The US takes some new action to escalate this cold war almost weekly and China is starting to push back with actions of its own. The two powers are now on a collision course in all dimensions and this will continue, to some extent, even if Joe Biden wins next month’s presidential election.
(This week in Say More, Project Syndicate talks with Nouriel Roubini, Professor of Economics at New York University's Stern School of Business, Chairman of Roubini Macro Associates, and host of the NourielToday.com broadcast.)
Nouriel Roubini Says More…
Project Syndicate: In August, you wrote that though predictions of the US dollar’s early demise were “greatly exaggerated,” if the US “keeps monetizing large budget deficits….a surge of inflation eventually could debase the dollar and weaken its attractiveness as a reserve currency.” Since then, US Federal Reserve Chair Jerome Powell announced that the central bank would loosen its approach to inflation-targeting and leave interest rates near zero through at least 2023. To what extent does this heighten the risks to the dollar? What about in combination with a second term for US President Donald Trump – a development that may accelerate the “loss of US geopolitical hegemony”?
Nouriel Roubini: I would separate the short-term forces that are likely to weaken the US dollar’s value over the next few years from the longer-term factors that could result in the dollar’s demise as the world’s major reserve currency. The former category does include loose US monetary policy, including the Fed’s move to average-inflation-targeting. It also includes large monetized fiscal deficits, twin current-account and fiscal deficits (with low savings rates), risk-on episodes, continued high COVID-19 infection rates, and weakening growth.
But for the dollar to lose its position as a major reserve currency, there will have to be an alternative ready to supplant it; you cannot replace something with nothing. And there is not yet a clear alternative available. The renminbi will not qualify until China implements more radical—and, in many cases, costly—reforms to internationalize it.
Yet, in the longer term, if the US continues to weaponize the dollar, using it to impose primary and secondary sanctions against rivals and allies, some central banks may have more incentive to move away from dollar assets and reserves. That is more likely if Trump is re-elected, and US geopolitical hegemony and soft power erode further.
So, for now the dollar is safe. But over the next two decades, things could change.
PS: Among the “white swans” that you warned could trigger a “massive global disturbance” this year is the “Sino-American cold war regarding trade, technology, data, investment, and currency matters”—a conflict the COVID-19 crisis has “severely exacerbated.” From this perspective, how consequential is the Trump administration’s recent decision to ban the Chinese-owned mobile apps WeChat and TikTok from US app stores, and prohibit American companies from processing transactions or hosting traffic for WeChat?
NR: The Trump administration’s recent actions against WeChat and TikTok are consistent with the ongoing escalation of the Sino-American cold war. So are its continued crackdown against Huawei and other Chinese tech firms; its threats to delist Chinese firms not adhering to US audit standards from US exchanges; its blacklisting of the major Chinese chipmaker SMIC; the expansion of the Clean Network program; and a new executive order entitled “Securing the Information and Communication Technology and Services Supply Chain.”
In fact, the US takes some new action to escalate this cold war almost weekly—and China is starting to push back with actions of its own. The two powers are now on a collision course in all dimensions—including military and geopolitical—of their relationship. This will continue, to some extent, even if Joe Biden wins next month’s presidential election, as some decoupling from China has become a matter of bipartisan consensus. The question is whether we will have unrestrained strategic competition bordering on containment or a “managed” rivalry.
In any case, the risk that a cold war could eventually escalate into a hot war is also rising. Taiwan and the South China Sea are both likely flashpoints for military confrontation—possibly triggered accidentally.
PS: In the same piece, you point out that “markets are not very good at pricing political and geopolitical—let alone environmental—tail risks, because their probability is difficult to assess.” But, as you make clear, this failure may have truly disastrous consequences. For example, climate “tipping points,” such as the collapse of major ice sheets in Antarctica or Greenland, could lead to a “sudden catastrophic sea-level rise.” What could be done to make markets price such risks better?
BRI after COVID-19
NR: Some of these tail risks cannot be easily priced, because they are subject to so-called Knightian uncertainty, which can’t be measured in probabilistic terms. Economics can more easily measure priceable risk from standard statistical distributions of events where extreme tail events are highly unlikely. In practice, financial markets tend to estimate that the probability of extreme tail events is lower than their actual frequency. For example, markets did not price in advance the “October surprise” of Trump testing positive for COVID-19, even though his reckless behavior was making it more likely.
Over time, as financial crises, natural disasters, pandemics, and geopolitical hostilities intensify and proliferate, markets may start to price them more and better. Already, some central banks –such as the European Central Bank and the Bank of England – are urging financial institutions to carry out stress tests focused on such tail risks, including environmental disasters. Because such events would affect the profitability of banks, non-bank financial institutions, asset managers, and insurance companies, assessing their short- and longer-term effects is imperative.
PS: Last November, you identified the biggest risks confronting the global economy, noting that “the fundamental risks to growth remain, and are actually getting worse.” One bright spot, you wrote, was that a “hard Brexit” seemed to be “off the table.” Eleven months later, a hard Brexit seems to be the only dish on offer. How does that change the economic-policy calculus in the European Union, whose COVID-19 response plan you’ve called “economically inadequate”? What about the United Kingdom, which you’ve indicated will suffer far more than the EU? Can anything be done to soften the blow?
NR: Last fall, a “hard Brexit” appeared less likely, because the UK and EU had reached a last-minute Withdrawal Agreement and settled on protocols for keeping the border with Northern Ireland open. But they gave themselves only one year to reach a final agreement on the nature of the post-Brexit trade relationship. Now, time is almost up—an agreement has to be reached by mid-October, if the UK and the EU27 are to have time to approve it—and the two sides are still locking horns. The specter of a hard Brexit looms again.
Open issues include state aid, data protection, fisheries, and degree of UK sovereignty on regulatory matters. A thin Free Trade Agreement on goods is still possible, but even that would amount to a relatively hard Brexit. Indeed, there isn’t much difference between a thin FTA and a return to a World Trade Organization regime (the no-deal default). That is why some Brexit hawks prefer no deal, especially if the EU doesn’t yield on state-aid rules. At least with a hard Brexit, the hawks say, the UK’s sovereignty would be complete.
But a hard Brexit would carry some additional costs, which the UK would have to bear on top of the costs of the COVID-19 crisis (and Prime Minister Boris Johnson’s botched response). It could also lead to another Scottish independence referendum—possibly resulting in the breakup of Britain. And a breakdown of the peace agreement in Northern Ireland over the border with the Republic of Ireland could spell the end of the UK. Meanwhile, the popularity of the Labour Party’s new leader, Keir Starmer, is rising.
Even if a thin FTA is agreed, potential economic growth in the UK will be lower than if there were no Brexit. In the event of a hard Brexit, both the ECB and the Bank of England might have to engage in further monetary easing to contain the short-term costs (which would be higher for the UK than for the EU). In the UK, fiscal policy will also become even looser, despite the risks, in the medium term.
By the Way…
PS: You recently retweeted a New York Times op-ed by Thomas B. Edsall, who highlights the dangers of the US election campaign’s “apocalyptic” rhetoric. Talk of post-election violence can become a self-fulfilling prophecy – the likelihood of which you consider in your latest Nouriel Today broadcast. What effect is such pre-election rhetoric likely to have on the economy and markets? Have investors become so inured to uncertainty under the Trump administration that they take the risks of a contested election in stride, or would it push them over the edge?
NR: Heightened polarization and acrimony between the Democrats, on one side, and the Republicans and the Trump administration, on the other, are already taking a toll on the economy and the markets. The lack of an agreement on a new fiscal-support package has been weakening the economy and the equity markets.
Equity markets are also starting to price in the risk of a contested election. In 2000, the contested election between Al Gore and George W. Bush led to a 7% equity-market correction. A contested election in 2020 may be much longer and uglier, pushing the market deep into bear territory. If Election Day becomes Election Week(s) or Month(s), the US may face a more severe risk-off episode, with much lower equities, lower bond yields, a weaker dollar, and higher gold prices. Now that Trump has tested positive for COVID-19, the US political, security, and electoral uncertainties are escalating. Indeed, this election cycle could well lead to total chaos and social unrest.
PS: Speaking of bleak prophesies, you earned the moniker “Dr. Doom” for warning during a decade-long boom that the global economy would soon face a reckoning. And, of course, in 2008, it did. “Dr. Sensible” may not have the same ring, but why should it? Do dramatic labels like “Dr. Doom” negatively skew investors’ expectations, and thus outcomes? Or, perhaps counterintuitively, does sensationalism cause people to dismiss the reality of the risks ahead?
NR: I always argue that I am Dr. Realist, rather than Dr. Doom. In fact, those who follow me regularly know that I have often been more optimistic than the markets were. For example, I correctly predicted that Greece wouldn’t leave the EU in 2015, when the market conventional wisdom was that Grexit was high likely to happen. And I dismissed the concerns about a Chinese hard landing in 2015 and 2016, when investors were pricing one in. I correctly predicted that China would manage a bumpy landing instead. So the Dr. Doom moniker is simply inaccurate.
No guru—however influential—can skew market outcomes either way. So I have no presumption of being more influential than I really am; I am one of the various public intellectuals who express views on economies, policies, and markets. And, in a world of massive uncertainties, no one’s crystal ball is perfectly clear.
PS: Is there something people still get wrong about the 2008 financial crisis – and need to get right in responding to the COVID-19 crisis?
NR: Monetized fiscal deficits may be the appropriate policy response when a credit crunch triggers a collapse of aggregate demand that threatens to lead to deflation. That is what happened in 2008. The COVID-19 crisis, by contrast, combines elements of negative aggregate demand and aggregate supply shocks.
In the short run, the demand shock is larger, and deflationary pressures dominate, so the usual monetary and fiscal stimulus is needed. But over time, negative supply shocks may dominate, owing to trends like deglobalization, the Sino-American decoupling, the balkanization of global supply chains, trade protectionism, the shift in investment away from China, and the broader fragmentation of the global economy.
In that context, persistent monetized fiscal deficits could, in a couple of years or so, lead to simultaneous recession and inflation. So-called stagflation occurred in the 1970s, when two negative oil-supply shocks—in 1973 and 1979—were followed by loose monetary and fiscal policies. History can repeat itself.
PS: It sometimes seems that we risk running out of letters to symbolize our economic prospects in the wake of the pandemic. V-shaped, U-shaped, W-shaped, and K-shaped recoveries have been mooted, as has an L-shaped depression. Will it be one of these, or should we pick another letter?
NR: This crisis may morph from one letter to another over time. The second quarter of 2020 looked like an I—free fall. The third quarter looked like a V, because any rebound from very low levels of activity initially does. But my baseline scenario is an anemic U-shaped recovery: given risks, uncertainty, and high debt levels, both corporations and households need to deleverage, spend less (including capital expenditures), and save more.
The U could turn into a W—a double-dip recession—if countries’ botched COVID-19 responses enables another spike in cases, if the second wave in the fall and winter is severe, if we don’t find a safe and effective vaccine until some time in 2021, and if US electoral chaos worsens. And if a wide range of old and new threats to the global economy are not addressed, an L-shaped depression by the middle of this decade cannot be ruled out.
At the same time, however, we are experiencing a persistent K-shaped recovery, characterized by a widening gap between Wall Street (representing big firms, big banks, and Big Tech) and Main Street (representing workers, households, and small businesses). The income of those with good, stable white-collar jobs and equity wealth is rising, while those with marginal blue-collar and service jobs are unemployed, under-employed, and own little financial wealth; as a result, they are falling even further behind. That is a recipe for social and political unrest.
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Recognizing that geopolitical tensions mount whenever a rising power challenges an incumbent power, Allison predicted the current escalating cold war between US and China. In 12 out of 16 historical episodes, such rivalries have led to military conflict. The question is whether the same will happen today, or the two superpowers will be able to manage their rivalry without violence. Allison reminds us that, with sound leadership on both sides, the latter scenario is possible. After all, history is not mechanically determined.
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Nouriel Roubini, Professor of Economics at New York University’s Stern School of Business, is host of NourielToday.com.
Copyright: Project Syndicate, 2020.
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