Question: What was the tipping point that confirmed your prediction?
Nouriel Roubini: Well folks had been speaking about the US and other housing bubbles for a number of years and that people were talking about the bubble in 2002, 3, 4, 5. I started to worry about it and warn about it in the middle of 2006 for the following reason.
A bubble can continue for awhile, right, if price is going up. Even if they are artificially going up because of a bubble there is more demand and if there is more demand there will be more supply and the bubble can continue for a while. So as long as in the case of housing prices were rising and as long as the supply of new homes and the demand for new homes was going higher, the bubble was continuing. So if I had predicted or anybody else that the bubble would burst in 2004 or 2005 I would have been proven wrong.
Why did I start predicting the bust in June, around June, July of 2006, because when you were looking at the U.S. data you were seeing that the quantities—both in terms of housing starts and demand—were starting to fall, so they were tapering off and then falling and prices had been rising say 15 to 20% per year. They had also plateaued and they were starting to fall. And a bubble is a bit like a fire that needs oxygen and once the oxygen is gone the unraveling starts. So I knew exactly that we were at the peak of that bubble because the increasing prices and demand and supply had stopped, and the beginning of the reversal had occurred.
And then by looking at how much real home prices had risen in the U.S., they doubled in a decade when usually they are flat over time. There is no reason why home prices should rise more than inflation, so real home prices in the U.S, have been flat for the last 120 years apart from some boom and bust. You knew that if home prices increased by 100% just to go back to their previous value they should fall by about 50%.
Question: Why were you able to connect the dots when so many of your colleagues were not?
Nouriel Roubini: Well first of all I was not the only one. In my book I recognized another dozen analysts, economics and others from Steve Roach, to David Rosenberg, to Ragu Rajan, to Ken Rogoff that they discussed many of these elements of these imbalances. So the were a number of us even in the policy community, people like Bill White of the BIS. And these are all people that have been studying usually financial crisis for a while. They know the history of financial crisis. They know them across the world.
You take any textbook of economics undergraduate, master, PhD level there is not usually even a single chapter about economic and financial crisis. They’re taught as being kind of freak events that occur once every 100 years—as economists say, 20 standard deviation away from the mean—but these things are occurring every other year, more frequently, more virulent and more severe in terms of their own economic financial cost in advanced economies, in emerging markets. If you look even at the history of just the last 30 years you see dozens of these episodes.
So there are economists first of all that have been studying them. They’re attune to them and the mainstream profession thinks always as the economy being an equilibrium, markets being rational and being efficient. The whole point about the bubble is that the price of an asset is about the fundamental value, so there is a market failure or inefficiency, so you start to think outside of the mainstream. You start to think about this equilibrium and imbalances and asset bubbles and credit bubbles, and then you can make sense of these things. And there are many economists who have been doing so and those who have been doing so can see these things coming earlier than the rest of them.
The other point about the bubble and why nobody gets them, usually very few is that... the issue is not why myself or a few others got them, but why most the people, not just economists don’t see them coming. And I think there is an element that when... there is a bubble. Everybody lives in a bubble. A U.S. consumer could spend more than their income by using their homes as ATM machine. Politicians were happy because the economy was growing and they were getting reelected. Wall Street and The City were making gazillions of profits by creating all these toxic instruments and securitizing them. Rating agencies were making a fee out of their own things. Everybody. And the regulators were asleep at the wheel and the central banks were feeding these bubbles through their own easy monetary policy, so whenever there is a bubble literally people live in a bubble. They don’t live in reality and the delude themselves that things are unsustainable like tech stocks doubling every year in the '90s or home prices rising 20% every year in the last decade—that things that are unsustainable can go on forever. People saying... silly books written in 2000, Dow at 36,000. Or books written by cheerleaders of the real estate industry saying home prices are going to go on forever higher and higher and so on and that this was not a bubble. So people really live in a bubble when there is a bubble and they delude themselves that the bubble can continue forever.
Question: What is the value of defying conventional thinking?
Nouriel Roubini: Well you know usually critical thinking and not always accepting the conventional wisdom. Having lateral thinking or contrarian thinking is useful in kind of any discipline. But in the case of the economic profession thinking about the crisis, I think there is also a bit of a political economy of this irrational exuberance. A lot of the sell-side research that is done by investment banks and other banks has all the biases of sell-side research. It is being paid by those who are underwriting securities or even if there are Chinese walls it’s very hard to be independent and speak the truth even if you can be very smart. So a lot of non-independent research. And one of the advantages of my firm Roubini Global Economics is that we don’t trade. We don’t manage assets. Our reputation is based on being right, and only on that. We’re never talking our book. So if you have truly independent research, it’s more likely to get things right than research that is not really independent that has all the biases we know.
For what concerns policymakers, policymakers will never be the first one to "cry wolf" or scream fire in a crowded theater because if they were warnings early on about stuff then there will be a panic. So whether it’s the Fed or the Treasury or the IMF of course you have to cautious. Myself, when I was in government for two years I could not speak as freely as I do when I'm an independent thinker. And so there is that bias. And then economists where are in academia are sometimes co-opted by mainstream views because it’s easier to succeed career-wise and otherwise by taking mainstream views rather than having lateral thinking as well, so there are systems of incentives and rewards that people have that lead to these kind of herding behavior both in the financial market and also into the collective thinking as well.
Question: How is China different from the U.S.?
Nouriel Roubini: Well there are differences in China, but there is also the case that there is a risk of asset bubbles in China. Monetary credit and fiscal policy has been very easy during the crisis to prevent the hard landing of the Chinese economy. But with a 25% of GDP stimulus now the economy is overheating, inflation is rising, monetary and credit growth is excessive. There are asset bubbles in commercial, residential real estate, and there is a risk that if these things are not controlled eventually—I'm not predicting a crisis in China in the next six months—but eventually those imbalances can lead also to a financial crisis in China. But the nature of it is really probably different from other ones because China has an undervalued currency because its running at current account surplus. So it’s not your typical kind of Anglo-Saxon kind of style of financial crisis.
Question: What happens when China becomes the dominant economic power?
Nouriel Roubini: Well China certainly is the second largest economy in the world right now and its share of global GDP and of global growth is rising and it’s not just China. It is also India, emerging Asia, and other larger emerging market economies, so I think that in the next decade the main trend in the global economy is going to be exactly the rise of China and other emerging markets in absolute and relative terms compared to advanced economies, U.S., Europe and Japan that are in relative and also maybe absolute decline. With economic power, trading power, financial power there is also a rise in political and geopolitical power as well. So one of the difficult questions is how much of the rise of China is going to be peaceful or not, how much China might be stretching its muscles also into the strategic and geopolitical area as opposed to just to be the economic one, but certainly adding 2.2 billion Chindians, Chinese and Indians, to the global economy and to the global labor force is going to be radically changing the global economies in ways that are not fully predictable.
Question: Will there be a currency war between the U.S. and China?
Nouriel Roubini: Well there are already currency tensions because of the U.S. and other deficit countries need nominal and real depreciation to improve their export growth and sustain economic growth as domestic demand is falling or is weak because of deleveraging. But then that requires China and other net exporter countries to allow their currency to appreciate to reduce their trade surpluses, and if they need then to grow they should rely more on domestic demand rather than on exports by changing policy so as to reduce their savings and increase their consumption. But China and other emerging markets are resisting this appreciation because their model of growth has always been based on weak currency and export-led industrialization and growth, so there is conflict between the need of U.S., U.K. and other deficit countries that need to have a real depreciation and the resistance that China and other emerging markets put through intervention in the Forex market to that appreciation of their own currency. And whether you want to call it a currency war or a currency tension or eventually trade war certainly that is one of the stresses of the global economy. The imbalances, we have a large number of surplus countries—China, Germany, Japan, emerging markets on one side—and a bunch of deficit countries—U.S., U.K., Ireland, Spain and other current account deficit countries. The tension is going to stay with us for awhile.
Question: Could the yuan replace the dollar as a de facto international currency?
Nouriel Roubini: Well I wrote a piece for the New York Times last year about the almighty Renminbi or Yuan saying that over the next 20 years that is a possibility. I don’t think it’s going to happen right away because for a currency to become a major reserve currency you need to have a more flexible exchange rate. You need to have elimination of most capital controls. You need to have liberalization of domestic capital markets and you need also a deep and liquid market for those securities and there is not enough Renminbi denominated bonds yet as a market, so those are the four key factors that are going to be necessary for the RMB to become a major reserve currency. That is going to take at least a couple of decades.
But it is certainly the case that the Renminbi is becoming gradually a reserve currency. The Chinese have taken a wide range of steps in the last couple of years to sort of internationalize the role of the Yuan or Renminbi as both a means of payment, as unit of account and a store of value. Those are the features of any money or any international money as well. So gradually the Yuan is going to become one of the reserve currencies and whether it could replace the dollar it’s more of a long term issue. There is a possibility, but it’s going to take a long time.
Recorded November 30, 2010
Interviewed by Peter Hopkins