Roubini: War in Ukraine Could Tip Europe Back into Recession; China is a Big Tail Risk

By: Bloomberg | Mon, Apr 28, 2014
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In an interview with Bloomberg's Erik Schatzker and Stephanie Ruhle at the Milken Institute conference in Los Angeles, California, Nouriel "Dr. Doom" Roubini said, war in Ukraine could tip 'fragile' and 'uneven' Europe back into a recession, " I would say the last thing that the eurozone can afford and need right now is another shock coming from an increase in gas prices and or even a cut off of supply of gas coming from Russia to the Western European economies. That would tip the European economies back into a recession if that were to occur."

Roubini also expressed concern regarding Chinese: "I would say the other big tail risk is the one coming from China. I spent many days in Beijing just last week, and I would say that while the consensus believes that China's going to have a soft landing, growth above 7 percent the next few reads, my reading of the data is that because of the build up of leverage, because of the need to rebalance the economy from fixed investment to consumption, they'll have to slow this excessive credit growth."


Roubini: Ukraine Could Tip Europe Back to Recession

Courtesy of Bloomberg Television


Highlights:

On whether Ukraine represents the single biggest risk:

"Certainly among the global tail risks, the one coming from Ukraine is the most important one. There is the beginning now of a new cold war between the West and Russia, and this cold war could actually become a hot war if it's possible Russia were to effectively destabilize and invade the eastern provinces of Ukraine, in which case things would escalate. You could have another episode of global risk aversion. If this were to become a real war, even a situation in which the supply of gas to Europe may be cut off from Russia. The European economy is barely now recovering from a recession. That could tip back the eurozone into a recession."

On how concerned he is that things could get catastrophic:

"Well today I would say the risk is around 7 [out of 10] and raising because the situation is (inaudible) one in which Russia seems to be really very aggressive in Ukraine. They want to try to take over Ukraine, and therefore an escalation is likely to occur."

On the possibility of a 'hot war':

"Suppose that Russia at this point decides to effectively either to destabilize, invade the eastern province of Ukraine. Two things will happen. The stance (ph) of the West will have to become more Russia and Russia could have (inaudible) going as far as limiting the supply of gas not just to Ukraine but also to Western Europe. Secondly, the NATO, even if they're not going to have a military intervention, they'll have certainty provide some military support to the government in Kiev. And that means that this war could escalate for quite a while. And therefore from a financial market point of view, there may be contagion deriving two (ph) advanced economy's financial market, especially in the eurozone."

"...the situation is such that even if he wanted to use force there (inaudible) first of all. Secondly, he's not going to invade all of Ukraine. And you don't know for how long a military conflict of this sort is going to continue, especially if the US and Europe were then to support militarily the government in Kiev. This war could continue and last for a while. So I'm saying this is not my baseline, but there is certainly downside risk that that will happen. But even a baseline (inaudible) remains lingering for a while, at some point investor may become worried about it."

On what it means for the European economy:

"Well the eurozone right now is recovering. There's been a severe recession. There's the beginning of an economic recovery, but this is a recovery that's fragile, it's anemic, it's uneven, especially in the periphery of the eurozone. I would say the last thing that the eurozone can afford and need right now is another shock coming from an increase in gas prices and or even a cut off of supply of gas coming from Russia to the Western European economies. That would tip the European economies back into a recession if that were to occur."

On whether it makes sense that Spain is selling bonds at record low yields:

"Well given the whatever it takes speech by Draghi, given the OMT, given the ESM, given the additional easing of monetary policy will occur by the ECB, given the beginning of an economic recovery, beginning of a banking union, it's not surprising that the tail risks of the eurozone have receded. The tail risk of a break up, of Italy and Spain losing market access, now given the spreads investors coming back into the eurozone, what can the (inaudible) the eurozone recovery could be a shock coming from Ukraine."

On what he is most concerned about:

"Well, I would say - leaving aside the issue of Ukraine, I would say the other big tail risk is the one coming from China. I spent many days in Beijing just last week, and I would say that while the consensus believes that China's going to have a soft landing, growth above 7 percent the next few reads, my reading of the data is that because of the build up of leverage, because of the need to rebalance the economy from fixed investment to consumption, they'll have to slow this excessive credit growth. And that implies that this year growth is going to be barely 7 percent, next year 6.5, the following year probably 6 percent of lower. It's not a true hard landing if you think about the financial meltdown with great at 3, 4 percent, but it's a bumpier and much rougher landing than the 7.5 percent that the consensus says about China. That means that if there one thing that is not priced in financial markets, it's a slowdown of China as sharp as I do expect in the next couple of years."

On why others aren't talking about the 'unexploded bombs' in China's shadow banking system:

"Well people are starting to talk about it. You have a huge amount of bad assets in the shadow banking system and also plenty of bad assets in the formal banking system. And now the Chinese authorities are telling us they want to crack down on the moral hazard coming from the shadow banking system. They want to led some institutions to fail. But without despite insurance and without any other types of guarantees, if they're serious about moral hazard, you could have a (inaudible) against the shadow banking system that has to be the beginning of unraveling of the Chinese financial system. I don't think that they - they underestimate the risks that are coming from Iran on the financial system if you are really serious about cracking down on moral hazard and imposing market discipline by having defaults

On what situation we have seen before is most comparable to what China may face:

"Well in East Asia for example in the 1990s, there was a booming fixed investment. From 30 to 37 percent of GDP was excessive (inaudible) East Asian financial crisis. In China, fixed investment was already in 2008 something like 42 percent of GDP, much higher in East Asia, and it went all the way to 50 percent of GDP. No country in the world can be so productive. You take every year half of your GDP. You invest it into real estate, infrastructure, excess capacity you're not going to go down the line first of all a hard landing of that fixed investment, a large surge of MPLs (ph) in the financial system, and three, a major surge of private and public debt. That's the risk that China is facing today."

On Janet Yellen:

"She's doing a very good job. What I'm pointing out is that while she's on the dovish side of the FOMC, there are now 12 members of the FOMC. The FOMC today is a collegial democracy. It's not the monarchy it used to be under Alan Greenspan. It changed under Bernanke. She's also collegial, and the entire FOMC has changed. Out of the seven members of the board, four are gone. (Inaudible) and Elizabeth Duke, Jeremy Stein and Ben Bernanke. There are two new members that are going to be confirmed later (inaudible) two new have to come in. Most likely the new members are not as dovish as Janet Yellen. And of the new voting members of the FOMC among the regional presence of the Fed, there are three new hawks. There's Plosser, there's Fisher and there's the new head of the Cleveland Fed who used to be the adviser of Plosser at the Philly Fed. So there's a shift towards I would say a less dovish composition of the FOMC. That means that the Fed might hike sooner and faster even if Janet Yellen personally is probably more dovish than the average FOMC member."

On how he expects the Fed to handle reversing unconventional monetary policy, shrinking the balance sheet:

"Well it's a bit of a delicate knife-edge situation for the Fed. Either they exit soon or too fast and there is a bond market rout and they have a hard landing of the economy, or if they wait too long and there is a risk they're going to wait too long and exit too late because the economy's still weak, unemployment is high, inflation is low. Think about it. They're not going to be done with tapering until the end of this year (inaudible) until the middle of next year. It's going to take them three to four years to normalize from zero to four. There is already frothiness in financial markets, in parts of the credit market, in parts of the equity market. A year from now or two years from now we've still (ph) policy that's very low. The risk is actually (inaudible) asset bubble. An asset boom and bubble eventually like 2007, '08 can lead to a bust and a crash. It's not the risk for this year, but I would say the risk is that the Fed exits too little, too late and we're going to recreate the same kind of frothiness or bubble we saw a few years ago followed by a bust and a crash."

On the overall world economy:

"Well I would say overall the global economy is recovering. The average advanced economy is going to grow 2 percent this year rather than one, better than that in the US and Canada and UK, less than that in Japan and the Eurozone. It has been a bumpy period of time for many emerging markets, but on average they're going to still grow 5 percent. So there is a recovery of the global economy, but I would say there are a whole bunch of risks. China is one. Ukraine and Russia is another one. And certainly about what the Fed is going to do is another one. Whether the eurozone's going to truly recover is another one. So there is a recovery. That's a positive, but then a bunch of tail risk and fragility."

 


 

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