Roubini's Case for a Double Dip Recession: Pretty Underwhelming

Nouriel Roubini’s column in the Financial Times discussing the possibility of a double dip recession has gotten a lot of play in the last twenty-four hours. I finally got around to reading it and it is pretty underwhelming.

I say that not to disparage the column, for I thought it was well written as usual, and for Roubini pretty balanced. He doesn’t seem to be throwing out any thunderbolts and I didn’t read a whole lot of conviction on his part in the likelihood of a “W-shaped” recovery.

He notes that economies are improving around the world and then throws out the usual suspects that stand in the way of recovery:

There are several arguments for a weak U-shaped recovery . Employment is still falling sharply in the US and elsewhere – in advanced economies, unemployment will be above 10 per cent by 2010. This is bad news for demand and bank losses, but also for workers’ skills, a key factor behind long-term labour productivity growth.

Second, this is a crisis of solvency, not just liquidity, but true deleveraging has not begun yet because the losses of financial institutions have been socialised and put on government balance sheets. This limits the ability of banks to lend, households to spend and companies to invest.

Third, in countries running current account deficits, consumers need to cut spending and save much more, yet debt-burdened consumers face a wealth shock from falling home prices and stock markets and shrinking incomes and employment.

Fourth, the financial system – despite the policy support – is still severely damaged. Most of the shadow banking system has disappeared, and traditional banks are saddled with trillions of dollars in expected losses on loans and securities while still being seriously undercapitalised.

Fifth, weak profitability – owing to high debts and default risks, low growth and persistent deflationary pressures on corporate margins – will constrain companies’ willingness to produce, hire workers and invest.

Sixth, the releveraging of the public sector through its build-up of large fiscal deficits risks crowding out a recovery in private sector spending. The effects of the policy stimulus, moreover, will fizzle out by early next year, requiring greater private demand to support continued growth.

Seventh, the reduction of global imbalances implies that the current account deficits of profligate economies, such as the US, will narrow the surpluses of countries that over-save (China and other emerging markets, Germany and Japan). But if domestic demand does not grow fast enough in surplus countries, this will lead to a weaker recovery in global growth.

Roubini doesn’t seem to think that the threats from these are sufficient to snuff out the recovery and relies instead on two other outliers.

One is the potential for government actions to precipitate another dip. He sees this occurring either by withdrawing stimulus too soon or using it so much that it pushes interest rates up to stagflation levels. The other threat is that rising oil, energy and food prices will send another shock through economies.

The argument that government could cause us to fall back into recession is not a new one and has been thoroughly discussed. Personally, I don’t think that the risk of withdrawing stimulus too soon is all that great. It just isn’t going to happen, politicians being politicians. If they hold on too long it could lead to higher rates but I think of that as a longer-term problem. Too many prognostications about QE and the other tools the central banks are using to fight the recession have proven to be wrong.

I do think he’s spot on when it comes to commodity prices. I have maintained for some time (previous post here) that the tremendous spike up in oil prices last summer had a lot more to do with the severity of this recession than has been acknowledged. Another one, even if it were only to $100 a barrel, would devastate recoveries around the globe. Whether that’s in the cards, I don’t know, I don’t feel comfortable saying it’s not possible given the recent performance of crude.

I think most economies can climb the “Wall of Worry” that Roubini lists in his seven points. I also think they can fumble and stumble through fiscal stimulus without blowing up the world. I don’t think they can control energy prices and if they take off, we are in for that “W” for sure.

Comments

[conceptwizard:]

Thats one economist. Here are a couple more nobel prize winning economists.

Yesterday, Nobel laureate Robert Merton and 2 other economists wrote in the Financial Times:

"Banks and other financial institutions are lobbying against fair-value accounting for their asset holdings. They claim many of their assets are not impaired, that they intend to hold them to maturity anyway and that recent transaction prices reflect distressed sales into an illiquid market, not what the assets are actually worth. Legislatures and regulators support these arguments, preferring to conceal depressed asset prices rather than deal with the consequences of insolvent banks.

Nobel economist Myron Scholes agrees:

"Financial institutions should use mark-to-market accounting or list the hard-to-value securities on public exchanges whenever possible, Scholes said in a Bloomberg Radio interview yesterday. Scholes ... said investors need better data on prices to accurately value the debt and equity securities of banks.

These economists believe that the economy will not recover unless and until the real state of the banks and their assets are acknowledged and insolvent banks broken up in an orderly fashion.

Aug 24 12:26 PM

[chap08:]

How is it possible that energy prices would not spike up if we get a strong recovery? The only way for that to happen is if the 2007 spike was purely due to speculation AND the speculators don't come back. I can't see it.

Aug 24 12:43 PM

[jp23:]

the charts in the stock market has been pointing to a U shape recovery. Like cup and handle. I don't see a W recovery based on stock prices.

Aug 24 12:53 PM

[Dave Wrixon:]

Frankly, I don't see the need to make a case.

A second down-leg is a given unless you are economically illiterate.

And, however far in the future it may be some sort of recovery at some stage is pretty much inevitable, but whether things will ever return to current values in relative terms is probably doubtful.

Aug 24 01:08 PM

[Donald Ingram:]

Dave - Common sense reply. Good for you.
Everyone keeps using the "Recession" term. Some indices and most major trend lines point to a Depression. I firmly believe that is exactly what we have happening. Remember, we where in recession for 12 months before the government started to refer to it as such. Talk about having your head in the sand! This is a Depression. Time will prove this out.


On Aug 24 01:08 PM Dave Wrixon wrote:

> Frankly, I don't see the need to make a case.
>
> A second down-leg is a given unless you are economically illiterate.
>
>
> And, however far in the future it may be some sort of recovery at
> some stage is pretty much inevitable, but whether things will ever
> return to current values in relative terms is probably doubtful.

Aug 24 01:18 PM

[Michael Clark:]

Stock prices recovered in 1933 in America and the economy recovered in 1947. Stocks are not a leading indicator of the economy.


On Aug 24 12:53 PM jp23 wrote:

> the charts in the stock market has been pointing to a U shape recovery.
> Like cup and handle. I don't see a W recovery based on stock prices.

Aug 24 01:27 PM

[Michael Clark:]

Couldn't agree more.


On Aug 24 01:18 PM Donald Ingram wrote:

> Dave - Common sense reply. Good for you.
> Everyone keeps using the "Recession" term. Some indices and most
> major trend lines point to a Depression. I firmly believe that is
> exactly what we have happening. Remember, we where in recession for
> 12 months before the government started to refer to it as such. Talk
> about having your head in the sand! This is a Depression. Time will
> prove this out.

Aug 24 01:50 PM

[short WFC:]

RE price declines triggered this crisis. RE continues to decline and impending resets will likely bring 2nd wave of defaults in 2010. this will likely precipitate another crisis and gov spending spree. but hey i guess thats 'long term' enough for few to bring up?

Aug 24 01:58 PM

[Fighting Yoda:]

Consumer delevraging will kill any hope of recovery. Job losses and foreclosures will keep the consumer sentiment very low. All the Govt propaganda and Trillions of dollar in stimulus can only go so far. Clunkers and home rebate programs will end soon - the sales will continue dipping. The consumer is totally shaken, very very unlikely they will be back anytime.

Aug 24 02:17 PM

[thiazole:]

While still considered part of the Great Depression (because there isn't a standardized definition for a depression), there was substantial economic growth between 1933 and 1937. Also, the stock market rallied from 1932 to 1937. If you are looking at recessionary cycles (where there is a definition), there were two separate recessions there - 1929 to 1933 and 1937-1938 www.nber.org/cycles.html (not to mention that most agree that the Great Depression ended in 1941). The reason the period from 1933 to 1937 was considered part of the Great Depression is because of the severity of the economic contraction from 1929-1933; it was a -43% GDP growth. The GDP contraction that we've seen in this recession so far (about -3%) is a drop in the bucket compared to the Great Depression, and the GDP isn't even contracting any more. If we saw the same kind of economic expansion right now that we had from 1933-1937, it would be a huge boom, not part of a depression. The difference is the starting point (of course it wouldn't be possible to have that kind of expansion, but just pointing out the obvious).


On Aug 24 01:27 PM Michael Clark wrote:

> Stock prices recovered in 1933 in America and the economy recovered
> in 1947. Stocks are not a leading indicator of the economy.

Aug 24 03:29 PM

[TxTim:]

Not only should the big banks be broken up for the reasons you stated but also for the risk they pose to the entire system (systemic risk). Most Americans are furious about the "too big to fail" doctrine that in fact exposes their wallets and their entire country to potential ruin.

Break 'em up NOW not later.

On Aug 24 12:26 PM conceptwizard wrote:

> Thats one economist. Here are a couple more nobel prize winning economists.
>
>
> Yesterday, Nobel laureate Robert Merton and 2 other economists wrote
> in the Financial Times:
>
> "Banks and other financial institutions are lobbying against fair-value
> accounting for their asset holdings. They claim many of their assets
> are not impaired, that they intend to hold them to maturity anyway
> and that recent transaction prices reflect distressed sales into
> an illiquid market, not what the assets are actually worth. Legislatures
> and regulators support these arguments, preferring to conceal depressed
> asset prices rather than deal with the consequences of insolvent
> banks.
>
> Nobel economist Myron Scholes agrees:
>
> "Financial institutions should use mark-to-market accounting or list
> the hard-to-value securities on public exchanges whenever possible,
> Scholes said in a Bloomberg Radio interview yesterday. Scholes ...
> said investors need better data on prices to accurately value the
> debt and equity securities of banks.
>
> These economists believe that the economy will not recover unless
> and until the real state of the banks and their assets are acknowledged
> and insolvent banks broken up in an orderly fashion.

Aug 24 04:08 PM

[David Van K...:]

Merton and Scholes are smart guys, Nobel Laureates. But they were partners in Long Term Capital Management, which blew up in 1998 and almost brought the world financial system down. LTCM was a preview of the financial disasters of 2007-2008, and, like the latter, required government bailouts to clean up. Their arrogance, greed, and terrible judgement in doubling and re-doubling their bets while LTCM was blowing up--using huge leverage--has been well documented. Tell me why we should listen to them? Their call for bank transparency and the breakup of insolvent banks--after the example they set with LTCM--is laughable, considering the source.

Aug 26 03:53 PM