Dr. Roubini:  I disagree with several things.  You wrote: “I expect no more than 1.5% growth for Q3, 0% for Q4 and outright recession by Q1 of 2007.”  First of all, “Wow! You are a pessimist!” I understand that 2.5% GDP growth of 2Q2006 was a bit lower than 3.0% widely expected. But it is really not the end of the world. We have gone from 4.2% in 3Q 2005, 1.8% in 4Q 2005 and 5.6% in 1Q 2006. Hence, the downward outcome in 2Q 2006 was obvious, and I expect an upward outcome in 3Q 2006, say 2.8% or at least 2.5%.  During the recesssion in 2001, unemployment rate surged from 4.3% in May 2001 to 5.7% in December 2001. That is a gain of 1.4% in five months. It is hard to imagine the current unemployment rate of 4.6% in the US reaching anywhere close to 6% by the end of this year.   Monetary policy is being tightened everywhere indeed, but I believe the hikes in the European countries are near over, maybe 50bps gradually at most. BoJ will certainly not raise any more than 25bps more for the rest of the year. Inflation rate throughout the world may not die down easily and many emerging economies may have to continue to rise a bit more. But that’s all trivial once the Fed stops hiking, and everybody today agrees that the Fed will pause on August 8th or raise 25bps more and pause for a while. Both stock market and bond market are already celebrating the end of the Fed rate hike. You may call this a knee-jerk reaction, but this knee-jerk reaction may stick around a bit, perhaps during the entire 3Q maintainign the GDP growth at where it was in 2Q.   In England, even though BoE raised its rate today, due to the pause at 4.75% since August 2004, the real estate sector in UK has already recovered. For example, morgage approvals have risen from 76 thousands in November 2004 to 120 thousands in June 2006. Not the same, but similar outcome can occur in the US.  You argued that the housing bubble bust in the US is becoming dramatic lately. Yes, the residentail investment in 2Q GDP Growth summary showed a decline of -6.3%. But look at the latest reports. The market is expecting a pause; hence, they are trading most Treasuries below 5%; the current 10-year is trading at 4.953% for example; hence, the mortgage rate has dropped significantly in the last two weeks. Pending Home Sales MoM in June was 0.4% while the market expected -0.5%. Construction Spending MoM was 0.3% in June while the market expected 0.1%.   Recently announced, the growth in total employee compensation was revised from 4.6% to 5.5% for 2005 and from 5.0% to 6.8% in 2Q 2006. That is a positive sign for more consumption to come.   Taking this opportunity, I also disagree that China will move big in the near future. Andy Xie has pointed out that the last revaluation of RMB in July 2005 was timely because it was right in the midst of the Fed rate hike and the USD appreciation. Now that the Fed rate hike will stop and the USD will depreciate, China has no incentive to let RMB appreciate. You say “Yes, inflation in domestic.” But I believe they will keep its rate around 7.9-8.0, make it clear that speculators will not profit and raise PBoC Rate. Moreover, as your partner Dr. Setser argues, if the USD depreciates, RMB depreciates against the rest of the world’s currencies as well. That attracts more hot money as it did in 2000 and 2001; less incentive for PBoC to reward speculators.

Just read that the European Commission is heading towards a number of bilateral trade agreements (Mercosur, ASEAN, Russia) and, miffed over the US decision to drive a stake thru the heart of Doha, leaving the US out in the cold.  

Prof. Roubini.  Though I have to admit I’m more inclined to agree with your predictions than not, there is a glimmer of hope that I have that I leave open to your deductive skills. It concerns the no decoupling argument.  1. Trade links are important in transmitting shocks from the US to the rest of the world, especially for countries that export a lot – directly or indirectly – to the US (China, East Asia, Mexico, Canada, etc.)  - Accepted.  2. The oil and commodity price shock is a shock that is common to the US and many other oil and commodity importing countries; actually EU, Japan, China, India depend on oil imports more than the U.S. does.  - A slow down in the US, combined with a drop in the dollar relative to other currencies should buffer commodity price increases and perhaps create a reverse trend in prices for respective areas. This would reduce reserve accumulation in Oil producing nations, and hit EM’s hard, but would be a positive for oil importing areas such as China, Japan and the EU.  3. Monetary policy is being tightened in the US and many other economies given global concerns about rising inflation. The era of cheap liquidity is over. See ECB, BoE tigthtening decisions today and the end of ZIRP in Japan.   - Monetary policy though tightening in all markets should remain historically lax. This due to the effects of reduced commodity and oil prices as mentioned in 2. geostrategic shocks notwithstanding.  4. Housing bubbles are bursting – or flattening – not just in the US (where the bust is becoming dramatic lately) but also in many other economies as easy liquidity had led to housing bubbles in many parts of the world.  - About time. Though in the EU, with the exception of some markets, the housing bubbles had only just begun. Soft landings can well be expected, rather than systemic shocks to the housing market. Japan has not experienced this house bubble, neither has Germany, and I suspect, real interest rates of one or two percent would provide a floor Europe wide, whilst real interest rates in Japan will probably remain negative for some time yet.  5. The recent fall in equity prices – during the May-June turmoil and the coming one once the U.S. slowdown dawns on Panglossian investors – will not be just US based; it will rather global and more severe in the rest of the world than in the US as foreign markets are more illiquid than the U.S. one (see what happened to EM equities and to the Nikkei and EU stocks in May-June); it will thus have negative effects on global consumption and investment spending and on business and consumer confidence in many economies.  - Accepted with caveats. Depends on exposure of national banks in EU to equity markets, lots of small and medium size businesses, receive funding through national banks as opposed to stock options. This is particularly the case in Germany where post dot.com bust, many banks got hit hard creating a negative credit climate for many businesses. This is one of the reasons for much of the Hartz IV reform in Germany and the opening to “the vultures” as they called US and UK investors. It’s an important point, economies are not just made up of large corporations and stock markets.  6. The weakening of the US dollar following the US slowdown will lead – and is already leading – to the appreciation of the Euro, Yen and other floating currencies. Given the tentative recovery of the Eurozone and Japan, this appreciation will hurt net exports and growth.  - If, and that is if, consumer demand is finally beginning to take off in Europe, that should provide some buffer against the burnt out American consumer. Further a significant portion of the exports from Germany are capex. It really depends to what extent the global slowdown affects all parts of the markets. Further, I believe that there is a higher tolerance for currency appreciation, and even an imperative, and in the case of some countries could help produce increased aggregate demand. There of course are limits, but I won’t be too quick to state where those limits are. The risk for Europe from a dollar depreciation is deflation as opposed to stagflation in this scenario.  7. Foreign direct investment (FDI) is another channel of transmission: when the US slows down the sales in the US of US-producing affiliates and subsidiaries of foreign firms fall, negatively affecting the profits of such firms in their home base in Japan, Europe and around the world.  - Accepted, with caveat, not everything made by US companies abroad is directed back to the US consumer.  8. Risk aversion rose globally in May-June and investors are still a nervous wreck given all the macro, financial and geopolitical uncertainties in the world; thus the downturn in markets will negatively affecting “animal spirits”, i.e. business and consumer confidence. Already the mood of global CEOs has totally soured based on the Goldman Sachs poll.  - In spite of this “animal spirit” depreciation, interest rate rises, etc, etc, M&A are still going ahead, businesses are still borrowing to invest. For how long I don’t know.  http://www.ireland.com/newspaper/breaking/2006/0804/breaking36.htm  9. The US and G7 slowdown will have negative growth and financial effects on emerging market economies that, until recently, had widely benefitted from high global growth, high commodity prices and low global interest rates. Lower global growth, lower commodity prices and reduced global liquidity will have negative effects of the real economies of emerging markets, as the May-June sharp market selloff in these markets has already signaling.   Accepted with caveat. Just what are they going to do with all those reserves being built up by oil producing nations. There is a wild card there.  10. The last four global recessions have been characterized by an oil shock and an inflation scare that led to monetary tightening and stagflationary outcomes. The same is happening this time around and global business cycles are highly correlated.   Accepted again. However I don’t think there is a set hierarchy of who will suffer most and least. Ok, EM’s excepting oil producers of course will suffer most, but with the rest it really does depend on both structural and adaptive responses.   Another interesting correlation with recession is war. I hope not but with the current Mafia running the US I won’t hold my breath.  11. There is now a serious risk of a systemic financial crisis – as in the 1987 stock market crash or the 1998 LTCM near collapse. The factors that led to systemic risk in previous episodes of systemic financial distress are present again today.   The scary one, all bets are off if that happens. And i wouldn’t bet against it happening.  12. Unlike the 2001 global downturn there is little room for monetary and fiscal policies to be eased to deal with the global slowdown; while exchange rates are now a zero sum game as, in a slowdown, most G7 economies will want to avoid an appreciaton of their currencies. Thus, the risks of trade and asset protectionism are rising in a global economy with large and increasing global imbalances and geostrategic risks.  Accepted again.  Some additional comments:  1) Arguably the US is in stagflation already and has been for some time. Remove hedonics and other manipulations from both inflation figures and GDP and you get a negative GDP, much hig
her inflation, and not to forget, much higher unemployment rate than is reported.   2) This manipulation has been in practice for sometime, and has required lots of people to say “I believe” to keep it going. In fact almost everyone. If you were to use European methodology, or US methods from 20 years ago, you would have seen that the US was growing in the past 5-6 years only in nominal terms, in real terms the economy has been in decline. Nothing like negative interest rates to mask that fact.  3) At risk of sounding like a Panglossian optimist, god help me, I’m not inclined to believe that the future is as clear cut as you make it out to be. It may yet hold a few surprises. It might be worse than you imagine, or no where near as bad, though the balance of risks are clearly in the negative.  4) Great Blog by the way.

The wallstreet got your message, professor. Now they act the way they should : fall on bad data.

AIC: i am not very good at giving a timing about stock market movements, let alone collapse. The only thing i can say with some certainty is that, once the markets wake up from the delusional panglossian dreams of continuation of goldilocks and realize the reality of a coming US recession, you will have a bear market with most indexes down 10 to 20% relative to current levels. Asian markets could do slightly better relative to the US but once the US slowdown leads to a global slowdown even Asian markets will underperform. in a US and global slowdown all equity markets will hurt. 

According to Google Trends, it seems that mention of and searches for recession has remained fairly stable for the last year, although stagflation is picking up nicely. Note the news mention item on the bottom of the chart.  http://www.google.com/trends?q=recession%2C+stagflation&ctab=0&geo=US&date=all

CBPGs (Chattering Baboons of Panglossian Goldilockism)–good one, Dr. R. It will be good to see the smirks wiped off the faces of those PWRTGs (Pollyannas Wearing Rose-Tinted Glasses).   Huge imbalances resulting from irresponsible behavior by virtually all parties concerned will be unwound quite spectacularly because none of them seems alarmed enough to take positive steps to resolve the situation.

“CBPGs (Chattering Baboons of Panglossian Goldilockism)–good one,”  It needs much more alliteration to be really effective. “Blabbering baboons/chattering chimps of Panglossian goldilockism” are a little closer but nowhere near good enough. It’s harder than you think.

Dr. Roubini, Someone once said that ..If something cannot go on…then it must end.  Your arguments are extremely convincing.   Its really absurd the way analysts and economists on business channels continue to talk up the US economy and the strength in the global economy,at a time of uncertainty and as we head to an end to the excesses enjoyed over the last 3 years.  When the recession comes through, what would be the impact on gold prices? Would there be an accelerated effort by central banks to rebalance forex reserves.. firstly to non US Dollar Currencies…and maybe then to non fiat currencies such as GOLD.

I enjoy Nouriel Roubini’s economic writings, but I have to admit, I’m disappointed that he repeats the old unproven assertion that a rise in the yen will hurt Japan’s net exports. This is one of those often-repeated assertions that sounds so obvious on its face that it doesn’t merit discussion. But in the real world, this has never proven to be the case. The yen has steadily been climbing now since the end of WWII (when it was valued at 360/one dollar). Despite the rise in the yen’s value, Japan’s exports have consistently set new records, year after year. Indeed, Japan’s current account surplus is today vastly higher than it ever was during the late 1980s (when the Western media was fretting about the “unstoppable” Japanese economic juggernaut that was supposedly on the verge of conquering the world). The bottom line is: there is zero evidence that a rising yen poses any real threat to Japan’s export prospects, despite the conventional wisdom. A good part of the reason for this is that Japan has long specialized in the sort of ultra-high-tech industry that has enormous entry barriers for would-be competitors. In a growing number of cases, Japan is the world’s SOLE producer of many of these ultra sophisticated products. If the yen rises in value, then Americans simply have to dig deeper in their pockets to pay for them. As an example, there is only one nation on earth that is currently capable of producing the ultra-high-tech wings that will be used in Boeing’s upcoming Dreamliner. That nation is Japan. If the yen rises in value, Boeing will still have no choice but to source from Japan: the only nation with the ultra-sophisticated manufacturing know-how to produce this product. On a side note to the conventional economist types who believe that Boeing outsources production because of lower wages overseas, I’d like to point out something. Japan has some of the world’s highest wages–indeed wages in Japan are some 20 to 30 percent higher than American wages.