Working Papers

A Roubini Forecast that is Dead on Arrival

It is not often you can dismiss a forecast as soon as it’s made, but Nouriel Roubini’s latest bit of doom-mongering is DOA.  Nouriel suggests that Australia and New Zealand, among others, are set to experience a disruptive currency and financial crisis:

Runs on currency and liquid local assets may still occur with severe and disruptive effects on currency values, bond markets, equity markets and the housing market.

In the case of Australia and New Zealand, this prospect can be dismissed out of hand (I wouldn’t necessarily make this claim for some of the emerging market economies Nouriel lumps in with Australia and NZ).  The best evidence against Roubini’s scenario is the experience of both countries in 2001, when the Australian and NZ dollars fell below 0.5000 and 0.4000 respectively.  Not only was there no significant disruption to the domestic economy and financial markets of either country, the boost to competitiveness added to the strength of both economies.  Nouriel’s assumption that a falling currency woud lead to a dumping of local currency-denominated assets by foreign investors didn’t play out then, not least because many foreign investors are significantly hedged against currency risk.  The Australian and NZ dollars are currently falling in part because their debt markets are outperforming the US.  If anything, a cheaper currency makes local asset markets even more attractive to fresh inflows of foreign capital. 

In recent months, New Zealand authorities have not only welcomed a falling currency, they have even been actively trying to scare-off foreign investors - hardly the actions of a government worried about a currency crisis.  The main risk to the NZ economy has been the domestic policy tightening that had seen the NZD trade weighted index to post-float record highs at the end of last year.  An exchange rate driven easing in overall monetary conditions is exactly what NZ needs right now.

Roubini’s forecast in relation to Australia and NZ is also difficult to square with his bearishness on the US dollar. According to Nouriel:

U.S. policymakers - both at Treasury and even some, but not all, at the Fed - live in this LaLa Land dream that the U.S. current account deficits and fiscal deficits do not matter and that the U.S. external deficit is all caused by a global savings glut or is actually a “capital account surplus” as it allegedly represents the foreigners’ desire to hold U.S. assets.  They - and financial markets and investors - may soon wake up from this unreal dream and face a nightmare where the U.S. looks like Iceland more than they have ever fathomed.

Roubini would have us believe that both the US dollar and the dollar bloc peripheral currencies are at risk, yet this would imply that the AUD-USD and NZD-USD exchange rates should remain relatively stable.  It is even harder to envisage an Australian and NZ currency or financial crisis, when the most important exchange rate, that with the US, is largely stable.

Nouriel is the one living in LaLa Land.

posted on 29 March 2006 by skirchner in Economics

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Economists used to be sophisticated enough to distinguish between structural and cyclical economic growth. These days it all seems too hard for them. “Just let the currency slide” is the maxim.

Structural economic development is difficult. It requires the appropriation of science and technology, and its application to world competitive industry. ITS DIFFICULT. It requires expert policy on infrastructure/ labour relations/ private capital markets/ education/ enabling technologies (IT/ ICT/ Telco), etc.

Cyclical growth is different. Just loosen capital adequacy banking requirements, and allow the punters to blow wads of foreign capital on housing speculation and home renovations. Services ‘industries’ such as banking replace production. Of course, when the punters reach debt saturation, or foreign creditors become nervous - the state of the real structural economy is revealed. The other draw-back is that this can only be done once, after which every other generation thereafter labour under the consumer debt/ equity interest/ dividend outflows.

A bias away from structural policy toward cyclical policy requires policy makers to ignore sound public finance principles, such as when the social benefits of capital exceed the private benefits.

It is said that ‘policy errors’ accumulate as a structural depreciation in the host currency. I note that the USD has depreciated 40% against the Euro since 2001. Currently the US rates 7th on PPP per capita, behind countries such as Switzerland, Ireland and Denmark. And it’s falling fast. http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)_per_capita

Once the USD fully depreciates to its long-term equilibrium rate (at least 40% below where it is now, and continuing to fall), and as global (ie Japanese, Chinese, Tiger-Economy and German) exchange & interest rates rise - the US will continue to fall in PPP per capita ranking (Australia will follow). We should see Japan rank above the US in the next decade or so. At that point, the Chicago School will be shown for what it is. A failure that ignored the inter-generational dynamics of financial intermediation on the real economy.

I’ve made a tonne of money betting against Anglo-Saxon service driven economies. With monetarisation of massive US deficits though the repo-desk, expect commodity/ gold inflation to continue. Also, expect the current account surplus/ technology focused countries to prosper. Cyclical (foreign debt-consumption driven) service economies will coninue to see widening current account deficits/ and continued depreciation of the currencies. {Even Keynes was worried about central banks debauching their host currencies. After all, its much easier to ‘manufacture’ GDP figures this way than actually become more productive against global competition. These days most economists seem unconcerned (witness the rise of an ounze of gold from $35 USD to $556 !! from 1970’s to 2006.} Maybe I’ll be able to retire 20 years early !?

Make no mistake. It will be an Asian century. Real (marketable) tech-intensive production will eventually trump foreign debt/ equity liability funded consumption/ housing speculation. renovations.

Craig Stevens   ACT

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