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Mr. Roubini, have you already secured your money? Oh, many years ago. This has nothing to do with the current bank earthquake.
You’ll have to explain that to us: how does someone with the nickname “Dr. Doom” and considered a crash prophet protect themselves? I have been reallocating my wealth into money market funds and bonds for many years. I was a bit ahead of my time with that. Many savers have only now noticed that four to five percent returns on bonds are better than one percent on overnight money. This is no different even in times of low interest rates: bonds and money market funds always achieve better returns than cash in the account. In this respect: No, I no longer had to bring my money to safety.
You mentioned it yourself: recently the financial markets have been under massive pressure. Some feared a new banking crisis when customers withdrew their deposits. Were you surprised? No, since deposits were typically over $250,000. If you have that much money in one account, you should have switched much earlier. If I’m a wealthy client with deposits above the protection limit – i.e. over 100,000 euros in Europe – then I have to diversify my risk. For example, through multiple accounts and with relatively safe financial products such as government bonds. This is nothing new, and there are two reasons for this. The first is what we’ve seen – a bank run at smaller institutions with low reserves, such as Silicon Valley Bank. These institutes generally stumble more quickly.
And the second reason? Today I get between four and five percent on T-bills, ie relatively safe American government bonds. At the same time, banks are paying me almost no interest on my deposits. Why should customers do this? So they buy bonds instead of hoarding cash. This can be a good thing for big banks, since their risk of a bank run is lower than for small institutions. At the same time, however, the little ones were wrong: They assumed that the deposits were “sticky” – that is, that customers would not exchange their money for bonds. That was also the case during the low interest rates. But times have changed, and this increases the risk for banks.
The banks justify this difference with the rapid rate hikes. Their business model cannot be changed at this rate. Could interest rates have been raised too quickly? No, definitely not. Interest rates are still below the inflation rate. The central banks had to react to the price increases and thus triggered a structural change to which banks now have to adjust: savers have been punished in the last 15 years. Now there are safe alternatives that you should use too. This creates problems for the banks. On the other hand, things have been too easy for them for a long time.
From a German point of view, the problems mainly took place in the USA and Switzerland. Is that naive? As of today, I would say no. But that does not mean that the eurozone is protected from it. If the euro countries slide into recession, very similar problems arise for banks: defaulting loans, duration risks with bonds. At the same time, the European Central Bank (ECB) has a problem.
That would be? Inflation is still too high. It actually has to keep raising interest rates, but that could trigger a recession – with all the associated problems for the financial market.
How do you see the German banks positioned for this? Different. I see a problem with the state banks and savings banks. They are largely under state management and many loans are not granted there according to commercial criteria, but on the basis of local political considerations. The German Savings Banks and Giro Association recently had to write off eight billion euros on its bonds because they have fallen in value. On the other hand, Bunds have climbed 300 basis points from the low. Not only does this create winners — pension funds and insurers in particular lose out when their old bonds are worth less.
And what about Deutsche Bank? The last time it was in focus for a day when the share fell by 15 percent… I have no information of my own. It appears that some hedge funds have cornered the credit default swap market and the stock has fallen.
In the USA and Switzerland, the governments and central banks have now promised billions to rescue the affected banks. In your book “Megathreats” you portray debt as one of the greatest threats to society. How do you assess the rescue programs from this point of view? After the financial crisis of 2008, we created a new architecture to minimize the risk on the financial market. Many thought the system was good. But that’s not true. The stress tests in the USA only check the credit risk, but not the rationality of the markets. And also the assumption that we can wind up banks without costs for the taxpayer: This idea was shattered by the Credit Suisse takeover at the latest. On the contrary: by merging with UBS, we have created an even bigger monster. The new major bank is both “too big to fail” and “too big to save”.
But back to the debt: Some economists believe that government debt hardly plays a role – not even in the recent banking crises. States would eventually repay the debt. What’s wrong with that? That’s only true as long as interest rates and inflation are low at the same time or we have deflationary effects – for example at the beginning of the corona pandemic. We saw a decline in the debt ratio in some cases. At some point, however, inflation got out of control, again due to Corona, and the ECB had to raise interest rates. But that increases the costs – for everyone: for governments, home builders, borrowers, and even banks. Debt ratios rise and at some point they can no longer be serviced. I therefore expect the banks to have a credit crunch in the next one or two years. In Europe, that might be less acute than in the US. But that would lead to a recession.
Why not just print money? Some economists who subscribe to Modern Monetary Theory (MMT) would probably welcome that, but it doesn’t work. MMT’s idea was based on the fact that we have too high a savings rate and too little demand for money. That was also the case for a while. There was a risk of zero growth and deflation at the same time. And there was no fantasy of inflation ever returning. But that is the fundamental problem of MMT. The truth is, if I pump more and more money into a system, it will eventually lead to inflation. It’s like a trick: you can fool people for a while, some forever. But eventually, most people stop falling for it. MMT is proven wrong – this is shown in Turkey and Argentina. And our smaller MMT experiment in Europe and the US during Corona also ended in high inflation.
The ECB has now responded by raising interest rates. However, core inflation excluding energy prices continues to rise. When will normality finally return? The problem is that if the ECB really wants to keep the inflation rate below two percent, it has to raise interest rates further.
How high then? Measured against the current core inflation in the US, the Fed would probably have to climb to over six percent. And in Europe, the corresponding value would be over four percent.
That would massively surprise the markets…Yes, the market is currently expecting five percent in the USA and 3.5 percent in Europe – and last but not least with the first interest rate cuts before the end of this year. I think that’s completely overblown wishful thinking. I think the central banks will raise interest rates again, but not to 6 percent. And then they will leave interest rates at that level for a longer period of time. But then I see a problem – a trilemma.
That would be? Inflation will not go down at this level of interest rates. If central banks are serious about fighting inflation and keep raising interest rates, they will have to accept a hard landing. Up to this point it is still a classic dilemma: fighting inflation versus recession. At the same time, the central bank wants to keep the financial system stable. We have already seen in the USA that this does not work. However, the central banks still want to achieve three things at the same time: fighting inflation with a soft landing and a stable financial system. And they only have one tool at hand for this: interest. For me this is a “mission impossible”.
So you don’t believe in the soft landing that the ECB and Fed are aiming for? That was unlikely even before the banking problems. We have had negative supply shocks that have reduced growth and fueled inflation. And there is the trade-off between fighting inflation and economic growth. In addition, there are high debt ratios, which we are now driving further with rising interest rates. I see no way to break inflation without recession.
People are already accepting real wage losses to prevent a wage-price spiral. Even the central banks are only talking about a short, mild recession at best. In your book, however, you warn of a long and difficult phase. Why? Central banks expect wages and prices to fall like a rock once the recession hits. I do not believe that. We have stress on the financial markets, an extremely tight labor market and high wage demands. This will continue to lead to inflation for the time being. There are fundamental problems with this.
Who would be? In addition to the debt problem, we see a number of geopolitical developments that could fuel inflation: de-globalization, friendshoring, demographics, migration, pandemics, cyber wars and last but not least climate change. The list is endless – and that’s just the supply side. Demand will eventually collapse through a credit trap that we’re already in. If interest rates continue to rise, many people will no longer be able to afford their follow-up financing or will not invest at all. Then the central banks would have to step in again, which, however, fuels inflation. So we see fundamental problems on both sides that will lead to higher inflation.
That doesn’t sound good…no. I don’t want to paint everything black. I don’t expect hyperinflation, not even double digits. I rather expect inflation rates of six percent for industrialized countries.
Couldn’t we prepare for that? Look at Bunds. They climbed from -50 to 250 basis points in the past year. At the same time, old federal bonds have lost up to 45 percent in value. If inflation is now at 6 percent, 10-year bonds should be at 8 percent. But if we go from 2.5 to 8 percent, the market value for old bonds drops between 50 and 60 percent. That would be a big problem for the financial market, and ultimately a nightmare for everyone.
What would a hard landing mean for ordinary people? Short-term inflation. As a result, real incomes are falling, but the market values of stocks, bonds and cash assets are also falling. In the longer term, we will see the typical consequences of a recession: layoffs, further real wage losses and loan defaults. A recession is bad for everyone, nobody wants that.
Will the recession in Europe be worse than in the US? Currently, I see the greater risk of a recession in the US. But the US is better positioned for the recession, especially on the energy front. Basically, Europe has a bigger demographic problem, high debt ratios and plays no role in future technologies. The practical advances are being made in China and the United States, while Europe may have the necessary knowledge. And when countries want to do something about it, there are street protests like in France. There is no reason for Europe to be complacent. The problems are huge.
How should people hedge against this? The traditional hedge is long-dated bonds. However, this is currently not working due to the interest and debt. Short-dated bonds or those linked to the inflation rate make more sense at the moment. In addition, an admixture of gold or other precious metals can be useful. Industrial metals are also exciting right now. And last but not least, sensible real estate investments.
And what about cryptocurrencies? Crypto is junk – the mother of all scams. It is neither a currency nor an object of value. Crypto is useless, and considering the environmental aspect, even harmful. In the long run, crypto will either disappear or remain irrelevant.
You describe climate change as one of the ten “megathreats” for society. Given our current efforts, how optimistic are you that we can solve all ten at once? That’s difficult. For each of these problems there are solutions, which I also show. But these are always associated with costs and restrictions. Anyone who wants to push through politically unpopular measures must expect to be voted out – like Gerhard Schröder, for example, after his Agenda 2010.
Is that a problem of democracies? Do we need autocracies to implement radical climate protection measures? No, that’s exactly how it is in authoritarian societies. Liberal democracies are always better. However, functioning climate protection has a number of hurdles: In the USA, only half believe in man-made climate change. In addition, young people take climate protection more seriously than older people. On a global level, we also have a free-rider problem: some countries go to great lengths to save greenhouse gases, while others consume even more to do so. These countries then point out that the industrialized countries themselves created the problem 200 years ago and demand subsidies in the trillions. Little comes of itself.
Is there no hope for us? My only hope is technology. Either we make it through technological solutions, or we are doomed to fail.
So you stay true to your reputation as “Dr. Doom”. What do you think of this nickname anyway? I would describe myself more as “Dr. Realistic”. I’m not talking about aliens taking over the world or an asteroid destroying the planet. Each of these issues is real and we must address them now. The “Financial Times” summarized 2022 with the word “polycrisis”. The Chair of the International Monetary Fund (IMF), Kristalina Georgieva, has spoken about the “confluence of disasters” – and Christine Lagarde about the “permacrisis”. So I’m not alone in my view.
Do you believe in happy endings? I draw solutions to all problems. But none of this is free. At the end I describe a dystopian and a utopian scenario. In the latter case there is a happy ending. But only this much: Technological innovations are necessary for this.
