Tuesday, September 23, 2014

The Changing Face of Global Risk

NEW YORK – The world’s economic, financial, and geopolitical risks are shifting. Some risks now have a lower probability – even if they are not fully extinguished. Others are becoming more likely and important.

A year or two ago, six main risks stood at center stage:

· A eurozone breakup (including a Greek exit and loss of access to capital markets for Italy and/or Spain).

· A fiscal crisis in the United States (owing to further political fights over the debt ceiling and another government shutdown).

· A public-debt crisis in Japan (as the combination of recession, deflation, and high deficits drove up the debt/GDP ratio).

· Deflation in many advanced economies.

· War between Israel and Iran over alleged Iranian nuclear proliferation.

· A wider breakdown of regional order in the Middle East.

These risks have now been reduced. Thanks to European Central Bank President Mario Draghi’s “whatever it takes” speech, new financial facilities to stabilize distressed sovereign debtors, and the beginning of a banking union, the eurozone is no longer on the verge of collapse. In the US, President Barack Obama and Congressional Republicans have for now agreed on a truce to avoid the threat of another government shutdown over the need to raise the debt ceiling.

In Japan, the first two “arrows” of Prime Minister Shinzo Abe’s economic strategy – monetary easing and fiscal expansion – have boosted growth and stopped deflation. Now the third arrow of “Abenomics” – structural reforms – together with the start of long-term fiscal consolidation, could lead to debt stabilization (though the economic impact of the coming consumption-tax hike is uncertain).

Similarly, the risk of deflation worldwide has been contained via exotic and unconventional monetary policies: near-zero interest rates, quantitative easing, credit easing, and forward guidance. And the risk of a war between Israel and Iran has been reduced by the interim agreement on Iran’s nuclear program concluded last November. The falling fear premium has led to a drop in oil prices, even if many doubt Iran’s sincerity and worry that it is merely trying to buy time while still enriching uranium.

Though many Middle East countries remain highly unstable, none of them is systemically important in financial terms, and no conflict so far has seriously shocked global oil and gas supplies. But, of course, exacerbation of some of these crises and conflicts could lead to renewed concerns about energy security. More important, as the risks of recent years have receded, six other risks have been growing.

For starters, there is the risk of a hard landing in China. The rebalancing of growth away from fixed investment and toward private consumption is occurring too slowly, because every time annual GDP growth slows toward 7%, the authorities panic and double down on another round of credit-fueled capital investment. This then leads to more bad assets and non-performing loans, more excessive investment in real estate, infrastructure, and industrial capacity, and more public and private debt. By next year, there may be no road left down which to kick the can.

There is also the risk of policy mistakes by the US Federal Reserve as it exits monetary easing. Last year, the Fed’s mere announcement that it would gradually wind down its monthly purchases of long-term financial assets triggered a “taper” tantrum in global financial markets and emerging markets. This year, tapering is priced in, but uncertainty about the timing and speed of the Fed’s efforts to normalize policy interest rates is creating volatility. Some investors and governments now worry that the Fed may raise rates too soon and too fast, causing economic and financial shockwaves.

Third, the Fed may actually exit zero rates too late and too slowly (its current plan would normalize rates to 4% only by 2018), thus causing another asset-price boom – and an eventual bust. Indeed, unconventional monetary policies in the US and other advanced economies have already led to massive asset-price reflation, which in due course could cause bubbles in real estate, credit, and equity markets.

Fourth, the crises in some fragile emerging markets may worsen. Emerging markets are facing headwinds (owing to a fall in commodity prices and the risks associated with China’s structural transformation and the Fed’s monetary-policy shift) at a time when their own macroeconomic policies are still too loose and the lack of structural reforms has undermined potential growth. Moreover many of these emerging markets face political and electoral risks.

Fifth, there is a serious risk that the current conflict in Ukraine will lead to Cold War II – and possibly even a hot war if Russia invades the east of the country. The economic consequences of such an outcome – owing to its impact on energy supplies and investment flows, in addition to the destruction of lives and physical capital – would be immense.

Finally, there is a similar risk that Asia’s terrestrial and maritime territorial disagreements (starting with the disputes between China and Japan) could escalate into outright military conflict. Such geopolitical risks – were they to materialize – would have a systemic economic and financial impact.

So far, financial markets have been sanguine about these new rising risks. Volatility has increased only modestly, while asset prices have held up. Noise about these risks has occasionally (but only briefly) shaken investors’ confidence, and modest market corrections have tended to reverse themselves.

Investors may be right that these risks will not materialize in their more severe form, or that loose monetary policies in advanced economies and continued recovery will contain such risks. But investors may be deluding themselves that the probability of these risks is low – and thus may be unpleasantly surprised when one or more of them materializes.

Indeed, as was the case with the global financial crisis, investors seem unable to estimate, price, and hedge such tail risks properly. Only time will tell whether their current nonchalance constitutes another failure to assess and prepare for extreme events.

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  1. CommentedDavid Donovan

    I bring this up to Nouriel because it is reflective as to why America's willingness to retreat will have adverse effects and in fact devastating effects on global security

  2. Commentedchristopher tingus

    Unfortunately while an avid reader of Nouriel for many years, what happens next as this grand superpower, my (our) beloved America fails given the lack of competency and leadership, understanding the fact that such a wonderful Blessing from God must be protected with strong arsenal against the many who seek her demise...

    ....well, what happens next is the fact that it has been the good 'ol USA who many could give a damn about which has assured some degree of political stability - pax Americana! Relative quiet and dominant world peace now breaking down quickly and certainly led by this present executive WH so perverse in its Chicago-Hollywood-Washington charade and its self-serving and narrow ideology that so many will again suffer much anguish -

    Pax Americana - Pax Britannica and Pax Romania - the truth be told....

    Credibility shattered, influence tattered and a weakened and all too political Congress enabling such circumvention of the Judeo-Christian principles of this great nation and a Constitution like none other where every real American has responsibility to protect and every global citizen should support as the only vision and hope to remain free of such brutality often seen globally from such reckless and self-serving governments seeking to enslave their populace and thieves by day and night fill their coffers with the earned wages of the good people who are often the ones who "entrust" politicians -

    As the famed and well deserving in accolade Israeli and global journalist, Caroline Glick said when learning that Washington had decided to offer Tehran - who I refer to as "The Brutes of Tehran" - relief from imposed sanctions, Ms. Glick saying in essence the "most significant international event since the collapse of the Soviet Union" -

    While a Boston native and a hugh supporter of the Boston Red Sox as well as a city who is rightfully referenced as Beantown, but more importantly, "Boston Strong" - proud of our first responders and such a metropolis of so many global nationalities and freedom in religious practice from Christianity, to Judaism, to Islamic mosque where all are respected to those who choose other, last year's bombing of Boston was an insult to good people everywhere, however it provided insight into why American and its people and people everywhere must be strong and not tolerate politicians whose empty political rhetoric is clear and here in this once great nation, America, it is unimaginable that such tolerance has been allowed to hear Washington tell Tehran that sanctions will be lifted if in fact it slowed down its nuclear activities, mind you, slow down, merely to reduce their pace when in fact Tehran is almost at its final stage of bomb making...how absurd Tehran with so much American (youth) soldier blood on its hands and its intent to commence a nuclear conflagration where Arab states are worried and scurrying to German weapons manufacture and distribution as Germany itself creates a new Confederate of Arab States in ally to Germany and the Assyrians and the ever powerful and corrupt itself, Vatican surround Tehran....The Israelis and the Saudis and so many have seen the deceit, the lies spewed forth by this current administration and the likes of John kerry and Ms. Hillary who looked at the 3pm phone call as the "Benghazi Massacre" unfolded and stood shoulder to shoulder with Barry Obama, nothing more than a Chicago city street slicker and blatantly lied to the facts, to the People of America, to the families of our brave warriors and they both indifferent to the fact that we leave no one behind and while the perpetrators sip wine at the local hotel even seen through the drones overhead, not an arrest nor any ramification and....

    ....an example Nouriel that while you do have vision, you have been blinded to the fact that Barry Obama sitting at the Rev Wright pew for 20+ years and in '08 as the Rev Wright clearly told this tainted American press as well as the all too liberal Jewish American population, "Tehran can have WMD as long as the 'Zionists' have same in hand" which prompted Barry Obama to stop prosecuting companies from violating sanctions long before lifting all these sanctions....

    I bring this up to Nouriel because it is reflective as to why America's willingness to retreat will have adverse effects and in fact devastating effects on global security and the global economy and unfortunately the American foreign policy now in free fall which is enabling a Spring love affair to now blossom as so many will have no choice to turn to Germany and allowing Germany with its new fast deployment Army and billions and billions in manufacture and distribution of weapons into the Gulf which will quickly see tumultuous economic markets and a renewed effort by the "KGB Putinites" as I refer to these thugs led by the ever popular duck hunter, Vladimir who should not be underestimated as he is keen, strategic in planning and intent on restoring the Soviet Union and openly supports Tehran's nuclear program so let's not kid ourselves, Tehran's purpose is to deliver nuclear weapons and it shall do so and you Nouriel and every economist noted must look at the lessons of history, 1890, 1917, 1939, and today for instance and understand that in fact as stated By Jesus Chris clearly in Matthew 24;21-22, "the great tribulation" is coming and given man's history of war unfortunately, prepare the world with your keen insight for the clock ticks and when the world dismissed the most powerful speech ever given at the (corrupt) United Nations last 1st October by MIT trained Benjamin Netanyahu, failing to raise the consciousness of the world and even the Israeli populace, for it will now take Karl-Theodor Zu Guttenberg to head off Tehran and he rightly referred to Merkel's decision to side with Russia and China against the west in Libya which he contends made Germany look like "a pygmy in foreign and security affairs" which will in fact be Merkel's undoing and the world and especially Tehran will understand just how powerful German has become in the void of American power and influence which means Nouriel that it is time to advise that War looms dead ahead as certain as the unsinkable Titanic came upon an iceberg....

    ....while a very proud Greek American to have seen such innovation, such technological enterprise, such Rights of free people, the willingness to send precious youth to far distant shore in great sacrifice against the foot soldiers of Lucifer, however today, the unwillingness to repent, the lack of sovereign pride willing to allow porous borders, a press and media so tainted and make a mockery of real journalism and understand that the media is very important to preserving liberty and well...the list goes on and while it does, Tehran prepares its bombs and hats off to the line of the Hapsburg line and their offspring, Karl Theodor Zu Guttenberg who will thwart and place his thumb on "the Brutes of Tehran" yet will the confront the alliance of Russia and China so Nouriel, let's get prepared -- if you though 2008 was scary for some, well, very shortly, unfortunately, the financial wizards will wonder themselves as they did for five days during Hurricane Sandy that the world can quickly change and it will do so as the American Congress is so weakened it even allows its federal employees from the Secretary of Defense to the IRS Director to the former queen, Ms. Hillary head of State, all allowed to stand without ramification from blatant lie and pledge in oath to protecting the greatest nation in the world, Pax Americana!

    God Bless America, God Bless the folks at NSA, God Bless our soldiers proudly depicting their commitment to good 'ol Glory and God Bless the good People everywhere, children of the Lord who have deserved far better and as a result of greed, lust in power and mankind's unwillingness to stand tall given all the Blessings God has bestowed upon humanity, it chooses to be abusive and disrespectful of another and willing to judge another and to kill another so easily though all witnessed by the Lord and soon the rock'n and roll'n will increase and Nouriel, as much as I respect you, the world is very sick and it fever will soon be as hot as the solar flare for certain....The choice of repenting and standing strong against Lucifer for the sake of humanity has passed and now the show truly begins....

    Christopher Tingus
    "Pax Americana - Pax Britannica and Pax Romania - the truth be told...." my new book now writing and ready for early 2015!
    PO Box 1612
    Harwich (Cape Cod), MA 02645 USA
    skype: christopher.tingus

  3. CommentedRishi Arora

    Although I agree with dr Roubini that the risks are mitigated, I have to disagree to what extent. Although we are not in a crisis, it doesn't mean the rose garden is flowering again! The structural reforms required whilst QE was in full flow were not carried out to a greater enough extend and I suspect we will see that as QE is wound up in the US. It may take longer if the EU take up the baton and continue where the US leaves off- which seems ever more likely.

    I am surprised after 5 years that the market hasn't worked out that this "medicine" (QE) is not working on the fundamental economy.

    I would argue a even more worrying sign- if you look at the trends, we are in a disinflationary world and with a lot of regions in Europe already in deflation... I personally can't see that stopping particularly if we see a significant external shock. My logic is this, we have had 4 trillion dollars printed in the US... They have disinflation- I would argue and I know this sounds contentious, QE isn't creating inflation.

    If this is the case, all QE effectively does is pump up asset prices... A problem pre 2008 was interest rates were too low for too long and I fear we are performing exactly the wrong medicine, creating a supercharged bubble that will eventually pop.

    The solution would have been supply side reforms, reforms to the tax systems to make them more progressive. Higher punishments on banks and strong regulation so they work for the people. International corporation including international rules on banking, trade and a world wide development strategy. I know a lot of what I recommend just isn't possible in a politically fractured world...

  4. CommentedMichael Cohen

    The two big recessions 1929 and 2008 were not caused by the kind of natural risks referenced here, they were instead caused by massive fraud in the financial sector.

    Specifically for the 2008 meltdown.
    - Banks gave over vetting home borrowers to independent retail mortgage brokers that lured people into unsustainable mortgages with teaser rates and high pre-payment penalties. The mortgage brokers didn't care, they unloaded the bonds onto banks
    - The banks with the collusion of the ratings agencies. Bundled the toxic waste into AAA rated securities.
    - Using political influence over Congress, the market for credit default swaps went completely unregulated. For every $1 in bad mortgage bonds, there was $10 in credit default swaps that the issuers were not required to maintain adequate funds to cover.
    - While all this was going on the SEC and Fed under Greenspan were asleep at the switch. As an example, given specific information about Bernie Maddof's Ponzi Scheme, the SEC sent in investigators that gave him a clean bill of health.
    - When the toxic waste bonds went bad as they were bound to do, there were so many suspect credit default swaps issued that nobody knew who would actually get paid off, banks and brokers financial statement became suspect, the overnight loan rate skyrocketed and the banking system threatened to seize up.

    THERE ARE NO MYSTERIES HERE; just public and private corruption and incompetence on a grand scale which has left a very well of class of rich and powerful un-indicted co-conspirators, still out there waiting for another opportunity to get rich on the backs of the people who make a living by producing goods and services of real value.

  5. CommentedJason Gower

    "Could" lead to bubbles in equity markets? Probably the only question here is who will be left holding the bag. It's like everybody has their finger on the sell button just waiting for the signal but of course the returns look good on the way up so don't want to get out of there too soon...

  6. CommentedZsolt Hermann

    I am not sure I would deem the listed problems even partially resolved at the beginning of the article.
    The "solutions" cited as lessening their threat, are simply sweeping the problems under the carpet, inflating the already stretched bubbles even more, none of the "solutions" addressed the true, core causes of the crises.
    Even the Middle East looks more dangerous than before to me. As the dominance, meaningful influence of the US lessens, and as the "rogue" actions of Russia and other states remain relatively unpunished, more and more countries, leaders will feel they can act in isolation, dictated by their personal or national interest even against the backdrop of international condemnation, or "sanctions". And in the complicated, overheated atmosphere of the Middle East such actions could lead to highly unpredictable consequences.
    Unfortunately I only see a generally worsening picture, a dark vacuum opening up as the crisis deepens on all fronts, the "solutions" are very clearly simply "kicking the can down the road" and there are no visionaries, leaders who at least promise something for a better, more sustainable future.
    Everybody is standing naked and empty handed.
    On top of this all we just received an even more alarmist environmental perspective than we had before.
    We are at very sensitive and volatile crossroads.
    We cannot delay further looking into the mirror and identifying the true causes of the crisis and all of humanity's problem.
    There cannot be a cure before a brutally honest diagnoses.
    Of course instinctively we try to avoid it since the diagnosis is not concerning some external factors, or "others", but the "disease", the "bug" is in us, in our self-centered and egoistic human nature.
    This is the nature that drives us towards ruthless competition, thriving to succeed at the expense of others, this is what drives us to live based on excessive and artificial demand way beyond available resources and necessities.
    And continuing life such a way in a closed and finite natural system, where we have become a global and integral human organism is like consciously driving off the cliff into the abyss.
    We cannot afford to continue existing on our instincts, without conscious and critical self-assessment and conscious and positive self-change.
    These conscious acts would make us truly human, a creature rising above its own inherent nature in order to adapt to the system around it, and only such a truly human being can adapt to and survive evolution.

  7. CommentedVal Samonis

    Deflation, esp. in Europe and Japan, is still a growing risk; nothing has been able to stop it so far (not Draghi, not Abe). What will stop deflationary tendencies are wars, precisely, with all kinds of fiscal and monetary stimulation they will require, as usual.

    A kind of deja vu from the Dirty Thirties and Bloody Forties?

    Val Samonis

    Vilnius U and Royal Roads U