Are Seeds of Next Financial Crisis Already Being Sown?
The ever-controversial Dr Roubini believes there is a high probability that the seeds of the next global financial crisis (possibly within a year) are already being sown in the very measures being taken today by various governments to address the domestic impact of the current financial crisis.
Speaking in a keynote address to the Standard Bank African Focus 2009 Conference, he said these measures had primarily been the cutting of interest rates to historic lows, near-zero in the case of the US, UK and elsewhere. Dr Roubini believes such policies, primarily in the case of the US, are creating a global currency bubble potentially more serious than the credit bubble created during 2003-7.
The described this scenario as potentially more dangerous than the current crisis, because the latter was originally limited to the US’ sub-prime crisis, whereas the potential currency bubble was truly global in scale.
The most obvious sign of this was to be seen in the rapid recovery of stock markets around the world. Roubini says this suggests investors are pricing in a ‘V’ shaped recovery, something he believes there is a low probability of. Instead, he believes that the Fed’s low interest rate policy has prompted a near-universal strategy of investors going short on the US dollar, in what he calls the “Mother of all Carry Trades”.
The combination of a weak dollar and near-zero US interest rates has effectively created negative borrowing rates, causing investors to borrow dollars to invest in more-risky assets such as equities and property around the world. Global liquidity has returned to 2008 levels, but instead of flowing into consumer buying as was the case in 2003-7 it is chasing global risk assets, causing a massive bubble in prices of everything from equities to oil and other commodities.
This cannot continue, he said, as either the dollar will at some point recover or the Fed will start tightening its monetary policy – at which point all the players will have to cover their short positions.
Not everyone believes that prices are in a bubble or that two global financial crises are possible in such rapid order. Delegates to the conference such as the central bank governors of both Nigeria and Kenya, and editor of China Confidential, James Kynge, all rebuffed the notion of a bubble, saying there was no sign of a bubble in their three respective countries. However, even before addressing the potential for a further financial crisis, Dr Roubini said policymakers had some tough decisions to make before the world emerges from the current one.
Dr Roubini said the actions of policymakers over the next few years and even months were poised on a knife edge. “It is a case of damned if you do and damned if you don’t” he said, in which the need to address budget deficits was the main driver of concern.
Developed markets needed to unwind their excessive borrowing incurred to stimulate their economies, which if left too long could stimulate inflation and potentially even stagflation (inflation combined with a renewed recession), but if unwound too quickly could remove the stimulus packages assisting recovery before that same recovery is well entrenched. Either scenario would plunge the recovering global economy back into recession.