Nouriel Roubini is known for his bearish prognostications. And unfortunately, he still doesn't see any good news on the horizon. In fact, things are going to get much worse, says the famous economist and author of the new book “ MegaThreats: Ten Dangerous Trends That Imperil Our Future, And How to Survive Them.” He believes that due to a rolling series of supply shocks, some of which are still unfolding, we'll have a severe downturn before we get relief from inflation. Unlike the 1970s he says, high levels of private sector debt will make it harder to fight higher prices, and that central banks will reverse course as things start to break in financial markets. This transcript has been lightly edited for clarity.
Points of interest in the pod:
Roubini’s victory lap on inflation — 03:07
Why has inflation persisted? — 06:25
What can central banks do about stagflation? — 11:13
How will a debt crisis unfold exactly? — 15:30
The impact of a stronger dollar on debt — 19:26
What can policymakers do? — 22:56
How can investors protect themselves from stagflation? — 26:34
What will cause the Fed to pivot? — 34:35
The social consequences of stagflation — 37:43
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Tracy Alloway: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:14)
And I'm Joe Weisenthal.
Tracy: (00:16)
Joe, I'm thinking back to the spring of 2020, the depths of the Covid-19 pandemic and the big market selloff.
Joe: (00:24)
I don't like thinking back, I mean, it was a terrible time.
Tracy: (00:27)
It was a terrible time.
Joe: (00:27)
So why are you reminding us of that?
Tracy: (00:30)
Well, I remember we spoke to one particular guest in, I think it was May of 2020, and he came on and basically said that ‘we're going to see a bad economic recovery and we're going to see inflation as a result of what was happening.’ And I think at the time, both you and I were a little, a little skeptical, you know, at that particular moment everyone was talking about deflation and the possibility of a prolonged depression.
Joe: (00:56)
Yeah, you're totally right. And then also by sort of late 2020 or even summer of 2020, optimism started to grow. Like, ‘oh, we're going to come out of this with a boom,’ that we got the policy just right, that we're going to have all, you know…
Tracy: (01:11)
We avoided the mistakes of 2008…
Joe: (01:13)
Yeah, that's right. That's right. And the stock market was surging and I think there was just a lot of optimism even outside the stock market that like we were going to be on this new superior trajectory post-pandemic.
Tracy: (01:23)
Yeah. And of course now fast forward about two years and we’re talking about the pain of higher interest rates as the Federal Reserve tries to tamp down on inflation that is at its highest in, I think, four decades. People are talking about stress in the financial market, the potential for something to break as these rate increases go through. And we we're already seeing some stuff internationally start to break. So I think it's a perfect time to catch up with that original guest who did get a lot right in May of 2020 when, you know, there was a lot of uncertainty.
Joe: (01:58)
Yeah. You know something, you mentioned these fears that something is going to break. And I'm thinking, you know, our regular guest Jon Turek has written about this and others, this idea that what if you know, in the real economy employment is holding up okay, but the financial system starts to creak and that something breaks. And the financial system creating this real tension for central banks that still want to fight inflation. It's a pretty confusing time.
Tracy: (02:23)
It is. So why don't we bring in Nouriel Rubini, of course. We're going to let him do a victory lap on the show. But we also want to talk to him about the risks that he's seeing now because he has a new book out. It's coming out on October 18th. It's called “MegaThreats: Ten Dangerous Trends That Imperil Our Future, And How to Survive Them.” So hopefully the perfect person to be speaking to right now. Nouriel Rubini, thank you so much for joining us.
Nouriel: (02:51)
Great being with you. Such a pleasure to do it again,
Tracy: (02:54)
Should we let you have that victory lap? So, you know, what did you see in early 2020 that you think other people, notably perhaps certain policy makers, might have missed?
Nouriel: (03:07)
Well, at that time, the entire talk was about the risk of not just an economic contraction, but also of deflation because it was a shock to aggregate demand and a credit crunch. But I think what I saw, that other people saw as well, you know, early on -- people like Larry Summers, Mohamed El-Erian and others -- thought that the amount of the stimulus, monetary and fiscal, will be excessive. Of course, we didn't do enough on the fiscal side in 2008, but between Trump and Biden then we had about $5 trillion of fiscal stimulus. That is something like about 20% of GDP. That was excessive. And of course, the Fed went back to zero, credit easing, quantitative easing, backstopping money markets, commercial paper, high-yield, high-grade, banks, non-banks, corporates, households, you name it, everybody under the sun.
I think the difference between me and people like Larry was that they were stressing that would be inflation because of an aggregate demand shock -- too much stimulus. And I agreed on that, that half of the problem was bad policies, too loose monetary, fiscal and credit easing. But from early on I also realized that this will be a negative aggregate supply shock, the disruption that came to global supply chains, the shutdown of economic activity from services to initially manufacturing, the reduction in the labor supply. And then we ended up with a great resignation. And those initial negative supply shocks was amplified of course this year by the Russian invasion of Ukraine. This brutal invasion has led to a spike in oil and natural gas prices, food fertilizers, industrial metals. That's another negative supply shock. And the third one is the continuation of the zero tolerance policy of China towards Covid is creating further bottlenecks.
So most people were saying, ‘We're going to get inflation because of excessive overheating, because of the bad policy and excessive stimulus.’ I think my contribution to that discussion was to emphasize the aggregate supply shocks. I'm old enough and I have gray hair and I remember the two oil shocks of ‘73 and ‘79 that led not only to inflation but also to stagflation. So most people were worried about inflation and overheating and excessive growth. I started to worry about instead, not only inflation, but also recession because of the negative supply shock. So that was maybe the new twist that I gave to that debate.
Joe: (05:44)
So looking at the situation today in October 2022, we still have obviously extremely elevated inflation. Really no signs that it's turning the corner yet at all, maybe a little bit if you look at headline. Of the elevated inflation today, how much would you at this point attribute it to the persistence of these supply shocks that you identify, including the ongoing war, versus still paying the price in some way for what you characterize as excessive fiscal and monetary policy? Because I think it matters when thinking about how much the Fed is going to have to tighten to get inflation back to its target.
Nouriel: (06:25)
Well it depends on the countries. I would say the Solomonic answer is half and half. But of course in Europe, given the exposure to Russia and energy, it’s more that shock, in the US where in terms of monetary, fiscal and credit using, even worse than Europe and Europe did a lot. In the UK, in addition to that, there was another negative supply shock, self-inflicted, it was that Brexit decision. That was stagflationary, reduced the growth and increased the cost of production. Same thing in China, some of it is self-inflicted. So I would say it depends on the country, but I would say it's a combination of both of them. You had serious negative supply shocks and you had really a policy stimulus that was by any standard massively excessive across the world in all advanced economies.
Now in my book what I point out is that while in the short term there are at least three negative aggregate supply shocks, that are Covid initially, Russia/Ukraine, and now the China policy, I identify in the book where I have a chapter about the great coming speculation that there are 11 medium-term aggregate supply shocks that are negative. They're going to reduce potential growth and they're going to increase cost of production. And if then you have a loose monetary fiscal policy, because I expect that central banks are going to blink for reasons I can discuss, then we end up like the seventies with inflation and speculation and with a debt crisis as well.
So it's going to be worse than the seventies. So this is not just the short term phenomenon. People say the global supply bottle necks may end after November when Xi Jinping is going to care about growth. I think there are many other forces, there is protectionism and deglobalization. Friend-shoring, reshoring of manufacturing from China to high-cost Europe and US, aging of population, restriction of migration, decoupling between US and China. Geopolitical risk and depression that's going to fragment, decouple, balkanize and deglobalize the global economy, the impact of global climate change, the impact of cyber warfare, the impact of recurrent pandemics, the backlash against income and wealth inequalities leading to policies pro-labor workers and so on. And of course de-dollarization of the dollar when eventually people are going to get out of dollar assets because of the financial sanctions and so on.
Those are 11 forces that are medium term that have nothing to do with Covid and Russia/Ukraine. They're going to be reducing growth, increase cost of production and I think central banks will have to blink. Like the first example is what happened in the UK. If you're going to have an economic crash, you're going to have a financial crash. As you increase interest rates, you're going to wimp out. Guaranteed. The Fed did it in 2019, the BOE has done it now, the ECB is going to have to do it, the Fed is going to do it. It's going to happen for sure and therefore we're going to have an unhinging of inflation expectations. I don't believe central banks when they say we're going to fight inflation at any cost, even if there is a recession, even if there's a hard landing, first of all it's not going to be a short and shallow recession, it's going to be ugly and then you'll have financial stresses and a financial and a debt crisis.
At that point they're going to wimp out. And wimp out actually worse than the seventies. Because in the seventies we had two stagflationary shocks and with inflation recession, but debt ratios were a 100% of GDP for private and public sector advanced economies. After the GFC where had the debt crisis, mortgage, housing, bank debt, but we had deflation because it was a negative aggregate demand shock and a credit crunch. So we could ease monetary fiscal policies like we wanted. Today we have levels of debt to GDP of 350% of GDP globally, 420% in advanced economies, private and public. And we have this massive negative supply shocks. So we are not going to have only inflation, we're not going to have only stagflation. We'll have a stagflationary debt crisis, the worst of the seventies and the worst of the post-GFC period.
Tracy: (10:27)
Nouriel, I’ve got to say you're not helping with my anxiety levels right now.
Joe: (10:32)
I’m going to go, I'm moving my portfolio to cash. One second. I gotta pause it.
Nouriel: (10:36)
Well, cash is not enough because it's going to be wiped out by inflation. They have to go to assets and I can discuss, they can hedge you against inflation.
Tracy: (10:43)
All right, so this idea of a great coming stagflation, I mean stagflation already seems like the nightmare scenario for central banks if you have high prices and lower growth. But if you tack onto that a debt crisis plus stagflation, that just seems incredibly difficult for any central bank to navigate. What is the appropriate policy response, especially if inflation is being driven by supply side bottlenecks as you described?
Nouriel: (11:13)
Well some people say if inflation is driven by negative supply shocks, we shouldn't tighten too much because central bank can affect aggregate demand, not aggregate supply. But the reality is that like in the seventies, if you don't fight inflation, you have a de-anchoring of inflation expectation. You have a wage price spiral and then you end up in a nightmare. So unfortunately, even if it’s a negative supply shock as opposed to aggregate demand, you have to tighten monetary policy to make sure that you don't have an unhinging of inflation expectation. Otherwise you make the same mistake that was done in the seventies when they replied to these two negative supply shop with loose monetary policy and loose fiscal policy. So the right response would be to fight this. But in the seventies we had the nasty recession, ‘74, ‘75 and a double dip recession in ’80 and ’82, when Volker came to power and he caused a double dip recession to finally break the back of inflation expectations.
And we're at the beginning of the American carnage because a lot of the industry went bust for good. But in the seventies we did not have a debt crisis in US or advanced economies. We had a debt crisis, of course, in Latin America because they borrowed like crazy in the seventies. And when the Fed went to 20% interest rates, of course Brazil, Argentina, Mexico, they all defaulted and went bankrupt. So we have the saturation but not the debt crisis. Today the problem we're facing is that if you fight inflation, not only are you going to have a recession and the idea you’re going to have a short and shallow recession – plain vanilla, garden variety -- is totally delusional. I mean it's totally delusional because we have amounts of debts like we've never seen before in previous recessions. Like Covid, GFC, we could do monetary fiscal easing because you have deflation. Now we have to tighten monetary fiscal policy into recession.
Inflation is global and everybody's tightening and therefore, as I pointed out, we get the worst of the seventies and the worst of the GFC. It's going to be long, ugly, protracted with financial stresses, financial instability and debt crises. That's what we're facing right now. So what would the optimal response be? Try to avoid an unhinging of inflation expectations. But you have two problems if you do the right thing. One, you have a recession that gets nasty. Second you have a financial and debt crisis like you've not seen before. And that's going to lead central banks to wimp out because between causing an economic crash that is severe and a financial crash, or blinking and wimping out and monetizing those deficits and wiping out the real value of nominal debt, long duration. The path of least resistance politically is going to be to monetize it, right?
And therefore to cause inflation and stagflation like the seventies. And the first example is exactly the BOE. Faced with a financial shock, what did they do? They totally wimped out and they go back to MMT. So that's going to happen across the board. So I don't believe central banks when they say we're going to fight inflation at any cost because they have a delusion of either a soft landing or a hard landing that is short and shallow, two quarters of negative growth and then you return to growth and easing. That's not going to happen. It's going to get ugly, the recession, and you'll have a financial crisis. So how can they do it? They're not going to do it.
Joe: (14:56)
Talk a little bit more about hiking rates and fighting inflation in a period of high levels of private sector debt. And I could see it going both ways because on the one hand I could imagine that in a heavily indebted economy, interest rate increases have a quick transmission mechanism and that that significantly impedes private sector activity and helps you fight inflation sooner. Or I could see it the other way that high levels of private sector debt create an oversensitivity, maybe the debt crisis scenario that you're talking about. Walk through specifically how it unfolds -- the intersection in the US of higher rates and high levels of indebtedness.
Nouriel: (15:40)
In short it becomes very ugly. And it becomes very ugly because the indebtedness of the private sector in the US was very high and rising even after the GFC because we had zero rates, QE, credit easing and so on. And then we doubled down on it during the Covid crisis. And of course during the GFC, it was household debt and banks. But then the build-up in the next decade was of corporate debt and of shadow banks, leveraged loans, CLOs, high-yield, high-grade, fallen angels, or you name it. And while the debt of the household sector is now reduced, there are significant pockets of the household sector, those who have low income and low wealth and have been borrowing, they're going to be under stress, especially as they get unemployed.
So the biggest stress is going to be corporates and shadow banks. But eventually the official banks are linked to the shadow banks and the household sector is going to also get in trouble. Those who have low income, they don't have much wealth, they have a lot of debt and their income is fragile to a recession. So we'll have a debt crisis. So what's happening in this situation is that if you don't fight inflation, if you fight inflation, first of all you have to jack up interest rates to the point in which there is a debt crisis, a recession. And then interest rates are so high that the zombie households, corporates, banks, shadow banks, governments, countries that are insolvent, are going to go bankrupt. And they were bailed out twice during the GFC and during Covid. We had high debt ratios, but we had low debt servicing ratio because of zero rates on the short end, on the long end and all the other policies of easing.
Now instead, into a recession we have to raise rates because there is inflation. So those who were swimming naked as the tide recedes, you’ll see who they were. Those who were the emperor without clothes, you’ll see who they were. And the zombies, you’re going to recognize that zombies are going to default. We're not going to be able to bail them out this time around. We'll have to raise rates and they're going to go bankrupt across the board. And I'm not saying everything and everybody in every country, but the amounts of debt – private, public, across advanced economies and emerging markets -- implies a severe debt crisis. Now interest rates for the public sector are going to rise. And in the UK with stupid fiscal policy, those spreads widened in significant terms. But then the private sector is spread over a riskless rate, right? You have spreads over Treasury, mortgages, high-yield, high-grade consumer loan and so on.
So if you are an insolvent agent, it's not going to be just increasing long-term interest on Treasury, it's going to increase your cost of servicing your debt. But the spread widening on your own private debt is going to cause another reason for default. And already high-yield right now has gone from 300 to over 600 [basis points]. The entire CLO and leveraged loan market right now is shut down. Literally shut down. And this is only the beginning of it, of that stress on the private sector. So we're going to see significant financial distress in the corporate sector, in the shadow banks, in parts of the household sector.
Tracy: (18:57)
So I mean, you just laid out basically the stuff that you think could break first as interest rates rise, where do you see other pockets of weakness? And I'm thinking specifically about some of the international developments, the impact of the stronger dollar. We've seen that weigh already on a number of emerging markets who have taken out dollar-denominated debt that's getting a lot more expensive as rates go up and the dollar strengthens at the same time. Talk to us about the sort of international repercussions here.
Nouriel: (19:26)
Well the international repercussions for emerging market is that many, not all of them, of these emerging markets are in deep, deep trouble. I don't want to lump them together. There are better credits, worse credits, better sovereigns, worse sovereigns. So you have about 40 countries, but I would say a good two-thirds of them are in trouble and they’re in trouble for several reasons. One, interest are rising in the US, in advanced economies. So their interest rates and their spreads are rising even more. Two, their currencies are weakening as the dollar is strengthening. And unless you are a commodity exporter, mostly the guys in the Gulf who are making a fortune, everybody else among emerging markets tend to be with few exceptions a commodity importer, especially in Asia but also in other parts of the world. And therefore you have also a terms of trade shock. So it's a quadruple whammy.
You have first of all the raise of interest rates in advanced economies pushing your interest rates higher. You have the weakening of your currency and you have a lot of dollar debt and the real value goes higher. You have a negative terms of trade shock and the slow down of growth in the recession. US, in Europe, in UK, in China, effectively the recession weakens your export markets, your own economic growth. So it's the perfect storm for the weakest emerging markets. And I would say a good two third of these emerging markets right now have these types of economic and financial fragility.
Now, if we're going to have a recession in the US, it's going to be even worse in Europe in my view, for several reasons. Reason number one, Europe is more exposed, to the Russian energy shock and it's going to get worse this war. And there'll be a total cutoff in natural gas. Secondly, the dollar is strong and that reduces inflation. The euro’s weak, that increases inflation. Inflation is already double digit in the eurozone, let alone in the UK. Three, Europe is exposed to exports to China and China is slowing down very, very, very sharply. And four, within the eurozone you have this fragmentation risk, of the risk of a widening of spreads of the periphery. They have this new tool, TPI. But if the new Italian government follows policies that are on a collision course with Europe, they're not going to qualify for the bailout that the ECB is going to make for those that have unwarranted widening of their spreads as opposed to those that are warranted by poor economic and fiscal policy.
So things are going to be even worse in Europe than they are in the US. And the basket case of course is the UK right now, that is pricing literally like in an emerging market, usually you do fiscal stimulus in the US, the dollar gets stronger, interest rates rise only a little. In the UK, the pound is collapsing and the interest rates are through the roof even with the support of the BOE. So it's really becoming an emerging market.
Joe: (22:22)
Is there, you know, the way you describe things so much is already baked in particularly with these trends that are in place with deglobalization and these shocks that we've seen to all supply chains and then the accumulated debts that we've seen, public and private. At this point, are there better policy paths than what you expect leaders, policy makers to take? I mean what is the wiggle room or what would you advise policymakers in, say, the US and Europe to do?
Nouriel: (22:56)
Well, you know, there's always a difference between normative statements about how the world should be, as opposed to positive statements about what is the world is going to be and likely to be, right? So I'm making for now a positive statement about the fact that we're going to have a nasty recession, nasty stagflation and another severe financial crisis. I think that's the baseline. And I think that the policy trade-off like during the GFC is too late right now, because if you fight inflation, you’ll have a recession and a financial crisis. And if you don't fight inflation, you're going to have a deanchoring of inflation and you get inflation and stagflation and still a financial crisis because you can wipe out with unexpected inflation the real value of nominal long duration debt at fixed interest rates.
But you can fool all of the people some of the time. You can fool some of the people all of the time. You cannot fool all of the people all of the time. And if we use the inflation tax to wipe out private and public debt, that is nominal long duration at fixed interest rates, that's going to come to maturity and then it's going to reprice either at very high interest rates if you borrow long-term, or if you borrow short-term, it's going to price in the inflation. So you can for a couple of years resolve a debt problem -- private and public -- with unexpected inflation. But then you're going to cause a bigger debt crisis because once prices reprice for inflation and the spreads, real spreads and nominal spread and the inflation volatility leads you to higher nominal interest rates, then you have a bigger debt problem down the line. So I fear that right now we have three problems, a problem of inflation, a problem of growth and a problem of financial stability with too much debt and collapsing asset bubbles and you cannot resolve them.
I could tell you what I would do in principle, but whatever you do is not going to avoid a crisis at this point. The margin for action is very, very limited. I would tell you if I were you, I would avoid the seventies, avoid inflation by going real hard on fighting inflation and avoiding a de-anchoring of inflation expectation. But that's going to lead to a nasty recession and a financial crisis like we didn't have in the seventies because we didn't have a debt problem and the recession in that seventies was a decade-long stagnation. This time it’s going to be worse because of the financials and the debt problem. So unfortunately at this point, damned if you do, damned if you don't. There is no easy way out.
Tracy: (25:50)
So let me ask you basically the same question but from a different perspective. What should investors do here? And this is something I've been thinking about recently and one of our recent guests, Toby Nangle came on the show. He was talking about the moves in the gilt market, basically saying you can't unburn toast. So once you have this extreme volatility, once interest rates start to reset higher, you can't undo that and all of that historic volatility, that anxiety for investors, it weighs on them for years to come and you potentially get a re-pricing of risk in general, capital becomes more expensive. Asset prices start to deteriorate as you just mentioned. So what can investors do here?
Nouriel: (26:34)
Well, usually investors have some variant of a 60/40 format for their portfolio. 60 equity, 40 fixed income, long duration Treasuries or 70/30 or even risk parity a la Bridgewater is a variant of this theme. But usually the price of bonds, that price of equities are negative correlated in normal times. Risk on, equity does well, bonds don’t do well. Risk off, bonds do well, equity doesn’t do well. Growth, equity does well. Bond yields go up, price falls. Recession, bond yields fall, price goes up, price of equity falls. So you're not really hedged and a 60/40 or 70/30 portfolio has given you for the last few decades positive returns normally. More so in good times, less so in back times but always. This year for the first time in 30 years you have lost money on your equity side and on your fixed income because 60/40 is based on low inflation.
But when inflation is rising, two things happen. Long-term interest rates go higher, that hurts equity because the discount factor for equity becomes higher. And we're seeing the correction of equity and growth stocks and tech stocks that are long duration hurt even more, because they're long duration assets and more sensitive to interest rates. But you lost 25% on the S&P. But this year, you have lost 25% on long duration Treasuries because 10-year Treasuries have gone up from one and a half to three and a half, four [percent] and that increase in interest rates is a 25% fall in their price. So you lost money on equity and you lost money even on the safe asset. There was nowhere to hide and if you went into cash you lost because of inflation. So that's the problem. When you have rising inflation that 60/40 doesn't work. What's the solution? It’s not cash that's been giving you zero nominal return wiped out by 10% inflation.
You have to go into assets that are a hedge against inflation. One of them is TIPs, they reprice when inflation is higher. The second one is very short duration Treasuries. Becaise as interest rates go higher, the price of them falls much less than the one of a 10-year or 30-year Treasury. As interests are higher, you get higher return even in expected inflation. That's one.
Secondly, you might want to go into gold. Gold has not done very well in the last year, but once inflation expectations become unhinged when the central banks are going to blink, and until now central banks have played tough. That's why gold has done poorly, because the real rates were going higher. Then gold is going to outperform like other precious metals, like probably many commodities. But the commodities are going to be hurt by the recession. So gold is actually less cyclical.
Three, in the seventies, both equities and real estate did poorly but equity did much worse than real estate. The PE ratio of S&P was down to eight in 1982. Because real estate is in fixed supply, you can often reprice the rents and it's a good hedge against inflation as long as monetary policy is not very tight. Of course the Reits this year have done poorly because the Fed was hiking. But again, when the Fed's going to wimp out, I think that real estate is going to outperform equities because of the nature of being a fixed supply kind of asset that, that is in the short run. The only caveat is that a lot of real estate is going to be stranded because of global climate change. Literally there are maps that show that half of the US in the next 20 years are going to be either underwater on the coastlines or too hot or droughts or wildfires, to be living in it.
And people have stupidly moved from New York to Miami and from San Francisco to Austin. But Florida's going to be flooded and Texas is going to be too hot to survive there. So there'll have to be a massive migration from south and the coastline towards the only part of the US that is going to survive climate change. It's the Midwest into essentially Canada. So there'll be trillions of dollars of real estate assets that are going to be damaged by essentially global climate change. So if you have to worry about that, you have to find the types of investment in the right parts of the United States. So I would say a combination of short-term Treasuries, of TIPs and other inflation index bonds, gold and the right type of real estate is going to be the future. And I'm actually working on a financial product that is exactly creating first an index and then an ETF along the lines of hedging the risk of inflation and debasement of fiat currency by having a combination, dynamically optimized ,of these assets. That's something I'm going to be launching in the next month or so.
Tracy: (31:19)
Yeah, I remember talking to you about it earlier in the year, this idea of a sort of tokenized dollar that's more tied to hard assets. You know, this is also something we've discussed many times on the podcast at this point. The idea of the dollar losing its reserve currency status. And one of the things about that is people have been talking about it for a long time and it hasn't yet happened. What in your opinion makes this time different?
Nouriel: (31:47)
Several things. Of course it's not going to happen overnight. The decline of reserve currency status takes many years. But there are at least two factors. One is that the US has very large current account of fiscal deficits. There are fiscal deficits in other advanced economies, but they tend to run current accounts surpluses or a balance while we have a twin deficits. And historically every time they had twin deficits and the dollar was too strong, you have a cycle of dollar going up and then has to go down in order to restore the external competitiveness. And the fall of the dollar can be 30 to 40% on a weighted basis. So that's going to be something that is going to happen, especially as the Fed is going to wimp out while other central banks will have to start to tighten.
Secondly, I think that the big revolution right now is that a regime change, is that we have weaponized the US dollar for national security and foreign policy purposes and that might be the right thing to do. We have to punish our enemies. Whether it’s Russia, North Korea, Iran, or even China with trade and financial sanctions, because there is a geopolitical rivalry, it's going to get worse. But they know right now, even the Chinese, that their dollars can be seized like they were seized in North Korea, in Iran, and now in Russia. And not just the dollar, also the yen, the euro, the pound, the Swiss dranc. So if you need another reserve currency, that is a reserve currency or asset. It’s not dollar euro, yen, pound and Swiss franc. Which one is the only one out there that is going to be an alternative that cannot be seized by the US or Europe or Japan?
Joe: (33:25)
Bitcoin.
Nouriel: (33:27)
It’s gold.
Joe: (33:28)
Oh.
Nouriel: (33:28)
It's gold, but gold not in the vault in New York, New York Fed or London, but gold in your own vault or caves in Russia or China, wherever you have it. So I think that that's going to be what's going to lead to a sharp fall of the value of the dollar, the strategic [inaudible] of the US have a plan to completely phase out their exposure to dollar assets. And that's going to be a regime change for the long run as opposed to doing a short-term factor. It's going to happen.
Joe: (33:54)
I really thought we might hear Nouriel make the case for Bitcoin there, but I have basically just one last question…
Nouriel: (34:01)
Bitcoin is another sh*tcoin. There's no fundamental value.
Joe: (34:04)
We'll break that out to a separate story.
Nouriel: (34:07)
It’s going to be gold, there's going to be TIPs. It's not going to be Bitcoin, frankly.
Joe: (34:10)
Last question from me. You know, investors are very big on this idea of like, ‘oh, when is the Fed going to pivot?’ And the way you see it is not pivot per se, but essentially crying uncle, wimping out. So what is that point? What will the Fed see, either in real economic activity or financial market conditions, that would be the catalyst for the Fed and maybe other central bankers to ‘wimp out,’ in your words?
Nouriel: (34:35)
Well, the Bank of England already wimped out. And if you remember what happened in ’18, ‘19, in December of ‘18, the Fed went from 225 to 250, then they said, ‘we're going to go to 3%, we're going to continue QT.’ What happened during that quarter? Stock market collapsed by 20%. High-yield spreads go from 300 to 900 and the entire CLO leveraged loan market shuts down. Two weeks later, January 2nd, 2019, Jay Powell comes up and says, ‘I was kidding when we said we're going to go to 3%. I was kidding when I said we're going to continue QT, we're going to stop raising rates, we're going to stop QT.’ And two months later, because there was a slowdown of growth, given the tension between the US and China on trade and because there were some problems in the repo market, what do they do? They cut rates from two and a half to 175 and they resume QE through the back door, through the reserve repo operation.
This was for a mild, mild financial shock and a growth slowdown. That's what they did. They totally wimped out. They totally blinked. Even the Fed. Later on the BOE. So when are they going to do it again? When the recession's going to start and it's going to get ugly and it's part of the recession. Inflation is not going to fall fast enough, because you have the negative supply shock. Remember when you have negative supply shock, you get the recession and high inflation, therefore we're not going to get a fall in inflation that’s rapid enough to go to 2%. And we're already in financial stress right now. Stock market down 25%, S&P, Nasdaq more than 30%. Meme stock collapse, stock collapse, crypto collapse, private equity collapse, housing is collapsing. CLO market is shut down, leveraged loan market is shutdown, high-yield spreads are already at 600+. Even high-grade is at interest rates like you’ve never seen in years. And this is just the beginning of that pain. Wait until it's a real pain. And then you have even a major financial institution that may crack globally, not in the US maybe now, but certainly internationally. There are couple of firms that are huge and systemic. They can go under. You might have another Lehman effect, then the Fed will have to wimp out. You'll have a severe recession and you'll have a financial market shock. They're going to wimp out for sure.
Tracy: (36:53)
So just to add to my anxiety levels, which are already through the roof, I want to talk about the social consequences of this because it seems like an environment where inflation is high, growth is slowing, you know, the Fed is explicitly trying to boost unemployment. It seems like that is probably the worst environment for, you know, your average person on the street. And it almost seems like the Fed's goals here, they're almost anti-American at this point, or like anti the American dream, right? Make housing more expensive, crushing demand, crushing the labor force. What are going to be the social consequences of central banks having to do this in order to put a cap on price increases?
Nouriel: (37:43)
They’re going to be severe. You know, we're already seeing of course a backlash against free markets backlash against trade and globalization. Even a backlash against technology, a backlash against, you know, let’s say fair policies because they are doing a massive, massive increase in income and wealth inequality. It’s leading to populism of the extreme right and of the extreme left in many countries across the world. And authoritarian regimes are becoming more popular across the board. It’s a repeat of the 1930s, literally. It's scary what's happening. And then if on the top of it, to fight inflation now we’re going to have a severe recession and unemployment going to 6%, 7%, 8% or more, and then your assets are collapsing, the value of your home, the value of your stocks and your debt service [cost] is going to go to a roof, there'll be a revolution. That's why the Fed cannot but monetize it because we're already having huge amounts of social tension.
There is already massive political polarization. There are already so many people who are angry, whether they're voting for the right or the left, it doesn't matter. There are those who are left behind, those who have been screwed by globalization and the current sets of policies, those who don't have jobs and skills and income and well, you have, you know, 100,000 deaths of despair every year in the US from opioids and other drug overdoses. You have 2 million people that are addicted to opioids. This is a massacre. Literally a massacre. People are helpless, hopeless, jobless, skilless, worthless, and they're desperate. That's leading to that resentment. And people either voting for on one side, Trump or right-wing conspiracy types, or for very extreme leftist policies, depending on whether you are socially and religiously conservative as opposed to liberal.
But economic policies are the same, nativist, nationalist, against trade, against migration, against free markets and so on. So it's going to get more ugly. It's going to get more ugly because we're already at the breaking point. We could have, literally in the US as we know, entire books written recently about the risk of civil war, violence, insurrection, succession. This is what is the risk that US is facing, let alone other countries. Not maybe in these elections, but in 2024. So we're already in a real time bomb in terms of social and political pressures and an economic crisis and a financial crisis and a geopolitical crisis that is going to make these things much worse. Much worse.
Tracy: (40:11)
All right, Nouriel. I think that's -- I can't say it's a good place to leave it, but it is definitely a place to leave it. We really appreciate you coming back on Odd Lots. As I mentioned before, your insights, you know, broadly proved to turn out correct the last time we had you on the show. The book, “Mega Threats: 10 Dangerous Trends That Imperil Our Future and How to Survive Them,” is out on October 18th. Thanks so much Nouriel!
Nouriel: (40:35)
Thanks for having me. Great pleasure again. Thank you.
Tracy: (40:52)
So Joe, I think I need therapy after that conversation. And you know, last time we spoke to Nouriel, we had a lot of commentators who were like shocked that we were so shocked by what he was saying, but I'm trying to use humor to diffuse the situation.
Joe: (41:07)
He sounds bearish.
Tracy: (41:07)
You think? Just a little bit?
Joe: (41:10)
He doesn't make me want to buy the dip.
Tracy: (41:14)
No, but I do think, you know, this is what we've been talking about for a long time. The economic mix this time does seem different. At minimum, inflation is a constraint on the central bank, and it's going to be much more difficult for them to come in and stabilize financial markets, stimulate the economy if they need to, if they're having to deal with that price constraint.
Joe: (41:39)
You know, something I keep thinking about how much this environment is sort of the mirror image of, the great financial crisis. You know, in coming out of the GFC, we had terrible growth, this big collapse and deflation.
Tracy: (41:50)
Everyone was worried about ‘we can't hit the 2% target.’
Joe: (41:53)
Yeah, and years, basically a decade of moderate growth in the economy, right? And this time the crisis coincided with a stock market surge and a growth surge. So maybe the mirror image is the long ugly slog for current crises. I don't know. Seems possible.
Tracy: (42:09)
Something to look forward to.
Joe: (42:10)
Something to look forward to. Many episodes to come.
Tracy: (42:13)
Right. Shall we leave it there?
Joe: (42:15)
Let's leave it there.
You can follow Nouriel Roubini on Twitter at @Nouriel.