The Monetary Policy Response to Coronavirus - Continued (w/ Nouriel Roubini)
ASH BENNINGTON: You talked about the massive dollar liquidity shortage that's being supported now with cross border central bank swap lines. How does that liquidity shortage develop? What's the underlying risk there? NOURIEL ROUBINI: Well, around the world, lots of people, governments, corporations, even households. In some companies, your mortgages are priced in dollars twice for various types of risk. There is a huge amount of dollar debt of the public sector, probably they issued dollar debt in euro bond markets and private sector, corporation banks and then even some households. What happens is that now, given the shock that occurred, risk off, the dollar was strengthening and the value of currencies around the world was falling. Now, in local currency, if you bought it in dollar and your currency depreciates, the real value in peso, in real, in krone, or whatever not, of your dollar that goes higher because you have a devaluation of your currency. That's called the balance sheet, the fact of having foreign currency debt when your currency depreciates and therefore, you have a risk of illiquidity and insolvency. As the currency of all these countries were going down in value, the real value of your dollar debt was going higher, everybody was essentially long dollar debt, borrowed in dollar and everybody was trying to buy dollar to hedge essentially their dollar liabilities. As people were trying to sell pesos and liras and buy dollar, their currency were depreciating, and the value of the dollar was skyrocketing, and yet this massive dollar illiquidity, not just in the US, but in Europe, in Asia, in advanced economies and emerging markets. Now, there are two solution to that. One, the swap lines within the Fed and major central banks in the world. That helps Europe and Japan, doesn't help emerging markets because most of the swap lines initially were only with ECB, BOJ, SMB and advanced economies. They complicate the rules of lending money to emerging markets directly from the Fed, and certainly US doesn't want to lend money to China. In addition to the Fed providing global liquidity and being an international lender of last resort for advanced economies, somebody has to provide liquidity to backstop emerging markets when you have a huge amount of dollar debt. The international lender of last resort is the IMF and the World Bank. If you are the Central Bank of Mexico, you can print pesos, but if you have dollar debt, you cannot backstop your firms or your government by issuing dollar by definition. The IMF and the World Bank can help emerging markets, their governments and then indirectly their firms and their banks but the current amount of capital of the IMF and the World Bank allows them to lend only $1 trillion globally. Now $1 trillion looks like a lot of money. In normal times, it is, because you have one little Argentina, or one little Turkey needs your money, so you have lots of funding and lending capacity. When you have now 50, 60 countries' government bank, the IMF and World Bank lending money, you're going to run over a trillion dollar very fast. That's why in emerging market, they need to hedge your dollar risk is in the order of $3 to $4 trillion. The Fed cannot help you, the IMF can help you only to the tune of a trillion dollar, therefore, the downside risks for many emerging markets are still severe. You need a bigger lender of last resort at the global level, you need to fund the IMF, you have to use their capital so they can lend more. ASH BENNINGTON: This is all happening against a backdrop of a collapse in global cross border trade, much of which is denominated in dollars. NOURIEL ROUBINI: Yes, it is denominated in dollars. When the dollar falls, the cost of imports for these countries go higher. Many of these economy in emerging markets also are one, commodity exporters and the price of commodities is collapsing because there is a recession, not just oil. Copper, industrial metal, and so on. These economies are also export led growth. If you have any collapse of your export because there is a recession in US, Europe and the rest of the world, you have another turn of trade shock on commodities and on exports of goods and services. You have a recession that just transmitted through commodity financial and trade channels, you have huge amount of dollar debt of these emerging markets, of the government and/or of the private sector. You don't have an international lender of last resort who is willing and able to print enough dollars or lend enough dollar to deal with this shock. That's why whenever there is a risk off in advanced economies, things go south, and we had that 30% fall in US and other advanced economies' equities. The shock in the emerging market is bigger than a shock not just to their stock market but to their debt markets. EM spreads for sovereigns go sharply up, EM spreads for corporates, not just in a foreign currency, but even local currency, they go higher. The stresses for emerging markets are much more severe. If you're in advanced economies, you can print your money, you can run a budget deficit, your market is going to strengthen. If you're an emerging market, you print money, and you're on a budget deficit, you're going to have inflation and collapse of your currency. Then you'll have balance sheet problems, and you have inflation. That's because these emerging markets don't have the same policy credibility as advanced economies. In Europe, US and Japan, we can run 10% budget deficit and print money, and everything is going to slightly improve over time. In emerging markets, you run a 10% budget deficit, you monetize it, you're going to end up like Zimbabwe, or Venezuela or Argentina. You don't have those options. Your policy options are also restricted in emerging markets. ASH BENNINGTON: The final question before we wrap up here, a place where we've seen a lot of activity has been in the FX markets, what's your outlook for the dollar, and what are you looking for in that context? NOURIEL ROUBINI: Well, usually whenever there is a risk of episode, people tend to dump other risky assets and currencies and go to the safety of a few assets. They tend to be US Treasuries, and the dollar because the dollar is considered as a safe haven currency. However, during this financial crisis and risk off episode, the dollar becomes the safe haven for say, Europe and for Latin America but the Swiss franc becomes the safe haven currency for the Eurozone, or the Japanese yen becomes the safe haven currency for Asia. During that episode between March 9th and March 20th, when everything was really, the correlation were going berserk, the dollar is going through the roof, but other safe haven currencies like Swiss franc and yen were falling sharply in value, because you had these lack of dollar liquidity. Now that the dollar liquidity problem is being normalized by the Fed, at least the Fed does it, the IMF can do it partly for emerging markets, EM currencies are going to weaken further out of the US dollar, because there is no funding, but maybe the relation between US dollar and Euro and yen is going to relatively stabilize. We are printing money like crazy, but they're printing money like crazy also in Europe and Japan. Among major currencies, probably that you'd have a currency stability. Now, over time, of course, whether the dollar goes up relative to Euro and yen depends on what happens to the economy and the markets in Europe and US relative to each other. That's harder to say. If we have another episode of severe risk off, even with the flooding by the Fed of liquidity, then if markets are going to go south and people seek the safety of US Treasuries, then they have to sell yen and Euro to buy US Treasuries, that strengthens the US dollar. The US dollar for now is still the only true safe haven, and therefore other episodes in my view, the current market has not bottomed out. People say when we fell 35%, that was the beginning of a rally. Guess what? Last week, market went up 15%, they're still 25% below the peak. They say this is the bottom. It's not the case. In any of these bear markets, and in many of these recessions, you have a fake head rally in a bear market. You have a dead cat bounce. I interpret what happened last week as a dead cat bounce or a fake head rally. Why do I say that? The entire set of policy news now is priced in. People know huge monetary bazooka, huge fiscal bazooka, that's already known and it's priced in. The two things that are not priced in is the spread of the epidemic and how bad the economic news are going to be. All the good policy news are already out and out in the market, they're fully priced. What, everyday, we're reading the contagion is spreading, US and globally worse than expected. The economic news surprise on the downside, as I said, instead of 2 million Unemployment Claims, 3.3 million. If you think about the flows of news in the next two months, the bad news on the economy and the macro and on the health situation and the contagion are going to be worse than expected. While the good economic news that central banks and governments are using their bazooka is already known. Now, there is a case in which we'll have more fiscal stimulus as a surprise. What will be that case? If the economy becomes so bad and if the pandemic becomes so worse, then we need a fort fiscal package to give money to households that are starving. If that fiscal policy surprise were to occur, it would occur only because the health news are becoming so bad and the macro news are becoming so bad that we need another fiscal stimulus. Even that surprise that we'll have a fall package is not going to be good news for the market because the trigger for that surprise on that policy is going to be terrible negative surprises on the macro and on the health situation. It's going to be awash or [indiscernible] actually the bad news are going to dominate the positive one. I fear that until we have positive news on the macro, and we have positive news on the health situation, the market can go only south. Of course, they're not going to go south in a mean that there'd be no way. Someday, they can go up, someday, the come down, but his is not the bottom of the bargain. This is not the beginning of the rally. We need to reach a point in which we've done enough testing and we've done enough suppression that we know that we're going to stop this virus, maybe two months from now, maybe three months from now. The market need to be able to price risk. They can price risk when you have distribution is known, they cannot price uncertainty when you have a distribution with fat tails. Right now, we have huge fat tails on what the health situation is going to be. Are there going to be 100,000, 200,000, 1 million, 2 million people dying of these things? We have no idea, and unless we do testing, tracing suppression, we don't know what's the end point where the second derivative becomes negative and eventually, asymptotically the number of new cases goes to zero. Once we know that the market can price in things from thereon. Once we know that the economy has really bottomed out, and we're going to see light at the end of the tunnel, the market can go up. This is a dead cat bounce. This is a head fake rally. This is not the bottom because of the reasons I discussed, and if the geopolitics, if the health pandemics and the policy response runs out the battle and instead of a greater recession, we end into a greater depression, that's not priced in. The market right now are fully pricing in a greater recession, they believe that by second or third quarter, we bought them out. Then by the third or fourth quarter, we started to grow positively. If this recession is going to continue in Q4 into 2021, because we have a greater depression, there's a 30% probability, my view, is not the baseline, the baseline is 60% greater recession, that is the probability of a greater depression occurs. In a great depression, market go down, not by 35%, they go down by 50% to 60%. Then they don't rally back. They stay down there for a while. That's a tail risk that's not priced by the market, and it's a rising thing in Greece. ASH BENNINGTON: It's all the same meta themes. It's unpredictable tail risk, asymmetric downside risks, unknowns, and unknowables breakdowns of historical correlations, and really, an uncertain outlook. Nouriel, thank you so much for joining us. In conclusion, we've gotten a lot of information, what should people be looking for very specifically, key data points going forward that might influence the chain of events that may unfold. NOURIEL ROUBINI: First of all, as I said, you have to be defensive. This is not the bottom, it could be a fake head rally. It's not the time to plunge into risky assets. You have to look, especially at the contagion, at the health situation. Is there light at the end of the tunnel? Is the second derivative of the contagion becoming negative? Is that asymptotically at time, May, June or July, when the number of new cases are going to go to zero? That's going to be key. What's the healthcare response? Are we going from mitigation light into true mitigation? Are we going from mitigation to suppression? We're not going to go into full suppression, we're going to do these mitigation, things are going to get worse. That's a key. Secondly, the market economic data in my view, for now, are going to surprise on the downside, growth, unemployment, defaults and you name it. Until we start to see things are priced in fully, and the economic news on the micro becomes surprised on the upside, rather than the downside, we're not going to see it through bottom. You have to look at the macroeconomic news and you have to look at the health news. Those are the two key things to understand when we're going to bottom out whether this is going to be a greater recession or greater depression, and when there is light at the end of the tunnel. It's not yet at the moment, but you have to monitor all of these factors, the health ones and the macro ones and of course, the policy, but for now, the policy is priced in ASH BENNINGTON: Nouriel, thank you for joining us. NOURIEL ROUBINI: Good being with you today. Thank you.