Eurozone may break up in 3-5 years: Nouriel Roubini
I n an interview with ET Now, Nouriel Roubini, Chairman, Roubini Global Economics, talks about the eurozone crisis and shares his outlook for the region. Excerpts:
Q: Will 2012 be the year in which the euro unravels and the union comes to an end?
The economic and financial conditions of the eurozone are very severe. Germany and France cannot impose their will on all the other countries because the decision of the eurozone had been taken by consensus. The trouble with the eurozone right now is that you have severe stock imbalances, large stocks of public debt, liabilities of their financial system and flow problems.
There has been the loss of competitiveness at the periphery of the eurozone. There are large external imbalances and all the policies that the Europeans are pursuing right now, fiscal austerity are going to make the recession in the eurozone worse.
Not just Greece, but a number of other countries over the next couple of years will have to restructure their public debt and private ones in a coercive way. I also expect that one or more members of the eurozone will eventually exit the eurozone.
If it is a small Greece exiting, that can be managed. If eventually it were an Italy or Spain having to exit, that would effectively be a break up of the eurozone. So of all the sources of systemic risk in the global economy, certainly the problems of the eurozone are the most severe.
Q: You do not expect a complete breakdown of the European Union? Are the concerns that are coming in on the status of the euro exaggerated?
No. Over time, not this year, some of the member states are going to restructure their debts in an orderly and in some cases disorderly way and eventually starting with Greece, but potentially even other countries could exit the eurozone.
I do not expect a break up of the eurozone in 2012, but if you take a horizon of the next three to five years, there is a meaningful prob- ability that a number of the member states of the eurozone might eventually decide to exit the eurozone and eventually a break up of the eurozone is going to occur.
The eurozone crisis is not going to be a sudden wreck. It is going to be a slow motion train wreck where initial economic difficulties, financials, fiscal then restructuring and eventually exit might occur. Separate countries will have difficulties at different points in time, Greece, Ireland, Portugal, Italy and Spain. It is not going to be a sudden collapse.
Q: How do you view the currency situation shaping up then? The last six months have been that of dollar strength. Over the next 12 months, how do you see the US dollar shaping up visa-vis the euro and how it may be over the next 12 months as also the other currencies?
Given the economic and financial difficulties of the eurozone, the euro should be weakening. There is a sovereign risk, risk of a break up. The European Central Bank is easing monetary policy while the FED for the time being is on hold. On a fun- damental basis, while Germany can live away with the euro at current level because it is over competitive, the countries in the periphery of the eurozone left to a chance to survive in the eurozone have to have a much weaker value of the euro.
The euro should be falling on a fundamental basis towards a parity with the US dollar to give a fighting chance for Greece, Ireland, Portugal, Italy and Spain to survive in the eurozone. In the next few months, as these economic and financial difficulties of the eurozone are going to become more exacerbated and the policy solutions are going to be limited, then the euro is going to weaken relative to the US dollar.
US dollar t ends to strengthen when t here are periods of risk off and risk aversion in the global economy. When there are episodes of risk aversion deriving from trouble in the eurozone or geopolitical risk, people tend to dump emerging market currencies, euro and seek safety of the US dollar, US treasuries. This is not because economic, financial and fiscal conditions in the US are very good, but the US is the least ugly in a contest where the issue is not who is the prettiest or more handsome, but who is the least ugly.
That overall might be bullish for the US dollar again, not because things are great in the United States, but just because in relative terms, they are worse in other parts of the world.
Q: We have seen some good news coming out of the US. Are these green shoots or do you believe these are one-offs which will probably taper away over the next couple of quarters?
Good news is going to be temporary. In terms of some of macro data, the US has been better than expected, but economic growth in the US is going to be anaemic this year. Subpar below trend, at best 1.5% growth year over year for a number of reasons.
First of all, the problems of the eurozone and through trade and financial links, those are going to slow down economic growth in the United States. Secondly, there will be a significant fiscal drag in the United States this year because of the gridlock in Congress.
Thirdly, since domestic demand is going to be weak because of private and public sect or deleveraging, the way that the US could grow f aster is by an improvement in net exports. However, trade balance is not going to i mprove because growth is slowing down in the rest of the world and Europe. That’s going t o be bad for US exports. Also, the dollar is going to be stronger and not weaker and that’s going to worsen the US trade balance.
Oil and energy prices are going to r e main high because of geopolitical risks in the Middle East and, therefore, the oil import bill for the US is not going to improve. Therefore, the net exports of the US are not going to improve and that’s going to be another factor that’s going to be a source of economic weakness. Finally, the US consumer is still very challenged-income-wise, wealth-wise and debtwise.
Income is not growing very much because the labour market is improving only weakly. The wealth has been sluggish because equity market has been flat and housing prices have been falling. The US consumer still has a huge amount of debt and debt servicing. The
US dollar tends to strengthen when there are periods of risk off and risk aversion in the global economy. When there are episodes of risk aversion deriving from trouble in the eurozone or geopolitical risk, people tend to dump emerging market currencies, euro and seek safety of the US dollar, US treasuries
cost of deleveraging of the US consumer has been just postponed. All these factors suggest that economic growth is going to remain anaemic in the United States in the next few quarters.
Q: What can the ECB do to replicate the US Fed’s success in re-inflating the economy?
In the eurozone sovereign and banking risks are highly interrelated with each other. The banking risk became sovereign when the banks were bailed out, but now sovereign risk has become a banking risk because a large part of the public debt is held by the banking system.
Right now there is a credit crunch and this credit crunch is becoming more severe because banks do not have enough capital, liquidity and have to reduce their leverage by essentially reducing credit and disintermediating. That’s going to create more credit crunch.
ECB is not a last resort for the sovereign, but has been increasingly playing a role of lender of last resort for their financial system. Without the liquidity support by the ECB, the credit crunch, deleveraging and the run on the banks will become even more severe.
The problem is that the ECB is going to do more to backstop the banks and the financial system, but for a number of legal and institutional reasons, the European Central Bank is not going to become a last resort lender for the sovereigns. Unlike the Federal Reserve where there is a dual mandate, growth, inflation and financial stability, the ECB has only one mandate, that of price stability.
There are legal and institutional constraints in the willingness and ability of the ECB to play a greater role.
Yes, they are going to play a greater role, but the fiscal, sovereign and financial and banking strains in the eurozone are going to remain severe. There is going to be only partial willingness of the ECB to address them.
(Courtesy Economic Times) (Part II of this interview will be published tomorrow)