A vision of gloom and chaos

By Felix Salmon
September 9, 2010
Ian Bremmer and Nouriel Roubini have delivered a 4,000-word thumbsucker on the global political economy. Essentially, they take Mohamed El-Erian's idea of a "new normal" and start getting very specific about where and how it's going to fall apart. And it's hard to disagree with things like this:

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Just in time for the new year, Ian Bremmer and Nouriel Roubini have delivered a 4,000-word thumbsucker on the global political economy. Essentially, they take Mohamed El-Erian’s idea of a “new normal” and start getting very specific about where and how it’s going to fall apart. And it’s hard to disagree with things like this:

G-20 heads of state will gather in Seoul in November, and there will be plenty more such summits in years to come. Yet policy responses to transnational problems will continue to be improvised and incomplete. U.S. negotiators will resist any institutional framework that allows foreign leaders to impose binding rules on Washington. China will stoke growth to create new jobs, managing development to try to prevent crises that could provoke the kind of social unrest the state can’t contain. Russian leaders will continue to try to attract foreign investment while extending state control across strategic sectors of the domestic economy and using the country’s energy resources as geopolitical leverage. India will pursue trade liberalization at its own pace. Brazil will try to use its newly discovered offshore oil to enable state-run oil company Petróleo Brasileiro to become an ever-more useful tool of economic policy. Saudi Arabia will use its still-considerable reserves to help manage oil prices and will act as producer and lender of last resort when it finds good value for its money. Efforts to move these governments toward harmonious and effective policy responses to problems that extend beyond the financial crisis — collective security, counterterrorism, climate change and global public health emergencies — will fall short.

The result is that the historical guardians of prosperity and growth will shrink in importance, to be replaced by mechanisms which are much more likely to fail.

State capitalism will produce a reversal in the trade and capital account liberalization of the past several years as protectionism breeds more protectionism…

The emergence, virtually overnight, of the formerly obscure G-20 as the world’s preeminent economic policymaking body provides a glimpse into a more chaotic future. It also suggests that the old levers of hegemonic stability and influence exercised so expertly by the British in the first golden age of globalization (roughly 1880 to 1914) and by the U.S. in the second (1989 to 2008) will have far less purchase in the new, postcrisis age.

By the time that Bremmer and Roubini work out what this all means for markets, the line of hypothetical causality is long and therefore no prediction can carry any great degree of certainty. But there’s no good reason why this shouldn’t be true:

The reopening of the fire hoses of credit and capital that occurred during the bubble years will happen again and intensify the boom-and-bust cycles. Driven by ever-more- desperate policymakers in the U.S., Europe and Japan, these cycles will both shorten and magnify. Political, policy and regulatory uncertainty will increase, and as a result, financial crises will become more frequent and costly, while risk aversion, volatility and uncertainty will rise. The illusions of the Great Moderation — a phrase coined by Harvard University economist James Stock to describe the two-decade period that started in the late ’80s, with its quasireligious embrace of market efficiency and infinite American power — will have created the era of the Great Financial Instability. And nothing could hasten the decline of American influence more than another self-inflicted catastrophe of global market capitalism.

Investors don’t even need to believe this; they just need to protect against it in order for it to start becoming self-fulfilling. The dot-com crash came from people taking too much risk, and was relatively harmless. The recent financial crisis was a consequence of too much risk-aversion — everybody piling into paper carrying the magical “AAA” branding. That kind of crisis is much more damaging. And risk-aversion is at least as prevalent now as it was during the Great Moderation: just look at the disconnect between fluffy bond prices and modest stock prices.

In order for capitalistic animal spirits, especially in fast-growing economies, to rescue us all from a series of horrible financial earthquakes, everybody’s going to have to become a lot less risk-averse. And I don’t see that happening any time soon.

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Comments
6 comments so far

So I guess it’s all over, then, civilization will come crashing down in the next year or two. What will happen to you, Felix? Reuters will be out of business – in fact, EVERYTHING will be out of business – but at least you will be proven correct, along with your hero Nouriel Roubini. I suppose that will prove a comfort to you trying to survive in a post-apocalyptic world, where no one will give a tinker’s damn about your opinion on anything.

Posted by Gotthardbahn | Report as abusive

I don’t think that’s what he’s saying, but that he agrees with Roubini et alia that we’re never going back to the Great Moderation status quo ante. Naturally, caveat that I am not he.

While I maintain some confidence that we can muddle through economically, the state of the world’s fisheries as indication of its ability to work collectively to solve collective-action problems makes me pretty depressed. If it were just fish, I’d shrug and live with the inevitable species loss. But global warming is a collective-action problem, too.

Posted by wcw | Report as abusive

Basically, bull. The notion that credit bubbles will reemerge denies the reality of how the last several bubbles have played out over time. Internet stocks trade at less than 20 times earnings, and telecom never much frothed again (a short rally around 2006 was capped by a BusinessWeek cover that invoked The Curse). Commercial real estate is still conservatively financed, and collapses are few even as the market struggles with elevated vacancies. People actually do learn their lessons. Banks will be cheap for years, they will be run on much less leverage permanently, and Fannie Mae or its successors will never, ever repeat the mistakes of 2003-05. They’ll find new ones to make.

The dot-com boom wasn’t much risk at all actually. The risk of loss was quite high but the amounts invested, systemically, were quite modest. And if you stick to just the dot-com companies — i.e. online media and commerce, and set aside the telecom and “infrastructure” plays — they were back in the black, in aggregate, by late 2002.

The experience so cured corporate decision makers of risk tolerance that they did, as you say, choose financial engineering over engineering for a decade. And we all see the results.

Posted by jerseycity64 | Report as abusive

Felix:

First, please accept my apologies for not posting in support of the 95% of your articles I fully agree with. Also, please forgive me if I misinterpreted this as your true voice and not as the irony with which you intended it. But this line really floored me:

“The recent financial crisis was a consequence of too much risk-aversion”

I could agree that the crisis was a result of the misperception or risk (hence AAA ratings) or the mis-pricing risk, but not the lack of appetite for risk. It was a gluttony for risk pre-2008 that led us to the current condition of extreme risk aversion.

As for the Bremmer/Roubini article, it seems to boil down to this argument:

“U.S. supremacy post-WWII led to the remarkable prosperity we find ourselves in now. By contrast, now that governments representing the majority of the world’s population have earned seats at the table, there is no hope for compromise between global mutual interest and national interest.”

The argument that a more inclusive global political scene leads to *more* volatility is flimsy. The more reasonable outcome is increased ’30s-style protectionism resulting in a longer recession. However, western central bank policy and corporate regulation failed to provide outcomes that good for the world as a whole, nor for those western powers themselves. Hopefully more voices in the discussion will lead to somewhat more rational policy in the future.

Re/ prospects for compromise and consensus in a G-20 era, failure at Copenhagen is good source for pessimism. But Kyoto, albeit flawed policy, showed that national interest and global consensus are compatible, even without U.S. participation. The authors provide no valid reason why the same compromise shouldn’t be possible toward a return toward healthy economic growth.

Let’s hope for an optimism pill to bring back appetite for risk, but let’s take a half dose this time, not whatever we were all smoking for most of the previous two decades.

Posted by michael8 | Report as abusive

Don’t see what’s so revolutionary or terrifying here… sounds like common sense to me: emerging markets are finally truly emerging, and as a result investing in ‘the West’ isn’t the best play in town anymore. I could be wrong but it sounds like you’re arguing that the world needs to come to together to keep ‘the West’ at the pinnacle of the world economy and keep other players out.

Posted by CDN_finance | Report as abusive

I have to chime in and say that I agree with Michael above. The idea that the problems of the last few years were brought about by risk aversion is one that you’ve expressed several times in the past, but that just doesn’t quite sit right with me.

Just because people piled into securities that were (misleadingly) rated AAA doesn’t mean that they were risk averse. It means that they were sold a product that was too good to be true. High returns with little perceived downside. Why would you buy stocks when you can buy mortgages? It’s not risk aversion, it’s risk ignorance.

How about the person that uses a credit card with a 0% interest rate but then doesn’t read the fine print (6 month teaser rate then 27% thereafter)? Is that person risk averse? If they were, then wouldn’t they have opted for the credit card at 4% interest? In my opinion, there’s a difference between aversion to cost and not actually knowing the cost.

Posted by spectre855 | Report as abusive
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