The Primacy of Politics Returns

Nouriel Roubini

A celebrated political economist who received fifteen years of fame for identifying the housing bubble and predicting banking crisis of 2008-9 now seems to have lost hope. In a recent article, Nouriel Roubini presents ten reasons why he thinks the Corona Recession will morph into a depression later on in the decade. Mr Roubini spent the better part of his career analysing the boom and bust cycles of emerging markets. He earned his ‘Dr Doom’ nickname for a slightly pessimistic slant when dissecting events and detecting trends.

Though Mr Roubini is not one of those dark economists who adhere to a mantra of doom and gloom for years on end only to proudly claim exceptional prescient powers when at long last proved right, he does tend to emphasise the downside. Mr Roubini worries that policymakers will yet again fail to address the structural imbalances that lessen the resilience of economies to exogenous shocks and sees them nosedive at the first sign of trouble.

Given the current meltdown, which occurred only days after the World Health Organisation called a pandemic, he has a point: the recovery that followed the Great Recession of the late 2000s was not just feeble but artificial as well. Quantitative easing in Europe and large tax cuts in the United States kept the economic ball rolling, albeit without much inertia.

However, the Corona Recession is a much different beast than any of the previous downturns. It struck suddenly and with a ferocity seldom seen before. One day in March, the world woke up to a nightmare and found that the global economy had come to an almost full stop. Just as terminally ill patients realise that in the face of death, yesterday’s problems seem frivolous, policymakers discovered that their old agendas had become irrelevant.

Going into the pandemic, many countries already carried high debt loads and sustained gaping fiscal deficits. Though banks have been shored up since the last crisis, most governments have not. Only a few oft-ridiculed frugal nations addicted to austerity and other forms of self-flagellation have used the mini-boom of the last seven years to pay down debts and eliminate deficits. Whilst these holier-than-thou countries now enjoy a marginal advantage over less prudent others, worries about national debt burdens are likely misplaced. It helps to remember a bankers’ adage that only small debtors can be taken to the cleaners whereas those that owe billions can easily turn the table and hold their lender to ransom.

This is why Greece could be tossed and bossed around by its creditors in a way that Italy and Spain cannot. In any case, Italy’s predicament is much less dire than reported by most. The country’s current account is fairly balanced, deficit spending has been curbed to a commendable -1.6% of GDP, whilst its foreign assets neatly match national liabilities resulting in a reasonable net international investment position (NIIP) of just -1.9 percent of GDP. This helps explain why the Banca d’Italia maintains that any spread higher than 1 percent over the German ‘bund’ does the country a grave injustice. The picture presented by Spain and France just before the onset of the pandemic was significantly less rosy.

However, all that matters less now. The old parameters used to gauge the structural integrity of economies have become next to meaningless since the entire structure has been reshaped by the pandemic. Not only were rulebooks binned in a rather unceremonious fashion, entire laws of economics seem have been suspended for the ‘duration’.

The day of reckoning is not when debts come due but is already upon us. The European Central Bank (ECB) removed any and all restrictions from its already outsized asset buying programme whilst the European Commission, the executive branch of the EU, scrapped the Stability and Growth Pact that imposed a measure of fiscal discipline on Eurozone member states.

National governments, even those of a more frugal disposition, have not just released the brakes, but removed them altogether. In Northern Europe, fiscal deficits surpassing the 12 percent mark have become the new normal. Central bank bond desks, until a few short weeks ago departments in hibernation, have turned into hives of frantic activity, bringing in billions by the truck load.

The pandemic has sparked a political response that merely harbours an economic component. The primacy of politics has been firmly re-established, and markets will have to toe the line. This massive shift in national priorities – taking power away from the market – sets the tone for the post-corona future.

Perhaps failing to recognise the momentous nature of this abrupt and profound change, Mr Roubini and many other economists insist on applying yesterday’s criteria to today’s problems. Inasmuch as the basic rules of accounting and economic science still hold, they are, of course, quite right. Even a major pandemic does not change the laws of nature. However, once all the political posturing is removed, the reality of what is left still inspires a degree of confidence.

The difference between then and now is a fundamental one: previous crises saw the body politic act and react to appease and please markets. The current recession sees governments take charge, break taboos, and ditch orthodoxy in an attempt to preserve the fabric of the entire society – not that of just the economy. Exceptions, well known to all, apply. Interestingly, market forces seem to appreciate the bold initiative and shrug off the seemingly unending stream of bad news, trusting that the state will muster sufficient power to fend off the worse.

One tool government has is to monetise the deficit, i.e. expand the ‘narrow’ money supply as opposed to the issue of debt instruments. This is an option considered in the Eurozone as well. In a world of ‘big bazookas’, the monetisation of deficits equates a hydrogen bomb. As Brazil, Argentina, and Zimbabwe know from recent experience, printing money and other heterodox approaches to national bookkeeping results in an inflationary spiral not easily tamed. Even today, Germans still suffer a collective trauma from the hyperinflation that defined the Weimar Republic – and the national psyche.

Couple inflation to a recession and stagflation rears its (ugly) head: no growth, high unemployment, and high inflation. However, contemporary political reality is polarised to such a degree that no western government is able to tolerate a prolonged low-growth environment.

Different from the 1970s, the last time when stagflation appeared, today’s political arena in Europe and the United States is inhabited by a multitude of ultra-nationalist forces up to and including borderline fascists. The menace to societal peace, well-being, and prosperity posed by politicians exploiting the extremes of the ideological spectrum force their more reasonable peers into a careful choreographed departure from the liberal orthodoxy that went unquestioned since Ronald Reagan and Margaret Thatcher decreed the ‘end of history’.

As such, the extremists serve a purpose as they question the conventional wisdom that has led to complacency – and a certain form of pragmatic fatalism amongst mainstream politicians: ‘the world is obviously far from ideal and we’re working at it, but in the meantime that’s just the way it is’. If anything, the pandemic has reminded governments of all stripes of their reason for being. The crisis has also focussed the mind to what really matters – and that does not include debts and deficits.

Post-corona, governments will want to rebuild fast, providing jobs to the tens of millions of newly unemployed and opportunity to the businesses that managed to survive. Then as now, money will not be a determining factor: it will be found, created, or otherwise called into existence. Besides, even inflation when taken in moderation has its uses.

It is a brave new world indeed where politicians take the lead and shape the future.