Arnab Das: We Are Caught in a Trap of Excessive Debt

By
Arnab Das, managing director of research and investment strategy at Roubini Global Economics

Arnab Das, managing director of research and investment strategy at Roubini Global Economics, began his speech at the CFA Institute Middle East Investment Conference in Dubai, United Arab Emirates, by outlining a global debt crisis in which we are all caught in “this trap of excessive debt”.

Das argued that the most important parallel issues are the distribution between creditors and debtors and the balance between future and present economic activity. Central banks have sought a way out of the macroeconomic crisis by smoothing consumption through expanding public sector balance sheets. But debt, defined as spreading the cost of current investment over the future, has, as Ken Rogoff and Carmen Reinhart have pointed out, brought too much future activity to the present.

Creditor countries, such as Japan, Germany, China, and some Middle Eastern countries, are caught in the middle of this trap because their client states (countries they have lent money to) are so overleveraged. Yet money, Das says, is not the same thing as capital. Central banks have been “reflating assets as a way of maintaining wealth and mitigating liability problems,” but they are “unwilling to grapple with the fact that there is a liability problem because there is a redistributional problem”. This redistribution between creditors and debtors, between the present and future activity, has to be solved eventually.

Inflation is a key mechanism in this redistribution, but inflation is not about money alone: It is also about velocity and the multiplier. Das points out that over the financial crisis, the level of broad money has come down very sharply, along with velocity and the multiplier. Central banks have “smoothed out a drastic deleveraging that would otherwise have taken place,” Das said.

For the United States, there has been political concern and public anger about reflating the public debt beyond anything seen outside wartime, but this reflation has been necessary to “keep everything going,” Das said. There are significant constraints on exiting the strategy, one of which is inflation — which Das believes is likely to be restrained, not least by fiscal drag from the budget sequestration and the fiscal cliff. Das expects below-trend U.S. economic growth this year of 1.5–1.7% with unemployment remaining elevated. Inflation will only return as a credible risk when credit and the velocity of money and the multiplier takes off and the adjustment is complete.

A key problem for the United States, Das said, is the “danger of asset inflation leading to bubbles”. The liability problem in the United States is being dealt with by reflation of assets and the “long period of easy money”. Although fiscal adjustments are a drag on inflation in the wider economy, asset bubbles can appear in various parts of the capital markets quite easily in the current environment.

Arnab Das, managing director of research and investment strategy at Roubini Global Economics

Arnab Das, managing director of research and investment strategy at Roubini Global Economics speaking at the CFA Institute Middle East Investment Conference

For Europe, Das sees large imbalances and a lack of union with many parallels in early American history. Mario Draghi, president of the European Central Bank (ECB), has so far managed to deflect opposing forces and bond spreads have managed to narrow. The ECB has suppressed the right hand tail risk of a collapsed euro but at the expense of increasing the left hand tail risk of slower European integration. In Europe, the choice is between mutualization and integration, politically or through the ECB balance sheet, and Das thinks Europe is actually being mutualized through the ECB balance sheet. Unfortunately, a consequence is that the peripheral countries are seeing fiscal cuts, savings rates forced up, and depression conditions emerge. Savings rates remain high in the Northern European countries, which have unrecognized losses on their balance sheets. Overall, the eurozone is heading for a current account surplus.

Elsewhere, the current account of Japan has recently gone into deficit but is likely to push back toward a surplus. China’s current account surplus has collapsed but still stands at around 3%. Some MENA countries also have large surpluses. So Das asks: Where are all of the current account surpluses going to go? The answer will be in capital outflows and central bank reflation. Ouflows will mainly go to the United States and emerging markets. Consequently, Das thinks there is a risk of asset bubbles in the United States and in emerging markets. “MENA has a substantial risk of being caught up with bubble risk,” added Das.

Das said that instead of dealing with the underlying fiscal issues, we are instead reflating assets. Central bank policy is sub-optimal and highly politicized. But Das does not see this leading to competitive currency wars, which featured in the Great Depression era. Now it’s more about dealing with the distributional issues between creditors and debtor countries.

In the Q&A session following his presentation, Das declared that the United States is in much better shape but suffers from a “lack of courage to deal with the redistributional issues”. He dismissed gold bugs outright, explaining that gold only works in two fat tail scenarios: deflation (when paper certificates of gold become useless) or high inflation, neither of which is expected to occur. Das was fairly confident about oil prices due in part to China’s rebalancing toward consumption growth. Overall, he thinks “asset bubbles are the main risks, not a great inflation.” Inflation is something the U.S. Federal Reserve would have difficulty dealing with and will, therefore, deflect. Das also described the U.S. polity as a tug-of-war in Congress between the haves and have-nots, neither of which benefits much from inflation. Labour inflation is being subdued by different labour markets than prevailed during the 1970s inflation. So inflation, at least in the United States, is very likely to be avoided.

Finally, Das asserted the importance of institutions in the development of emerging markets, not just as providers of cheap labour, and he concluded by remarking on two puzzles about the United Kingdom: its falling labour productivity and the wisdom of the half-in, half-out approach to Europe.

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One Response to Arnab Das: We Are Caught in a Trap of Excessive Debt

  1. sumiallen says:

    I’m writing because this issue hasn’t been address. From what I’ve witnessed through experience, this is going to be up for debate but I’m being honest here. *FISCAL* policies and strong trends drive economy growth and vitality, not Monetary policy.
    The United States has a severe disequilibrium throughout the world. The United States has a massive trade and business backed private sector deficit and as a result we are leaning on the federal deficit for “cash flows” which explains our aggression on the democratic side of politics. Which is what we don’t need.
    Back in 1996, there were 675 IPOs and Glass Stegall was still in place. Last year, there were 19 IPOs. 47 million Americans are still dependent on foodstamps.
    Back during the Reagan administration, he cut taxes so the wealthy would bring their money back into the country. So they did and they had nothing better to do with it than to invest it, which is why the Reagan administration resulted in an 84% employment to population ratio, still 5% higher than Clinton’s impressive employment to population ratio.
    Mind you, Glass Stegall was still good during both times.
    In 1995, the Multilateral Investment Agreement between the U.S. and China was a disaster. This was about 4 years before the repeal of the Glass Stegall Act. China refused to remove it’s barriers on her citizens from investing in the U.S. financial sector.
    Asians LOVE to invest, and you need to market to where the money is.
    Hollywood of all industries figured out and negotiated arrangements for their products to be sold in China. Wall Street on the other hand, didn’t bother even though the profits from commissions would’ve been outstanding. Therefore Avitar, a Cameron movie brought in $1 billion dollars in 17 days for $400 million in investments. James Cameron, in the private sector outperformed Wall Street on their best day. Mind you, $400 million is just shy of the $600 million provided by the Gore Act to Silicon Valley. So apparently, much of Silicon Valley’s epic growth was the result of either bank or investor loans. Oh by the way, the U.K. provides huge tax breaks for investments in entertainment which is why Cameron was blessed with such venture in the first place. Without that fiscal policy on behalf of the U.K., the project would not run as smoothly as it has.
    The United States has a VALUE (money in real terms) deficit due to both a trade and investment shortgage. John Maynard Keynes addressed this as a
    “money shortage” in Chapter 5, section 22 in the short notes of General Theory of Employment, Interest and Money. He said that countries during a trade deficit should do everything in it’s power to resolve that deficit. Which is balancing trade, INCREASING INVESTMENTS TO GROW VALUE and combining currencies with the country that one is in a trade deficit with. The concept behind the latter is to match interest rates which would eliminate carry trade incentives to put too many investments in one area over another.
    This is exactly what the U.S. should be doing with OPEC and China.
    If you want a robust economy, look at the countries with legitimate and stable governments. Look at Iceland, Sweeden, Germany and Australia.
    Australia exports raw materials to Asia when neocons said that Asia would buy them from us. Germany proved that quality sells exports more than price, Germany increased the demand for quality goods.
    Which brings us to the next point. Monetary policy only brings about MARGINABLE effects on market and economic policy. Like I mentioned, the quality of German goods created so much demand that they don’t need to devalue their currency for exports. The Arabs, OPEC and China buy luxury imports from Germany; like BMWs and China’s favorite-the Mercedes.
    IN the same way tech stock demands overrode Greenspan’s interest rate hike back in 2001-2002. People told me that they wanted 5000 shares of JNPR at $300/each.
    The Chinese American POA of 15-20 different accounts made over 50 buy orders in a call, bringing the firm over $3000 in commission. The Asians are incredible opportunity for investments, more than they are as a movie audience. And companies do offer A shares, proxies and the like where shareholders yield more democracy than the taxpayers and government bond holders of the U.S.
    A much better policy for economic recovery would be low or no capital gains tax rates. Carlos Slim made a killing in Mexico, which has 0% capital gains tax rates. We could also bring back the Glass Stegall Act.
    America has a bunch of young aspiring Zuckerbergs ready to go after tech. There’s much more talent, I personally would like to see LEGAL immigration made easier and AFFORDABLE for greencard holders while the US comes up with business friendly and encouraging protocols.
    Unfortunately, the lobbyists and the delegates of the United States don’t see it that way. And the one with the gold makes the rules- not the ones who can make value and retain it unfortunately.
    And if we are going to even think about attracting international investments, we need serious transparancy and ethics.
    The CFTC corrupted the courts during the subprime scandal. Not one of the bankers or public officials affiliated with the CFTC was even tried for that massive, greatest financial scandal in the history of the world.
    Ethics is often synonymous with value growth, protection and retention. There’s absolutely no way we could build volume back up in our markets without the application of ethics.

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