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 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 13-Dec-2008
Nouriel Roubini predicts recession will end in 2009

Web Log - December, 2008

Nouriel Roubini predicts recession will end in 2009

The magic elixer: President Obama's economic stimulus package

I've always had a mixed opinion of Nouriel Roubini and his RGE Monitor blog. Roubini is a professor of economics and international business at the Stern School of Business, New York University. He's world-renowned, not only because he's a professor, but also because he's been economics adviser to Presidents and other government officials.

He appears on television constantly, and is always portrayed as a "bear" who predicted what was coming before anyone else did. In particular, he bragged that he had predicted a housing recession in 2006, when it's been perfectly obvious since 2004 that "Real estate is in an overpriced bubble all over the world."

But OK, I've characterized Roubini's "12 steps to financial disaster" as brilliant, and I summarized Roubini's 12 steps in an article last April.

Roubini's 12 steps were REALLY grim. So what did Roubini say would be the outcome? "A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress."

This totally absurd conclusion has always been completely baffling to me. His 12 steps predict something really horrible, but in the end he says that the result would only be a fairly mild recession.

Actually, when I saw different appearances on tv, he seems to change his mind every day. Will there be a recession, or not? Will it be V shaped or U shaped or L shaped? If you don't like his answer, then wait a minute.

However, whatever Roubini says on any particular day, the formula is always the same: "Unless the Administration does exactly what I say, then the world is going to suffer systemic financial crisis." He's got it both ways. If there's no crisis, then he can slide by; if there is a crisis, he can claim that he predicted it, because they didn't listen to him.

I finally ended up calling him the "Paris Hilton of economics:" He always knows exactly how much leg to show in order to keep himself in the headlines.

A new Roubini tv interview

Nouriel Roubini <font face=Arial size=-2>(Source: Bloomberg)</font>
Nouriel Roubini (Source: Bloomberg)

On Friday, Nouriel Roubini gave a lengthy interview on Bloomberg. I transcribed most of it, because I think it's important.

Roubini has become the most respected of the "bears." His opinions are viewed with great respect, and as things have gotten worse, he's increasingly viewed as the only analyst who got things right.

So this interview is very interesting because it provides a broad, definitive summary of his views, including specific numerical predictions.

If you don't feel like reading the entire interview, then skip to the summary at the end.

Text in brackets [...] are questions from the anchor.

"[You've already said we're heading for a severe recession. If the problems with the auto makers aren't resolved, how much worse can it be?]

It could become more severe, definitely. I think that these auto makers are systemically important. Directly and indirectly, a couple of million jobs are related to the auto sector. If they collapse, it's not just them. It's the auto dealers, the part makers, there's a whole economy in the midwest that's related.

The financial consequences on the CDS market could be severe.

Let's think about this. We're providing almost $2 trillion within TARP and liquidity support to financial institutions, some of which were nearly insolvent. So providing $15-30 billion of low-interest loans to auto makers seems to be fair, in my view. We need to do something for an important part of the real economy.

[what should be done for the real economy?]

Well, private demand is collapsing right now, consumption is falling. Residential investment is still in free fall, and capex [capital expenditure] spending by the corporate sector is falling. And then if there's no private demand, either we need to boost up demand coming from the public sector, through a major fiscal stimulus by the government of the order of $500-700 billion."

This is where he names the "$500-700 billion" figure. This figure has become the common wisdom, and it's apparently been accepted by President-elect Obama's team as the size of the stimulus package that will be passed by Congress and signed within a day or two after Obama takes office on January 20.

I don't believe that anyone has developed any real justification for this figure. It was probably chosen because it's as high as possible, while still being less than $1 trillion, which would frighten people.

Gosh, it was just a few months ago when we would have been talking about a stimulus package in the tens of billions, rather than the hundreds of billions, but these amounts have been growing exponentially. (See "One, Two, Three ... Infinity.")

Unemployment: downward trend is accelerating <font face=Arial size=-2>(Source: WSJ)</font>
Unemployment: downward trend is accelerating (Source: WSJ)

One thing's pretty sure: The $500-700 billion won't be enough. Obama has said that he wants to create 2 million jobs through public works programs. But the economy lost over million jobs in November, and the downward trend is accelerating.

Now let's return to Roubini's interview, where he gives some specific figures for his predictions:

"Otherwise, even if we help the financial system, if the economy's going to tank in a severe recession because there is no fiscal boost, whatever we do to help the financial system is going to be undone.

Make a more severe recession, where credit losses [garbled sound] so we need a major fiscal stimulus, like the one that the new administration is planning to have.

[And how would you differentiate between a severe recession and a depression? Is that off the table?]

I don't believe we're going to be in a severe depression, but this is going to be the worst recession we've had in 50 years. It started in December, 2007, and I expect it's not going to be over until December of 2009, 24 months, 3 times as long as the previous two."

Roubini has no idea how long the "recession" is going to be. Last April, Roubini predicted a "U-shaped" recession, lasting 12-18 months, with the following incredible reasoning: "The last two recessions in 1990-91 and 2001 lasted 8 months each and today the macro and financial conditions are worse relative to those two previous recessions."

So his estimate in April was derived by doubling the length of the last two recessions.

Well, now he's increased his estimate to 24 months -- 3 times as long as the last two recessions. Obviously he has no idea, and he's just guessing.

Would anybody like to start a pool where we bet on the date when he changes his prediction to 4 times as long as the last two recessions?

"And even the recovery could be so shallow in 2010-11, it's going to feel like a recession, even if we're out of it.

So not a Great Depression, but you could have this global stag-deflation -- a global recession and deflationary forces in the economy 2009 into 2010. so it's severe, short of a Depression, but very severe, by any standard.

[How severe - drop in GDP and rise in unemployment rate in the US?]

I expect the GDP is going to be negative growth until the end of 2009, and the recovery in 2010 is going to be well below potential. I see the unemployment rate peaking about 9% sometime in the early part of 2010. And I see a cumulative falling output from the peak until the bottom of about 4% -- it is the worst we've had in the last 50 years. So by any standard, this is going to be the worst recession the US has experienced since the 1950s. ...

[How will the global markets behave?]

Well I'm still bearish about US and global equity for a variety of reasons. First of all, the macroeconomic news is going to be much worse than expected. People are not yet pricing in a severe global recession. Secondly, earning surprises are going to be on the down side. I see earnings per share of S&P 500 firms next year, [with earnings] between 50 and 60 [dollars per share], with multiples that could range between 10 to 12 in a severe recession. You could have the S&P [500 index] as low as 600, for example. So, I'm bearish."

In this last paragraph, he predicts that the S&P 500 price/earnings ratio will fall from its current level (around 18) to the 10-12 range, before it bottoms out.

This is just slightly less airheaded a prediction than the UBS AG analyst who predicts a huge 53% stock surge in 2009 based on a faulty reading of the P/E ratio.

As I've written many dozens of times on this web site, the historical average of the P/E ratio is 14, and it's been way above historical averages since 1995. By the Law of Mean Reversion, it must fall below 5 for roughly an equally long period of time -- probably a dozen years.

Another interesting thing is that Roubini is now saying that the S&P 500 index "could" fall to 600, which is roughly equivalent to 6000 in the Dow Industrials.

It was just two months ago, in October, that he predicted that the Dow Industrials could fall as low as 7000, some time next year. Now he's changing his prediction to 6000. Obviously he's just guessing, and has no idea.

Would anybody like to start a pool where we bet on the date when he changes his prediction to 5000 for the Dow Industrials?

"Also you're going to have a number of other financial shocks. There is still deleveraging by hedge funds and other highly leveraged institutions.

A number of emerging market economies could get into a financial crisis. So I think that the equities are going to fall another 20% before they're going to start to recover when there are stronger signs of a global economic recovery towards the end of 2009. ...

It is [an unprecedented period], but this has been the worst financial crisis since the Great Depression. The credit losses are going to be close to $2 trillion. There's also a huge bubble in housing and credit across the world in commodities and now we're seeing the deleveraging process, and it's a severe recession."

I can't imagine where he gets this $2 trillion for credit losses. The bursting of the real estate bubble accounts for $5-10 trillion in credit losses all by itself. My expectation is that there will be tens of trillions of dollars of credit losses.

A member of the Generational Dynamics forum posted a message pointing out a new video of Oppenheimer analyst Meredith Whitney.

I always enjoy watching Meredith Whitney, and I've quoted her a number of times.

One very interesting thing that Whitney says in the new video is something I hadn't heard before: The "natural rate" of home ownership is about 64%, but during the real estate bubble it shot up, and it's now at 69%.

She says it will drop back down to 64-66%, but if 64% is the average, then by the Law of Mean Reversion, it will actually drop down to 58-60% for a while. In fact, that's very likely to happen anyway, as we enter the new Great Depression and have massive homelessness.

This drop in home ownership, combined with another 20-30% fall in residential real estate prices, is huge, resulting in a credit loss that's many times larger than Roubini's $2 trillion.

"It's going to be globally, therefore I see still downside risk to a variety of risky assets -- equities, also commodities, even credit. ...

[what's the bright spot?]

Well, the bright spot is that the policy makers now, at least in the US, are realizing, this is very severe, and the monetary policy and the fiscal policy response is going to be very aggressive.

But it's not very aggressive all over the world. In Europe, the ECB is behind the curve, the fiscal stimulus is too weak. And therefore there's a concern that while the US may be stimulating the growth rate through monetary and fiscal policy, other countries are not doing as much."

This appears to be where he's leaving himself some wiggle room. When it turns out that all his predictions were wrong, he'll be able to say, "Well, other countries didn't do enough stimulus."

"I think the weakness in the dollar is going to continue. Severe recession, monetary easing by the fed, interest rates down to zero, quantitative easing, fiscal deficits -- still large current account deficits -- those are all going to be bearish for the dollar in 2009."

In other words, he's predicting an inflationary dollar in 2009, at the same time that's he's predicting a "stag-deflation" above. These predictions aren't necessarily contradictory, since he may be predicting deflation domestically, and a weaker (inflationary) dollar on the foreign exchange markets, but it really sounds as if he's trying to have it both ways -- deflation and inflation. That way, he can't be wrong.

"Well, in a scenario of a severe recession, in the US and globally, commodity prices have already fallen about 30% from their summer peak. But I see them falling by another 15-20% before they bottom out, because there's going to be further economic contraction in the US, slow down in the BRICs, in China, all over the world. [Note: BRIC = Brazil, Russia, India, China.]

[Is there something fundamental about the US economy that has to change that has made this cycle worse than others?]

Well, the excesses were really severe. Too much borrowing by the housing sector, too much leveraging by the financial system, easy money, easy credit, poor regulation and supervision.

We've gone through cycles of boom and bust in the US economy. And every time there is a boom, and there is a bust and there is easing, and there's another bubble in the economy. We have to start growing in a way that's more sustainable, and less based on asset and credit bubbles.

Could be manufacturing, it could be maybe investment in alternative energies in renewable resources, probably those are going to be growth sector for the US economy over time."

Once again, these final conclusions show that he's just guessing. He really has no idea what's going to happen.

Summary of Roubini's predictions

So, let's make a summary of all his predictions, in convenient list that we can easily quote later:

From the point of view of Generational Dynamics, this is all wrong.

As I showed in "How to compute the 'real value' of the stock market," the stock market has been substantially overpriced since 1995, and MUST fall to well below Dow 4000 (and probably much lower) for many years.

I used to think that Roubini knew what was going on, but was simply hiding his conclusions in order to remain a popular tv guest.

But this interview has changed my mind. Roubini has gotten some things right and other things wrong. He's changed his mind several times, especially as his predictions proved to be too optimistic. Most of his predictions, it now turns out, are guesses, with nothing really to back them up except comparing today's recession to the 1991 and 2001 recessions. I used to think that he had a system view of the global economy through time, but now it turns out that he's like everyone else, believing that "history always begins this morning."

(For a description of the problems with mainstream economics models, see "System Dynamics and the Failure of Macroeconomics Theory.")

Journalist/economist Paul Krugman has gotten just about everything wrong, and each mistake seems to make him even more popular, so much so that he recently won the Nobel Prize in Economists, based on his ideological hatred of George Bush.

Roubini seems to be following a similar path. Although he's less ideological, it's obvious that he thinks that President Bush got everything wrong, but that President Obama will get everything right.

Roubini himself has gotten a number of things wrong, and as he makes more and more mistakes, and changes his forecasts, we can expect him to become more and more popular, and more and more respected. By next year, he may well be the next winner of the Nobel Prize for Economics.

(Comments: For reader comments, questions and discussion, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (13-Dec-2008) Permanent Link
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