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Nouriel Roubini's Global EconoMonitor

Is Capitalism Doomed?

The massive volatility and sharp equity-price correction now hitting global financial markets signal that most advanced economies are on the brink of a double-dip recession. A financial and economic crisis caused by too much private-sector debt and leverage led to a massive re-leveraging of the public sector in order to prevent Great Depression 2.0. But the subsequent recovery has been anemic and sub-par in most advanced economies given painful deleveraging.

Now a combination of high oil and commodity prices, turmoil in the Middle East, Japan’s earthquake and tsunami, eurozone debt crises, and America’s fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion. Economically, the United States, the eurozone, the United Kingdom, and Japan are all idling. Even fast-growing emerging markets (China, emerging Asia, and Latin America), and export-oriented economies that rely on these markets (Germany and resource-rich Australia), are experiencing sharp slowdowns.

Until last year, policymakers could always produce a new rabbit from their hat to reflate asset prices and trigger economic recovery. Fiscal stimulus, near-zero interest rates, two rounds of “quantitative easing,” ring-fencing of bad debt, and trillions of dollars in bailouts and liquidity provision for banks and financial institutions: officials tried them all. Now they have run out of rabbits.

Fiscal policy currently is a drag on economic growth in both the eurozone and the UK. Even in the US, state and local governments, and now the federal government, are cutting expenditure and reducing transfer payments. Soon enough, they will be raising taxes.

Another round of bank bailouts is politically unacceptable and economically unfeasible: most governments, especially in Europe, are so distressed that bailouts are unaffordable; indeed, their sovereign risk is actually fueling concern about the health of Europe’s banks, which hold most of the increasingly shaky government paper.

Nor could monetary policy help very much. Quantitative easing is constrained by above-target inflation in the eurozone and UK. The US Federal Reserve will likely start a third round of quantitative easing (QE3), but it will be too little too late. Last year’s $600 billion QE2 and $1 trillion in tax cuts and transfers delivered growth of barely 3% for one quarter. Then growth slumped to below 1% in the first half of 2011. QE3 will be much smaller, and will do much less to reflate asset prices and restore growth.

Currency depreciation is not a feasible option for all advanced economies: they all need a weaker currency and better trade balance to restore growth, but they all cannot have it at the same time. So relying on exchange rates to influence trade balances is a zero-sum game. Currency wars are thus on the horizon, with Japan and Switzerland engaging in early battles to weaken their exchange rates. Others will soon follow.

Meanwhile, in the eurozone, Italy and Spain are now at risk of losing market access, with financial pressures now mounting on France, too. But Italy and Spain are both too big to fail and too big to be bailed out. For now, the European Central Bank will purchase some of their bonds as a bridge to the eurozone’s new European Financial Stabilization Facility. But, if Italy and/or Spain lose market access, the EFSF’s €440 billion ($627 billion) war chest could be depleted by the end of this year or early 2012.

Then, unless the EFSF pot were  tripled – a move that Germany would resist  – the only option left would become an orderly but coercive restructuring of Italian and Spanish debt, as has happened in Greece. Coercive restructuring of insolvent banks’ unsecured debt would be next. So, although the process of deleveraging has barely started, debt reductions will become necessary if countries cannot grow or save or inflate themselves out of their debt problems.

So Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labor income, increases inequality and reduces final demand.

Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China – and soon enough in other advanced economies and emerging markets – are all driven by the same issues and tensions: growing inequality, poverty, unemployment, and hopelessness. Even the world’s middle classes are feeling the squeeze of falling incomes and opportunities.

To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.

The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.

Over time, advanced economies will need to invest in human capital, skills and social safety nets to increase productivity and enable workers to compete, be flexible and thrive in a globalized economy. The alternative is – like in the 1930s – unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.

Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics.

This post originally appeared at Project Syndicate.

12 Responses to “Is Capitalism Doomed?”

brilliantjamesAugust 19th, 2011 at 9:38 am

Think outside the box on QE3. It should be bottom up not top down? Use QE3 to pay off credit cards, banks receive liquidity, consumer returns to shop and ecomomy returns to growth. Brilliant?

EmpiricoAugust 19th, 2011 at 10:31 am

Bonjour

Nouriel Roubini is one of the best & brightest minds of this decades.
All the best .
Merci
Waltz Lannes ( which is a proxy…)

(Bonjour Nouriel. We have many common acquittance, among the others NNT, Didier Sornette….)

VamAugust 19th, 2011 at 10:52 am

What interests me in this whole situation is the global lack of leadership. The political cultures of the world’s major, and not so major powers are remarkably similar on this point. Maybe because the current generation of leaders grew up in a world with an established orthodoxy, where since at least the 80s both left and right have been pretty much right-wing. I believe the international system is rotting because it hasnt been salted with enough socialism.

Hayes77August 19th, 2011 at 12:03 pm

RGEmonitor was the premier econo blog in the day but for whatever reason was shutdown by the professor, so it is nice to see that Roubini has created this new version of RGE.

The busine$$ of econo blogs is huge (just ask Mr. Blodget or Mr. Durden) and when RGE closed its doors it was a windfall for them and others (especially Zero Hedge).

There is a large RGE diaspora that will hopefully discover Nouriel's economonitor blog.

johnlewisgrantAugust 19th, 2011 at 12:06 pm

The comment on Marx has provoked strong reaction in some quarters. Politics aside, I think Roubini is quite right. Marx, love him or hate him, opined inter alia that Capitalism's crises were built-in, cyclical, and inevitable. Overproduction coupled with underconsumption, if you will, are built in to the system and make these cyclical (or "secular") crises ineluctable.

But Marx was also an inveterate materialist/objectivist; so he would have readily acknowledged that once the nature of these crises was understood, just like any natural phenomena, economists–like scientists–could take steps to dull their impact.

The difficulty is that in a competitive environment (both policial and economic) no single corporation, sector, social class, or nation state wants to make the first move, for fear of leaving itself vulnerable economically, politically, militarily, etc., as the case may be. That, again, is the achilles heel of capitalism. Collective decision-making does not come, shall we say, "naturally." And, regrettably, it is not an egalitarian economic system either. Even if corporations, banks, countries, and entire economic markets can manage a co-ordinated response, one or more of the various "sectors" into which captalist economies can be conveniently divided will take a hit at the expense of some other "sector".

maolivieAugust 19th, 2011 at 1:20 pm

Talk about a generation of lost wealth. My thoughts on the number one thing that is keeping us in the whole is education debt. We are socialized in America into this idea of buying your way into a certain lifestyle by attending university, no matter the cost. You want to know why no one is buying houses? It's because the generation that should be buying their first house is not making the purchase – is it an income issue? Do they know something that none of us know? Or is it their debt to income ratio? For sure it is the latter. And at this stage in their life (pre-mortgage), the debt that is consuming their income is education loans (The avg. student exits school with $30k in bills which takes many years to pay back).

So what are the consequences? The most obvious is the lack of home purchases. The cohort of post grads that are indebted to the dept. of ed. are not buying homes and will not be for many years to come. The second is that the system is crushing entrepreneurism – another pseudo Marx argument that edifies his theory of economic stages (capitalism progresses into socialism). Without entrepreneurism, the future of multi-national corporations birthed in America is bleek, households with high incomes are minimized, tax revenue decreases, etc.

I like the idea of a top down approach with QE3 presented by brilliantjames. However, we need a more targeted approach on how to move monetary policy into a higher valued use. My recommendation would be to use it for education loans. Reasons for this are: 1) assuming education increases human capital, an education loan bailout will be a stimulus that could catalyze a thriving workforce (as opposed to a workforce) 2) it could be the solve to the housing crisis since it then opens up the income of the post grad cohort to a higher valued use – such as a home, as opposed to a lower valued use such as the dept. of ed. 3) It will grant those that would have become entrepreneurs had it not be for their debt, another opportunity to start a business now that they will no longer be slaves to the dept. of ed.

Thoughts?

DrembahAugust 22nd, 2011 at 12:48 am

The Great Depression was caused by WWI, clearly, and was exacerbated by SmootHawley, not by the causes he lists.
It is true that Europe’s market socialism has failed; as have areas of the US (the Rust Belt, California) where large, intrusive governments control vast swathes of the economy.
Large infrastructure projects have been tried in the past as stimuli. They almost invariably add to debt, provide little long term employment
gain, and waste resources.
The best solutions include avoiding stagflation whipsaws, keeping growth killing taxes and reg at low or lower levels, and heavily reforming America’s failed civil service and education sectors.
Once the world’s largest economy recovers, the rest of the world can follow, assuming they abandon failed statist models of governance.

drewmbahAugust 22nd, 2011 at 12:58 am

It’s also impossible for capital to not be deployed; deposits are lent or invested as wealth is created.
So a “shift from labor to capital” is by definition impossible.
Employment will resume once structural issues are resolved and illusory real estate and asset gains are purged from the market, allowing expansionary cycles to resume.

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