“Mother of all crises” ahead?
Despite the gloomy prophecy, hopes for an economic upswing are germinating
By Diana Dittmer
10/27/2022 12:42 p.m
Nouriel Roubini aka Dr. Doom is once again living up to its reputation as a prophet of doom: High debts and rising interest rates would soon trigger the “mother of all financial crises”, he warns. There is talk of an unprecedented recession and a stock market tremor. Some data for Germany tells a different story.
If anyone can successfully paint the devil on the wall, it’s Nouriel Roubini aka Dr. doom The economist has honestly earned his reputation as a chronic pessimist over many years and crises. To his credit, he was correct in his warning of a real estate crash before the global financial crisis of 2008. Fortunately, many of his other end-of-the-world scenarios did not materialize. Apparently the time has come to try a new nightmare prophecy.
With inflation ramping up, Roubini’s latest book, Megathreats, identifies ten major threats that could usher in an era of conflict and chaos. Two of them are particularly important for investors: a possible end to globalization and a possible financial crisis due to rising interest rates and high debt.
Higher interest rates are the most important way to fight inflation – the economy dreads it. Nevertheless, the ECB is likely to follow the Fed and, in view of inflation of almost ten percent in the euro zone, raise its key interest rate again today by 0.75 percentage points to at least 2 percent.
For Roubini, the “mother of all financial crises” is unavoidable given the central banks’ aggressive interest rate policy. States, households and companies bought a lot of money when interest rates were low. They have accumulated debts that are impossible to service as interest rates rise. From Roubini’s point of view, Argentinean conditions are now fatal all over the world. The monetary authorities could only decide whether to inflate away government debt through low interest rates or protect private wealth through high interest rates. But the chaos will follow one way or another.
His conclusion: the coming decade could be marked by a debt crisis “like we’ve never seen before.” There will be “a severe recession,” he predicts, and it will be “long and ugly,” he said in an interview with Bloomberg. Is it really that dramatic? How desperate is the situation?
“Winter recession is coming”
It is correct: The macroeconomic conditions caused by the Ukraine war and the energy crisis are stoking concerns about the economy. The risks are real. Germany slides into recession. The IFO business climate index, which is considered a reliable economic barometer, fell again in October. Retail expects fewer customers because of the high prices. And the once booming construction is losing orders. “The winter recession is coming,” warns IFO expert Klaus Wohlrabe.
Because consumers consume less during economic downturns and companies also invest less, rising interest rates are counterproductive for the economy. They dampen the unwanted price development as desired, but at the same time they slow down the economy. In other words, for the national economies, things are coming thick and fast. However, the situation is not hopeless. Because despite ongoing complaints about high inflation, many prices are currently moving backwards again.
Commodity prices come back
The price of gas contracts, for example – inflation is being fueled in large part by energy prices – is already trading at pre-Russian invasion Ukraine levels. What is true for the price of gas is also true for other commodities such as aluminum, steel, gold, wheat and cotton. Economists assume that the price reductions will also reach consumers in a few months.
That doesn’t mean the times are rosy, but it does mean that the economy can and has responded by diversifying its gas supply sources. Not only the companies, but also the consumers are adapting, moving along and saving wherever possible. That has a positive impact. The poor economic forecasts have already deflated overheated sectors and bubbles. If an industry now weakens, such as house construction, prices drop. The supply adjusts to the falling demand.
Industry insiders report that calm has also returned to agricultural commodities, which had exploded. As a study by the IFO Institute in Dresden shows, many companies had built in an exaggerated price buffer to absorb an explosion in costs for themselves. Germany therefore not only has cost inflation, but also “profit inflation”, study author Joachim Rangnitz commented on the phenomenon in the “Welt am Sonntag”.
A correction was overdue. If inflation were to fall across the board, there would be no need to continue aggressively raising interest rates. It’s not that far yet. Nevertheless, when assessing the current situation – as always in crises – gut feeling is involved. That’s why a cool head is required. Despite the horror scenarios à la Roubini, there are actually other bright spots.
It is also positive, for example – in addition to the falling prices for various goods – that the order books of German industrial companies are fuller than ever. Compared to the same month last year, there was an increase of 11.1 percent. “The manufacturing industry has recorded a new high in open orders every month since February 2022,” according to the statisticians. The only fly in the ointment: In addition to high energy costs for industrial companies, the ongoing shortage of primary products leads to problems when processing orders.
Euro weakness, population growth and lower savings rate
The weak euro, which has lost 15 percent of its value against the dollar in the past 12 months, is also helping the ailing economy to get going. Above all, he helps the export companies that are important for the German economy. As reported by the Federal Statistical Office last week, German exports to non-EU countries rose by 20.4 percent in September compared to the same month last year – mainly due to strong demand from the USA. It is correct to add that the weak euro also makes imports more expensive, which in turn supports inflation. What weighs more heavily in the end remains to be seen.
The German economy should also benefit from the growing population, which at 84 million people in the first half of the year was almost 4 million more than in 2011. Five percent more residents consume more and also generate more added value. Private consumption should also benefit from the declining propensity to save. The statistics show that Germans are currently putting less money aside than at the peak of the pandemic due to the loss of purchasing power caused by high inflation. At around 11 percent, the adjusted savings rate for private households in the first half of the year is roughly the same as before the outbreak of the corona pandemic in 2019.
Viewed in this light, Roubini’s prophecy seems overly gloomy. That doesn’t make it silly or useless. In the tried and tested manner, Dr. Doom puts his finger in the wounds and draws attention to major challenges that urgently need to be mastered – and not just in Germany. The Fed’s interest rate policy is dangerous because the US is now paying significantly more interest on its debt. Officially, Germany is still in pretty good shape when it comes to debt. But the government wants to take on a total of 300 billion euros in new debt for the Bundeswehr and the gas price brake. That corresponds to at least seven percent of the gross domestic product. On the one hand, Roubini’s warning is ringing alarm bells. On the other hand, the world is not lacking in experiences of crises. So far she has survived them all.