income and wealth inequality that unless you address it with policy that we distribute income to those who are left behind, you'll have massive civil strife, really, on the level of major social strife across advanced economies and emerging markets. Historically, whenever there is a real war, as Neil Ferguson has shown, there is a budget deficit and then we monetize them, we cause inflation.

14:59This time around, there's not just hot and cold war to fight, but four other wars to fight. Each one of them is implying more government spending as a shared GDP. We're not going to be able to raise taxes enough. One, because it's politically not feasible and economically is going to damage growth. So we'll have structural budget deficits that are going to be larger. We either monetize them and cause inflation, or if we don't monetize them, eventually you'll have a debt crisis or you're going to crowd out economic growth or both. So we'll have to monetize them. And therefore, we're going to have a structurally high inflation.

15:33So the great moderation is over, and we're going to be in a world of great inflationary and speculationary instability. These are all both cyclical and secular factors that are going to lead us to higher inflation over the medium term. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

15:57yeah i want to talk about geopolitics your points there remind me of the great dwight eisenhower speech from 1953 the chance for speech speech where he said every gun that is made every warship launched every rocket fired signifies in the final sense a theft from those who hunger and are not fed those who are cold and are not clothed dwight eisenhower is nobody's idea of a hippie peacenik, certainly by any stretch. Talk a little bit about the geopolitical context that we find ourselves within today and what it implies for fiscal and economic activity in the world. Well, he was thinking about the trade-off between bread and butter on one side and guns, implying that if you want more guns, maybe there's less bread and butter.

16:45the world in which you can borrow. We want the guns and we need also the transfers to make sure that you don't have social political instability. And the consequences of having guns, bread and butter is more spending, with less taxes, more budget deficits, and eventually we're going to monetize them. Now, what about the geopolitics? The geopolitics implies that there's geopolitical depression because you have a bunch of revisionist powers, China, Russia, Iran, North Korea, possibly Pakistan and others that are effectively allied. These strategic rivals of the U.S. and the West are essentially challenging the economic, trade, monetary, financial, investment, political, geopolitical, security, and military order that the U.S., Europe, and the West created after World War II.

17:41They want a different order. That's why we have a cold war. It's getting colder. We already have a hot war between Russia and Ukraine. It's going to get uglier. It could involve NATO. It could become non-conventional. And therefore, this geopolitical depression is going to be one of the key factors leading to deglobalization. The globalization was already occurring because they're winners and losers, because environmental concern, because of labor concern. But now geopolitics is going to divide the world in two. It's going to fragment it, it's going to vulcanize it. And rather than having free trade, now we're talking not only about fair trade, but also secure trade.

18:23Instead of offshoring, we're talking about reshoring or French shoring. And instead of just in time, global supply chains, we are thinking about just in case global supply chains are a bit redundant in case there is a shock with China and so on. All this leading to decoupling, to balkanization, to fragmentation, to the division of the world. And it's going to reduce potential growth and it's going to increase cost of production, causing stagflationary shock. Look no further than the UK. Why the UK is now much higher inflation than the rest of Europe and the recession is going to last much longer.

19:07It's subject to the same shocks, energy shocks like the rest of Europe, but it's a much worse situation because they shoot themselves in the foot, a self-inflicted goal like Brexit that reduces trade in goods, reduce trading services, reduce the mobility of labor, and that's why the UK has inflation much higher than the rest of the Eurozone, and the recession is more severe already now than the rest of the Eurozone. So globally, think about Brexit, and think about deglobalization, and protection is a big, a larger version of Brexit. That's some of the economic consequences of going in a world that is geopolitically divided, where there is fragmentation, where there is protection, where there is decoupling, reshoring, french shoring, fair and secure trade, and it leads to higher cost of production, lower growth, and it's stagflationary, among other things.

20:04Leaving aside the risk of war among a great nation that could be not just conventional, but escalate into unconventional. Yeah, and for those who don't know, of course, unconventional is the potential threat of tactical or even strategic nuclear weapons being deployed, a horrifying scenario. Yeah. And by the way, I said today things are the worst of the 70s in terms of staccolationary shock and the worst of the post-GFC in terms of that problems. But in many ways, this geopolitical depression makes the world look like the 1930s that then led to the worst of World War II. and yet 30 years between 1914 and 1945 were 30 years of a nightmare.

20:50In spite of the first era of globalization, in spite of the first industrial revolution, we did not prevent World War I. And after World War I, we had the Spanish flu, then with the stock market crash of 29, then we had the beginning of the Great Depression, then we had trade and currency war, then we had financial crisis and massive bankruptcies and defaults. Then we had capital controls. Then we had the economic meltdown with the Great Depression becoming worse and unemployment rates of 20%. And then the Nazis came to power in Germany, the fascists in Italy, Franco in Spain and the militaries in Japan.

21:30And then we ended up with World War Two and then the Holocaust. So and today, by the way, things are worse than the 30s. Why? In the third days, we didn't have to worry about global climate change. It was not even in the radar screen. In the third days, we didn't have to worry about AI destroying most jobs. They were not even computer, let alone AI. In the third is we didn't have to worry about implicit liability of governments. In addition to explicit debts, implicit liability coming from aging, Social Security, and Medicare systems that are pay-as-you-go funded did not exist. Social Security had been barely created, and the average worker would die at the age of 60 before he or she would get the first Social Security check at the age of 62.

22:19And as ugly as World War I and World War II were, there were conventional wars. It was only at the end of World War II that luckily the U.S. got the bomb, rather Nazi Germany or Japanese, and unfortunately nuclear bombs were used in Hiroshima and Nagasaki to end World War II. This time around, if you're going to have a war within great powers, it's not going to be conventional because all these great powers have the nuclear bomb, and a war that starts as conventional conventional is going to become unconventional and with the specter of a nuclear winter. So compared to the 30s, where four mega threats, climate change, AI, unfunded implicitly of the government and the risk of a nuclear winter, they did not even exist in the 1930s.

23:07So the risk to destroy our own species either through climate destruction or a nuclear winter or through AI destroying most of humanity is a bigger threat today than it was even in 1930s. Yeah, and by the way, not merely atomic, but hydrogen, thermonuclear weapons, whose yields are measured in megatons rather than kilotons, a significant advance, unfortunately, in that technology as well. You touched on Spanish flu in your remarks. I want you to come back to the economic costs of pandemics. The word pandemic appears in mega threats 56 times. Talk a little bit about the economic impact of pandemics.

23:47Well, before I speak about the economic impacts, you have to ask yourself why we did not have any pandemics after the Spanish flu since the early 1980s. And since the 1980s, we've had a series of one more virulent than severe. We had first HIV, then SARS, then MERS, then swine flu, then several episodes of bird flu, Zika, Ebola, and now COVID-19. And it's only a matter of time we're going to have COVID-23 or 24 or whatever else. There is a very strong correlation within global climate change and global pandemics. As we destroy the animal ecosystems by encroaching on them, what's happening is that animals that have pathogens like pandering, bats and others, get closer to livestock animals and to humans.

24:44That's why we have these zoonotic diseases that transfer from animal to human. And that's why we get them more frequent and more virulent. By encroaching on the ecosystem, they're closer, they make the animals sick and the humans sick. So because of climate change, man-made disaster, global pandemics are becoming more frequent and more virulent. And trust me, COVID-24 or 25 or whatever, the next pandemic is going to be maybe another more severe episode of birth flu. Science is already telling us it's going to be more severe than COVID-19. And COVID-19 led to dozens of millions of people dying, and economic costs like the worst recession we had since World War II.

25:28and fiscal costs in the trillions of dollars that we had spent a fortune to deal with the economic impact of that recession. So COVID-19 was a disaster economically, was a disaster fiscally, was a disaster from a health point of view in all dimensions. And the next pandemic is going to be worse than COVID-19. So that's the risk we're facing right now. We're still recovering from the consequences of COVID-19. The fiscal impact of it, the economic impact of it, the health impact of it, the social and political impact of it. Even geopolitical, as U.S. and China have been blaming each other on what was at fault for COVID-19.

26:13So it's not just economic and financial impact, it's also the severe social, health, political and geopolitical of pandemics we have to keep in mind. So Nouriel, I want to switch gears here from the global to the national. You mentioned that Scylla and Charybdis, that the Fed has to steer itself between with the risk of recession on the one hand and the risk of inflation on the other. Talk a little bit about what your view is in terms of what you expect to see from the Fed. You've spent time at the New York Fed yourself. How do you think they're processing this information and what's the most likely outcome?

26:50Well, I'm still one week ago, as I pointed out, there was a dilemma. Now it's a trilemma. It's not how you trade off fighting inflation without causing a recession, but also how you fight inflation without causing a financial meltdown, because raising rates leads to financial instability. So that trade-off was hard enough before, has become harder. But I said it in my book. I said, we're in the debt trap, as you raise interest to fight inflation, you'll have financial instability. And what has happened with Silicon Valley Bank and Credit Suisse and other regional banks is the beginning of manifestation of that kind of a financial instability.

27:29So you know the Fed is right now in a difficult spot. If you want to fight inflation, the Fed should be raising rates you know this week in March by 50 basis points. If you want to avoid financial instability, the Fed should be actually pausing any Fed rate hike. And if you're worried about growth, growth is already slowing down and with the banking problem there'll be a serious credit crunch. It's going to limit the ability of regional banks to lend money to households and small and medium sized businesses and those households and small and medium sized businesses that are relying on bank financing not from money center banks but from the First Republic, Silicon Valley and other regional banks.

28:14Then there'll be a credit crunch that's going to lead to a recession and that would imply we should not raise rates by 50, maybe only by 25. Now whether the Fed is going to stay on hold this time around or raise rates by 25, 50 is off the table, in some sense doesn't matter because even if you do zero or 25 you're still going to be in trouble. Be in trouble because inflation is still too high and you should be raising rates all the way not just to five you have to raise rates all the way to six percent if you're serious about inflation but with rates already in the 4.5 range we're already seeing cracks in the financial system let alone if you were to go to five five and a half and six and therefore this trilemma to fight inflation we're cause a recession and a financial crisis now has become worse, given the events of the last couple of weeks.

29:15And either way, we're going to have a hard landing of the economy and of financial markets. Central banks are damned if they do, damned if they don't. They were in the pickle before, they are now in the worst pickle. So there is no easy way out of it because the forces that lead to inflation are there, the forces that lead to recession and stagflation are there, And the forces that lead to financial instability, high private and public debt, are historic. They've been going on for decades. So you cannot resolve them overnight. So either way, you get the hard landing of the real economy and or of financial markets.