Jim O'Neil and Nouriel Roubini: FT.com Interview

April 6, 2009: Nouriel Roubini of New York University and Jim O'Neil, Chief Economist at Goldman Sachs, talk to John Thornhill about the G20 summit and the road to economic recovery.

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John Thornhill (FT.com): Nouriel, The G20 has just concluded. What difference do you think the agreement will make to the global economy?

Nouriel Roubini: There was some positive developments, I think the most important one was this commitment of resources for the IMF is going to triple the resources of the IMF. There is also the creation of this new SDR, Special Drawing Rights. There are many Emerging Market economies that are in trouble, some of them with better market financial and policy fundamentals subject to a liquidity crunch, a sudden stop and reversal. You know the Brazils and Chiles and Mexicos of the world, and some others which have significant financial difficulties because of policy mistakes. And imbalances like those in emerging europe on the verge of a financial crisis. So I think that these additional IMF resources provide monies to both groups of emerging markets and help both of them to avoid a more severe crisis, especially those who are in trouble, they need good policies and IMF resources.

John Thornhill (FT.com): Now the three of us were here exactly a year ago, and Nouriel, you were pretty pessimistic about the global economy and Jim, you're more upbeat, and ummm, I guess Nouriel won that argument, but um you see Jim is of hope again, in the global economy.

Jim O'Neil: Well, maybe I'm an perpetual optimist. Part of the reason why I guess I had a different view a year ago is to do with the whole focus of mine, you know, often about the role of China and the so-called BRICs. And, whilst China has been really severely challenged by the crisis, in the past couple of months theres some encouraging signs that China might be actually coping with it better than many other countries. That's really where I see the most sustainable glimmers of hope. And then, even in some of the real crisis places, the UK actually, is showing one or two cyclical signs that the severity of the problems are starting to ease a little bit. We've had a tiny glimmer of that in the US as well. I guess what I really see is that its unlikely that the worlds going to continue decelerating at the rate that its been doing since October.

John Thornhill (FT.com): I think Nouriel, do you agree with that?

Nouriel Roubini: I agree in the following sense that the peak of the economic contraction in the US and in advanced economies and emerging markets was between the 4th quarter and 1st quarter of this year, you know a contraction of -6 percent among advanced economies compared to this contraction I think policy stimulus, monetary fiscal and otherwise, is going to imply that this economic contraction is going to slow down the rest of the year but while the more bullish consensus is US growth by Q3, it will be positive, by Q4, close to 2%, and next year something closer to a potential 2 to 2.5%. My view is that the imbalances of the United States are going to imply that economic growth is going to be negative in the second half of this year, -2% still by the fourth quarter, and next year the recovery's going to be so weak, less than 1%, between zero and 0.5%, and then unemployment rising to above 10% and effectively its going to feel like a recession even if we're technically out of the recession, so certainly I do believe that that 2nd derivative is in due time becoming positive, but has to be very positive for reaching faster rather than later the bottom, and therefore I see that bottom of that business occuring later than those who are more optimistic. [351]

John Thornhill (FT.com): There still seems to be a lively debate about the relative risks of inflation or deflation. Which do you think is the bigger threat at the moment?

Jim O'Neil: I've a pretty simple stance on that. I get asked it all the time everywhere I travel. I can almost anticipate it coming, "Aren't you really worried about inflation?" My view is that its a nice problem to have. We've lost so much output the past 6 months around the developed world, there's just no pricing power, and unless we can stop the deflationary mechanism now, the last thing people should be worried about is inflation, and be actually wanting to have some. Moreover, even if I'm wrong with aspects of that, against a background of globalization hopefully continuing, I think once you see any evidence of pricing pressures or inflation starting, compared to the current challenges policymakers have got it would pretty easy to stop. I don't have the same concerns as appear to be so widely held by many many people in the financial markets all over the world, its quite interesting.

John Thornhill (FT.com): Nouriel, one of the most optimistic things I've heard over the last two days is that you're now beginning to talk about an 'exit' strategy out of this economic crisis., but you nonetheless say that this is going to be very difficult. Could you explain that?

Nouriel Roubini: Well, you know, I agree with Jim, that deflationary pressures are going to be very significant. Over a year ago, I wrote this piece, titled, "The risk of a Global Stag-deflation Depression," a combination or recession and deflation, because I was expecting a severe global recession, and now the slacking goods market, with demand falling relative to supply, and the slacking labour market, where the unemployment is going above 10% for most OECD countries, the slacking commodities market means that for the next few years, means that deflation is going to be the problem to be faced and therefore this huge output gap and slacking labour market would have to shrink significantly before we're going to have any kind of pressures on resources.

I think that eventually, but that's kind of a 2011 story, not even a 2010 story, there would have to be a mop up of the liquidity once there is a more sustained US and global economic recovery, and that's going to be a tricky issue. I think the lesson we learned from the last bubble is that the Fed cut rates and kept them too low for too long and then the normalization occurred too slowly, 25 basis points every 6 weeks.

This time around you want to normalize it faster, not just because you worry about the inflation, but also because you should worry about asset inflation, creating another bubble, but the problem is that if the recovery is tentative, then you want to do is slowly because of the concerns about the growth, but on the other side, if you do it too slowly, you could create down the line, another asset bubble, more than actual inflation. That exit issue is going to be a serious issue, how you mop up the liquidity, how you sell back to the market all these illiquid and toxic assets you bought, how you make sure that these fiscal deficits are shrinking so you don't have to monetize them, so you don't cause longer term inflationary pressures.

Certain things are not questions that we have to worry about today or next year, but by 2011, we'll have to start thinking about those questions.

John Thornhill (FT.com): Do you think, Jim, that there is a risk that we'll have an unsustainable recovery because of the policy mix.

Jim O'Neil: Well, you know, listening to Nouriel, and thinking about it myself, its difficult to avoid creating booms and bursts, that's almost how life is. I think there is a likelihood that to solve this crisis, governments will probably overextend their friendliness, and could create quite a few issues in the government bond markets around the world. We're already seeing one or two signs of that. But, again, when I think about what those challenges would be, compared to the ones that they're currently facing, I think they're relatively manageable.

At least I certainly hope so.

John Thornhill (FT.com): Final question to both of you. What is the danger of a political backlash to globalization and could that derail any global recovery?

Nouriel Roubini: certainly the longer this crisis lasts, the more severe it is, the more the [risk of] backlash is there, in terms of backlash against the markets, against globalization, against free trade, in the form of financial protectionism, and a whole slew of actions. The G20 November promised free trade and now we know that 17 out of 20 countries already have had protectionist actions. 50 plus actions, and that't the risk. That's why in my view, its so paramount that we follow the aggressive monetary, fiscal, credit, and other policies to clean up the banks, to make sure that the recovery occurs faster than otherwise because the longer the crisis lasts, the more this backlash is going to be, and then you'll have a risk of a vicious circle with that backlash and the policy actions that are negative, having negative effects on the economic recovery.

John Thornhill (FT.com): Jim?

Jim O'Neil: I'll bring you back to where you started at with the G20. Again in the statement, they re-iterated slightly more briefly than in November, a strong stance against protectionist policies.

Its really important they follow it up this time and stick with it, because this time, the thing that would cause me to change my relative optimism would be a further acceleration of protectionist tendencies around the world. And I think its really really important that it doesn't happen otherwise things will be a lot worse, and then could end up being a much more prolonged
problem, and a severe cyclical recession.

In that regard, another thing that I'm encouraged about from the BRIC world, is that the two big population nations, China and India, interestingly enough, despite how much we all stress out in Western Europe and the US, don't appear to have lost any of their desire to slowly engage more and more in the world through trade and financial liberalization, which in many ways is the one thing that really grounds me in longer term hope, because if you really think about the engines of world activity the past decade, as much as its been the US, its been these guys, and if they lose their enthusiasm for engaging with the rest of the world then we'd have an entirely different situation.


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