It’s the message, not the messenger

Once upon a time, a commentator said of him: “Roubini predicted a recession in 2004, 2005, 2006 and 2007. He was wrong four years in a row. So, in 2008, his prediction appears to be finally coming true. Well, a stopped clock is correct twice each day.” This was the same observation of an assistant editor of UK’s The Daily Telegraph. His correct call on the 2008 crisis showed that “if you say something consistently enough for long enough, eventually you will be proved right.”

Nouriel Roubini is a good example of an academic steeped in theory, teaching at Yale and then in New York, while working for the IMF, the Federal Reserve, World Bank, and the Bank of Israel, posts that grounded him in public policy. He served in the White House Council of Economic Advisers under President Bill Clinton and then moved to the US Treasury to advise former Treasury Secretary Tim Geithner.

While at the IMF in 2006, he warned about the Global Financial Crisis, “that the US was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence, and, ultimately, a deep recession.” A year earlier, he observed that home prices rode a speculative wave that was expected to sink the economy. Before he got the economics right, people in the profession called him a Cassandra. Since then, he has been considered a sage. Even Nobel laureate Paul Krugman was quoted to have said that Roubini’s outlandish predictions have been matched “or even exceeded by reality.”

While the messenger of doom speaks English, Persian, Italian, Hebrew, and conversational French, having been born an Iranian Jew in Turkey, lived briefly in Iran and Israel, and studied in Italy and now a US citizen, he would always have a singular message and would stick to it for years. That is tenacity.

His latest warning against a repeat of the 1970s stagflation and 2008 debt crisis promises to be another interesting treat to central bankers and finance officials. His point of departure is the pandemic-induced extremely loose monetary and fiscal policies.

Roubini wrote on April 15 “Why stagflation is a growing threat to the global economy.” On June 30, he reiterated his arguments in another article with a catchy title “The Looming Stagflationary Debt Crisis.” And on July 2, he followed up with another article “Conditions are ripe for repeat of 1970s stagflation and 2008 debt crisis.”

Roubini’s thesis is bad news. He argues that excessively “loose monetary and fiscal policies when combined with a number of negative supply shocks, could result in 1970s-style stagflation.”

Before stagflation in the 1970s, we saw a stable relationship between inflation and unemployment. Inflation was deemed tolerable because output was growing, jobs were being created. It seemed a great brave world with a little price run-up in a condition of increasing demand and employment.

Such a relationship was debunked by stagflation — slow growth with rapidly rising inflation — which came about with the phenomenal climb in oil prices, higher inflation and joblessness, and ultimately economic recession. Most important, as Milton Friedman became very relevant in the 1970s, it was proven that “inflation is always and everywhere a monetary phenomenon.” US Fed Chairman Paul Volcker delivered the monetarist solution by escalating the policy rate to double digits, taming inflation but bringing the economy to a deep recession. The earlier 15 years of easy monetary policy disanchored inflation expectations and harmed the Fed’s credibility as an inflation fighter.

Historically, stagflation has not been associated with bursting debt ratios. High inflation wiped out debts in real terms at fixed rates. Public debt burdens in advanced economies were effectively reduced.

But high debts became problematic during the 2007-2008 financial crisis. With the asset bubbles bursting, recession resulted in weaker price movement that finally morphed into deflation. With the credit crunch, we saw aggregate demand weakening in a big way. In contrast, the shocks today are coming from the supply side.

What Roubini is suggesting is that we might be seeing the worst of both the stagflation of the 1970s and the Global Financial Crisis of 2007-2010. His analytical harbor lights include high debt ratios, expansionary monetary and fiscal policies, supply shocks for both food and non-food commodities — all tending to elevate inflation. More supply shocks could come from trade protectionism, population ageing, tight immigration policy, manufacturing re-shoring, and what Roubini called Balkanization of global supply chains.

The great risk could come from the anticipated difficulty among central banks to immediately act against inflation. Many monetary authorities during the pandemic lost their independence trying to support government pandemic measures and infrastructure spending by monetizing massive fiscal deficits because of rising public debt levels. Many governments are virtually in a debt trap. Previously the only game in town, central banks would be facing a hard choice. If they lift their unconventional policies and begin to jack up their policy rates to fight inflation, Roubini argues that massive debt problems and deep recession may be triggered. Maintaining their easy monetary policy up to what it takes to see stronger evidence the economy is already on the mend will risk both high inflation and output decline.

Bottomline, stagflation becomes unavoidable should another negative supply shock come around.

While indebtedness in some advanced economies may be mitigated by higher unanticipated inflation, emerging-market debts in foreign currency may have to be addressed either by default or basic restructuring. Corporates, banks, and shadow banks stand to lose because of interconnectedness.

If there’s a Minsky moment, or the beginning of market collapse due to speculative activities, there could likely be a Volcker moment, that which would require a sharp increase in interest rates to force a disinflation but at the expense of the real sector. A double dip recession ensued in the US after the Volcker gambit.

Our ears should be attentive to today’s possibility that the future stagflation could be a lot worse. Debt levels and ratios to national output are many times bigger than those in the 1970s. Any central bank action to tame inflation “may likely lead to a depression rather than a severe recession.” The situation could get more serious because the global economy is still recovering from negative aggregate supply shock. Loose monetary and fiscal policies are bound to lead to higher inflation or that plus depressed output.

Roubini concludes his piece by likening the forthcoming crisis to a slow-motion train wreck. Needless to say, it is into everybody’s best interest to avoid it.

This was also where we were coming from last March when we suggested the need for an exit strategy for our ultra-loose monetary policy. We recognize that domestic inflation appears to be slowing down but this is due more to the negative output gap, or because the economy is still weak. Once the rebound gains traction, we would be facing the risks of an overly expansionary money measures.

Roubini is cognizant of the counter-narrative to his thesis and it is based on technological innovation and demographic factors being offset by higher retirement age, as well as by regional integration and outsourcing of services providing the counterweight to limited labor migration. The first prevents tight labor supply from pushing wages and prices up. The second promotes the greater supply of labor beyond national borders as a dampener to higher wages and prices.

If Roubini got it right only after a few years, that means we have a window of opportunity to prepare our economy against this global threat. As a Roubini fan said: “Who knows what economic perils lie in store ahead of us because even today, we’re dissecting the credibility of the Doomsayer rather than heeding his downbeat message…”

Diwa C. Guinigundo is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was Alternate Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.