Moderated by Adrian DEARNELL, Chairman, EuroBusiness Media                               

Should the years 2018 and 2019 be seen as a period of transition or of potential crisis? The risk of inflation is probably not resurfacing, but questions about US growth are rising. The recalibration of monetary policies is proceeding smoothly, but the divergence between the Fed and ECB/BoJ in particular, or the lack of room for manoeuvre could become a major issue. Should we fear a new financial crisis from excesses of private debt in China, excessively low bond market rates, excessive valuations, or from a simple global repricing of risk premia?

The first question from the moderator was whether the world faces another recession. The answer from the panelists was a clear “no”. Kenneth Rogoff put the chances at 15%, Nouriel Roubini said only if the Federal Reserve gets left behind and financial vulnerability rises, and Philippe Ithurbide said only if there is a major trade war.

WHERE DO RECESSIONS USUALLY COME FROM?

The US and Japan are experiencing a very long economic cycle, and some observers believe that we are entering a period a stable growth, or even the end of market cycles. Is this end of recessions? Certainly not. History recalls that past recessions were usually triggered by three factors:
• Inflation and higher interest rates. At present full unemployment has not meant higher wages and the credibility of central banks is at stake. 
• Excessive debt. The deleveraging of banks, households and corporates is done, but public deleveraging and corporate debt in China pose threats. 
• Bubbles bursting with contagion to the real sphere. 
 

NO LOOMING RECESSION BUT SOME UNCERTAINTIES

Mr. Rogoff pointed out that a credit built up is a good predictor, but the Fed is tightening the cycle gently. However, recessions are inevitable, it is just a question of when and where. Mr. Roubini added that debt ratios are higher but are sustainable, since debt service ratios are very low. This is ending, so the question is how much debt can be sustained. Asset prices are high and inflation or trade shocks could come, and this at a time when the world has fewer fiscal and monetary weapons at its disposal.

Mr. Ithurbide reminded the audience that after the crisis forward guidance and quantitative easing helped, but that central banks can change their strategy if they have to fight inflation. Growth synchronization is growing but is not complete. Mr. Roubini added that the growth scenario is distorted by “artificial expanders” such as the fiscal stimuli in the US and China.

Mr. Rogoff emphasized that it is not what central banks do but what they need to do to maintain a global clearing interest rate. No one knows why it went down so far – in the US to only one percent. There will be some reversion to the mean, which could become dangerous. Mr. Roubini agreed, adding that the Fed has already raised rates four times, and that if inflation goes up in the US and elsewhere there could be further increases. Moreover there are dangers in countries such as Argentina and Turkey, which do not pose systemic risks, but also Italy, which does. Mr. Rogoff warned that Fed rate rises have a huge effect since the global economy remains very dollarized. However, the real worry is what Donald Trump will do if the November elections look bad. Will he try to force the Fed to lower rates?

Meanwhile Mr. Roubini stated that the key risk is a trade war. A NAFTA deal could be off the table, and the EU could retaliate strongly. China has already been categorized by the US as a strategic rival in national policy papers. There is some chance of “a mini perfect storm affecting markets”.

« I agree that a trade war is a wild card – although I don’t think it’s just the trade war. I worry what is going to happen if there is an election and Donald Trump is not doing well. »

Kenneth Rogoff

 

 » I agree that a trade war is a wild card – although I don’t think it’s just the trade war. I worry what is going to happen if there is an election and Donald Trump is not doing well. »

Kenneth Rogoff

 

GDP GROWTH – RESYNCHRONISATION OR NOT?

Do we see a real resynchronisation of growth? Yes and no. Growth is up everywhere and many countries are closing their output gaps, two factors which speak for resynchronisation. However, growth is peaking globally while positioning in the cycle is very different, with Europe, Brazil and Russia for example, lagging behind. This explains different monetary policy and inflation expectations. As a consequence there is market divergence, such as between US and European spreads and asset valuations, which represent investment opportunities. So perhaps it is better to look at the current period from a different perspective and not necessarily focus on resynchronisation.

A POSSIBLE BOND BUBBLE AND RISING DEBT ARE CONCERNS

Asked if he thinks there may be a bond bubble, Mr. Rogoff stated that for the first time in decades the odds of deflationary scenarios are as great as inflationary scenarios. The long-term expected inflation in bond prices is not far from 2%, which is unusual since the target is 2%. Since he assumes the game plan in the US would be to inflate if current fiscal measures lead to a debt problem, they must think there is deflation going forward.

Mr. Ithurbide said that it is no surprise that bond yields are so low; the question is how long it will take to fill the gap. The ECB is betting that unemployment is far below social employment, so they think they have time before tightening, and they are convinced that by keeping rates very low, inflation will surface sooner or later. If they are wrong, it means that rates will remain low for a very long time. This is leading to excess leveraging, which is healthy in the beginning of the cycle but not at the end.

Mr. Roubini added that with the absolute level of debt higher today than ten years ago, the question is only when and where the next recession will occur, not whether. The policy response to the global financial crisis of back-stopping with monetary and fiscal easing was right, but by doing so debt ratios became higher while debt servicing ratios were kept low. This created artificially high asset prices. Mr. Ithurbide added that the longer the period of stability, the deeper the financial crisis due to more speculative financing. This is what we call the paradox of tranquility. Are we living in such an environment at present, he wondered? Probably yes.

Mr. Rogoff interjected that the underlying trend of rising productivity could push up real interest rates, which would be good for a lot of countries. He does not believe in the secular stagnation view. “In the long run technology is going to lead to much higher productivity growth.” Mr. Ithurbide agreed, pointing out that we cannot measure productivity gains properly because the phases that follow a recession always lead to a phase of “creative destruction”, partially obscuring the positive effects, which will only surface later.

Mr. Roubini cautioned that a lot of technological innovations are capital-intensive, skills-biased, and labour-saving. If you deal in financial capital or have modern skills you are going to do well, but if you are a blue-collar worker, or increasingly a white-collar worker with low-value added, your job is threatened. Mr. Ithurbide added that in asset management, for example, 30-40% of the jobs can be totally or highly automated.

This uncertain rise in productivity presents a problem for central banks, he continued, since none of the traditional measuring models work anymore. This is why central banks, and especially he ECB are almost playing two bets. The first is that the unemployment rate in the Eurozone is significantly higher than the structural unemployment rate. If not, the Eurozone’s key rate would have to be close to the neutral interest rate (2 % – 2 ½%) and not be zero. And second, that expansionary monetary policy has a positive effect on wage growth, unit wage costs, and thus on underlying inflation in the Eurozone. If this is not the case, the ECB is condemned to maintain zero interest rates with no time limit if it wants to restore inflation. There are consequences: higher rates and higher bond yields in the US, and low rates and low bond yields in the Eurozone.

“Maybe the ECB will be right, maybe it will be wrong, but the consequences will be enormous. Same for the Fed: maybe the Fed is massively behind the curve today,” cautioned Mr. Ithurbide. Mr. Rogoff added that raising productivity will require massive investment, which is going to push the real interest rate up. Central banks may be chasing to follow. Some say this is the reason for having low rates.

« So, the major problem is going to be that technology increases productivity, but the distribution of the gains will be unequal and there will be a problem with labour that is going to be part of the backlash. »

Nouriel Roubini

 

« Money supply is supposed to be an indicator for long-term inflation, but today I think we are lost about the determinants of long-term inflation. This is one of the problems. »

Philippe Ithurbide

« So, the major problem is going to be that technology increases productivity, but the distribution of the gains will be unequal and there will be a problem with labour that is going to be part of the backlash. »

Nouriel Roubini

 

THE PARADOX OF CREDIBILITY

Long-term low and stable inflation tends to favour excessive risk-taking (leveraging), especially if the central bank is credible. Indeed, when agents are assured of the central bank’s commitment to ensure price stability, their inflation expectations are more firmly anchored around its target, so the rise in credit and asset prices will not necessarily translate into higher inflation. This is positive to some extent.

However, the maintenance of price stability does not encourage the central bank to tighten its monetary policy, so that the latter ultimately allows excessive financial imbalances to accumulate. This is what we call the « paradox of credibility ».

LONG-TERM GROWTH – UNCERTAINTY AT THE HIGHEST

Uncertainty about long-term growth and long-term inflation is currently high in OECD countries, which greatly disrupts the valuation of financial assets. This uncertainty has different origins: 
• Uncertainty about current growth (end-of-cycle or new expansion?). 
• Uncertainty over the magnitude of the link between new technologies and productivity, which partially determines potential growth. 
• Uncertainty about the precise link between inequality and growth. 
• Uncertainty about the global reorganization of production, with the « desegmentation » of value chains. 
• Uncertainty about inflation, and particularly the long-term determinants of inflation. 

« Money supply is supposed to be an indicator for long-term inflation, but today I think we are lost about the determinants of long-term inflation. This is one of the problems. »

Philippe Ithurbide

WHAT WILL THE NEXT REGIME BE – RISING INTEREST RATES AND VOLATILITY?

Concerning what the next regime might be that governs the world economy, Mr. Ithurbide said it was hard to tell. However, it is clear that the various regimes over the last twenty years – global savings or liquidity gluts, the bond yield conundrum, the great moderation, and secular stagnation fears all favoured low rates, low yields, and low volatility, except in times of crisis. Maybe the next regime will not be the same. The immediate next one will be a period when interest rates rise gently, without major damage, but volatility will also probably rise. The regime after that will probably feature a combination of higher rates, higher yields  and higher volatility. “We hope it will not lead to a debt crisis, because the debt hangover is not over”, he warned.

Mr. Rogoff was also unsure about the next regime. “What is going to happen in the next year is probably what has happened in the last year, although a possible trade war is a wild card.” Before the financial crisis we went through the Great Moderation. Looking at data such as volatility measures we are back to that. “We ought to be a little nervous about it, because we can have these regime shifts, where it leads to excessive debt and suddenly when something changes, we are not prepared,” he added.

Mr. Roubini argued that the period of unconventional monetary policy, forward guidance, and quantitative easing is ending, and we are entering a period of policy normalisation. If there is a return of the business cycle, there will be some pick-up in inflation, and that will lead to further tightening. Additionally, the political and geopolitical risks are having a slow but steady effect on the market.

At the end of the roundtable the panellists responded to audience questions. On the effect of blockchains on the power of central banks, Mr. Rogoff said governments will regulate this as they did when checks, credit cards, andmobile payments were invented. Blockchains have many good uses, but bitcoins will not replace dollars. Central Banks will retain their control over price-setting.

Responding on whether increasing job losses make a case for basic guaranteed incomes, Mr. Roubini said the first solution should be education and re-training. The second is to accept that people cannot have the same job forever, and to provide them with a social safety net of unemployment insurance, portable healthcare, training, and pensions. If all else fails, those who are winners will have to help those who are losers through redistribution via taxes or a universal basic income. The only problem with that is that most people believe in the dignity of work. They don’t want to just have a welfare check.

Mr. Rogoff agreed on the need for a universal basic income, saying that economist James Tobin proposed it decades ago and George McGovern made it part of his presidential campaign platform in 1972. In addition, governments need to break up technology monopolies. In the US monopoly law is not enforced. For example, the Supreme Court just made a dangerous ruling in favour of American Express, cementing their monopoly. And no one says anything when the tech giants buy up the competition. “You need to enforce antimonopoly to have competition, which parenthetically would help with productivity,” he concluded.

« We are in a more fragmented world in which the major powers don’t agree on many things. »

Nouriel Roubini

 

« We are in a more fragmented world in which the major powers don’t agree on many things. »

Nouriel Roubini

 

REGIME SHIFT: A HISTORICAL PERSPECTIVE

We had different regimes in the past. In the 70s there was stagflation (economic stagnation with inflation) and then slumpflation (economic recession with inflation). Since the 80s, there have been different regimes or specific situations, such as the Great Moderation (low volatility of macro aggregates such as GDP and inflation, bond yield conundrum (too low bond yields), global savings glut (excess savings), global liquidity glut (excess liquidity), secular stagnation (fears of long-term low growth), or even secular deflation (fears of sustainable deflation). However, different regimes do not necessarily mean different market conditions. In fact, all the regimes have had similar impacts since the 80s: low interest rates, low bond yields, low credit spreads, and low global volatility globally. However, crises leave legacies of low growth and higher debt; for example the global financial crisis of 2008 was a cause of the Eurozone debt crisis of 2011-2012.

CRYPTOCURRENCIES – THE VIEW FROM CENTRAL BANKS

Central banks are becoming interested in cryptocurrencies, and their views are not always favourable. 
• Randal Quarles, Vice Chairman of the Fed’s Supervisory Committee, considers that cryptocurrencies are likely to become an issue for monetary policy. 
 • ECB Vice-President Vitor Constancio refers to a “tulipmania” bubble, and Benoît Coeuré warns about the instability of their price and the links with tax evasion and organized crime. Mr Draghi considers that the impact of cryptocurrencies remains limited and safe so far. 
 • The Reserve Bank of India and the Bank of Korea are hostile to bitcoin, considering that cryptocurrencies may be used for money laundering and terrorism financing. 
 • Elvira Nabiullina, governor of Russia’s central bank, is fiercely opposed to any private currency, whether physical or virtual. According to Sergey Shvetsov, a deputy governor, the central bank even planned to block web sites that provide access to bitcoin exchanges. 
 • The People’s Bank of China has taken control of cryptocurrencies and banned trading. 
 • The Bank of Japan is still in the study phase. 
 • Mark Carney, governor of the Bank of England, speaks of a real revolution but does not think that the BoE will issue a digital version of sterling anytime soon. 
• The Bank of Canada considers cryptocurrencies as financial assets and not as real currencies.
• The Dutch central bank has created its own cryptocurrency (the DNBcoin) to better understand how it works and recognizes the value of the blockchain for settlement of financial transactions, including complex transactions.
• The Central Bank of Sweden and the Central Bank of Norway do not seem hostile to the introduction of digital currencies (e-krona). 
• The Bank of International Settlements recognizes the success of cryptocurrencies, but also raised the risk of bank runs.