Dan Alpert is a founding Managing Director of Westwood Capital LLC and has more than 30 years of international merchant banking and investment banking experience. Alpert, NYU economist Nouriel Roubini, and Cornell law professor Robert Hockett are authors of the new report, The Way Forward.
Harlan Levy.: Will anything positive come out of Europe’s two big meetings this week to deal with the eurozone countries’ massive debt problems and lift the U.S. stock market?
Dan Alpert: The news that comes out of Europe has to be enormously positive to extend the rally, because the market has been trading on relatively low volume and a lot of hope.
I think the European problems will be extended for many, many months. There’s going to be something coming out of the two summits. God knows what it ultimately will be, and then you’ve got to gauge the reactions of the rating agencies and what they’ll say in terms of country ratings, bank ratings, and ultimately whether or not they’ll declare a default with respect to the solution applied to Greece.
Then, of course, you have the credit default swaps issue and what the position is going to be there, because everybody is desperately trying to avoid triggering the credit default swaps. Until we see what the final view looks like it’s impossible to guess, and the market’s just taking a flyer until we do.
H.L.: The new report written by you, Roubini, and Hockett says that unless we take drastic steps we face waves of recurring recessions. What happened?
D.A.: We have a surplus of labor, of productive capacity, and of capital in the world. It dates back to the emergence of the former socialist countries, but it clearly didn’t grow to be a big problem until the last decade. We were able to avoid any connection to the issue during the late 1990s, simply because we had one of the world’s greatest productivity boosts, because of the Internet technology revolution, of a type we hadn’t seen since the invention of railroads and radios and other things going back a century.
After that productivity boost leveled off, and especially after the technology took root globally so other countries benefited from it, we ended up with a period where capital flows from the U.S. and Europe to the emerging markets started to reverse, flow back to the developed markets, and become a tidal wave of capital, which allowed us to pursue easy-money policies for most of the last decade. That ended up fueling an enormous asset bubble which couldn’t be supported- because one thing that didn’t rise during that period was wages on a real basis. Without real wage growth, any asset price growth that exceeds inflation is not supportable.
So the house of cards came down. We’re still left with this massive global supply glut, which has actually become worse over that period. Unfortunately, there’s no other way of hiding it at this point. We’re facing the full brunt of it. On top of, and as a result of that we have a massive debt overhang which needs to be eliminated.
H.L.: What should we do about it?
D.A.: The first thing we propose is a very significant, massive infrastructure repair and replacement program to spur domestic employment. We’re talking about having about 5.5 million more people being employed in any given year of a five-year program than would be employed without the program. That is an expenditure that’s tied to what the U.S. Society of Civil Engineers has determined to be the difference between amount that is budgeted for infrastructure expenses at the state and federal level and the amount that’s necessary to be expended on infrastructure to avoid further deterioration, without which we’re going to end up even less productive going forward.
A second thing is a very extensive program to facilitate the de-levering of the excess debt. During the course of the 2000s we more than doubled outstanding debt in this country. Most of that was in the financial services sector and the household sector. The household sector is extremely constrained by both consumer debt and mortgage debt. In order to get that down to a level that reflects the ability of people to pay and the value of assets that secure that debt we’re going to need to effectuate some fairly drastic measures.
We have three measures that are basically tied to the various types of borrowers that are affected, ranging from bridge loan programs for people who are temporarily distressed; to large-scale contingent principal write-offs; to surrendering of the deed to a house and forcing lenders to give the former homeowner a lease for a five-year lease at prevailing rents.
The third program is focused on resolving global imbalances, especially what things we need to be done to bring the Chinese to the table, and avoid an additional recession in this country, and how we start to rebalance the global economy. The rough numbers are this: 3.5 billion people in emerging nations with about 2 billion employable, compared to Japan, the U.S., Canada, and Western Europe with 500 million employable. From 1989 on we’ve quintupled the labor force in the world, and that has enormously deflationary characteristics in the developed world, and chiefly the U.S. which is the largest economy.
People will have a very difficult time emerging from this. This is not a cyclical crisis. This is a major secular crisis, because on top of it we have this massive debt overhang. This is like the Depression on steroids from a macroeconomic standpoint because of the global labor glut. That impacts standards of living and tax and wage rates.
We have a good laboratory to look at to understand what’s likely to happen if we don’t do anything. Japan had massive debt problems, a huge debt overhang, challenges from the Asian tigers, Taiwan, Singapore, Korea and the rest of the “Asian Tigers” during the 1990s that really prevented it from inflating its economy out of its debt overhang. It was faced with the option of either having massive unemployment, which the Japanese won’t tolerate, as we will, or allowing wage rates deflate and prices to deflate and asset values to further deflate to the point at which they become competitive and so Japan maintains itself as a current account surplus country by virtue of the fact that they’ve sustained deflation over the course of 15 years.
H.L.: So how do you solve our imbalance?
D.A.: There are three ways of resolving this type of imbalance: There’s the classic way, protectionism, which goes back hundreds and hundreds of years. We could theoretically go to the Chinese and say, you know all this global trade stuff we’ve been talking about for the last 15 years? We really didn’t mean it. It didn’t work out so well for us, so we’re going to erect all sorts of tariffs and barriers and make it difficult to trade with us. I certainly don’t want to see a world like that, because if the Chinese were smart they’d ally themselves with all the other countries in the world that we don’t like and God knows what kind of destabilization would occur after that monetarily, because we’d be crushed.
The second way is also traditional: devaluation of the debtor’s currency -- we’re the debtor -- and consequently you’d be able to inflate yourself out of some of the excess debt.
But to a certain extent we’ve eliminated the possibility of unilateral devaluation, not only for the United States relative to its “involuntary currency union” with China that has an unofficial peg to the dollar, but also, depending on what happens in Europe over the next couple of weeks, if you’re going to keep the Southern-tier countries in the Euro zone, you’re effectively saying to those countries that they can’t devalue their currency, because their currency is your currency [the euro]. That makes it very difficult for a country to recover, which is why I think something ultimately has to be done.
The third way of resolving imbalance is deflation in the debtor country and inflation in the creditor country, and that’s something that people try to avoid. Deflation is a very messy business, very uncertain. You could potentially have a deflationary spiral along the lines of the Great Depression, although I don’t think you would in modern days. I think we’re a hell of a lot more interventionist than that, and I think the Japanese have proven that you don’t need to necessarily incur a deflationary spiral, because you can manage monetary and fiscal policy in order to prevent that, and you can generally treat it as a slow bleed of deflation where prices and wages drop over a period of time. They’ve had a stagnant economy for 20 years, but in terms of keeping society together and keeping people employed, it’s gotten the job done in Japan.
But that would be a very devastating thing for the U.S. economy, which for the past 30 years has been entirely driven by credit creation and controlled inflation. We’re reversing that right now. There’s very little incentive to borrow. So you need to manage the process in a way that recognizes that these imbalances need to be reversed.
Eventually the imbalances are reversed by the increasing internal demand in the emerging nations. But you’ve got to remember the Chinese savings rate is near 50 percent, so there’s not a lot of net consumer demand. So we have to encourage the Chinese to reverse their savings rate and get themselves more focused on a consumption economy. Eventually, we’re talking about3 ½ billion people in the BRIC (Brazil, Russia, India, China) nations, and that’s a lot of people representing a lot of potential demand. It just takes a lot of time. And then the world hits what I call the “Kumbaya” moment.
H.L.: Many economists say it’s not Obama who’s the cause of the U.S. economy’s problems. It’s a lack of demand by worried consumers. What do you think?
D.A.: It’s not a lack of demand. It’s an excess of supply. What people tend to do in the business sector is they say, “I’m not getting enough orders. It’s a lack of demand.” But effectively what this has been is a supply-side nightmare, relative to global demand – not the other way round.
H.L.: Are uncertainty, high taxes, and excessive business regulations killing the economy?
D.A.: That’s complete and utter hogwash. This isn’t a confidence issue. It’s not an uncertainty issue. It’s not a worry-about-taxes issue. It’s a simple, horrible, macroeconomic crisis. It has nothing to do with confidence fairies, or tax concerns, or worries that if we spend money we’ll have to raise taxes. Any businessman who sees an opportunity to lift his net profit doesn’t sit up all night worrying that he’s going to have to pay more taxes. It’s a complete red herring, and any opportunity to speak against it I take.
H.L.: What’s the problem you see in 2012?
D.A.: We’re caught up in a presidential race. The likelihood of doing anything material is very, very small. That’s why we wrote the paper. We really can ill-afford to sit on our hands for another 12 to 14 months. That’s the biggest problem that we see. On top of that we’re extremely exposed right now to one of any number of events, like Europe and so forth that can dislodge the economy that are real risks.
We’ve exhausted whatever engineered demand that we created through aggressive monetary policy, creating huge amounts of liquidity in the economy. We’ve come to the point where quantitative easing is of very, very diminished return going forward, because it all seems to flow into commodities and tradable assets like stocks. As soon as you remove the excess liquidity, the markets tank. While the prices of commodities accelerate, both food and oil, the global labor glut actually chokes off economic activity in the U.S., simply because wages refuse to rise in accordance with them, because of the supply issue. You’re talking about a situation where you can’t wait for the next 12 to 14 months.
What is the next leap forward from the standpoint of producing growth in the economy in the U.S. and globally? The next space age or Internet era? It’s hard to identify. You can pray that it’s there. You can hope that it’s there, but you can’t bank on it.
H.L.: So what do you see in 2012?
D.A.: More of the same. Scraping along, or there’ll be the moment of truth if we do hit a renewed recession. A renewed recession actually creates the driver that will have the electorate insist that we do something more. If you see the unemployment rate go over 10 percent, that’s going to be an emotional turning point, and people will react accordingly.
H.L.: What do you think if the Republicans’ and Democrats’ opposing plans to create jobs and fix the economy?
D.A.: Not much of either. Obama’s plan is fine as far as it goes, but when you net out all the tax breaks, he’s really only spending about $100 billion on infrastructure, which is really inadequate.
We strongly don’t believe that indirect stimulus is of any use any more. It may make the Republicans happy to hand tax breaks to companies, but companies don’t take on additional employees because of tax breaks any more than they’ll refuse to hire additional employees until they see demand. At the end of the day, it’s all about the bottom line.
The Republican plan is utter lunacy, while the Democratic plan is merely inadequate.
H.L.: What do you think of the stock market’s volatility?
D.A.: The stock market is trading on light volume. It demonstrates that there’s no commitment either way. You get massive swings on that kind of environment, because it takes very little trading to move the market. We’ve seen many of those types of days. When we were kids we played a game called “running bases,” also called “monkey in the middle,” where you throw the ball back and forth and the guy in the middle tries not to get tagged. And that’s what traders are doing right now. They’re running back and forth between bases just hoping not to get tagged before they can find a bid for what they are long.